In the opinion of the Company’s management, our executive offices are suitable for our current business and are adequately maintained.
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 each of Maison, MMI and ClaimCor, on the one hand, and FedNat, on the other hand (the “Asset Sale”).
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. 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 determination of whether or not to consolidate a variable interest entity under GAAP requires a significant amount of judgment concerning the degree of control over an entity by its holders of variable interests. To make these judgments, management has conducted an analysis, on a case-by-case basis, of whether we are the primary beneficiary and are therefore required to consolidate the entity. Management continually reconsiders whether we should consolidate a variable interest entity. Upon the occurrence of certain events, such as modifications to organizational documents and investment management agreements, management will reconsider its conclusion regarding the status of an entity as a variable interest entity.
The provision for income taxes is calculated based on the expected tax treatment of transactions recorded in the Company’s consolidated financial statements. In determining its provision for income taxes, the Company interprets tax legislation in a variety of jurisdictions and makes assumptions about the expected timing of the reversal of deferred income tax assets and liabilities and the valuation of net deferred income taxes.
On June 18, 2018, the Company invested approximately $2.2 million in FGI Metrolina Property Income Fund, LP (“Metrolina”), which invests in real estate through a real estate investment trust which is wholly owned by Metrolina. The general partner of Metrolina, FGI Metrolina GP, LLC, is managed, in part, by Mr. Cerminara, the Chairman of the Company’s Board of Directors. The Company, a limited partner of Metrolina, does not have a controlling interest, but exerts significant influence over the entity’s operating and financial policies as it owns an economic interest of approximately 53% as of December 31, 2020. Accordingly, the Company has accounted for this investment under the equity method of accounting, recognizing any unrealized holding gains or losses in income. On August 6, 2020, the Company increased its total investment in Metrolina to $4.0 million. As of December 31, 2020, Metrolina’s carrying amount on the Company’s balance sheet was approximately $4.7 million, including of $0.7 million in undistributed earnings.
In September 2020, the Company invested $5.0 million into its joint venture, Fundamental Global Asset Management, LLC (“FGAM’), to capitalize FG Special Situations Fund Advisor, LLC (“Advisor”), a Delaware limited liability company formed on September 2, 2020, and to sponsor the launch of FG Special Situations Fund, LP (the “Fund”), a Delaware limited partnership formed on September 2, 2020. The Fund is wholly owned by FGAM through the Fund’s general partner and Advisor, both of which are ultimately controlled by Mr. Cerminara, the Chairman of the Company’s Board of Directors. Of the total $5.0 million invested into the Fund, $4.0 million was used by FG New America Investors, LLC (the “Sponsor”) as part of a total $8.6 million of risk capital used to launch FG New America Acquisition Corp (NYSE: FGNA), a special purpose acquisition company which consummated its initial public offering on October 2, 2020, and entered into a definitive business combination with Opportunity Financial, LLC, on February 10, 2021. The Fund’s specific investment consists of both class A and class A-1 interests of the Sponsor, purchased for approximately $4.0 million. The interests represent a potential beneficial ownership of approximately 1.4 million common shares of FGNA as well as approximately 0.4 million warrants to purchase common shares of FGNA at a price of $11.50 per share. Both the class A and class A-1 interests of the Sponsor are subject to complete loss if FGNA is not able to consummate a business combination in accordance with the terms of its initial public offering. The class A and class A-1 interests have not been registered under the Securities Act of 1933, as amended, and are not transferrable, except as provided for in the operating agreement of the Sponsor. The remaining $987,000 invested in FGAM consists of cash equivalents owned by the Fund as of December 31, 2020, which are expected to be invested by the Fund in the future. Mr. Cerminara, the Chairman of our Board, is the President and a director of FGNA and a manager of the Sponsor. Mr. Swets, our Chief Executive Officer, is the Chief Executive Officer and a director of FGNA and a manager of the Sponsor.
As of December 31, 2020, the assets of the Fund, which have been included in the Company’s consolidated balance sheet as of the dates listed are as follows in the table below. The Fund reported no liabilities as of either date presented. The assets of the Fund may only be used to settle its obligations. The Company’s maximum exposure to loss as a result of its involvement with the Fund is $5.0 million as of December 31, 2020.
The Company performs a quarterly analysis of its investments to determine if an impairment exists on its investments. Further information regarding the Company’s detailed analysis and factors considered in the evaluation of impairment is discussed within Note 5 to the consolidated financial statements in Item 8 of this report.
We have not recorded any write-downs for an other-than-temporary impairment on our investments for either of the years ended December 31, 2020 and 2019.
On November 12, 2020, FGRe, our Cayman Islands based reinsurance subsidiary, initially funded a trust account at Lloyd’s with approximately $2.4 million in cash, to collateralize its obligations under a quota share agreement with a Funds at Lloyds syndicate. The quota share agreement is effective January 1, 2021.
As of December 31, 2020, the Company had net operating loss carryforwards (“NOLs”) for federal income tax purposes of approximately $5.4 million, which will be available to offset future taxable income. Approximately $0.6 million of the Company’s NOLs will expire on December 31, 2039, while the remaining $4.8 million of the Company’s NOLs do not expire under current tax law.
On September 14, 2020 and September 28, 2020, the Company provided Seed Capital of $2.0 million and $3.0 million, respectively, into FGAM, to capitalize FG Special Situations Fund Advisor, LLC (“Advisor”), a Delaware limited liability company formed on September 2, 2020, and to sponsor the launch of FG Special Situations Fund, LP (the “Fund”), a Delaware limited partnership also formed on September 2, 2020. The Fund is wholly owned by FGAM through the Fund’s general partner and the Advisor, both of which are ultimately controlled by Mr. Cerminara, the Chairman of the Company’s Board of Directors. Of the total $5.0 million invested into the Fund, $4.0 million was used by FG New America Investors, LLC (the “Sponsor”) as part of a total $8.6 million of risk capital used to launch FG New America Acquisition Corp (NYSE: FGNA), a newly formed special purpose acquisition company which consummated its initial public offering on October 2, 2020, and entered into a definitive business combination with Opportunity Financial, LLC, on February 10, 2021. The Fund’s specific investment consists of both class A and class A-1 interests of the Sponsor, purchased for approximately $4.0 million. The class A and class A-1 interests represent beneficial ownership of approximately 1.4 million common shares of FGNA as well as approximately 0.4 million warrants to purchase common shares of FGNA at a price of $11.50 per share. Both the class A and class A-1 interests of the Sponsor are subject to complete loss if FGNA is not able to consummate a business combination in accordance with the terms of its initial public offering. The class A and class A-1 interests have not been registered under the Securities Act of 1933, as amended, and are not transferrable except as provided for in the operating agreement of the Sponsor. The remaining $1.0 million invested in FGAM consists of cash owned by the Fund as of December 31, 2020 and will be used by the Fund to sponsor additional future investments. Mr. Cerminara, the Chairman of our Board, is the President and a director of FGNA and a manager of the Sponsor. Mr. Swets, our Chief Executive Officer, is the Chief Executive Officer and a director of FGNA and a manager of the Sponsor.
On September 15, 2020, the Company entered into a Share Repurchase and Cooperation Agreement (the “Share Repurchase Agreement”) with Hale Partnership Capital Management, LLC and certain of its affiliates (collectively, the “Hale Parties”), which, prior to the transaction, owned more than 18% of our outstanding common stock (the “Share Repurchase Transaction”).
Pursuant to the Share Repurchase Agreement, the Company agreed to purchase (exclusive of any fees or expenses) all of the 1,130,152 shares of the Company’s common stock, owned, of record or beneficially, by the Hale Parties, in exchange for an aggregate approximately $2.8 million in cash and 330,231 shares of common stock, par value $0.01 per share, of FedNat Holding Company previously owned by the Company (the “FedNat Shares”) having an estimated fair value of approximately $2.7 million on September 15, 2020. As acknowledged by the Hale Parties in the Share Repurchase Agreement, that certain Standstill Agreement, dated December 2, 2019, by and between FedNat Holding Company and the Company, imposes certain restrictions in respect of the FedNat Shares transferred by the Company to the Hale Parties. FedNat Holding Company is not party to, or a third-party beneficiary of, the Agreement.
The Share Purchase Agreement contains certain customary standstill provisions that, for a period of five years commencing September 15, 2020 (the “Standstill Period”), prohibit, among other things, the Hale Parties from (i) making certain announcements regarding the Company’s transactions, (ii) soliciting proxies, (iii) acquiring ownership of any securities of the Company, (iv) advising, encouraging or influencing any vote or disposition of any securities of the Company, (v) selling securities of the Company resulting in any third party owning more than 4.9% of the outstanding shares of the Company’s common stock (subject to certain exceptions set forth in the Share Purchase Agreement), (vi) taking actions to change or influence the Board of Directors of the Company, Company management or the direction of certain Company matters and (vii) exercising certain stockholder rights. The Company and the Hale Parties further agreed that they will not disparage each other and that they will not initiate any lawsuit, claim or proceeding with respect to any claims against the Company or any of the Hale Parties, as applicable, based on facts known as of the Effective Date, in each case applicable during the Standstill Period, and to a mutual release of claims.
Each of the Company and the Hale Parties has the right to terminate the Share Purchase Agreement prior to the end of the Standstill Period if (i) any of the Hale Parties, in the case of the Company, or (ii) the Company, in the case of the Hale Parties, commits a material breach of the Share Purchase Agreement and such breach is not cured within 15 days after notice is given to the breaching party.
On January 4, 2021, FG SPAC Partners, LP (“FGSP”) was formed as a Delaware limited partnership to co-sponsor newly formed SPACs with their founders or partners. The Company is the sole managing member of the general partner of FGSP and holds an approximate 49% limited partner interest in FGSP directly and through its subsidiaries. Certain of our directors and officers also hold limited partner interests in FGSP. Our Chief Executive Officer and Director, Larry G. Swets, holds a 10% limited partner interest through Itasca Financial LLC, an advisory and investment firm for which Mr. Swets is managing member. The Chairman of our Board of Directors, D. Kyle Cerminara also holds a limited partner interest in FGSP through Fundamental Global, LLC, a newly formed holding company for which Mr. Cerminara is the manager and a member.
The table below presents the primary drivers behind the changes to total shareholders’ equity for the years ended December 31, 2020 and 2019.
The following table presents a reconciliation of the major classes of line items constituting pretax profit (loss) of discontinued operations to the after-tax profit (loss) of discontinued operations that are presented in the Company’s consolidated statement of operations for the year ended December 31, 2019.
Dollar amounts included in the “Liquidity and Capital Resources” are presented in thousands, except as otherwise specified.
The following table summarizes the Company’s consolidated cash flows for the years ended December 31, 2020 and 2019.
● Payments of dividends in the amount of $1.4 million on our Series A Preferred Shares.
We have audited the accompanying consolidated balance sheets of FG Financial Group, Inc. (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
As described in Note 5 to the consolidated financial statements, in 2020, the Company entered into a joint venture, FG Asset Management (“FGAM”), and created wholly owned subsidiaries under FGAM. Through these subsidiaries, the Company invested in the sponsor of a special purpose acquisition company (“SPAC”). The creation of these subsidiaries resulted in the determination that one of these subsidiaries meets the definition of an investment company under ASC 946, Financial Services - Investment Companies as of December 31, 2020. As a result, any investments held by this subsidiary are to be recognized at fair value and the specialized accounting and reporting requirements of this subsidiary is carried into the Company’s consolidated financial statements.
We identified the determination of whether FGAM or any of its wholly owned subsidiaries qualify as investment companies as a critical audit matter. Auditing the Company’s investment company assessment with respect to FGAM and its wholly owned subsidiaries involved significant judgment in consideration of their purpose and design, specifically whether the entity’s only substantive activities are investing for returns solely for capital appreciation and/or investment income and whether any other benefits are anticipated that are not normally attributable to ownership interests. Auditing these characteristics involved especially challenging and subjective auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included the following:
● Utilizing personnel with specialized knowledge and skill to assist in the assessment of whether FGAM and its wholly owned subsidiaries qualify as investment companies. This includes evaluation of management’s conclusion with respect to the purpose and design of FGAM and its wholly owned subsidiaries, specifically (1) an evaluation of the activities performed by the subsidiaries, and (2) assessment of whether any other benefits are anticipated that are not normally attributable to ownership interests.
FG Financial Group, Inc. (“FGF”, the “Company”, “we”, or “us”) is a reinsurance and investment management holding company focused on opportunistic collateralized and loss capped reinsurance, while allocating capital to SPAC and SPAC sponsor-related businesses. The Company’s principal business operations are conducted through its subsidiaries and affiliates. We were incorporated on October 2, 2012 in the State of Delaware under the name Maison Insurance Holdings, Inc., and changed our legal name to 1347 Property Insurance Holdings, Inc. on November 19, 2013. On March 31, 2014, we completed an initial public offering of our common stock. Prior to the offering, we were a wholly owned subsidiary of Kingsway America Inc., which, in turn, is a wholly owned subsidiary of Kingsway Financial Services Inc., or KFSI, a publicly owned Delaware holding company. From our inception through December 2, 2019, we operated as an insurance holding company, writing property and casualty insurance throughout the states of Louisiana, Florida and Texas through our subsidiaries. On December 2, 2019 we sold our three insurance subsidiaries as further described below, and embarked on a new strategy focused on insurance, reinsurance, real estate, and asset management. Accordingly, on December 14, 2020, our shareholders approved a change in our corporate name to FG Financial Group, Inc., to better align with this new business strategy.
All of the employees of the Company became employees of FedNat as of the closing of the Asset Sale, other than John S. Hill, then serving as Vice President, Chief Financial Officer and Secretary of the Company and now serving as Executive Vice President, Chief Financial Officer and Secretary, and Brian D. Bottjer, then serving as Controller of the Company and now serving as Senior Vice President and Controller.
The Reinsurance Agreement provides the Company with a right of first refusal to sell reinsurance coverage to the insurance company subsidiaries of FedNat, providing reinsurance on up to 7.5% of any layer in FedNat’s catastrophe reinsurance program, subject to the annual reinsurance limit of $15.0 million, on the terms and subject to the conditions set forth in the Reinsurance Agreement. All reinsurance sold by the Company pursuant to the right of first refusal, if any, will be memorialized in an agreement in such form and subject to such terms and conditions as are customary in the property and casualty insurance industry. The Reinsurance Agreement is assignable by the Company subject to conditions set forth in the agreement. The term of the Reinsurance Agreement is five years. As of December 31, 2020, the Company has not provided any reinsurance coverage to FedNat under the Reinsurance Agreement.
Our strategy has evolved to focus on opportunistic collateralized and loss capped reinsurance, while allocating capital to special purpose acquisition companies (“SPACs”) and SPAC sponsor-related businesses. Accordingly, in the first quarter 2021, we have launched our “SPAC Platform,” as further discussed below. As part of our refined focus, we have adopted the following capital allocation philosophy:
The Company has formed a wholly-owned reinsurance subsidiary, Fundamental Global Reinsurance Ltd. (“FGRe”), a Cayman Islands limited liability company, to provide specialty property and casualty reinsurance. FGRe has been granted a Class B (iii) insurer license in accordance with the terms of The Insurance Law, 2010 and underlying regulations thereto and is subject to regulation by the Cayman Islands Monetary Authority (the “Authority”). The terms of the license require FGRe to receive a capital infusion in the amount of $5.0 million, which the Company effected in July 2020 via the transfer of 156,000 shares of FedNat common stock from the Company along with approximately $3.3 million in cash. The terms of the insurer license also require advance approval from the Authority should FGRe wish to enter into any reinsurance agreements which are not fully collateralized to their aggregate exposure limit. In November 2020, FGRe entered into its first reinsurance transaction, through a Funds at Lloyds syndicate. The maximum loss exposure in the transaction is approximately $2.9 million and covers all risks written by the syndicate during the 2021 calendar year. On November 12, 2020 FGRe initially funded a trust account at Lloyd’s with approximately $2.4 million in cash to collateralize its obligations under the contract.
FGSC serves as an investment advisor to FedNat Holding Company under the investment advisory agreement entered into at the closing of the Asset Sale. The Company has also formed Fundamental Global Asset Management, LLC, a joint venture with a wholly owned subsidiary of FGI, to sponsor investment advisors that will manage private funds ranging the full spectrum of alternative equities, fixed income, private equity and real estate. In September 2020, the joint venture sponsored the launch of FG Special Situations Fund via an investment of $5.0 million. Approximately $4.0 million of this investment represented the sponsorship of our first special purpose acquisition company, or “SPAC”.
FGRe is currently in the process of establishing and seeking regulatory approvals for a Risk Retention Group (“RRG”) to be domiciled in the state of Vermont for the purpose of providing directors and officers insurance coverage to special purpose acquisition vehicles. The Company expects to begin operation of the RRG in the 4th quarter of 2021. FGRe would anticipate providing capital, along with others, to facilitate the underwriting of such insurance coverage. The Company will focus on fee income derived from originating, underwriting, and servicing the insurance business, while mitigating our financial risk with external reinsurance partners.
Effective November 10, 2020, the Company appointed Larry G. Swets Jr., to serve as the Company’s Chief Executive Officer (“CEO”). Mr. Swets, who has served as a director on the Board since November 2013, had been appointed to serve as the Company’s Interim Chief Executive Officer on June 17, 2020. As Interim CEO, Mr. Swets replaced D. Kyle Cerminara as the Company’s principal executive officer. Mr. Cerminara continues to serve as the Chairman of the Board of the Company.
In the event that the Company terminates Mr. Swets without cause, subject to Mr. Swets execution of a general release of waiver and claims in favor of the Company and such general release becoming fully irrevocable, Mr. Swets will be entitled to severance consisting of two years of annual base salary continuation and benefits continuation to the extent permitted by, and in accordance with, the Company’s applicable health and welfare plans. In the event that the parties mutually agree to terminate Mr. Swets’ employment regardless of the reason, subject to Mr. Swets’ execution of a general release and such general release becoming fully irrevocable, Mr. Swets will be entitled to severance consisting of one year of annual base salary continuation and benefits continuation to the extent permitted by, and in accordance with, the Company’s applicable health and welfare plans. The Swets Agreement also provides that Mr. Swets is subject to post-termination confidentiality covenants.
On January 18, 2021, Company entered into an Equity Award Letter Agreement (the “Letter Agreement”) with Mr. Swets, pursuant to which the Company clarified its intention to grant an additional 370,000 stock options, restricted shares or restricted stock units pursuant to a future award (the “Future Award”), subject to the approval of an amended and/or new equity plan, among other conditions. Specifically, under the Letter Agreement, no such Future Award may be granted until there is a determination by the Compensation Committee of the specific vesting and other terms of the award, and an amended and/or new equity plan, in a form to be prepared and reviewed by the Board of Directors of the Company (the “Board”), has been approved by the Board and stockholders of the Company that authorizes a sufficient number of shares of common stock to make such Future Award.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the application of policies and the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. 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 consolidated financial statements include the valuation of our investments, the valuation of net deferred income taxes and stock-based compensation expense. The business and economic uncertainty resulting from the novel coronavirus (COVID-19) pandemic has made such estimates and assumptions difficult to calculate.
The Company’s 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. Effective January 1, 2019, we adopted Accounting Standards Update No. 2016-01, Financial Instruments-Overall, requiring us to recognize unrealized gains and losses on our equity securities through income.
Limited liability investments include investments in a limited partnership and a limited liability company for which there does not exist a readily determinable fair value. The Company accounts for these investments at their cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer. Any profit distributions the Company receives on these investments is included in income.
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. 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.
Additionally, in September 2020, the Company invested approximately $5.0 million, through its joint venture, Fundamental Global Asset Management, LLC (“FGAM”) to sponsor the launch of FG Special Situations Fund, LP (the “Fund”). The Fund, a VIE which the Company is required to consolidate, is considered an investment company for GAAP purposes and follows the accounting and reporting guidance in the Financial Accounting Standards Codification (“ASC”) Topic 946, Financial Services-Investment Companies, which includes the presentation of its investments at fair value. See Note 5 for additional information on the Company’s investment in the Fund.
The Company accounts for its investments using trade date accounting and also conducts a quarterly review to identify and evaluate investments that show objective indications of possible impairment. Impairment is charged to the statement of income if the fair value of the instrument falls below its amortized cost and the decline is considered other-than-temporary. Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been below cost, the financial condition and near-term prospects of the issuer, and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
The Company had not experienced significant losses related to its amounts due from reinsurers.
Service charges on installment premiums were recognized as income upon receipt of related installment payments and were reflected in other income up to the date of the Asset Sale transaction.
Revenue from policy fees was deferred and recognized over the term of the applicable policy period, with revenue reflected in other income up to the date of the Asset Sale transaction.
The carrying values of certain financial instruments, including cash, short-term investments, deposits held, 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 5 for further information on the fair value of the Company’s financial instruments.
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 is 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, like the Company, 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.
The following table presents a reconciliation of the major classes of line items constituting pretax profit (loss) of discontinued operations to the after-tax profit (loss) of discontinued operations that are presented in the Company’s consolidated statement of operations for the year ended December 31, 2019
On June 18, 2018, the Company invested approximately $2.2 million in FGI Metrolina Property Income Fund, LP (“Metrolina”), which invests in real estate through a real estate investment trust which is wholly owned by Metrolina. The general partner of Metrolina, FGI Metrolina GP, LLC, is managed, in part, by Mr. Cerminara, the Chairman of the Company’s Board of Directors. The Company, a limited partner of Metrolina, does not have a controlling interest, but exerts significant influence over the entity’s operating and financial policies as it owns an economic interest of approximately 53% as of December 31, 2020. Accordingly, the Company has accounted for this investment under the equity method of accounting, recognizing any unrealized holding gains or losses in income. On August 6, 2020, the Company increased its total investment in Metrolina to $4.0 million. As of December 31, 2020, Metrolina’s carrying amount on the Company’s balance sheet was approximately $4.7 million, consisting of $0.7 million in undistributed earnings.
The Company has determined that its investment in FGAM represents an investment in a variable interest entity (“VIE”) in which the Company is the primary beneficiary and as such, has consolidated the financial results of FGAM as of December 31, 2020. The Company evaluates whether it is the primary beneficiary of a VIE at the time it becomes involved with a variable interest entity and continuously reconsiders that conclusion. In determining whether the Company is the primary beneficiary, the Company evaluates its control rights as well as economic interests in the entity held either directly or indirectly through affiliates via both qualitative and quantitative analysis. Further investments in, or redemptions of investments in FGAM, by either member of joint venture could affect the entity’s status as a VIE or the determination of the primary beneficiary. At each reporting date, the Company assesses whether it is the primary beneficiary and will consolidate or deconsolidate accordingly.
We have determined that the Company’s Quarterly Report on Form 10-Q for the period ending September 30, 2020 contained an immaterial error as the Fund was not presented as an investment company under ASC 946. The Company assessed the materiality of the error considering both qualitative and quantitative factors and determined that the adjustments for the nine-month period ended September 30, 2020 were immaterial. These adjustments resulted in a revision within the Company’s consolidated statement of cash flows for the nine months ended September 30, 2020. Cash flows from investing activities were understated by $4.0 million while cash flows from operating activities were overstated by $4.0 million. As revised, purchases of other investments within the cash flows from investing activities is an outflow of $1.2 million and purchases of investments by consolidated investment company subsidiary within cash flows from operating activities is an inflow of $4.0 million. Furthermore, the Company’s quarterly report should have contained, in footnote 12 to the financial statements, disclosure of $4.0 million as a Level 3 investment as of September 30, 2020, in the fair value hierarchy promulgated by the FASB, as it has been presented in this annual report.
The error had no impact on the consolidated balance sheets, statements of operations and comprehensive loss or statements of shareholders’ equity presented in the Company’s quarterly report.
For equity securities without readily determinable fair values, such as the Company’s two limited liability investments, impairment is determined via a qualitative assessment which considers indicators to evaluate whether the investment is impaired. Some of these indicators include a significant deterioration in the earnings performance or asset quality of the investee, a significant adverse change in regulatory, economic or general market conditions in which the investee operates, or doubt over an investee’s ability to continue as a going concern. If the investment is deemed to be impaired after conducting this analysis, the Company would estimate the fair value of the investment to determine the amount of impairment loss.
For equity method investments, such as the Company’s investment in Metrolina, evidence of a loss in value might include a series of operating losses of an investee, the absence of an ability to recover the carrying amount of the investment, or a deterioration in the value of the investee’s underlying assets. If these, or other indicators lead to the conclusion that there is a decrease in the value of the investment that is other than temporary, the Company would recognize that decrease in value even though the decrease may be in excess of what would otherwise be recognized under the equity method of accounting.
The risks and uncertainties inherent in the assessment methodology used to determine impairment include, but may not be limited to, the following:
● the opinions of professional investment managers and appraisers could be incorrect;
● the past operating performance and cash flows generated from the investee’s operations may not reflect their future performance; and
● the estimated fair values for investments for which observable market prices are not available are inherently imprecise.
We have not recorded an impairment on our investments for either of the years ended December 31, 2020 and 2019.
Net investment income (loss) for the years ended December 31, 2020 and 2019 is as follows:
The availability of valuation techniques and observable inputs can vary from investment to investment and are affected by a variety of factors, including the type of investment, whether the investment is new and not yet established in the marketplace, the liquidity of markets and other characteristics specific to the individual investment. In some cases, the inputs used to measure fair value might be categorized within different levels of the fair value hierarchy. In those instances, the fair value measurement is categorized in its entirety in the hierarchy based on the lowest level input that is significant to the fair value measurement. When determining fair value, the Company uses valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
We have valued our FedNat common stock at their last reported sales price as the shares are traded on a national exchange. They have been characterized in Level 1 of the fair value hierarchy.
Our investment in the class A and class A-1 interests of the Sponsor consist of limited partner interests in a private operating company which have been characterized in Level 3 of the fair value hierarchy. For private operating companies, the transaction price, excluding transaction costs, is typically the best estimate of fair value at acquisition. As of December 31, 2020, the Fund’s investment in the class A and class A-1 interests in the Sponsor have been valued at their transaction price, excluding transaction costs, due to: 1) the fact that the Fund just recently acquired these securities, in September 2020, 2) there have not been any additional transactions in these securities, or in substantially similar securities since our original purchase and; 3) no significant events have occurred with respect to the Sponsor or to FGNA as of measurement date, which warranted an adjustment to fair value.
Financial instruments measured, on a recurring basis, at fair value as of December 31, 2020 and 2019 in accordance with the guidance promulgated by the FASB are as follows.
The following table presents the changes in assets classified in Level 3 of the fair value hierarchy during the year ended December 31, 2020.
Actual income tax expense (benefit) differs from the income tax expense computed by applying the applicable effective federal and state tax rates to income before income tax expense as follows:
As of December 31, 2020, the Company had no unrecognized tax benefits. The Company analyzed its tax positions in accordance with the provisions of Accounting Standards Codification Topic 740, Income Taxes, and has determined that there are currently no uncertain tax positions. The Company generally recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
On May 31, 2018, our shareholders approved the 1347 Property Insurance Holdings, Inc., 2018 Equity Incentive Plan (the “2018 Plan”). The purpose of the 2018 Plan is to attract and retain directors, consultants, and other key employees of the Company and its subsidiaries and to provide to such persons incentives and rewards for superior performance. The 2018 Plan is administered by the Compensation and Management Resources Committee of the Board and has a term of ten years. The 2018 Plan allows for the issuance of both incentive stock options and non-qualified stock options, stock appreciation rights, RSUs, and other stock-based, as well as cash-based awards, and provides for a maximum of 300,000 shares available for issuance.
The following table summarizes activity for stock options issued under the 2014 Plan for the year ended December 31, 2019. There was no activity for the year ended December 31, 2020.
The RSUs granted on December 15, 2017 will also vest in full as of the last date of service as a director of the Company should the director make himself or herself 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.
For the year ended December 31, 2019, a total of 406,875 warrants expired having a weighted average exercise price of $9.69. Warrants were neither granted nor exercised during the two years ended December 31, 2020. As of December 31, 2020, the Company had 1,500,000 warrants outstanding with an exercise price of $15.00, which expire on February 24, 2022.
The Preferred Stock is not redeemable prior to February 28, 2023. On and after that date, the Preferred Stock will be redeemable at our option, for cash, in whole or in part, at a redemption price of $25.00 per share of Preferred Stock, plus all accumulated and unpaid dividends to, but not including, the date of redemption. The Preferred Stock has no stated maturity and will not be subject to any sinking fund or mandatory redemption. The Preferred Stock will generally have no voting rights except as provided in the Certificate of Designations or as from time to time provided by law. The affirmative vote of the holders of at least two-thirds of the outstanding shares of Preferred Stock and each other class or series of voting parity stock will be required at any time for us to authorize, create or issue any class or series of our capital stock ranking senior to the Preferred Stock with respect to the payment of dividends or the distribution of assets on liquidation, dissolution or winding up, to amend any provision of our Certificate of Incorporation so as to materially and adversely affect any rights of the Preferred Stock or to take certain other actions. The shares trade on the Nasdaq Stock Market under the symbol “FGFPP”.
A fund managed by Fundamental Global Investors, LLC, the Company’s largest shareholder, purchased an aggregate of 34,620 shares of the Series A Preferred Stock in the Company’s public offering of the shares, at the public offering price of $25.00 per share, including 31,680 shares purchased for a total of approximately $792,000 on February 28, 2018, the closing date of the offering, and 2,940 shares purchased for a total of approximately $74,000 on March 26, 2018 in connection with the underwriters’ exercise of their over-allotment option. No discounts or commissions were paid to the underwriters on the purchase of these shares.
On March 31, 2020, the Company entered into the Limited Liability Company Agreement (the “LLC Agreement”) of Fundamental Global Asset Management, LLC (“FGAM”), a newly-formed joint venture owned 50% by each of the Company and FGI Funds Management, LLC, an affiliate of FGI (“FGIFM” and together with the Company, each a “Member” and collectively, the “Members”). The purpose of FGAM is to sponsor, capitalize and provide strategic advice to investment managers (“Underlying Managers”) in connection with the launch and/or growth of their asset management business and the investment products they sponsor (each, a “Sponsored Fund”).
On March 31, 2020, the Company entered into a Shared Services Agreement (the “Shared Services Agreement”) with Fundamental Global Management, LLC (“FGM”), an affiliate of FGI, pursuant to which FGM provides the Company with certain services related to the day-to-day management of the Company, including assisting with regulatory compliance, evaluating the Company’s financial and operational performance, providing a management team to supplement the executive officers of the Company, and such other services consistent with those customarily performed by executive officers and employees of a public company (collectively, the “Services”). In exchange for the Services, the Company pays FGM a fee of $456,250 per quarter (the “Shared Services Fee”), plus reimbursement of expenses incurred by FGM in connection with the performance of the Services, subject to certain limitations approved by the Company’s Board of Directors or Compensation Committee from time to time.
The Shared Services Agreement has an initial term of three years, and thereafter renews automatically for successive one-year terms unless terminated in accordance with its terms. The Shared Services Agreement may be terminated by FGM or by the Company, by a vote of the Company’s independent directors, at the end of the initial or automatic renewal term upon 120 days’ notice, subject to payment by the Company of certain costs incurred by FGM to wind down the provision of Services and, in the case of a termination by the Company without cause, payment of a termination fee equal to the Shared Services Fee paid for the two quarters preceding termination.
As the total consideration paid in the Share Repurchase transaction exceeded the fair value of the treasury shares repurchased by the Company, the Company recorded a charge of approximately $0.2 million to general and administrative expense for the year ended December 31, 2020, representing the estimated fair value of the rights conveyed to the Company pursuant to the standstill provisions in the agreement. The fair value of the 1,130,152 shares of Company common stock, or approximately $5.2 million, was recorded to treasury stock.
Net earnings per share is computed by dividing net income by the weighted average number of common shares and common share equivalents outstanding during the periods presented. In calculating diluted earnings per share, those potential common shares that are found to be anti-dilutive are excluded from the calculation. The table below provides a summary of the calculations used in determining basic and diluted earnings per share for the years ended December 31, 2020 and 2019.
The table below details the change in the balance of each component of accumulated other comprehensive loss, net of tax, for the years ended December 31, 2020 and 2019.
Effective December 1, 2020, the Company entered into a lease agreement for office space in St. Petersburg, FL. The lease has a term of six months. Total minimum rent over the six-month term is expected to be $9,000. Due to the short term nature of the lease, the Company has recognized lease expense on a straight line basis over the term of the lease, with any variable lease payments recognized in the period in which the obligation for the payment occurred.
Rent expense was $32,000 and $443,000 for the years ended December 31, 2020 and 2019, respectively. The entirety of rent expense for the year ended December 31, 2019 has been included as part of net income from discontinued operations, as it was associated with the operations of the Maison Business, sold on December 2, 2019.
On March 5, 2021, FedNat Holding Company filed a preliminary prospectus supplement with the SEC indicating that, as of the date of that filing, FedNat is prohibited from paying dividends on their common stock under the terms of their indenture for their senior notes, as their debt-to-capital ratio currently exceeds 35%. As of March 15, 2021, the Company owns 1,442,871 shares of FedNat Holding Company common stock.