As consideration for the Asset Sale, FedNat paid the Company $51.0 million, consisting of $25.5 million in cash and $25.5 million in FedNat’s common stock, or 1,773,102 shares of common stock. The stock consideration was determined by dividing $25.5 million by the weighted average closing price per share of FedNat’s common stock on the Nasdaq Stock Market during the 20-trading day period immediately preceding December 2, 2019. In addition, upon the closing of the Asset Sale, $18.0 million of outstanding surplus note obligations payable by Maison to the Company, plus all accrued but unpaid interest, was repaid to the Company.
The Company’s fixed income and equity securities are recorded at fair value using observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. Any change in the estimated fair value of its investments could impact the amount of unrealized gain or loss the Company has recorded, which could change the amount the Company has recorded for its investments and on its consolidated balance sheets and statements of income.
The following table presents a reconciliation of the carrying amounts of major classes of assets and liabilities included in discontinued operations which are presented separately in the Company’s consolidated balance sheet as of December 31, 2018. On December 2, 2019 the assets and liabilities previously included in discontinued operations had been disposed of in the Asset Sale transaction.
On December 2, 2019, the Company received 1,773,102 shares of FedNat Holding Company common stock (Nasdaq: FNHC), along with $25,500 cash as consideration for the Asset Sale. The stock consideration was determined by dividing $25,500 by the weighted average closing price per share of FedNat’s common stock on the Nasdaq Stock Market during the 20-trading day period immediately preceding December 2, 2019.
The table below summarizes, by type, the Company’s investments as of December 31, 2019 and 2018.
Additionally, on June 18, 2018, Maison invested $2,219 in FGI Metrolina Property Income Fund, LP (the “Fund”), which invests in real estate through a real estate investment trust which is wholly owned by the Fund. The general partner of the Fund, FGI Metrolina GP, LLC, is managed, in part, by Messrs. Cerminara and Johnson, the Chairman and Co-Chairman of the Board of Directors of the Company, respectively. The Company, a limited partner of the Fund, does not have a controlling financial interest in the Fund, but exerts significant influence over the entity’s operating and financial policies as it owns an economic interest of approximately 49%. Accordingly, the Company has accounted for this investment under the equity method of accounting, with any unrealized gains or losses on the investment recorded in income. The Company has committed to a total potential investment of up to $4,000 in the Fund. As of December 31, 2019, the total amount invested in the Fund was $2,719, while the carrying amount on the Company’s balance sheet was $3,229.
Pursuant to the terms of the Purchase Agreement, Maison assigned all of its right, title and interest in each of the limited liability investments to the Company in exchange for the statutory carrying value of each investment (approximately $4,200). Accordingly, these investments have been included on the Company’s consolidated balance sheet as of December 31, 2019 and 2018 as part of continuing operations. Investment income resulting from the Company’s limited liability investments has also been included in net investment income as part of continuing operations, on the Company’s consolidated statement of operations for the years ended December 31, 2019 and 2018.
The Company performs a quarterly analysis of its investments to determine if declines in market value are other-than-temporary. Further information regarding the Company’s detailed analysis and factors considered in establishing an other-than-temporary impairment on an investment is discussed within Note 4 - “Investments,” to the consolidated financial statements in Item 8 of this report.
Other assets increased $121, to $188 as of December 31, 2019 from $67 as of December 31, 2018. The major components of other assets, and the change therein, are shown below.
Accounts payable increased $334, to $400 as of December 31, 2019, compared to $66 as of December 31, 2018 largely as a result of unpaid professional fees associated with the closing of Asset Sale.
As of December 31, 2019, the Company has invested $2,719 as a limited partner in Metrolina Property Income Fund, LP (the “Fund”). The general partner of the Fund, FGI Metrolina GP, LLC, is managed, in part, by Messrs. Cerminara and Johnson, the Chairman and Co-Chairman of the Board of Directors of the Company, respectively. As of December 31, 2019, the Company’s investment represents a 49% ownership stake in the Fund.
Pursuant to the Investment Advisory Agreement entered into upon closing of the Asset Sale, Fundamental Global Advisors LLC, a wholly-owned subsidiary of the Company (“Advisor”), was formed to provide investment advisory services to FedNat, including identifying, analyzing and recommending potential investments, advising as to existing investments and investment optimization, recommending investment dispositions, and providing advice regarding macro-economic conditions. In exchange for providing the investment advisory services, FedNat has agreed to pay Advisor an annual fee of $100. FGI Funds Management, LLC will serve as the manager to the Advisor. FGI Funds Management, LLC is an affiliate of Fundamental Global Investors, LLC, the Company’s largest stockholder. The term of the Investment Advisory Agreement is five years.
Dollar amounts included in the “Results of Operations” are presented in thousands, except as otherwise specified. Net Investment Income
Net investment income increased from $1,208 to $5,587 for the years ended December 31, 2018 and 2019, respectively, primarily as a result of the unrealized holding gains on the 1,773,102 shares of FNHC common stock which the Company received upon the closing of the Asset Sale. Net investment income for the years ended December 31, 2019 and 2018 is as follows:
As of March 26, 2020, the estimated fair value of the Company’s 1,773,102 shares of FNHC common stock was $20,320, resulting in an unrealized, pre-tax holding loss of $5,180 as of that date.
Other income was $10 compared to $0 for the years ended December 31, 2019 and 2018, respectively and is comprised solely of fees earned under the Investment Advisory Agreement between our wholly-owned subsidiary, Fundamental Global Advisors, LLC and FedNat Holding Company.
General and administrative expenses increased $1,331 to $2,476 for the year ended December 31, 2019, compared to $1,145 for the year ended December 31, 2018. The increase was primarily due to professional fees associated with developing our new business plan following the closing of the Asset Sale along with the fees associated with forming our new investment advisory and reinsurance subsidiaries.
Our actual effective tax rate varies from the statutory federal income tax rates as shown in the following table.
On April 23, 2018, the Company and MMI executed a Commercial Business Loan Agreement and related Promissory Note with Hancock Bank, a trade name for Whitney Bank (n/k/a Hancock Whitney Bank) (the “Lender”). The agreements provided for a revolving line of credit of $5,000. The line of credit expired pursuant to its terms on April 19, 2019. The Company and MMI did not draw down funds under the Loan Agreement during the period it was outstanding.
Upon the closing of the Asset Sale, the Company received cash consideration from FedNat in the amount of $25,500 as well as $18,728 representing the repayment of surplus notes and accrued interest due from Maison to the Company. Pursuant to the terms of the Purchase Agreement, at the closing, the Maison Business was required to have a consolidated net GAAP book value of at least $42,000 and was also required to settle any balances between the Company and the Maison Business. Additionally, prior to the closing of the Asset Sale, Maison was a limited partner in two limited partnerships and also had a limited interest in a limited liability company (collectively, the “Funds”). Pursuant to the terms of the Purchase Agreement, Maison assigned its interests in the Funds to the Company in exchange for the statutory carrying value of the Funds, paid in cash, at the closing of the Asset Sale. This resulted in net cash proceeds to the Company of $24,778, as shown in the table below.
The following table summarizes the Company’s consolidated cash flows for the years ended December 31, 2019 and 2018.
On December 2, 2019, we completed the sale of all of the issued and outstanding equity of three of the Company’s wholly-owned subsidiaries, Maison Insurance Company (“Maison”), Maison Managers Inc. (“MMI”) and ClaimCor, LLC (“ClaimCor” and, together with Maison and MMI, the “Maison Business”), to FedNat Holding Company, a Florida corporation (“FedNat”), pursuant to the terms and conditions of the Equity Purchase Agreement, dated as of February 25, 2019 (the “Purchase Agreement”), by and among the Company and the Maison Business, on the one hand, and FedNat, on the other hand (the “Asset Sale”).
As consideration for the Asset Sale, FedNat paid the Company $51,000, consisting of $25,500 in cash and $25,500 in FedNat’s common stock, or 1,773,102 shares of common stock. The stock consideration was determined by dividing $25,500 by the weighted average closing price per share of FedNat’s common stock on the Nasdaq Stock Market during the 20-trading day period immediately preceding December 2, 2019. In addition, upon the closing of the Asset Sale, $18,000 of outstanding surplus note obligations payable by Maison to the Company, plus all accrued but unpaid interest, was repaid to the Company.
In addition to the Registration Rights Agreement, the Company and FedNat entered into a Standstill Agreement, a Reinsurance Capacity Right of First Refusal Agreement (the “Reinsurance Agreement”), an Investment Advisory Agreement and a Transition Services Agreement at the closing of the Asset Sale.
The Company has formed a wholly owned subsidiary, Fundamental Global Advisors, LLC to serve as an investment advisor to FedNat Holding Company under the investment advisory agreement entered into at the closing of the Asset Sale. In addition, the Company intends to form a joint venture with Fundamental Global Investors, LLC to sponsor investment advisors that will manage private funds ranging the full spectrum of alternative equities, fixed income, private equity and real estate. FGFC will seek to benefit from the growth of the assets under management of the investment advisors it sponsors and the performance of the funds they manage.
FGFC plans to purchase controlling interests in income producing real estate assets. FGFC will seek to benefit from underlying rental income on long-term leases with high quality tenants as well as the capital appreciation from the underlying real estate assets.
Due to the sale of all of the issued and outstanding equity of Maison, MMI and ClaimCor on December 2, 2019, these operations have been classified as discontinued operations in the Company’s financial statements presented herein. Certain transactions between the Company and its subsidiaries, which have historically been eliminated upon consolidation, are shown on a gross basis in the accompanying financial statements as such transactions have occurred between discontinued operations and those operations which the Company intends to continue to utilize. These items include surplus notes in the amount of $18,000 plus approximately $728 in accrued interest, all of which was settled upon the closing of the Asset Sale. These notes, which had been issued by Maison to the Company, have been reflected as both an asset of continuing operations and liability of discontinued operations on the Company’s consolidated balance sheet as of December 31, 2018. Interest associated with these surplus notes has been recorded as part of net investment income from continuing operations as well as interest expense as part of discontinued operations on the Company’s consolidated statement of operations for the years ended December 31, 2019 and 2018. Similarly, amounts due from the Company to Maison upon the assignment of certain of Maison’s investments to the Company have been reflected as an asset of continuing operations under the heading “Limited liability investments”, as well as a corresponding liability under the heading “Due to affiliates” on the Company’s consolidated balance sheet as of December 31, 2018. Pursuant to the terms of the Purchase Agreement, this assignment of investments was settled, in cash, prior to closing of the transaction. All other significant intercompany balances and transactions have been eliminated upon consolidation.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures about contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the period reported. Actual results could differ from those estimates. Changes in estimates are recorded in the accounting period in which the change is determined. The critical accounting estimates and assumptions in the accompanying consolidated financial statements include the provision for loss and loss adjustment expense reserves, the valuation of fixed income securities and limited liability investments, valuation of net deferred income taxes, the valuation of various securities we have issued in conjunction with the termination of the management services agreement with 1347 Advisors, LLC, the valuation of deferred policy acquisition costs, and stock-based compensation expense.
Limited liability investments also include an investment where the Company is a limited partner in a limited partnership, which we have determined to be a variable interest entity (VIE), in which the Company is not the primary beneficiary. The Company does not have a controlling financial interest in the limited partnership, but exerts significant influence over the entity’s operating and financial policies as it owns an economic interest of approximately 49%. Accordingly, the Company has accounted for this investment under the equity method of accounting, recognizing any unrealized gains or losses on the investment through income. See Note 5 for additional information on the Company’s investment in the VIE.
Revenue from policy fees was deferred and recognized over the term of the respective policy period, with revenue reflected in other income up to the date of the Asset Sale transaction.
Ceded premiums were charged to income over the applicable term of the various reinsurance contracts with third party reinsurers.
Based upon the Company’s historical forfeiture rates relating to stock options and RSUs, the Company has not made any adjustment to stock compensation expense for expected forfeitures as of December 31, 2019. See Note 7 for further disclosure.
The carrying values of certain financial instruments, including cash, short-term investments, premiums receivable, accounts payable, and other accrued expenses approximate fair value due to their short-term nature. The Company measures the fair value of financial instruments in accordance with GAAP which defines fair value as the exchange price that would be received for an asset (or paid to transfer a liability) in the principal or most advantageous market for the asset (or liability) in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. See Note 12 for further information on the fair value of the Company’s financial instruments.
In January 2016, the FASB issued ASU 2016-01: Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 amends various aspects of the recognition, measurement, presentation, and disclosure for 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. The Company adopted ASU 2016-01 effective January 1, 2019, resulting in a cumulative-effect adjustment to retained earnings in the amount of $104, representing the after-tax unrealized holding gains in accumulated other comprehensive income as of December 31, 2018, related to the Company’s available-for-sale equity securities. Subsequent changes in the estimated fair value of the Company’s equity securities have now been recognized in the Company’s consolidated statement of operations rather than in comprehensive income.
The Company’s right-of-use assets and lease liabilities were reflected in the Company’s consolidated balance sheet in assets of discontinued operations and liabilities of discontinued operations, respectively, prior to the Company’s leases being sold with the insurance operations of the business on December 2, 2019.
In June 2016, the FASB issued ASU 2016-13: Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. ASU 2016-13 was issued to provide financial statement users with more useful information regarding the expected credit losses on financial instruments held as assets. Under current GAAP, financial statement recognition for credit losses on financial instruments was generally delayed until the occurrence of the loss was probable. The amendments of ASU 2016-13 eliminate this probable initial recognition threshold and instead reflect an entity’s current estimate of all expected credit losses. The amendments also broaden the information that an entity must consider in developing its expected credit loss estimates for those assets measured at amortized cost by using forecasted information instead of the current methodology which only considered past events and current conditions. Under ASU 2016-13, credit losses on available-for-sale debt securities will be measured in a manner similar to current GAAP; however, the amendments require that credit losses be presented as an allowance against the investment, rather than as a write-down. The amendments also allow the entity to record reversals of credit losses in current period net income, which is prohibited under current GAAP. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted, however smaller reporting companies may delay adoption until January 2023. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.
On December 2, 2019, the Company received 1,773,102 shares of FedNat Holding Company common stock (NASDAQ: FNHC), along with $25,500 cash as consideration for the Asset Sale. The stock consideration was determined by dividing $25,500 by the weighted average closing price per share of FedNat’s common stock on the Nasdaq Stock Market during the 20-trading day period immediately preceding December 2, 2019. As of March 26, 2020, the estimated fair value of the Company’s 1,773,102 shares of FNHC common stock was $20,320.
A summary of the Company’s investments as of December 31, 2019 and 2018 is as follows.
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:
We have not recorded any write-downs for an other-than-temporary impairment on the equity investments listed in the table above. The Company did however record a write-down for an other-than-temporary impairment on a single equity investment resulting in a charge of $215 for the year ended December 31, 2018. As this investment was held by our former insurance subsidiary, Maison, this charge has been included as part of income from discontinued operations for the year ended December 31, 2018. We recorded this write-down as a result of our analysis of the investment’s operating losses for 2018, which showed a considerable decline when compared to its results for 2017.
As of December 31, 2019, the Company had net operating loss carryforwards (“NOLs”) for federal income tax purposes of approximately $2,204, which will be available to offset future taxable income. Approximately $2,069 of the Company’s NOLs will expire on December 31, 2039, while the remaining $135 of the Company’s NOLs do not expire under current tax law.
Due to the sale of the Maison Business on December 2, 2019, the December 31, 2019 financial statements show a net deferred tax liability in the amount of $106. Given that the Company’s deferred tax assets can be fully offset with deferred tax liabilities within the expiration window of the deferred tax assets, the Company has determined that it is more likely than not that its deferred tax assets will be utilized. As such, the Company has not set up a valuation allowance for its deferred tax assets as of December 31, 2019.
In April 2014, the Company established an equity incentive plan for employees and directors of the Company (the “2014 Plan”). The purpose of the Plan was to create incentives designed to motivate recipients to significantly contribute toward the Company’s growth and success, to attract and retain persons of outstanding competence, and to provide such persons with an opportunity to acquire an equity interest in the Company.
Restricted Stock Units Issued under both the 2014 and 2018 Plans
On May 31, 2017, the Compensation Committee of the Company’s Board of Directors approved a share matching arrangement resulting in the issuance of 108,330 RSUs to the Company’s officers and non-employee directors then serving under the 2014 Plan. The RSUs were issued on December 15, 2017, and entitle each grantee to one share of the Company’s common stock upon the vesting date of the RSU, which will vest 20% per year over a period of five years following the date granted, subject to each officer’s continued employment with the Company, or each director’s continued service on the Board. Prior to the vesting of the RSUs, the grantee will not be entitled to any dividends declared on the Company’s common stock. The RSUs do not expire; however, should the grantee discontinue employment with the Company for any reason other than death or disability, all unvested RSUs will be deemed forfeited on the date employment is discontinued. The Board of Directors may, in its discretion, accelerate vesting in the event of early retirement. In connection with the Asset Sale, the Compensation and Management Resources Committee (the “Compensation Committee”) of the Board previously approved the accelerated vesting of the RSUs granted to the Company’s former executive officers, Douglas N. Raucy and Dean E. Stroud, under the share-matching arrangement. Accordingly, pursuant to the employment and resignation agreements entered into between the Company and Messrs. Raucy and Stroud, a total of 34,400 unvested RSUs issued to Messrs. Raucy and Stroud vested in full on December 2, 2019.
Similarly, should a director make himself available and consent to be nominated by the Company for continued service but is not nominated by the Board for election by the shareholders, other than for good reason as determined by the Board in its discretion, then such director’s RSU grant will vest in full as of his last date of service as a director with the Company. Accordingly, since Mr. Joshua Horowitz’s term as a director did not continue following the Company’s annual meeting of stockholders held on May 31, 2018, Mr. Horowitz’ 6,666 RSUs shares vested in full on May 31, 2018. Directors are required to maintain ownership of the shares purchased through the full five-year vesting period, except as set forth above.
On August 22, 2018, the Company’s Board of Directors granted 1,000 shares of the Company’s common stock to the Company’s Chief Financial Officer, John S. Hill, as previously discussed in Note 7.
Trading of the shares commenced on March 22, 2018 on the Nasdaq Stock Market under the symbol “PIHPP”. Net proceeds received by the Company were approximately $16,500. The Company used $1,500 of the net proceeds to repurchase 60,000 shares of its Series B Preferred Stock from IWS Acquisition Corporation, as discussed under Note 9 - Related Party Transactions.
Pursuant to the Stock Purchase Agreement, the Company also agreed to repurchase the remaining 60,000 Series B Preferred Shares from IWS Acquisition Corporation for an aggregate purchase price of $1,500, upon the completion of a capital raise resulting in the Company receiving net proceeds in excess of $5,000. On February 28, 2018, the Company purchased the remaining 60,000 Series B Preferred Shares from IWS Acquisition Corporation for $1,500 with the proceeds from the offering of the Company’s 8.00% Cumulative Preferred Stock, Series A (the “Preferred Stock”) offering (discussed under Note 8 - Shareholders’ Equity).
The Company applied the guidance outlined in ASC 480 - Distinguishing Liabilities from Equity in recording the issuance of the Series B Preferred Shares. Because the shares had a mandatory redemption date of February 24, 2020, applicable guidance required that we classify the shares as a liability on our consolidated balance sheet, rather than recording the value of the shares in equity. The resulting liability was recorded at a discount to the $4,200 redemption amount plus dividends expected to be paid on the shares while outstanding, discounted for the Company’s estimated cost of equity (13.9%). As a result, total amortization in the amount of $33 has been charged to continuing operations for the year ended December 31, 2018. Upon our repurchase of the Series B Preferred Shares in both January and February 2018, we compared the amortized carrying amount of the liability to the amount paid to repurchase the shares, resulting in a charge of $366 to Loss on repurchase of Series B Preferred Shares and Performance Shares on the Company’s consolidated statement of operations for the year ended December 31, 2018.
As of December 31, 2019, the Company has invested $2,719 as a limited partner in FGI Metrolina Property Income Fund, LP (the “Fund”). The general partner of the Fund, FGI Metrolina GP, LLC, is managed, in part, by Messrs. Cerminara and Johnson, the Chairman and Co-Chairman of the Board of Directors of the Company, respectively. The Fund’s investment program is managed by FGI Funds Management LLC, an affiliate of FGI, which, with its affiliates, is the largest stockholder of the Company. The Company’s investment represents an approximate 49% ownership stake in the Fund.
As of December 31, 2019, the total assets of the Fund were approximately $6,849. Our maximum exposure to loss associated with our investment in the Fund was $2,719 as of December 31, 2019. The Company’s maximum exposure to loss associated with the Fund is limited to our investment; however, the Company has committed to invest up to $4,000 in the Fund. Our investment is reflected on our consolidated balance sheet under the heading Limited liability investments. Although it is not the Company’s intent, should the Company’s ownership percentage in the Fund exceed 50% of the total ownership interest in the Fund, we would be required to consolidate the Fund’s financial statements with our results in future periods as we would be deemed to have a controlling interest in the Fund.
(amounts presented in thousands, except share and per share data and as otherwise specified)
Financial instruments measured at fair value as of December 31, 2019 and 2018 in accordance with this guidance are as follows.
On April 23, 2018, the Company and MMI executed a Commercial Business Loan Agreement and related Promissory Note with Hancock Bank, a trade name for Whitney Bank (the “Lender”). The agreements provided for a revolving line of credit of $5,000. The line of credit expired pursuant to its terms on April 19, 2019. The Company and MMI did not draw down funds under the Loan Agreement during the period it was outstanding.
On November 21, 2019, the Company entered into a lease agreement for office space in St. Petersburg, FL. The lease commenced on December 1, 2019 for a term of six months as the Company assesses its need for future office space following the sale of the Maison Business. Total minimum rent over the six-month term is expected to be $14.
Management is actively monitoring the global situation on its financial condition, liquidity, operations, industry and workforce. Given the daily evolution of the coronavirus and the global responses to curb its spread, the Company is not able to estimate the effects of the coronavirus on its results of operations, financial condition or liquidity for fiscal year 2020.
As of March 26, 2020, the estimated fair value of the Company’s 1,773,102 shares of FNHC common stock was $20,320, representing an unrealized, pre-tax holding loss of $5,180.