STLY 10-K
HG Holdings, Inc. (STLY)
| UNITED STATES |
| SECURITIES AND EXCHANGE COMMISSION |
| Washington, D.C. 20549 |
| FORM |
| |
| OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended |
| |
| OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from _______________ to _______________ |
Commission file number
HG HOLDINGS, INC.
(Exact name of Registrant as specified in its Charter)
| | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| | |
| (Address of principal executive offices, Zip Code) |
Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes ☐
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: Yes ☐
Indicate by check mark 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 that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Indicate by check mark whether the Registrant has submitted electronically every Interactive Date File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.504 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act, (check one):
| Large accelerated filer ☐ | Accelerated filer ☐ | Smaller reporting company | Emerging growth company |
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. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant based on the closing price on July 1, 2021: $
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of March 25, 2022:
| Common Stock, par value $.02 per share | ||||
| (Class of Common Stock) | Number of Shares |
Documents incorporated by reference: Portions of the Registrant’s Proxy Statement for our 2022 Annual Meeting of Stockholders are incorporated by reference into Part III.
TABLE OF CONTENTS
| Part I | Page | |
| Item 1 |
Business |
3 |
| Item 1A |
Risk Factors |
8 |
| Item 1B |
Unresolved Staff Comments |
15 |
| Item 2 |
Properties |
15 |
| Item 3 |
Legal Proceedings |
15 |
| Item 4 |
Mine Safety Disclosures |
16 |
| Item 4 |
Information about our Executive Officers |
16 |
| Part II | ||
| Item 5 |
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
16 |
| Item 6 |
Selected Financial Data |
17 |
| Item 7 |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
17 |
| Item 7A |
Quantitative and Qualitative Disclosures About Market Risk |
22 |
| Item 8 |
Financial Statements and Supplementary Data |
22 |
| Item 9 |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
22 |
| Item 9A |
Controls and Procedures |
22 |
| Item 9B |
Other Information |
23 |
| Part III | ||
| Item 10 |
Directors, Executive Officers and Corporate Governance |
23 |
| Item 11 |
Executive Compensation |
23 |
| Item 12 |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
23 |
| Item 13 |
Certain Relationships and Related Transactions, and Director Independence |
24 |
| Item 14 |
Principal Accounting Fees and Services |
24 |
| Part IV | ||
| Item 15 |
Exhibits, Financial Statement Schedules |
24 |
| Item 16 |
10-K Summary |
26 |
|
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Signatures | 27 |
| Index to Financial Statements and Schedule | F-1 |
|
PART I
| Item 1. |
Business |
General
We were incorporated in Delaware in 1984. Until March 2, 2018, we were a leading design, marketing and distribution resource in the upscale segment of the wood residential furniture market. On March 2, 2018, we sold substantially all our assets and changed our name to HG Holdings, Inc. In this Annual Report on Form 10-K, we sometimes refer to HG Holdings, Inc. by the terms “we,” “our,” “it,” “its,” and “Company.” Our two executive officers are both part-time employees. See Item. 1A Risk Factors for more information.
HG Holdings, Inc, together with its consolidated subsidiaries (the “Company”), operates through its wholly owned subsidiaries National Consumer Title Insurance Company (“NCTIC”), National Consumer Title Group, LLC (“NCTG”), Title Agency Ventures, LLC (“TAV”), HG Managing Agency, LLC (“HGMA”), and Omega National Title Agency, LLC (“Omega”) and through an affiliated investment in HC Government Realty Trust, Inc., a Maryland corporation (“HC Realty”).
The Company engages in the business of providing title insurance through our subsidiary NCTIC and providing title agency services through our subsidiaries NCTG, TAV, and Omega. Through NCTIC, the Company underwrites land title insurance for owners and mortgagees as the primary insurer. The Company currently only provides title insurance services in the state of Florida. The Company is also engaged in real estate related activities through its equity investments in HC Realty.
The title insurance segment provides title insurance, closing and/or escrow services and similar or related services in connection with residential and commercial real estate transactions. The substantial majority of our business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal.
Our strategy is to profitably grow our core title insurance and settlement services business through a focus on continued improvement of our customers’ experiences with our products and services. Our growth strategy also includes potential acquisitions to expand our market share, geographic footprint, enhance our data or technological capabilities. We remain committed to efficiently managing our business to market conditions throughout business cycles and to deploying our capital to maximize stockholder returns.
The real estate related segment invests in rental real estate through an equity investment in HC Realty. HC Realty is an internally-managed real estate investment trust (“REIT’) formed to grow the business of acquiring, developing, financing, owning and managing build-to-suit or improved-to-suit, single-tenant properties leased primarily to the United States of America and administered by the General Services Administration (“GSA”) or directly by the federal government agencies or departments occupying such properties (referred to as “GSA Properties”).
Title Insurance Segment
Our title insurance segment issues title insurance policies on residential and commercial property in the state of Florida. This segment also provides closing and/or escrow services to facilitate real estate transactions. Our title insurance subsidiaries had 38 employees as of December 31, 2021.
Overview of Title Insurance Industry
Title insurance protects against loss or damage resulting from title defects that affect real property. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a covered claim is made against real property, title insurance provides indemnification against insured defects. There are two basic types of title insurance policies – one for the mortgage lender and one for the real property owner. A lender often requires the property owner to purchase a lender’s title insurance policy to protect its position as a holder of a mortgage loan, but the lender’s title insurance policy does not protect the property owner. The property owner has to purchase a separate owner’s title insurance policy to protect its investment.
Title Insurance Policies. Title insurance policies insure the interests of owners or lenders against defects in the title to real property. These defects include adverse ownership claims, liens, encumbrances or other matters affecting title. Title insurance policies generally are issued at the request of a preliminary title report or commitment, which documents the current title to the property and any exceptions and/or limitations. The preliminary title report or commitment includes specific exceptions and/or limitations (i.e. the existence of easements, restrictions, rights of way, conditions, encumbrances or other matters affecting the title to, or use of, real property), which the title agent determines through a search of public records and prior title policies.
The beneficiaries of title insurance policies generally are real estate buyers and mortgage lenders. A title insurance policy indemnifies the named insured and certain successors in interest against certain title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from its provisions. The policy typically provides coverage for the real property mortgage lender in the amount of its outstanding mortgage loan balance and for the buyer in the amount of the purchase price of the property. The potential for claims under a title insurance policy issued to a mortgage lender generally ceases upon repayment of the mortgage loan. The potential for claims under a title insurance policy issued to a buyer generally ceases upon the sale or transfer of the insured property. A title insurer, however, generally does not know when a property has been sold or refinanced except when it issues the replacement coverage. Due to these factors, the total liability of a title underwriter on outstanding policies cannot be precisely determined.
Prior to issuing title policies, title insurers attempt to reduce the risk of claim losses by performing title searches and, in most cases, curing identified title defects. A title insurance company’s primary expenses relate to such searches and examinations and the curative process of defects, preparation of title reports, policies and commitments, and facilitating the close of the real estate transaction. Claim losses typically result from errors made in the title search and examination process, from hidden defects such as fraud, forgery, incapacity, or missing heirs of the property, and from closing-related errors.
Issuing the Policy. Title insurance companies typically issue title insurance policies directly by the title insurer, through affiliated title agencies, or indirectly through independent third-party agencies unaffiliated with the title insurance company. When the policy is issued by a title insurer, the search is performed by or on behalf of the title insurer, and the premium is collected and retained by the title insurer. In a policy issued through an affiliated or independent third-party title agency, the agent performs the title search, collects, and retains a portion of the premium. The agent remits the remainder of the premium to the title insurance company as compensation for bearing the risk of loss in the event a claim is made under the policy. The percentage of the premium retained by an agent varies by geography and may be regulated by the state. The title insurance company is obligated to pay title claims in accordance with the terms of its policies, regardless of whether the title insurance company issues policies through its direct operations, affiliated agents or independent agents.
The Closing Process. In the United States, title insurance is essential to the real estate closing process in most transactions involving real property mortgage lenders. In a typical residential real estate sale transaction where title insurance is issued, a third party, such as a real estate broker or agent, lawyer or closer, orders the title insurance on behalf of an insured or in certain instances, such as with respect to a lender, the insured orders on its own behalf. Once the order has been placed and a title insurance company or an agent has determined the current status of the title to the property to its satisfaction, the title insurer or agent prepares, issues and circulates a commitment or preliminary report. The commitment or preliminary report identifies the conditions, exceptions and/or limitations that the title insurer intends to attach to the policy and identifies items appearing on the title that must be eliminated prior to closing.
In the United States, the closing or settlement function is, depending on the region, performed by a lawyer, an escrow company or a title insurance company or agent, generally referred to as a “closer.” Once documentation has been prepared and signed, and any required mortgage lender payoff demands are obtained, the transaction closes. The closer typically records the appropriate title documents and arranges the transfer of funds to pay off prior loans and extinguish the liens securing such loans. Title policies are then issued, typically insuring the priority of the mortgage of the real property mortgage lender in the amount of its mortgage loan and the buyer in the amount of the purchase price. Before a closing takes place, however, the title insurer or agent typically provides an update to the commitment to discover any adverse matters affecting title and, if any are found, works with the seller to eliminate them so that the title insurer or agent issues the title policy subject only to those exceptions to coverage which are acceptable to the title insurer, the buyer and the buyer’s lender.
Premiums. The premium for title insurance is typically due and earned in full when the real estate transaction is closed. Premiums generally are calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from jurisdiction to jurisdiction. In the state of Florida, where all our operations are currently, the state insurance regulator promulgates title insurance rates.
Escrow and Other Title Fees. In addition to fees for underwriting title insurance policies, we derive a significant amount of our revenues from escrow and other title-related services including closing. The escrow and other services provided include all of those typically required in connection with residential and commercial real estate purchases and refinance activities. These fees are earned when the title policy is issued. Escrow and other title fees included in our Title Insurance segment represented approximately 33% of total Title Insurance segment revenues in 2021.
Title Insurance Operations
Overview. The Company issues title insurance policies in Florida through its home office and through a network of affiliated and independent title agents. Issuing agents, in the state of Florida, are independent agents or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations.
Revenues for the title insurance segment primarily result from purchases of new and existing residential and commercial real estate, refinance activity and certain other types of mortgage lending such as home equity lines of credit. Title insurance premiums vary from state to state and are subject to extensive regulation. Statutes generally provide that rates must not be excessive, inadequate or unfairly discriminatory. The process of implementing a rate change in most states involves pre-approval by the applicable state insurance regulator.
The substantial majority of our title insurance business is dependent upon the overall level of residential and commercial real estate activity and mortgage markets, which are cyclical and seasonal. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months and is sensitive to interest rates. Refinance activity is not seasonal, but is generally correlated with changes in interest rates and general economic cycles. Commercial real estate volumes are less sensitive to changes in interest rates than residential, but fluctuate based on local supply and demand conditions and financing availability. Commercial real estate historically has elevated activity towards the end of the year. However, changes in general economic conditions in the United States and abroad, can cause fluctuations in these traditional patterns of real estate activity, and changes in the general economic conditions in a geography can cause fluctuations in these traditional patterns of real estate activity in that geography.
The Company’s title insurance premiums in future periods are likely to fluctuate due to these and other factors which are beyond management’s control.
Distribution, Sales and Marketing. We distribute our title insurance policies and related products and services through our direct and agent (affiliated and independent) channels. In our direct channel, the distribution of our policies and related products and services occurs through sales representatives located throughout our geographic footprint. Title insurance policies issued, and other products and services delivered through, this channel are primarily delivered in connection with sales and refinances of residential and commercial real property.
Within the direct channel, our sales and marketing efforts are focused on the primary sources of business referrals. For residential business, we generally market to real estate agents and brokers, mortgage brokers, real estate attorneys, mortgage originators, homebuilders and escrow service providers. For the refinance business, we market primarily to mortgage originators and servicers. For the commercial business, we market primarily to commercial real estate professionals, law firms, commercial lenders, commercial brokers and mortgage brokers.
In our agency channel, we issue policies in accordance with agreements with authorized agents. The agency agreements typically state the conditions under which the agent is authorized to issue our title insurance policies. The agency agreement specifies the services and price, if not regulated by the state, for those services and typically describes the circumstances under which the agent may be liable if a policy loss occurs. As is standard in the industry, title agents operate largely independent of the Company and may act as agents for other title insurers.
Within the agency channel, our sales and marketing efforts are directed at the agents themselves and emphasize the quality and timeliness of our underwriting, our customer service and other title service offerings.
Reserves for Title Claims. We reserve for claim losses associated with title insurance policies based upon our historical loss patterns and other factors by a charge to expense when the related premium revenue is recognized. The reserve for incurred but not reported (“IBNR”) claims, together with the reserve for known claims, reflects management’s best estimate of the total costs required to settle all current and future claims on title insurance policies issued through December 31, 2021, and are considered to be adequate for such purpose. We continually update loss reserve estimates as new information becomes known, new loss patterns emerge or as other contributing factors are considered and incorporated into the analysis of reserve for claim losses. Due to the uncertainty inherent in the process and to the judgment used by management, the ultimate liability may be greater or less than our current reserves. If actual claims loss development varies from what is currently expected and is not offset by other factors, it is possible that additional reserve adjustments may be required in future periods in order to maintain our recorded reserve within a reasonable range of our actuary's central estimate.
Reinsurance. Within our title insurance segment, we limit our maximum loss by reinsuring risk of loss with other insurers (“reinsurers”) under reinsurance agreements. In reinsurance arrangements, the primary insurer retains a certain amount of risk under a policy and cedes the remainder of the risk under the policy to the reinsurer. In exchange for accepting the risk of loss, the primary insurer pays the reinsurer premiums and benefits. The primary insurer generally remains liable to its insured for the total risk, but is reinsured for a portion of the total risk under the terms of the reinsurance agreement.
Competition. Competition for title insurance, escrow and other title services is based primarily on service, quality, price, customer relationships and the ease of access and use of our products. The number of competing companies and the size of such companies significantly vary by geographic regions. The four largest title insurance companies typically maintain greater than 80% of the market for title insurance in the United States. In our principal market, competitors include other major title underwriters such as Fidelity National Financial, First American Financial Corporation, Old Republic International Corporation, Stewart Information Services Corporation, Westcor Land Title Insurance Company, and WFG National Title Insurance Company, as well as other regional title insurance companies, underwritten title companies and independent agency operations. Some title insurers currently have greater financial resources, larger distribution networks and more diverse offerings and geographic footprint than us. The addition or removal of regulatory barriers and/or new technologies may result in changes to competition in the title insurance business. Numerous agency operations throughout our geographic footprint also provide aggressive competition to our wholly owned agency.
Regulation. Our title insurance subsidiaries are subject to extensive regulation under applicable state laws. The title insurer is subject to a holding company act in its state of domicile, which regulates, among other matters, the ability to pay dividends and enter into transactions with affiliates. State statutes establish supervisory agencies with broad administrative powers relating to issuing and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, accounting practices, financial practices, establishing reserve and capital and surplus, defining suitable investments for reserves and surplus, and approving premium rate schedules.
Real Estate Related Segment
The Company engages in rental real estate through our equity investment in HC Realty. HC Realty is an internally-managed REIT formed to acquire, develop, finance, own and manage GSA Properties. HC Realty invests primarily in GSA Properties in sizes that range from 5,000 to 50,000 rentable square feet that are in their first lease term after original construction or renovation-to-suit date. HC Realty further emphasizes GSA Properties that fulfill mission critical or direct citizen service functions. Leases associated with the GSA Properties in which HC Realty invests are full faith and credit obligations of the United States of America. HC Realty intends to grow its portfolio primarily through acquisitions of single-tenanted, federal government-leased properties in such markets; although, at some point in the future HC Realty may elect to develop, or joint venture with others in the development of, competitively bid, built-to-suit, single-tenant, federal government-leased properties, or buy facilities that are leased to credit-worthy state or municipal tenants.
On March 19, 2019, we purchased 300,000 shares of HC Realty’s Common Stock (the “HC Common Stock”) for an aggregate purchase price of $3,000,000 and 200,000 shares of HC Realty’s 10.00% Series B Cumulative Convertible Preferred Stock (the “HC Series B Stock”) for an aggregate purchase price of $2,000,000. On April 3, April 9, and June 29, 2020, the Company entered into subscription agreements with HC Realty, pursuant to which we purchased 100,000, 250,000, and 475,000 shares of Series B Stock, respectively, for an aggregate purchase price of $8,250,000. As a result of these purchases, we currently own 33.9% of the as-converted equity interest of HC Realty; however, we do not believe we control HC Realty as a result of our current ownership interest.
Certain other investors, including certain investors affiliated with Hale Partnership Capital Management, LLC (“HPCM”), purchased an additional 850,000 shares of Series B Stock for an aggregate purchase price of $8,500,000 on March 19, 2019. While some of these investors have other investments with HPCM, each of these investors made a separate and direct investment in HC Realty and HPCM does not receive management fees, performance fees, or any other economic benefits with respect to these investors’ investment in HC Realty’s Series B Stock.
On March 19, 2019, we, together with certain other lenders, including certain entities affiliated with HPCM (collectively, the “Lenders”), entered into a loan agreement (the “Loan Agreement”) with HC Realty’s operating partnership, pursuant to which the Lenders provided HC Realty’s operating partnership with a $10,500,000 senior secured term loan (the “Initial Term Loan”), of which $2,000,000 was provided by us. On August 14, 2020, pursuant to the terms of the Loan Agreement, HC Realty’s operating partnership repaid the loan in full, including all accrued interest and make whole interest.
In connection with the transactions discussed above, Steven A. Hale II, our Chairman and Chief Executive Officer, was appointed to serve as HC Realty’s Chairman and Chief Executive Officer. In addition, Mr. Hale and Brad G. Garner, our Principal Financial and Accounting Officer, are directors of HC Realty. HC Realty’s Board of Directors is composed of five directors.
Additional information on HC Common Stock, HC Series B Stock, the Loan Agreement and HC Realty is disclosed in the Annex D in the prospectus included in our Registration Statement (No. 333-235539) on Form S-1 as amended, filed with the Securities and Exchange Commission (the “SEC”) on May 8, 2020, which Annex D is incorporated herein by reference.
Forward-Looking Statements
Certain statements made in this report are not based on historical facts, but are forward-looking statements. These statements can be identified by the use of forward-looking terminology such as “believes,” “estimates,” “expects,” “may,” “will,” “should,” “could,” or “anticipates,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. These statements reflect our reasonable judgment with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include the occurrence of events that negatively impact the Company’s liquidity in such a way as to limit or eliminate the Company’s ability to use its cash on hand to fund further asset acquisitions, an inability on the part of the Company to identify additional suitable businesses to acquire or develop, and the occurrence of events that negatively impact the title insurance operations and/or the business or assets of HC Realty and the value of our investment in HC Realty. Any forward-looking statement speaks only as of the date of this filing and we undertake no obligation to update or revise any forward-looking statements, whether as a result of new developments or otherwise.
No assurance can be given that the actual future results will not differ materially from the forward-looking statements that we make for a number of reasons including those described above and in Item IA. Risk Factors below.
Available Information
Our principal Internet address is www.hgholdingsinc.net. We make available free of charge on this web site our annual, quarterly and current reports, and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
In addition, you may request a copy of these filings (excluding exhibits) at no cost by writing, telephoning or e-mailing us at the following address, telephone number or e-mail address:
HG Holdings, Inc.
2115 E. 7th Street, Suite 101
Charlotte, North Carolina 28204
Attention: Steven A. Hale II
Telephone: 252-355-4610
Or e-mail your request to: [email protected]
| Item 1A. |
Risk Factors |
An investment in our common stock involves a high degree of risk. You should consider carefully the specific risk factors described below in addition to the other information contained in this Annual Report on Form 10-K, including our financial statements and related notes included elsewhere in this Annual Report on Form 10-K, before making a decision to invest in our common stock. If any of these risks actually occurs, our business, financial condition, results of operations or prospects could be materially and adversely affected. This could cause the trading price of our common stock to decline and a loss of all or part of your investment.
Material risks of the Company
We may not receive the amount owed us under the secured promissory note from S&L.
The Subordinated Secured Promissory Note with S&L (the “S&L Note”), which had an outstanding principal amount of $3.1 million as of December 31, 2021, will mature and the entire principal amount will be payable in March 2023. During 2021 and 2020, we recorded impairment losses of $701,000 and $833,000, respectively, on the S&L Note as a result of concluding, based on current information and events, including the impact of the COVID-19 on S&L’s business and its customers, that we did not believe we would be able to collect the entire amount due under the S&L Note. S&L’s ability to make payments to us under the S&L Note may continue to be adversely impacted by the current pandemic health event resulting from COVID-19 as S&L’s operations may continue to be adversely impacted by disruptions to the supply chain and distribution channels for its products caused by this pandemic. Consequently, we may have to record additional impairment charges with respect to the S&L Note. There is no guarantee that S&L will pay us the amounts owed under the S&L Note or that, in the event of default by S&L, the collateral securing the S&L Note will be sufficient to pay the S&L Note in full.
An “ownership change” could limit the use of our net operating loss carryforwards and our potential to derive a benefit from our net operating loss carryforwards.
If an “ownership change” occurs pursuant to applicable statutory regulations, we are potentially subject to limitations on the use of our net operating loss carryforwards which in turn could adversely impact our potential to derive a benefit from our net operating loss carryforwards. While we have entered into a rights agreement designed to preserve and protect our net operating loss carryforwards, there is no guarantee that the rights agreement will prevent us from experiencing an ownership change and, therefore, having a limitation on our ability to use our net operating loss carryforwards. In general, an “ownership change” would occur if there is a cumulative change in the ownership of our common stock of more than 50% by one or more “5% shareholders” during a three-year test period.
Failure to successfully identify, acquire and, to the extent applicable, operate non-furniture related assets could cause our stock price to decline.
We continue evaluating alternatives for using remaining cash proceeds from the Asset Sale and Rights Offering to acquire non-furniture related assets. Since the Asset Sale, we have obtained an equity interest in HC Realty and completed the Acquisition of NCTIC and NCTG. We may not be able to acquire other profitable assets with the remaining cash proceeds of the Asset Sale and its June 2020 rights offering. In addition, any assets that we do acquire, including the Acquisition and our equity interest in HC Realty, may not be profitable. If we are not successful in identifying, acquiring and, to the extent applicable, operating non-furniture related assets, our stock price may decline.
We have no operating history in the NCTIC’s title insurance and Omega’s title agency businesses, and therefore, with respect to certain assets, we will be subject to the risks inherent in establishing a new line of business.
We have had no operating history in the title insurance and title agency lines of business for which NCTIC and Omega operate. Accordingly, our future success may in part be subject to the risks, expenses, problems and delays inherent in establishing a new line of business and the ultimate success of such new business cannot be assured.
Resources may be expended in researching potential acquisitions that might not be consummated.
The investigation of additional non-furniture company assets to acquire and the negotiation, drafting and execution of relevant agreements and other documents will require substantial management time and attention in addition to potentially incurring legal and other professional expenses. If a decision is made not to complete a specific acquisition, the costs incurred up to that point for the proposed transaction likely would not be recoverable. As of December 31, 2021 and December 31, 2020, we had incurred no such related expenses. Furthermore, even if an agreement is reached relating to a specific acquisition, we may fail to consummate the acquisition for any number of reasons including those beyond our control.
We may be required to register under the Investment Company Act of 1940.
Under Section 3(a)(l) of the 1940 Act, an issuer is deemed to be an investment company if it is engaged in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. The 1940 Act defines “investment securities” broadly to include virtually all securities except U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves regulated or exempt investment companies. Consequently, the S&L Note, as well as the securities of HC Realty we hold, may be considered investment securities and we may fall within the scope of Section 3(a)(1)(C) of the 1940 Act.
A company that falls within the scope of Section 3(a)(1)(C) of the 1940 Act can avoid being regulated as an investment company if it can rely on certain of the exclusions or exemptions under the 1940 Act. One such exclusion is Rule 3a-2 under the 1940 Act, which temporarily relieves certain issuers that are in transition to a non-investment company business from regulation under the1940 Act (a “transient investment company”). The rule provides a one-year safe harbor for a company to comply with another exemption or exclusion under the 1940 Act provided that the company has a bona fide intent to be primarily engaged in a business other than that of investing, reinvesting, owning, holding or trading in securities. The one-year grace period started on the date of the Asset Sale, which was March 2, 2018, and ended on March 2, 2019. We did not acquire sufficient assets within one year from closing the Asset Sale as contemplated by Rule 3a-2. There is no assurance that we will not be deemed subject to the 1940 Act and be required to register as an investment company.
While in transient investment company status, we actively pursued alternatives for using cash proceeds from the Asset Sale for the acquisition of non-furniture related assets and acquired an equity interest in HC Realty on March 19, 2019. On April 3, 2020, we used $1.0 million of our cash to purchase an additional 100,000 shares of HC Realty Series B Stock. On April 29, 2020, we used an additional $2.5 million of our cash to purchase an additional 250,000 shares of HC Realty Series B Stock. On June 29, 2020, we used $4.75 million of the cash proceeds from the Rights Offering to purchase an additional 475,000 shares of HG Realty Series B Stock. As a result of these purchases, we now own approximately 33.9% of the as-converted equity interest in HC Realty. We believe that these additional purchases allow us to rely on the exemption from investment company registration set forth in Rule 3a-1 of the 1940 Act because we own (i) at least 25% of the HC Realty Common Stock on an as-converted basis, resulting in us being presumed to control HC Realty within the meaning of Section 2(a)(9) of the 1940 Act and (ii) a sufficient number of shares of HC Realty Series B Stock so that we primarily control HC Realty within the meaning of Rule 3(a)-1 of the 1940 Act.
The Company has not sought or obtained an exemptive order, no-action letter or any other assurances from the SEC or its staff regarding the Company’s ability to rely on Rule 3a-2 or Rule 3a-1 of the 1940 Act, nor has the SEC or its staff provided any such order, no-action letter or other assurances. If we are required to register under the 1940 Act, compliance with these additional regulatory burdens would significantly increase our operating expenses. Registered investment companies are subject to extensive, restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates.
Other risks specific to our investment in HC Realty
Our investment in HC Realty may lose value.
In connection with using cash proceeds from the Asset Sale to acquire non-furniture related assets, we acquired an equity interest in HC Realty on March 19, 2019 by purchasing HC Common Stock and HC Series B Stock. We acquired additional HC Series B Stock on April 3, April 29, and June 29, 2020. As a result of these stock purchases, we currently own 33.9% of the as-converted equity interest of HC Realty. There is no guarantee that HC Realty will be successful implementing its business strategy for the acquisition, management and disposition of GSA properties and as a result our HC Common Stock and HC Series B Stock may lose value.
The value of our equity investment in HC Realty would be adversely affected if HC Realty failed to qualify as a REIT.
HC Realty has elected to be treated as a REIT for U.S. federal income tax purposes. Its continued qualification as a REIT depends on its satisfaction of certain asset, income, organizational, distribution and stockholder ownership requirements on a continuing basis. Its ability to satisfy some of the asset tests depends upon the fair market values of its assets, some of which are not able to be precisely determined and for which HC Realty has indicated it will not obtain independent appraisals. If HC Realty fails to qualify as a REIT in any taxable year, and certain statutory relief provisions are not available, HC Realty would be subject to U.S. federal income tax on its taxable income at regular corporate rates and distributions to stockholders would not be deductible by it in computing its taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution. Unless entitled to relief under certain Internal Revenue Code provisions, HC Realty also would be disqualified from taxation as a REIT for the four taxable years following the year during which HC Realty ceased to qualify as a REIT. In addition, if HC Realty fails to qualify as a REIT, HC Realty will no longer be required to make distributions. As a result of all these factors, HC Realty’s failure to qualify as a REIT could impair its ability to expand business and raise capital and could adversely affect the value of our HC Common Stock and HC Series B Stock.
Other risks specific to the Acquisition of the Title Insurance Businesses
Conditions in the real estate market generally impact the demand for a substantial portion of the Company’s title insurance subsidiaries’ products and services and NCTIC’s claims experience.
Demand for a substantial portion of the Company’s title insurance subsidiaries’ products and services generally decreases as the number of real estate transactions in which its products and services are purchased decreases. The number of real estate transactions in which the insurance subsidiaries’ products and services are purchased typically decreases in the following situations, among others:
| ● |
When mortgage interest rates are high or rising; |
| ● |
When the availability of credit, including commercial and residential mortgage funding, is limited; and |
| ● |
When real estate affordability is declining. |
There is an additional risk that these circumstances, particularly when combined with declining real estate values and the increase in foreclosures that often results therefrom, may adversely impact NCTIC’s title claims experience.
Unfavorable economic conditions may adversely affect NCTIC and Omega.
Historically, uncertainty and negative trends in general economic conditions in the United States and abroad, including significant tightening of credit markets and a general decline in the value of real property, have created a difficult operating environment for the NCTIC and Omega’s core title and settlement businesses. Uncertainty and a deterioration in economic conditions in connection with the coronavirus pandemic adversely affected the NCTIC and Omega early in the pandemic. These conditions also tend to negatively impact the amount of funds NCTIC receives from third parties to be held in trust pending the closing of commercial and residential real estate transactions. During periods of unfavorable economic conditions, the return on these funds deposited with third party financial institutions, tends to decline. In addition, title agencies, such as Omega, and other securities in NCTIC has in its investment portfolio, may be negatively impacted by these potential unfavorable economic conditions. Depending upon the ultimate severity and duration of any economic downturn, the resulting effects on NCTIC and Omega could be materially adverse, including a significant reduction in revenues, earnings and cash flows, deterioration in the value of or return on its investments and increased credit risk from customers and others with obligations to NCITC and Omega.
Changes in NCTIC’s relationships with large mortgage lenders or government–sponsored enterprises could adversely affect the Company.
Large mortgage lenders and government-sponsored enterprises, because of their significant role in the mortgage process, have significant influence over NCTIC and other service providers. Changes in NCTIC’s relationship with any of these lenders or government-sponsored enterprises, the loss of all or a portion of the business NCTIC derives from these parties, any refusal of these parties to accept NCTIC’s products and services, the modification of the government-sponsored enterprises’ requirement for title insurance in connection with mortgages they purchase or the use of alternatives to NCTIC’s products and services, could have a material adverse effect on NCTIC.
A downgrade by ratings agencies, reductions in statutory capital and surplus maintained by NCTIC, the Company’s title insurance underwriter, or a deterioration in other measures of financial strength could adversely affect the Company.
The financial strength of NCTIC may be measured by ratings provided by ratings agencies and levels of statutory capital and surplus maintained by NCTIC, in determining the amount of a policy they will accept and the amount of reinsurance required. Demotech currently rates the NCTIC’s operations. NCTIC’s financial strength ratings are “Exceptional” or “A” by Demotech, Inc. This rating provides the agency’s perspective on the financial strength, operating performance and cash generating ability of the operation. The agency will continually review these ratings and the ratings are subject to change. Statutory capital and surplus, or the amount by which statutory assets exceed statutory liabilities, is also a measure of financial strength. Accordingly, if the rating or statutory capital and surplus of NCTIC are reduced from the current level, or if there is a deterioration in other measures of financial strength, the NCTIC’s results of operations, competitive position and liquidity could be adversely affected.
The issuance of a title insurance policies and related activities by title agents, some of which operate with substantial independence from the Company, could adversely affect NCTIC.
The Company’s title insurance subsidiaries issue a significant portion of their policies through title agents, some that may operate largely independent of the Company. There is no guarantee that these title agents will fulfill their contractual obligations to the Company’s insurance subsidiaries, which contracts include limitations that are designed to limit NCTIC’s risk with respect to their activities. In addition, regulators are increasingly seeking to hold NCTIC responsible for the actions of these title agents and, under certain circumstances, NCTIC may be held liable directly to third parties for actions (including defalcations) or omissions of these agents.
Errors and fraud involving the transfer of funds may adversely affect the Company’s insurance subsidiaries.
The Company’s insurance subsidiaries rely on their systems, employees and domestic banks to transfer funds on behalf the Company’s insurance subsidiaries as well as title agents that are not affiliates of the Company. These transfers are susceptible to user input error, fraud, system interruptions, incorrect processing and similar errors that from time to time result in lost funds or delayed transactions. The Company’s insurance subsidiaries’ email and computer systems and systems used by its agents, customers and other parties involved in a transaction may be subject to, and may continue to be the target of, fraudulent attacks, including attempts to cause the Company’s insurance subsidiaries or its agents to improperly transfer funds. Funds transferred to a fraudulent recipient are often not recoverable. In certain instances, the Company’s insurance subsidiaries may be liable for those unrecovered funds. The controls and procedures used by the Company’s insurance subsidiaries to prevent transfer errors and fraud may prove inadequate, resulting in financial losses, reputational harm, loss of customers or other adverse consequences which could be material.
Regulatory oversight and changes in government regulation could prohibit or limit the Company or its insurance subsidiaries’ operations, make it more costly or burdensome to conduct such operations or result in decreased demand for their products and services.
The title insurance business is regulated by various federal, state, local governmental agencies and operates within statutory guidelines. The industry in which the title insurance business operates and the markets into which it sells its products are also regulated and subject to statutory guidelines. In general, the title business may be subject to increasing regulatory oversight and increasingly complex statutory guidelines. This may be due, among other factors, to the passing of, and significant changes in, laws and regulations pertaining to privacy and data protection.
Regulatory oversight could require the Company to raise capital, and/or make it more difficult to deploy capital. For example, regulatory capital requirements for the Company have historically applied only at the subsidiary level, specifically the insurance underwriter subsidiaries. However, the National Association of Insurance Commissioners have issued a proposal for group capital calculations. The proposal, if finalized and adopted in their current forms, may apply to the Company at the group level and would be in addition to existing subsidiary-level capital requirements. It is possible that the requirements, particularly in an economic downturn, could have the effect of requiring the Company to raise capital and/or making it more difficult to otherwise deploy capital.
In addition, changes in the applicable regulatory environment, statutory guidelines or interpretations of existing regulations or statutes, enhanced governmental oversight or efforts by governmental agencies to cause customers to refrain from using the Company’s insurance subsidiaries’ products or services could prohibit or limit its future operations or make it more costly or burdensome to conduct such operations or result in decreased demand for their products and services or a change in its competitive position. The impact of these changes would be more significant if they involve the Florida jurisdiction, as all of the Company’s title premiums are currently generated in the state of Florida. These changes may compel the Company to reduce its prices, may restrict its ability to implement price increases or acquire assets or businesses, may limit the manner in which the Company conducts its business or otherwise may have a negative impact on its ability to generate revenues, earnings and cash flows.
Regulation of title insurance rates could adversely affect the Company
Title insurance rates are subject to extensive regulation, which varies from state to state. Our title insurance subsidiaries currently only operate in the state of Florida. In Florida, rates are promulgated by the state insurance regulator. The Company’s insurance subsidiaries’ ability to promptly adapt to changing market dynamics through price adjustments may be limited due to the rates promulgated by the state’s insurance regulator, particularly in a rapidly declining market.
Changes in certain laws and regulations, and in the regulatory environment in which the Company operates, could adversely affect the Company
Federal and state officials are discussing various potential changes to laws and regulations that could impact the Company’s businesses, including the reform of government-sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) and additional data privacy regulations, among others. Changes in these areas, and more generally in the regulatory environment in which the Company’s insurance subsidiaries and its customers operate, could adversely impact the volume of mortgage originations in the United States and the Company’s insurance subsidiaries competitive position and results of operations. In addition, in connection with the coronavirus pandemic, the Company’s insurance subsidiaries and generally its agents have been deemed in most areas an essential business and have been permitted to operate. A change in this determination, particularly in jurisdictions where the Company generates a large portion of its revenues, could adversely impact the Company’s insurance subsidiaries’ business.
Actual claims experience could materially vary from the expected claims experience reflected in the NCTIC’s reserve for incurred but not reported claims
NCTIC maintains a reserve for IBNR claims pertaining to its title, insurance products. The majority of this reserve pertains to title insurance policies, which are long-duration contracts with the majority of the claims reported within the first few years following the issuance of the policy. Generally, 70% to 80% of claim amounts become known in the first six years of the policy life, and the majority of IBNR reserves relate to the six most recent policy years. Changes in expected ultimate losses and corresponding loss rates for recent policy years are considered likely and could result in a material adjustment to the IBNR reserves. Loss rates for recent policy years, positive or negative, may vary significantly given the long duration nature of a title insurance policy. In uncertain economic times, such as those currently being experienced as a result of the coronavirus pandemic, larger changes may be more likely. Material changes in expected ultimate losses and corresponding loss rates for older policy years is also possible, particularly for policy years with loss ratios exceeding historical norms. The estimates made in determining the appropriate level of IBNR reserves could ultimately prove to be materially different from actual claims experience.
Changes in laws or regulations impacting real estate, particularly when applied retroactively, may cause a material change in expected ultimate losses and corresponding loss rates for recent and/or older policy years.
We have recorded goodwill as a result of prior acquisitions, and an economic downturn could cause these balances to become impaired, requiring write-downs that would reduce our operating income.
Goodwill aggregated approximately $4.5 million, or approximately 11.6% of our total assets as of December 31, 2021. Current accounting rules require that goodwill be assessed for impairment at least annually or whenever changes in circumstances indicate that the carrying amount may not be recoverable from estimated future cash flows. Factors that may be considered a change in circumstance indicating the carrying value of our goodwill may not be recoverable include, but are not limited to, significant underperformance relative to historical or projected future operating results, a significant decline in our stock price and market capitalization, and negative industry or economic trends. As of December 31, 2021, management has deemed there is no impairment of our recorded goodwill. However, if there is an economic downturn in the future, the carrying amount of our goodwill may no longer be recoverable, and we may be required to record an impairment charge, which would have a negative impact on our results of operations and financial condition. Management will continue to monitor our operating results, our market capitalization, and the impact of the economy to determine if there is an impairment of goodwill in future periods.
Risks related to the effects of COVID-19 and other potential health crises, climate change, severe weather or other catastrophic events
The pandemic health event resulting from COVID-19 has adversely impacted, and may continue to adversely impact, economic activity nationally and globally. These economic and market conditions and other effects resulting from COVID-19 may adversely affect us. S&L’s ability to make payments to us under the S&L Note may continue to be adversely impacted by the current pandemic health event resulting from COVID-19 as S&L’s operations may continue to be adversely impacted by disruptions to the supply chain and distribution channels for its products caused by this pandemic. Consequently, we may have to record additional impairment charges with respect to the S&L Note.
We will also monitor the impact of this pandemic on our investment in HC Realty, but we are not currently anticipating a significant impact as HC Realty holds properties that are leased entirely to the United States Government for occupancy by federal agencies. Many of these federal agencies are deemed essential and continued operations amidst the various federal, state, and local restrictions aimed at slowing the spread of COVID-19. It is possible, however, that a resurgence in COVID-19 cases resulting in tighter restrictions may have the effect of heightening adverse impacts to HC Realty’s operations.
We will also monitor the impact of the pandemic on NCTIC and Omega’s products and services. The COVID-19 pandemic has caused the Company’s title insurance subsidiaries to modify its business practices (including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences), and the Company may take further actions as may be required by government authorities or that the Company believes is in the best interests of its employees. The extent to which COVID-19 impacts the Company's future operations, primarily its impact on the demand for real estate transactions, will depend on uncertain developments, including the duration and severity of the pandemic (including any of its variants), as well as uncertainty regarding the effects of government measures already taken, and which may be taken or continued in the future, to continue to combat the spread of the virus and any of its variants, and/or provide additional economic stimulus. This situation is continually changing, and additional impacts may arise that the Company is not aware of currently. It is not currently possible to predict the extent that COVID-19 will impact the Company's title insurance subsidiaries financial position or results of operation, although it is possible that it could have a material adverse effect on the Company's business.
Climate change, extreme weather conditions and catastrophic events, such as future pandemic diseases, natural disasters and terrorist attacks, could have a material adverse effect on the Company’s future results of operations and financial condition. The Company’s business operations could be impacted, including availability of key Company personnel or the Company’s information technology systems, by volatility of real estate prices, significant climate migration, and disruptions to the real estate environment or financial markets. Given the unpredictable nature of these events with respect to size, severity, duration and geographic location, it is not currently possible to quantify the ultimate impact that they may have on the Company’s business.
Risks related to our common stock
Our common stock is listed on the OTCQB and there may be limited ability to trade our common stock.
Trading of our common stock is currently conducted in the over-the-counter market on the OTCQB, which is generally a less active, and therefore a less liquid, trading market than other types of markets such as stock exchanges. As a result, an investor may find it more difficult to dispose of, or obtain accurate quotations for the price of, our common stock than if our stock was traded on other markets.
Risks related to our management
Our executive officers, one of whom is a current director, may have potential or actual conflicts of interest because of their positions with HCPM and HC Realty
Steven A. Hale II, our Chairman and Chief Executive Officer, is sole manager of HPCM which serves as the investment adviser for the Hale Funds and two current holders of HC Realty Series B Stock. The Hale Funds own approximately 33.9% of our outstanding common stock. We also own HC Realty Series B Stock and HC Realty Common Stock. Mr. Hale also serves as Chairman and Chief Executive Officer and a director of HC Realty. Bradley G Garner, our Principal Financial and Accounting Officer, also serves as a director of HC Realty and is chief compliance officer for HPCM.
Mr. Hale and Mr. Garner owe fiduciary duties to us, as well as to HC Realty as a result of their positions with HC Realty and to the Hale Funds and two current holders of HC Realty Series B Stock as a result of their positions with HPCM, the investment adviser to these parties. As a result, these executive officers may have potential or actual conflicts of interest when faced with decisions that could have different implications for us and HC Realty. In addition, Mr. Hale and Mr. Garner may have potential or actual conflicts of interest when faced with decisions that could have different implications for us and the Hale Funds or the one holder of HC Realty Series B Stock advised by HPCM. For example, these potential conflicts could arise over matters such as funding and capital matters.
Our executive officers, directors and 10% stockholders have significant voting power and may vote their shares in a manner that is not in the best interest of other stockholders.
Our current executive officers, directors and 10% stockholders control approximately 76.0% of the voting power represented by our outstanding common stock. If these stockholders act together, they may be able to exert significant control over our management and affairs requiring stockholder approval, such as the election of directors or the dissolution of the company. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our stockholders.
Our management, who will be employed on a part-time basis for the foreseeable future, currently has outside business interests that will require their time and attention and may interfere with their ability to devote all of their time to our business, which may adversely affect our business and operations.
Our two executive officers will be employed for the foreseeable future on a part-time basis and have outside business interests that could require substantial time and attention. Our executive officers are associated with Hale Partnership Capital Management LLC and devote significant time to its affairs. Our executive officers are also associated with HC Realty. We cannot accurately predict the amount of time and attention that will be required of our officers to perform their ongoing duties related to outside business interests. The inability of our officers to devote sufficient time to managing our business could have a material adverse effect on our business and operations.
| Item 1B. |
Unresolved Staff Comments |
None.
| Item 2. |
Properties |
Our corporate headquarters is located in Charlotte, North Carolina where we lease office space. The Company’s subsidiaries, principally Omega, lease office space throughout Florida.
| Item 3. |
Legal Proceedings |
Hollie Drive Litigation
In November 2019, we received notice that the Company and Stanley Furniture Company, LLC, formerly known as Churchill Downs, LLC (the “Buyer”) were defendants in a pending case in the Circuit Court for Henry County, Virginia. The case, which had been instituted on September 18, 2019 by Hollie Drive Associates, LLC (“Hollie”), raises issues arising from the purported breach of a lease for warehouse space in Henry County, Virginia, which is owned by Hollie and was previously rented by the Company. The relevant lease was assigned to the Buyer in connection with the Asset Sale. The complaint asserts that the Buyer breached various provisions of the lease including failure to make certain rental payments and failure to pay for certain clean-up and reconstruction after the Buyer vacated the property. The complaint seeks damages in the amount of approximately $555,000 and attorney’s fees. Hollie named the Company as a party because the Company was the original tenant under the lease. Under the Asset Purchase Agreement, the Buyer agreed to assume and indemnify the Company against post-closing liabilities arising under the lease including those asserted in the complaint. The Buyer’s filings in the case do not dispute the obligation to indemnify the Company for any damages awarded in the case. Based upon discussions with the Buyer and documents produced to date by Hollie, it appears Hollie has asserted damages greatly exceeding the likely recovery in the case. Given these facts and the Buyer’s indemnity obligation, the Company believes it is not probable the case will result in a material adverse effect on its financial statements.
Graham County Property Litigation
As previously disclosed, on November 26, 2019, Graham County (the “County”), North Carolina filed a complaint against the Company and the Buyer in the Superior Court for Graham County, North Carolina asserting claims arising out of a conveyance to the County of approximately 36 acres (the “Property”) in November 2014. The Complaint sought, among other things, (i) rescission of the conveyance of the Property to the County, (ii) reimbursement of expenses incurred by the County in connection with the Property, (iii) to invalidate the indemnity agreements entered into in connection with the conveyance, (iv) and other damages, or (iv), in the alternative to rescinding the conveyance, expenses necessary to make the Property suitable and useable for a public park and outdoor recreation area. Pursuant to the Asset Purchase Agreement, the Buyer agreed to assume and indemnify the Company against certain pre-closing liabilities including those relating to the conveyance of the Property. After the filing of the complaint, the Company entered into an agreement with the Buyer providing that, if the Company reaches a settlement with the County resulting in transfer of the Property back to the Company, then the Company can retain the Property notwithstanding provisions of the Asset Purchase Agreement and will waive any right to indemnification from the Buyer with respect to the claims by the County with respect to the Property. In January 2021, representatives of the Company and the County reached an agreement to resolve all claims asserted by the County in the litigation. Under the terms of the agreement, the County has agreed to transfer the Property back to the Company, lease a portion of the Property from the Company, and dismiss the litigation in exchange for Company making cash payments to the County in a total amount that is immaterial to the Company’s financial performance. The litigation has been dismissed and the other material terms of the settlement have now been completed.
| Item 4. |
Mine Safety Disclosures |
Not Applicable.
Information about our Executive Officers
Our executive officers who are elected annually and their ages as of January 1, 2022 are as follows:
| Name |
Age |
Position |
||
| Steven A. Hale II |
38 |
Chairman, Chief Executive Officer and Director |
||
| Brad G. Garner |
39 |
Principal Financial and Accounting Officer |
Steven A. Hale II is the founder of Hale Partnership Capital Management, LLC, an asset management firm that serves as the investment manager to certain privately held investment partnerships. Mr. Hale has held his position since 2010. From 2007 to 2010, prior to founding Hale Partnership Capital Management, LLC, Mr. Hale was an associate director with Babson Capital Management, LLC, an asset management firm, where he had responsibility for coverage of distressed debt investments across a variety of industries. From 2005 to 2007, Mr. Hale was a leveraged finance analyst with Banc of America Securities. Mr. Hale has served as a director of the Company since February 2017, as Chairman of the Company’s Board of Directors since November 2017 and an officer of the Company since March 2018.
Brad G. Garner joined Hale Partnership Capital Management, LLC, an asset management firm that serves as the investment manager to certain privately held investment partnerships, in 2015 as Chief Financial Officer and Partner. Mr. Garner served as Chief Financial Officer of Best Bar Ever, Inc. while raising and structuring capital investments and successful exit to a strategic partner. Prior to taking on that role, he spent 10 years in public accounting at Dixon Hughes Goodman LLP. Mr. Garner has served as an officer of the Company since April 2018.
PART II
| Item 5. |
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock is traded in the over-the-counter market on the OTCQB under the symbol “STLY”. Any over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of March 22, 2022, we had approximately 625 beneficial stockholders. We currently anticipate that we will retain all future earnings for the operation of our business, and we do not currently intend to pay any cash dividends on our common stock in the foreseeable future.
Issuer Purchases of Equity Securities
None.
Equity Compensation Plan Information
The following table summarizes our equity compensation plans as of December 31, 2021 (in thousands):
| Number of shares |
Weighted-average |
Number of shares |
|||
| to be issued upon |
exercise price |
remaining available |
|||
| exercise of |
of outstanding |
for future issuance |
|||
| outstanding options, |
options, warrants |
under equity |
|||
| warrants and rights |
and rights |
compensation plans |
|||
| Equity compensation plans approved by stockholders |
- |
- |
1,186 |
| Item 6. |
Reserved |
| Item 7. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and Selected Financial Data included elsewhere in this Annual Report.
Principles of Consolidation
The consolidated financial statements have been prepared in accordance with GAAP and reflect the consolidated operations of the Company. The consolidated financial statements include the accounts of HG Holdings, Inc. and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Equity investments in which the Company exercises significant influence but does not control and is not the primary beneficiary, are accounted for using the equity method of accounting. Equity investments in which the Company does not exercise significant influence over the investee and without readily determinable fair values, or non-marketable equity securities, are accounted for at cost, less impairment, and are adjusted up or down for any observable price changes.
Overview
For a description of our business, including descriptions of segments, see the discussion under Business in Item 1 of Part I of this Annual Report, which is incorporated by reference into this Item 7 of Part II of this Annual Report.
COVID-19 Pandemic
Despite the widespread availability of vaccines, COVID-19 (including its variant strains) continues to impact U.S. states where the Company conducts business. The COVID-19 pandemic has negatively impacted worldwide economic activity and created significant volatility and disruptions of financial markets. In response, the U.S. government and its agencies have taken a number of significant measures to provide fiscal and monetary stimulus. Such actions have included an unscheduled cut to the federal funds rate, the introduction of new programs to preserve market liquidity, extended unemployment and sick leave benefits, mortgage loan forbearance actions, low-interest loans for working capital access and payroll assistance, and other relief measures for both workers and businesses. Many such actions have lapsed or otherwise been reduced as time has passed since the onset of the pandemic. The Company and its subsidiaries have remained fully operational throughout the pandemic and did not have any reductions in workforce during 2021.
The COVID-19 pandemic has caused the Company to modify its business practices (including employee travel, employee work locations and cancellation of physical participation in meetings, events and conferences). The COVID-19 pandemic and any of its variants could continue to affect the Company in a number of ways including, but not limited to, the impact of employees becoming ill, quarantined, or otherwise unable to work or travel due to illness or governmental restriction, potential decreases in net premiums written in the future, and future fluctuations in the Company's investment portfolio due to the pandemic and the economic disruption it is causing. Because of the inherent uncertainty regarding the duration and severity of the COVID-19 pandemic (including any of its variants) and its effects on the economy, as well as uncertainty regarding the effects of government measures already taken, and which may be taken or continued in the future, to combat the spread of the virus and any of its variants, and/or provide additional economic stimulus, the Company is currently unable to predict the ultimate impact of the pandemic.
Title
Our title insurance segment revenue is closely related to the level of real estate activity that includes sales, mortgage financing and mortgage refinancing. Declines in the level of real estate activity or the average price of real estate sales will adversely affect our title insurance revenues.
We believe that real estate activity is generally dependent on mortgage interest rates, access and availability to mortgage debt, residential housing inventory, home prices, commercial property supply and demand, and the general economic conditions in the U.S. economy.
As of the January 21, 2022 Mortgage Finance Forecast, the Mortgage Bankers Association (“MBA”) expects residential purchase transactions to steadily increase through 2023 before leveling out in 2024. Additionally, the MBA expects residential refinance transactions to steadily decrease in 2022 and 2023 before leveling out in 2024 as interest rates are expected to rise. The MBA expects overall mortgage originations to decrease in 2022 and thereafter as compared to 2021 levels.
The industry as a whole saw growth in total real estate transactions in 2021, largely due to a strong residential real estate market driven by increasing home prices and low mortgage interest rates. Mortgage rates remained historically low after emergency actions taken by the Federal reserve to reduce its benchmark interest rate in first quarter 2020. Despite the lingering impact of COVID-19 in 2021, purchase and refinance activity grew due to migration of out of dense urban areas into less populated geographies as well near historically low interest rates. Per MBA’s Mortgage Finance Forecast, interest rates on a Freddie Mac 30-year, fixed rate mortgage averaged 3.1% in 2021.
See Item 1A of Part I of this Annual Report for further discussion of risk factors related to COVID-19.
Historically, real estate transactions have produced seasonal revenue fluctuations in the real estate industry. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. The second and third calendar quarters are typically the strongest quarters in terms of revenue, primarily due to a higher volume of residential transactions in the spring and summer months.
Real Estate Related
The Company acquired an equity interest in HC Realty. HC Realty currently owns and operates a portfolio of 27 single-tenant properties leased entirely to the United States of America for occupancy by federal agencies including the Federal Bureau of Investigation, the Department of Veterans affairs, the Drug Enforcement Administration, Immigration & Customs Enforcement, the Social Security Administration and the Department of Transportation. On March 19, 2019, we purchased 300,000 shares of HC Common Stock for an aggregate purchase price of $3,000,000 and 200,000 shares of HC Series B Stock for an aggregate purchase price of $2,000,000. On April 3, April 9, and June 29, 2020, the Company entered into subscription agreements with HC Realty, pursuant to which we purchased 100,000, 250,000, and 475,000 shares of Series B Stock, respectively, for an aggregate purchase price of $8,250,000. As a result of these purchases, we currently own approximately 33.9% of the as-converted equity interest of HC Realty.
On March 19, 2019, the Company, together with certain other Lenders, entered into a loan agreement (the “Loan Agreement”) with HC Realty’s operating partnership, and HCM Agency, LLC, as collateral agent (the “Agent”), pursuant to which the Lenders provided HC Realty’s operating partnership with Initial Term Loan, of which $2,000,000 was provided by the Company. On August 14, 2020, pursuant to the terms of the Loan Agreement, HC Realty’s operating partnership repaid the loan in full, including all accrued interest and make whole interest.
For the year ended December 31, 2021, HC Realty owned 27 GSA Properties, comprised of 23 GSA Properties that it owns in fee simple, one GSA Property that it owns subject to a ground lease and three GSA Properties for which it has all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership including for federal income tax purposes, each of which is leased to the United States. HC Realty’s portfolio properties contain approximately 508,092 rentable square feet located in 18 states. As of December 31, 2021, its portfolio properties are 100% leased to the United States of America and occupied by 12 different federal government agencies. Based on net operating income of each property, the portfolio has a weighted average remaining lease term of 8.8 years if none of the early termination rights are exercised and 4.9 years if all of the early termination right are exercised.
Results of Operations
2021 Compared to 2020
As of December 31, 2021, our sources of income include earnings on our title insurance subsidiaries, dividends on HC Realty Series B Stock, and interest paid on our cash deposits. The Company believes that the revenue generating from these sources, dividends paid on HC Realty Common Stock, and cash on hand is sufficient to fund operating expenses for at least 12 months from the date of these consolidated financial statements.
The Company generated interest income of $15,000 for the year ended December 31, 2021 as compared to $0.6 million for the year ended December 31, 2020. The decrease was primarily a result of decreased interest income from the Second Amended and Restated Subordinated Secured Promissory Note (the “Second A&R Note”) pursuant to the October 31, 2019 Forbearance Agreement (“Forbearance Agreement”) with Buyer and payoff of that note in March 2020, decreased interest income from the HC Realty Loan Agreement as a result of the payoff of that note in August 2020, ceasing to accrete interest income on the S&L Note in third quarter 2020, recognizing interest payments on the S&L Note as principal payments, and lower interest rates on our cash deposits. The Company generated dividend income of $1.0 million for the year ended December 31, 2021 as compared to $684,000 for the prior year, which is reported in our real estate related segment. The increase resulted primarily from the receipt of a full year of dividends from the April 3, April 29, and June 29, 2020 acquisitions of additional HC Realty Series B Stock.
As a result of the Company’s acquisition of the title insurance operations, the Company generated title premium and other title fee revenue of $2.4 million and management fees of $37,000. The title insurance subsidiaries cost of revenue consists primarily of a provision for title claim losses and underwriting expenses, which is primarily commissions to title agencies. The title insurance operating expenses consist primarily of personnel expenses, office and technology expenses and professional fees. Operating expenses for the period subsequent to the Company’s acquisition of NCTIC on July 1, 2021 and the acquisition of TAV on September 1, 2021 was $2.1 million.
Corporate general and administrative expenses are not directly allocable to either of our reporting segments and consist primarily of wages and personnel costs, legal and professional fees, insurance expense, and stock based compensation. Corporate general and administrative expenses of $1.3 million for the year ended December 31, 2021 at the corporate level remained flat as compared to the year ended December 31, 2020. Included in the general and administrative expenses incurred in the year ended December 31, 2021 was approximately $242,000 of legal and professional fees and other due diligence costs related to the acquisitions of the title insurance business.
Our effective tax rate for the year ended December 31, 2021 was effectively (3.8)% resulting from a tax benefit from unrecognized tax benefits position under FASB Interpretation No. 48 (“FIN 48”). Our 2020 effective tax rate was 0.0% due to our net operating loss carryforwards.
Financial Condition, Liquidity and Capital Resources
Sources of liquidity include cash on hand, cash interest earned on our cash on hand and the S&L Note, earnings from our title insurance subsidiaries, and dividends from our HC Realty common and Series B Stock. We expect cash on hand to be adequate for ongoing operational expenditures for at least 12 months from the date of these consolidated financial statements. At December 31, 2021, we had $11.8 million in cash and an additional $8.3 million in restricted cash, of which $8.1 million is cash held in escrow for title insurance transactions. The company records an offsetting escrow liability given that we are liable for the disposition of these escrowed funds. A portion of our unrestricted and restricted cash is currently held in savings accounts earning approximately 0.05% annually. We also received quarterly dividends on our HC Realty common and Series B Stock at annual rates of 5.5% and 10%.
Cash flows provided by operating activities differ from net income due to adjustments for non-cash items, such as gains and losses on investments and affiliates, impairment losses on note receivables, the timing of disbursements for taxes, claims and other accrued liabilities, and collections or changes in receivables and other assets. Net cash used in operations for the year ended December 31, 2021 of $935,000 consisted of dividends on our HC Realty common stock of $165,000, dividends on our HC Realty Series B Stock of $1 million, income tax refund of $491,000 offset primarily by an increase of $1.2 million in escrow liabilities on the title insurance subsidiaries, personnel costs of $1.3 million, and legal and professional fees of $605,000.
Cash provided by investing activities of $9.4 million for the year ended December 31, 2021 consisted primarily $7.7 million of cash used for the acquisition of our title insurance subsidiaries offset by cash acquired of $16.9 million from the title insurance subsidiaries acquired, of which $9.3 million was restricted cash held in escrow for title insurance transactions, and the cash principal payments received on the S&L Note of approximately $190,000.
Recent Accounting Pronouncements
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”). The amendments in ASU 2016-13 require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendment is effective for public entities for annual reporting periods beginning after December 15, 2022. Early application is permitted for reporting periods beginning after December 15, 2018, although the Company has not opted to do so. The Company does not anticipate the adoption of ASU 2016-13 to have a material impact to the consolidated financial statements.
Critical Accounting Policies
We have chosen accounting policies that are necessary to accurately and fairly report our operational and financial position. Below are the critical accounting policies that involve the most significant judgments and estimates used in the preparation of our financial statements.
Equity Investments - Long-term investments consist of investments in equity securities where our ownership is less than 50% and the Company has the ability to exercise significant influence, but not control, over the investee. These investments are classified in “Investment in affiliate” on the balance sheets. Investments accounted for under the equity method of accounting are initially recorded at cost and subsequently increases or decreases the investment by its proportionate share of the net income or loss and other comprehensive income or loss of the investee. For investments that do not have readily determinable fair values, the Company made an accounting policy election for a measurement alternative. Upon adoption of ASU 2016-01, the Company carries these investments at cost minus impairment, if any, plus or minus any changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.
If the Company believes a decline in market value below cost is other than temporary, a loss is charged to earnings, which establishes a new cost basis for the security. The Company determination of whether an equity investment is other than temporarily impaired incorporates both quantitative and qualitative information. The Company considers a number of factors including, but not limited to, the length of time and the extent to which the fair value has been less than cost, the length of time expected for recovery, the financial condition of the investee, the reason for decline in fair value, the ability and intent to hold the investment to maturity, and other factors specific to the individual investment.
Fair Value of Assets Acquired and Liabilities Assumed in Business Combinations - FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations, requires an acquirer to recognize, separately from goodwill, the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree, and to measure these items generally at their acquisition date fair values. Goodwill is recorded as the residual amount by which the purchase price exceeds the fair value of the net assets acquired. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, we are required to report provisional amounts in the financial statements for the items for which the accounting is incomplete. Adjustments to provisional amounts initially recorded that are identified during the measurement period are recognized in the reporting period in which the adjustment amounts are determined. This includes any effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. During the measurement period, we are also required to recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends the sooner of one year from the acquisition date or when we receive the information we were seeking about facts and circumstances that existed as of the acquisition date or learn that more information is not obtainable. Contingent consideration liabilities or receivables recorded in connection with business acquisitions must also be adjusted for changes in fair value until settled.
Note Receivable - In accordance with the Financial Accounting Standard Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 810-40-5, upon the sale of substantially all of the assets the Company recorded a gain on the deconsolidation of a group of assets based on the difference between the fair value of the consideration received and the carrying amount of the group of assets. As the Subordinated Secured Promissory Note with Buyer in the principal amount of approximately $7.4 million (the “Original Note”) was part of the consideration received for the sale of substantially all of the Company’s furniture related assets and liabilities, the Company recorded the Original Note at its fair value on March 2, 2018. The fair value of the Original Note was estimated using discounted cash flow analyses, using market rates at the acquisition date that reflect the credit and inherent rate-risk inherent in the Original Note. The discount resulting from the fair value adjustment was recorded as a direct reduction to the original principal balance and amortized to interest income using the effective interest method. As of the date of the assignment and transfer from the Buyer to S&L, it was determined that the Original Note was extinguished and therefore both the A&R Note and the S&L Note were measured based on their fair value in accordance with Emerging Issues Task Force (EITF) – Creditors Accounting for Modification or Exchange of Debt Instruments. The discounts resulting from the fair value adjustments for the A&R Note and the S&L Note were recorded as a direct reduction to the original principal balance and amortized to interest income using the effective interest method. When impairment is determined to be probable, the measurement will be based on the fair value of the collateral securing the notes. The determination of impairment involves management’s judgment and the use of market and third-party estimates regarding collateral values.
The Company concluded, based on current information and events, including the impact of COVID-19 on S&L’s business and its customers, that the Company did not believe it would be able to collect the amount due under the S&L Note and determined that the note was other than temporarily impaired. The evaluation was generally based on an assessment of the borrower’s financial condition and the adequacy of the collateral securing the S&L Note. Given the facts and circumstances, the Company recorded an impairment loss of $701,000 during the year ended December 31, 2021. The Company further ceased accruing interest and accreting interest income on the fair value discount of the S&L Note on the date in the third quarter of 2020 it determined the note was other than temporarily impaired
Interest Income – Interest income is recorded on an accrual basis based on the effective interest rate method to the extent that we expect to collect such amounts.
Deferred taxes – We recognize deferred tax assets and liabilities based on the estimated future tax effects of differences between the financial statements and the tax basis of assets and liabilities given the enacted tax laws. We evaluate the need for a deferred tax asset valuation allowance by assessing whether it is more likely than not that the company will realize its deferred tax assets in the future. The assessment of whether or not a valuation allowance is required often requires significant judgment, including the forecast of future taxable income. Adjustments to the deferred tax valuation allowance are made to earnings in the period when such assessment is made.
In preparation of our financial statements, we exercise judgment in estimating the potential exposure to unresolved tax matters and apply a more likely than not criteria approach for recording tax benefits related to uncertain tax positions. While actual results could vary, we believe we have adequate tax accruals with respect to the ultimate outcome of such unresolved tax matters.
Long-lived assets – Property, plant and equipment is reviewed for possible impairment when events indicate that the carrying amount of an asset may not be recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges in future periods that would lower our earnings. Our depreciation policy reflects judgments on the estimated remaining useful lives of assets.
Stock-Based Compensation – We record share-based payment awards at fair value on the grant date of the awards, based on the estimated number of awards that are expected to vest, over the vesting period. The fair value of stock options was determined using the Black-Scholes option-pricing model. The fair value of the restricted stock awards was based on the closing price of the Company’s common stock on the date of the grant. For awards with performance conditions, we recognize compensation cost over the expected period to achieve the performance conditions, provided achievement of the performance conditions are deemed probable.
Premiums Written and Commissions to Agents – Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of the issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and a provision for future claims are recognized concurrent with recognition of related premium revenue. Fee income related to escrow and other closing services is recognized when the related services have been performed and completed. Rather than making estimates that could be subject to significant variance from actual premium and fee production, the Company recognizes revenues from those sources upon receipt. Such receipts can reflect up to a three to four month lag relative to the effective date of the underlying title policy, and are offset concurrently by production expenses and claim reserve provisions.
Quarterly, the Company evaluates the collectability of receivables. Write-offs of receivables have not been material to the Company.
Reserve for Title Claims – The total reserve for all reported and unreported losses the Company incurred is represented by the reserve for title claims. The Company’s reserve for unpaid losses and loss adjustment expenses (LAE) is established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders that may be reported in the future (“IBNR”). The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
Reinsurance – The accompanying balance sheets reflect reserves for claims gross of reinsurance ceded. The accompanying statements of operations reflect premiums and provision for claims net of reinsurance ceded. The reinsurance arrangements allow management to control exposure to potential claims arising from large risks and catastrophic events. Amounts recoverable from reinsurers are estimated in a manner consistent with the reserves associated with the reinsured policies. Reinsurance premiums, losses, and LAE are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance agreements.
Off-Balance Sheet Arrangements
We do not have transactions or relationships with “special purpose” entities, and we do not have any off-balance sheet financing other than normal operating leases for office space.
| Item 7A. |
Quantitative and Qualitative Disclosures about Market Risk |
Not required to be provided by a smaller reporting company.
| Item 8. |
Financial Statements and Supplementary Data |
The financial statements and schedule listed in item 15(a) (1) hereof are incorporated herein by reference and are filed as part of this report.
| Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. |
Controls and Procedures |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15I promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded our disclosure controls and procedures were effective as of December 31, 2021, the end of the period covered by this Annual Report.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2021.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| Item 9B. |
Other Information |
None.
PART III
| Item 10. |
Directors, Executive Officers and Corporate Governance |
Information related to our directors will be set forth under the caption “Election of Directors” of our proxy statement (the “2022 Proxy Statement”) for our 2022 annual meeting of shareholders. Such information is incorporated herein by reference.
Information relating to compliance with section 16(a) of the Exchange Act will be set forth under the caption “Delinquent Section 16(a) Reports” of our 2021 Proxy Statement and is incorporated herein by reference.
Information relating to the Audit Committee and Board of Directors’ determinations concerning whether a member of the Audit Committee of the Board is a “financial expert” as that term is defined under Item 407(d) (5) of Regulation S-K is set forth under the caption “Board and Board Committee Information” of our 2021 Proxy Statement and is incorporated herein by reference.
Information concerning our executive officers is included in Part I of this report under the caption “Information about our Executive Officers.”
We have adopted a code of ethics that applies to our associates, including the principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Our code of ethics is posted on our website at www.hgholdingsinc.net. Amendments to and waivers from our code of ethics will be posted to our website when permitted by applicable SEC rules and regulations.
| Item 11. |
Executive Compensation |
Information relating to our executive and director compensation will be set forth under the caption “Executive Compensation” and “Director Compensation” of our 2022 Proxy Statement. Such information is incorporated herein by reference.
| Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Our information relating to this item will be set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” of our 2022 Proxy Statement. Such information is incorporated herein by reference.
Information concerning our equity compensation plan is included in Part II of this report under the caption “Equity Compensation Plan Information.”
| Item 13. |
Certain Relationships and Related Transactions, and Director Independence |
Our information relating to this item is set forth under the captions “Corporate Governance – Review of Transactions with Related Persons” and “Corporate Governance - Board and Board Committee Information” of our 2022 Proxy Statement. Such information is incorporated herein by reference.
| Item 14. |
Principal Accounting Fees and Services |
Our information relating to this item is set forth under the caption “Independent Public Auditors” of our 2022 Proxy Statement. Such information is incorporated herein by reference.
PART IV
| (1) | Item 15. | Exhibits, Financial Statement Schedule Documents filed as a part of this Report: |
| (1) |
The following financial statements are included in this report on Form 10-K: |
| Report of Independent Registered Public Accounting Firm (PCAOB ID 00 |
|
| Consolidated Balance Sheets as of December 31, 2021 and 2020 |
|
| Consolidated Statements of Operations for each of the two years in the period ended December 31, 2021 |
|
| Consolidated Statements of Changes in Stockholders’ Equity for each of the two years in the period ended December 31, 2021 |
|
| Consolidated Statements of Cash Flows for each of the two years in the period ended December 31, 2021 |
|
| Notes to Financial Statements |
|
| (b) |
Exhibits: |
| 3.1 |
|
| 3.2 |
|
| 3.3 |
|
| 4.1 |
|
| 4.2 |
|
| 4.3 |
|
| 4.4 |
|
| 4.5 |
| 10.1 |
|
| 10.2 |
|
| 10.3 |
|
| 10.4 |
|
| 10.5 |
|
| 10.6 |
|
| 10.7 |
|
| 10.8 |
|
| 10.9 |
|
| 10.10 |
|
| 10.11 |
|
| 10.12 |
|
| 21 |
| 23.1 |
|
| 31.1 |
|
| 31.2 |
|
| 32.1 |
|
| 32.2 |
|
| 101 |
The following financial statements from the Company's Annual Report on Form 10-K for the year ended December 31, 2021, formatted in Inline Extensible Business Reporting Language (“IXBRL”): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Changes in Stockholders’ Equity (iv) Consolidated Statements of Cash Flows, and (v) the Notes to the Financial Statements. (3) |
| 104 |
Cover Page Interactive Data File (embedded within the Inline XBRL and contained in Exhibit 101) |
| (1) |
Certain schedules to these agreements have been omitted in accordance with Item 601(b)(2) of Regulation S-K. A copy of any omitted schedules and/or exhibits will be furnished to the SEC upon request. |
| (2) | Management contract or compensatory plan |
| (3) | Filed Herewith |
| (4) | Furnished Herewith |
| Item 16. |
10-K Summary |
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| HG HOLDINGS, INC. |
||
| March 28, 2022 |
By: | /s/Steven A. Hale II |
| Steven A. Hale II |
||
| Chairman, Chief Executive Officer and Director |
||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Signature |
Title |
Date |
||
| /s/Steven A. Hale II (Steven A. Hale II) |
Chairman, Chief Executive Officer and Director |
March 28, 2022 |
||
| /s/Brad G. Garner (Brad G. Garner) |
Principal Financial and Accounting Officer |
March 28, 2022 |
||
| /s/Peter M. Sherman (Peter M. Sherman) |
Director |
March 28, 2022 |
||
| /s/Jeffrey S. Gilliam (Jeffrey S. Gilliam) |
Director |
March 28, 2022 |
||
HG HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2021
INDEX TO FINANCIAL STATEMENTS
| Page |
|
| Reports of Independent Registered Public Accounting Firm (PCAOB ID 00 |
F-2 |
| Financial Statements |
|
| Consolidated Balance Sheets as of December 31, 2021 and 2020 |
F-4 |
| Consolidated Statements of Operations for each of the two years in the period ended December 31, 2021 |
F-5 |
| Consolidated Statements of Changes in Stockholders’ Equity for each of the two years in the period ended December 31, 2021 |
F-6 |
| Consolidated Statements of Cash Flows for each of the two years in the period ended December 31, 2021 |
F-7 |
| Notes to Financial Statements |
F-8 |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
HG Holdings, Inc.
Charlotte, North Carolina
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of HG Holdings, Inc. (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2021, 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 as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years in the two-year period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of Acquired Businesses
Description of Matter
As discussed in Note 2 to the consolidated financial statements, on July 1, 2021 the Company acquired National Consumer Title Insurance Company and National Consumer Title Group, LLC, which included a 50% ownership in Title Agency Ventures, LLC, for total consideration of $5.46 million. On September 1, 2021 the Company acquired the remaining 50% interest in Title Agency Ventures, LLC and its wholly owned subsidiary Omega National Title Agency, LLC for total additional consideration of $2.20 million. The Company accounted for these transactions under the acquisition method of accounting, and the acquisitions resulted in the recording of $4.45 million of goodwill and a $3.33 million gain on remeasurement of equity interest. The fair value of the remaining acquired equity interest was estimated using a market approach which requires the use of estimates and assumptions related to comparable market transactions.
The Company had to determine the appropriate accounting for the acquisitions and subsequent remeasurement of the equity interest which required the Company to make significant estimates and assumptions. As a result, testing these assumptions and the related accounting conclusions involved a high degree of auditor judgment and effort, including involving the use of our valuation specialists. In addition, the fair value of this equity interest was challenging to audit due to the sensitivity of the fair value determination to changes in these assumptions.
How We Addressed the Matter in Our Audit
Our audit procedures included the following:
| ● |
Obtained an understanding of the internal controls and processes over the valuation of the acquired assets, including management's controls over the selection of significant assumptions. |
| ● |
Evaluated the appropriateness of the accounting treatment selected and recalculated the equity interest remeasurement. |
| ● |
With the assistance of our valuation specialists, evaluated the valuation methodologies and significant assumptions, and developed a range of independent estimates and compared those to the significant assumptions used by management. |
We have served as the Company’s auditor since 2019.
/s/
March 28, 2022
HG HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | $ | ||||||
| Restricted cash | ||||||||
| Accounts receivables | ||||||||
| Interest and dividend receivables | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Income tax receivable | ||||||||
| Total current assets | ||||||||
| Property, plant and equipment, net | ||||||||
| Lease assets | ||||||||
| Investment in affiliate | ||||||||
| Subordinated note receivable | ||||||||
| Goodwill | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | $ | ||||||
| Accrued salaries, wages and benefits | ||||||||
| Lease liabilities, current portion | ||||||||
| Escrow liabilities | ||||||||
| Other accrued expenses | ||||||||
| Total current liabilities | ||||||||
| Long-term liabilities: | ||||||||
| Reserve for title claims | ||||||||
| Lease liabilities | ||||||||
| Other long-term liabilities | ||||||||
| Total long-term liabilities | ||||||||
| Total liabilities | ||||||||
| STOCKHOLDERS’ EQUITY | ||||||||
| Common stock, par value, shares authorized and shares issued and outstanding on each respective date | ||||||||
| Capital in excess of par value | ||||||||
| Retained deficit | ( | ) | ( | ) | ||||
| Total stockholders’ equity | ||||||||
| Total liabilities and stockholders’ equity | $ | $ | ||||||
The accompanying notes are an integral part
of the consolidated financial statements.
HG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
| For the Years Ended | ||||||||
| December 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenues: | ||||||||
| Net premiums written | $ | $ | ||||||
| Escrow and other title fees | ||||||||
| Management fees | ||||||||
| Total revenues | ||||||||
| Cost of revenues: | ||||||||
| Underwriting expenses | ||||||||
| Provision for title claim losses | ||||||||
| Search and other fees | ||||||||
| Total operating expenses | ||||||||
| Gross underwriting profit | ||||||||
| Operating expenses: | ||||||||
| General and administrative expenses | ( | ) | ( | ) | ||||
| Other income/expenses: | ||||||||
| Interest income | ||||||||
| Dividend income | ||||||||
| Other income | ||||||||
| Gain on extinguishment of debt | ||||||||
| Gain on settlement of subordinated note receivable | ||||||||
| Gain on remeasurement of equity interest | ||||||||
| Loss from affiliate | ( | ) | ( | ) | ||||
| Loss on impairment | ( | ) | ( | ) | ||||
| Income from operations before income taxes | ||||||||
| Income tax benefit | ||||||||
| Net income | $ | $ | ||||||
| Basic and diluted income per share: | ||||||||
| Net income – basic | $ | . | $ | . | ||||
| Net income – diluted | $ | . | $ | . | ||||
| Weighted average shares outstanding: | ||||||||
| Basic | ||||||||
| Diluted | ||||||||
The accompanying notes are an integral part
of the consolidated financial statements.
HG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For each of the two years in the period ended December 31, 2021
(in thousands)
| Capital in | Retained | |||||||||||||||||||
| Common Stock | Excess of | Earnings | ||||||||||||||||||
| Shares | Amount | Par Value | (Deficit) | Total | ||||||||||||||||
| Balance at January 1, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Net income | - | |||||||||||||||||||
| Issuance of common stock | ||||||||||||||||||||
| Restricted stock forfeited or expired | ( | ) | ||||||||||||||||||
| Stock-based compensation | ||||||||||||||||||||
| Balance at December 31, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Net income | - | |||||||||||||||||||
| Effect of reverse stock split | ( | ) | ( | ) | ||||||||||||||||
| Redemption of fractional shares | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Stock-based compensation | ||||||||||||||||||||
| Balance at December 31, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
The accompanying notes are an integral part
of the consolidated financial statements.
HG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| For the year ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | $ | $ | ||||||
| Adjustments to reconcile net income from operations to net cash flows from operating activities: | ||||||||
| Depreciation expense | ||||||||
| Accretion income on notes receivable | ( | ) | ||||||
| Stock compensation expense | ||||||||
| Paid in kind interest on subordinated note receivable | ( | ) | ||||||
| Bargain purchase gain on acquisition of subsidiary | ( | ) | ||||||
| Gain on remeasurement of equity interest | ( | ) | ||||||
| Gain on settlement of subordinated note receivable | ( | ) | ||||||
| Gain on extinguishment of debt | ( | ) | ||||||
| Impairment loss on subordinated note receivable | ||||||||
| Dividends on HC Realty common stock | ||||||||
| Loss from affiliate | ||||||||
| Changes in assets and liabilities: | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Accounts receivable | ||||||||
| Interest and dividends receivables | ( | ) | ||||||
| Income tax receivable | ||||||||
| Deferred tax assets and other assets | ( | ) | ||||||
| Accounts payable | ( | ) | ||||||
| Commissions payable | ( | ) | ||||||
| Escrow liabilities | ( | ) | ||||||
| Reserve for title claims | ||||||||
| Other accrued expenses | ( | ) | ( | ) | ||||
| Other long-term liabilities | ( | ) | ( | ) | ||||
| Net cash (used in) provided by operations | ( | ) | ||||||
| Cash flows from investing activities: | ||||||||
| Purchase of property, plant, and equipment | ( | ) | ( | ) | ||||
| Investment in affiliate | ( | ) | ||||||
| Investment in subsidiaries, net of cash acquired | ||||||||
| Principal payments received on loan to affiliate | ||||||||
| Principal payments received on subordinated secured notes receivable | ||||||||
| Net cash provided by (used in) investing activities | ( | ) | ||||||
| Cash flows from financing activities: | ||||||||
| Issuance of common stock | ||||||||
| Redemption of fractional shares from stock split | ( | ) | ||||||
| Net cash (used in) provided by investing activities | ( | ) | ||||||
| Net increase in cash and restricted cash | ||||||||
| Cash and restricted cash at beginning of period | ||||||||
| Cash and restricted cash at end of period | $ | $ | ||||||
| Cash | $ | $ | ||||||
| Restricted cash | ||||||||
| Cash and restricted cash | $ | $ | ||||||
| Supplemental Non-Cash Disclosures: | ||||||||
| Dividends on investment in affiliate | $ | $ | ||||||
| Extinguishment of debt | $ | $ | ||||||
The accompanying notes are an integral part
of the consolidated financial statements
HG HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENT
| 1. | Significant Accounting Policies |
Principles of Consolidation and Basis of Presentation
The accompanying Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles in the United States ("GAAP") and include our accounts as well as our wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. In our title segment, our investments in unconsolidated subsidiaries and affiliates are accounted for using the equity method until such time that they become wholly or majority-owned.
All prior period share numbers, stock option numbers, exercise prices and per share data appearing in this Annual Report on Form 10-K has been retroactively adjusted to reflect the reverse stock split effective July 15, 2021, unless otherwise indicated or unless context suggests otherwise. As previously stated in our proxy statement, the Reverse Stock Split (as defined in Note 12 herein) did not affect the par value of our common stock, which remained $
HG Holdings, Inc, together with its consolidated subsidiaries (the “Company”), operates through its wholly owned subsidiaries National Consumer Title Insurance Company (“NCTIC”), National Consumer Title Group, LLC (“NCTG”), Title Agency Ventures, LLC (“TAV”), HG Managing Agency, LLC (“HGMA”), and Omega National Title Agency, LLC (“Omega”) and through an affiliated investment in HC Government Realty Trust, Inc., a Maryland corporation (“HC Realty”).
Cash
We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Restricted Cash
Restricted cash includes collateral deposits required under the Company’s letter of credit agreement, which expires in June 2022, to guarantee the Company’s workers compensation insurance policy, and cash held in escrow under escrow agreements. As of December 31, 2021, there was no outstanding balance on the letter of credit agreement. Cash held by the Company in escrow was approximately $
Concentration of Credit Risk
The Company place its cash and restricted cash with financial institutions and, at times, cash held in depository accounts may exceed the Federal Deposit Insurance Corporation insured limit.
Interest Income
Interest income is recorded on an accrual basis based on the effective interest rate method and includes the accretion of fair value adjustments/discounts. Fair value adjustments to par value are accreted/amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of fair value adjustments, if any.
Other revenues are recognized when contractual obligations are fulfilled or as services are provided.
Payment-in-Kind Interest
The Company has a subordinated secured notes receivable that may contain payment-in-kind (“PIK”) provisions. The PIK interest, computed at the contractual rate specified in the loan agreement, is added to the principal balance of the loan and recorded as interest income.
Variable Interest Entities
As a result of the September 6, 2018 sale of certain of Stanley Furniture Company, LLC’s, formerly known as Churchill Downs, LLC (the “Buyer”) assets, including certain inventory and the Stone & Leigh tradename (the “S&L Asset Sale”) to Stone & Leigh, LLC (“S&L”), we have a variable interest in one entity that has been determined to be variable interest entity ("VIE"). If we conclude that we are the primary beneficiary of a VIE, we are required to consolidate it. To determine if we are the primary beneficiary, we evaluate whether we have the power to direct the activities that most significantly impact the VIE's economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our evaluation includes identification of significant activities and an assessment of our ability to direct those activities based on governance provisions and arrangements to provide or receive product and process technology, product supply, operations services, equity funding, financing, and other applicable agreements and circumstances. Our assessments of whether we are the primary beneficiary of our VIE requires significant assumptions and judgments. We have concluded that we are not the primary beneficiary of the three VIEs as we do not have the power to direct the activities that most significantly impact the VIEs’ economic performance and therefore are not required to consolidate these entities.
Fair Value of Assets Acquired and Liabilities Assumed in Business Combinations
FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations, requires an acquirer to recognize, separately from goodwill, the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree, and to measure these items generally at their acquisition date fair values. Goodwill is recorded as the residual amount by which the purchase price exceeds the fair value of the net assets acquired. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, we are required to report provisional amounts in the financial statements for the items for which the accounting is incomplete. Adjustments to provisional amounts initially recorded that are identified during the measurement period are recognized in the reporting period in which the adjustment amounts are determined. This includes any effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. During the measurement period, we are also required to recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends the sooner of one year from the acquisition date or when we receive the information we were seeking about facts and circumstances that existed as of the acquisition date or learn that more information is not obtainable. Contingent consideration liabilities or receivables recorded in connection with business acquisitions must also be adjusted for changes in fair value until settled.
Leases
The Company enters into lease agreements that are primarily used for office space, and all current leases are accounted for as operating leases. Amounts related to operating leases are included in lease assets and lease liabilities on the Consolidated Balance Sheets. Lease assets represent the Company’s right to use an underlying asset for the stated lease term. Lease liabilities represent the Company’s obligation to make lease payments arising from an operating lease. Lease assets and liabilities are recognized at the date of the lease commencement, and are based on the present value of lease payments over the lease term. The Company's current leases do not provide an implicit interest rate, thus the Company calculated a discount rate using estimates of our incremental borrowing rate for similar collateralized borrowings and capitalizations rates in determining the present value of lease payments. A portion of the Company's current leases includes an option to extend or cancel the lease term. The exercise of such an option is solely at the Company's discretion. The operating lease liability recorded in the Consolidated Balance Sheets includes lease payments related to options to extend or cancel the lease term if the Company determined at the date of adoption that the lease was expected to be renewed or extended. A lease expense is recognized on a straight-line basis over the lease term. Adjustments for straight-line rental expense for the periods presented are not material and as such, the lease expense recognized was reflected in cash used in operating activities for the respective periods. For further information on the Company’s Leasing arrangements see Note 14.
Goodwill
Goodwill represents the excess of cost over fair value of identifiable net assets acquired and assumed in a business combination. Goodwill and other intangible assets with indefinite useful lives are reviewed for impairment at the reporting unit level on an annual basis or more frequently if circumstances indicate potential impairment, through a comparison of fair value to the carrying amount. In evaluating the recoverability of goodwill, we perform an annual goodwill impairment analysis based on a review of qualitative factors to determine if events and circumstances exist, which will lead to a determination that the fair value of a reporting unit is greater than its carrying amount, prior to performing a full fair-value assessment. For the year ended December 31, 2021, we determined there were no events or circumstances which indicated that the carrying value of a reporting unit exceeded the fair value.
Subordinated Notes Receivable
As of the date of the September 6, 2018 sale of certain of the Buyer’s assets, including certain inventory and the Stone & Leigh tradename (the “S&L Asset Sale’) to Stone & Leigh, LLC (“S&L”) and resulting assignment and transfer of the note from the Buyer to S&L, the S&L Note was measured based on their fair value in accordance with Emerging Issues Task Force (EITF) – Creditors Accounting for Modification or Exchange of Debt Instruments. The discounts resulting from the fair value adjustments for the S&L Note were recorded as a direct reduction to the original principal balance and amortized to interest income using the effective interest method. When impairment is determined to be probable, the measurement will be based on the fair value of the collateral securing the notes. The determination of impairment involves management’s judgment and the use of market and third-party estimates regarding collateral values. During 2021 and 2020 management determined that S&L Note was other than temporarily impaired and recorded an impairment loss of $
Property, Plant and Equipment
Depreciation of property, plant and equipment is computed using the straight-line method based upon the estimated useful lives. Depreciation expense is charged to general and administrative expenses. Gains and losses related to dispositions and retirements are included in income. Maintenance and repairs are charged to expense as incurred; renewals and betterments are capitalized. Assets are reviewed for possible impairment when events indicate that the carrying amount of an asset may not be recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of property, plant and equipment, which could result in impairment charges in future periods. Our depreciation policy reflects judgments on the estimated useful lives of assets. Our long-lived assets were tested for impairment at December 31, 2021 and determined that the long-lived assets were not impaired.
Equity Investments
Long-term investments consist of investments in equity securities where our ownership is less than
Income Taxes
Deferred income taxes are determined based on the difference between the financial statement and income tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax expense represents the change in the deferred tax asset/liability balance. Income tax credits are reported as a reduction of income tax expense in the year in which the credits are generated. A valuation allowance is recorded when it is more likely than not that a deferred tax asset will not be realized. Interest and penalties on uncertain tax positions are recorded as income tax expense.
Fair Value of Financial Instruments
Accounting for fair value measurements requires disclosure of the level within the fair value hierarchy in which fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3). The fair value of receivables and payables approximate the carrying amount because of the short maturity of these instruments.
Earnings per Common Share
Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share includes any dilutive effect of outstanding stock options and restricted stock calculated using the treasury stock method.
Reserve for Claim Losses
The total reserve for all reported and unreported losses the Company incurred is represented by the reserve for claims. The Company's reserve for unpaid losses and loss adjustment expenses (LAE) is established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders that may be reported in the future (incurred but not reported, or "IBNR"). The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
Reinsurance
The accompanying consolidated balance sheets reflect reserves for claims gross of reinsurance ceded. The accompanying consolidated statements of operations reflect premiums and provision for claims net of reinsurance ceded. The reinsurance arrangements allow management to control exposure to potential claims arising from large risks and catastrophic events. Amounts recoverable from reinsurers are estimated in a manner consistent with the reserves associated with the reinsured policies. Reinsurance premiums, losses, and LAE are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance agreements.
Stock-Based Compensation
We record share-based payment awards at fair value on the grant date of the awards, based on the estimated number of awards that are expected to vest, over the vesting period. The fair value of stock options was determined using the Black-Scholes option-pricing model. The fair value of the restricted stock awards was based on the closing price of the Company’s common stock on the date of the grant. For awards with performance conditions, we recognize compensation cost over the expected period to achieve the performance conditions, provided achievement of the performance conditions are deemed probable.
Premiums Written and Commissions to Agents
Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of the issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and a provision for future claims are recognized concurrent with recognition of related premium revenue. Fee income related to escrow and other closing services is recognized when the related services have been performed and completed. Rather than making estimates that could be subject to significant variance from actual premium and fee production, the Company recognizes revenues from those sources upon receipt. Such receipts can reflect up to a three to four month lag relative to the effective date of the underlying title policy, and are offset concurrently by production expenses and claim reserve provisions.
Quarterly, the Company evaluates the collectability of receivables. Write-offs of receivables have not been material to the Company.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Changes in such estimates may affect amounts reported in future periods.
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The amendments in ASU 2016-13 require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendment is effective for public entities for annual reporting periods beginning after December 15, 2022, however early application is permitted for reporting periods beginning after December 15, 2018. The Company does not anticipate the adoption of ASU 2016-13 to have a material impact to the consolidated financial statements.
| 2. | Business Combinations |
On July 20, 2021, the Company completed the acquisition (the “Acquisition”) pursuant to that certain Equity Purchase Agreement (the “First Purchase Agreement”) dated April 20, 2021 with NCTIC, a Florida corporation, NCTG, a Florida limited liability company, Southern Fidelity Insurance Company, a Florida corporation (“SFIC”), Southern Fidelity Managing Agency, LLC, a Florida limited liability company (“SFMA”), and Preferred Managing Agency, LLC, a Florida limited liability company (“PMA” and together with SFIC and SFMA, each, a “Seller” and collectively, the “Sellers”). On such date, pursuant to the First Purchase Agreement, the Company purchased
Pursuant to the Acquisition, the Company effectively purchased (i)
On September 1, 2021, the Company entered into a Membership Interests Purchase Agreement (the “Second Purchase Agreement”) with TAV and Fidelis US Holdings, Inc., a Delaware corporation (“Second Agreement Seller”). On such date, pursuant to the Second Purchase Agreement and in an immediate sign-and-close transaction, the Company purchased 50% of the membership interests of TAV from Second Agreement Seller (the “Second Acquisition”) for $
Combined with the Acquisition by the Company in July 2021 of a 100% membership interest in NCTG, which owns a 50% membership interest in TAV, the Company now is the sole owner of TAV, and by virtue thereof, owns all of the membership interests in Omega. The 50% non-controlling membership interest in TAV was accounted for under the equity method of accounting until the Second Acquisition.
The purchase price allocation for NCTIC and NCTG is as follows (in thousands):
| Cash paid for NCTIC | $ | |||
| Cash paid for NCTG | ||||
| Total consideration paid. | $ |
| NCTIC | NCTG | |||||||
| Cash and cash equivalents | $ | $ | ||||||
| Accounts receivable | ||||||||
| Deferred tax assets | ||||||||
| Investment in TAV | ||||||||
| Other assets | ||||||||
| Total assets acquired | ||||||||
| Accrued expenses | ||||||||
| Reinsurance payable | ||||||||
| Escrow liability | ||||||||
| Reserve for claims | ||||||||
| Total liabilities assumed | ||||||||
| Net assets acquired | $ | $ | ||||||
| Bargain purchase gain | $ | ( | ) | $ | ||||
A bargain purchase gain is recognized in current earnings when the aggregate fair value of the consideration transferred and any noncontrolling interest in the acquiree is less than the fair value of the identifiable net assets acquired. The bargain purchase gain was primarily driven by differences in NCTIC’s statutory surplus and GAAP surplus at the date of acquisition. The Company believes that the Sellers wanted to exit the business relatively quickly and there were a limited number of potential buyers due to factors inherent to the property and casualty market, which resulted in a bargain purchase gain. The bargain purchase gain is recorded in other income on the Consolidated Statement of Operations.
On September 1, 2021, the Company acquired the remaining 50% membership interests of TAV for $
The operating results of TAV are included in the Company’s consolidated statements of operations beginning September 1, 2021. TAV’s results are included in the title insurance segment.
The final purchase price allocation for TAV at fair value is as follows (in thousands):
| Cash paid for remaining of TAV | $ | |||
| Fair value of existing equity interest | ||||
| Total consideration | $ | |||
| Cash and cash equivalents | $ | |||
| Accounts receivable | ||||
| Prepaid expenses | ||||
| Lease assets | ||||
| Fixed assets | ||||
| Total assets acquired | ||||
| Accrued expenses | ||||
| Management fee payable | ||||
| Lease liability | ||||
| Escrow liability | ||||
| Payable to affiliate | ||||
| Note payable | ||||
| Total liabilities assumed | ||||
| Net assets acquired | ||||
| Goodwill | $ |
The acquisition date fair value of the Company’s previously held equity interest in TAV was $
The acquisition of the remaining equity interest was accounted for as a step-transaction in accordance with FASB Accounting Standards Codification Topic 805, Business Combinations ("Topic 805"). The Second Acquisition Purchase Price has been allocated to TAV's assets acquired and liabilities assumed based on our best estimates of the fair values as of the acquisition date. Due to the close proximity in timing of the Second Acquisition and our filing of this Annual Report on Form 10-K, the fair value of assets acquired and liabilities assumed represent a preliminary allocation as our evaluation of facts and circumstances available as of December 31, 2021 is ongoing. Goodwill has been recorded based on the amount that the purchase price exceeds the fair value of the net assets acquired. Goodwill consists primarily of intangible assets that do not qualify for separate recognition.
Pursuant to Topic 805, the consolidated financial statements will not be retrospectively adjusted for any provisional amount changes that occur in subsequent periods. Rather, we will recognize any provisional adjustments as we obtain information not available as of the completion of this preliminary fair value calculation as determined within the measurement period. We will also be required to record, in the same period as the consolidated financial statements, the effects to any income statement captions, if any, as a result of any change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. We expect to finalize the purchase price allocation as soon as practicable, but no later than one year from the acquisition date.
The following table presents unaudited pro forma financial information as if NCTIC, NCTG, and TAV had been included in the Company’s financial results as of January 1, 2021 and 2020:
| For the year ended | ||||||||
| December 31, | ||||||||
| 2021 (a,b,c) | 2020 | |||||||
| Revenues | $ | $ | ||||||
| Net income | $ | $ | ||||||
| (a) | Pro forma net income for the year ended December 31, 2021 excludes $ |
| (b) | Pro forma net income for the year ended December 31, 2021 excludes $ |
| (c) | Pro forma net income for the year ended December 31, 2021 excludes approximately $ |
| 3. | Property, Plant and Equipment |
| Depreciable | ||||||||||||||
| lives | (in thousands) | |||||||||||||
| (in years) | 2021 | 2020 | ||||||||||||
| Computers and equipment | to | $ | $ | |||||||||||
| Furniture and fixtures | to | |||||||||||||
| Property, plant and equipment, at cost | ||||||||||||||
| Less accumulated depreciation | ||||||||||||||
| Property, plant and equipment, net | $ | $ | ||||||||||||
| 4. | Subordinated Notes Receivable |
The Company received a $
A&R Note
On October 31, 2019, the Company entered into a Forbearance Agreement (“Forbearance Agreement”) with the Buyer and certain affiliates (the “Loan Parties”) pursuant to which the Company agreed, subject to certain conditions, to forbear until February 24, 2020 from exercising its rights and remedies under the Second Amended and Restated Subordinated Secured Promissory Note (the “Second A&R Note”) issued by Buyer to the Company. On February 24, 2020, the Company and the Loan Parties entered into a letter agreement (the “Forbearance Extension Letter Agreement”) extending the outside termination date for the forbearance period under the Forbearance Agreement from February 24, 2020 to February 26, 2020. The other terms and conditions of the Forbearance Agreement remained the same. The forbearance period terminated on February 26, 2020 under the terms of the Forbearance Extension Letter Agreement and Forbearance Agreement.
The Company received payments on January 31, 2020, February 28, 2020, and March 4, 2020 of $
On March 6, 2020, the Company and the Loan Parties entered into a letter agreement (the “Second Forbearance Extension Letter Agreement”) extending, subject to certain conditions, the outside termination date from February 26, 2020 to March 17, 2020. The extension of the outside termination and the effectiveness of the Second Forbearance Extension Letter Agreement was conditioned on Buyer making payments to be applied to the outstanding principal balance of the Second A&R Note of $
On March 12 and 13, 2020, the Company received payments from Buyer of $
On March 16, 2020, the Company received payment of $
S&L Note
The S&L Note had a principal amount of $
At the assignment date, the Company evaluated the fair value of the S&L Note. As a result of the Company’s recording of impairment losses, based on current information and events, including the impact of COVID-19 on S&L’s business and its customers, the Company ceased accruing interest and accreting interest income on the fair value discount of the S&L Note on the date in the third quarter of 2020 the Company determined the note was other than temporarily impaired. As such, the Company did not record accreted interest income on the fair value adjustment of the S&L Note for the year ended December 31, 2021. The company recorded accreted interest income of $
The Company recognized interest payments of $
During 2021, the Company concluded that the S&L would not have adequate cash required to repay the carrying value of the S&L Note. Given the facts and circumstances, the Company recorded an impairment loss of $
A reconciliation of the activity in the S&L Note for the years ended December 31, 2021 and 2020 is as follows (in thousands):
| Principal | Discount | Balance | ||||||||||
| Balance at January 1, 2020 | $ | $ | ( | ) | $ | |||||||
| Principal payments | ( | ) | - | ( | ) | |||||||
| Accretion of discount | - | |||||||||||
| Impairment | - | ( | ) | ( | ) | |||||||
| Balance at December 31, 2020 | $ | $ | ( | ) | $ | |||||||
| Principal payments | ( | ) | - | ( | ) | |||||||
| Accretion of discount | - | |||||||||||
| Impairment | - | ( | ) | ( | ) | |||||||
| Balance at December 31, 2021 | $ | $ | ( | ) | $ | |||||||
| 5. | Loan to Affiliate |
On March 19, 2019, the Company, together with certain other Lenders, entered into a loan agreement (the “Loan Agreement”) with HC Realty’s operating partnership, and HCM Agency, LLC, as collateral agent (the “Agent”), pursuant to which the Lenders provided HC Realty’s operating partnership with a $
On August 14, 2020, pursuant to the terms of the Loan Agreement, HC Realty’s operating partnership repaid the loan in full, including all accrued interest and make whole interest. Interest earned for the year ended December 31, 2020 was $
| 6. | Investment in Affiliate |
On March 19, 2019, the Company entered into subscription agreements with HC Realty, pursuant to which it purchased (i)
The Series B Stock is not deemed to be in-substance common stock and is accounted for using the measurement alternative for equity investments with no readily determinable fair value. The Series B Stock will be reported at cost, adjusted for impairments or any observable price changes in ordinary transactions with identical or similar investments issued by HC Realty.
The following table summarizes the Company’s investment in HC Realty as of the two years ended December 31, 2021 (in thousands):
| Ownership % | Investment in Affiliate Balance | Loss recorded in the Consolidated Statements of Operations (b) | ||||||||||||||||||||||
| December 31, 2021 | December 31, 2020 | December 31, 2021 | December 31, 2020 | 2021 | 2020 | |||||||||||||||||||
| HC Realty Series B Stock (a) | % | % | $ | $ | $ | $ | ||||||||||||||||||
| HC Realty common stock | % | % | ( | ) | ( | ) | ||||||||||||||||||
| Total | % | % | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||||
| (a) | Represents investments in shares of HC Realty preferred stock with a basis of $ |
| (b) | Loss from these investments is included in “Loss from affiliate” in the consolidated statements of operations. Since HC Realty is a Real Estate Investment Trust and not a taxable entity, the loss is not reported net of taxes. |
The Company’s investment in HC Realty common stock is accounted for under the equity method of accounting. For portions of the year ended December 31, 2020, the Company owned less than 20% of the fully diluted shares outstanding. The Company determined that accounting for the investment in HC Realty common stock under the equity method was appropriate for the portion of time the Company owned less than 20% because the Company holds significant influence of HC Realty.
| 7. | Paycheck Protection Program (“PPP”) Loan |
On May 7, 2020, prior to the Company’s acquisitions, Omega entered into a loan agreement with Wells Fargo, N.A. in the aggregate amount of $
The Loan was scheduled to mature five years from the date on which Omega applies for loan forgiveness under the CARES Act, bore interest at a rate of 1% per annum and is subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration (“SBA”) under the CARES Act. The PPP provided that the use of the Loan amount shall be limited to certain qualifying expenses and may be partially or wholly forgiven in accordance with the requirements set forth in the CARES Act. Omega used all of the PPP proceeds toward qualifying expenses.
On September 16, 2021, Omega received notice from the SBA that the full amount of the loan was forgiven. The forgiveness of the loan is included as gain on extinguishment of debt on the Consolidated Statements of Operations.
| 8. | Statutory Reporting |
NCTIC's assets, liabilities, and results of operations have been reported in accordance with GAAP, which varies from statutory accounting practices (SAP) prescribed or permitted by insurance regulatory authorities. Prescribed SAP are found in a variety of publications of the National Association of Insurance Commissioners (NAIC), state laws and regulations, as well as through general practices. Statutory accounting principles differ in some respects from GAAP, and these differences include, but are not limited to, non-admission of certain assets (principally limitations on deferred tax assets, goodwill, capitalized furniture and equipment, investment in subsidiaries and affiliates, real estate, capitalized software, and premiums and other receivables 90 days past due), reporting of bonds at amortized cost, recognition of credit losses against unassigned surplus, deferred income taxes, changes in the fair values of marketable equity securities, amortization of goodwill, deferral of premiums received as statutory premium reserve, supplemental reserve and exclusion of the incurred but not reported claims reserve. The Company must file with applicable state insurance regulatory authorities an “Annual Statement” which reports, among other items, net income or loss and stockholders' equity (called “surplus as regards policyholders” in statutory reporting).
Capital and surplus on a statutory basis was $
| 9. | Reserve for Title Claims |
NCTIC’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy claims that have been IBNR. Despite the variability of such estimates, management believes that the total reserve for claims is adequate to cover claim losses which might result from pending and future claims under title insurance policies issued through December 31, 2021. We continually update loss reserve estimates as new information becomes known, new loss patterns emerge or as other contributing factors are considered and incorporated into the analysis of reserve for claim losses. Due to the uncertainty inherent in the process and to the judgment used by management, the ultimate liability may be greater or less than our current reserves. If actual claims loss development varies from what is currently expected and is not offset by other factors, it is possible that additional reserve adjustments may be required in future periods in order to maintain our recorded reserve within a reasonable range of our actuary's central estimate.
A reconciliation of the activity in the reserves account for the period since the Acquisition ending December 31, 2021 is as follows (in thousands):
| Beginning Reserves | $ | |||
| Provision for claims related to: | ||||
| Current year | ||||
| Prior years | ||||
| Total provision for claim losses | ||||
| Claims paid related to: | ||||
| Current year | ||||
| Prior years | ||||
| Total title claims paid | ||||
| Ending Reserves | $ |
At December 31, 2021, there were
For the period subsequent to the Acquisition ending December 31, 2021, there was no development of the net provision for claims attributable to insured events of the prior year as a result of estimation of the reserve for claims. Original estimates are decreased or increased as additional information becomes known regarding individual claims.
A summary of the Company’s loss reserves at December 31, 2021 is as follows (in thousands):
| Known title claims | $ | |||||||
| IBNR title claims | % | |||||||
| Total title claims | % | |||||||
| Non-title claims | ||||||||
| Total title claims reserves | $ | % |
| 10. | Reinsurance |
Certain premiums and benefits at NCTIC are ceded to other insurance companies under various reinsurance agreements. The reinsurance agreements provide NCTIC with increased capacity to write more risk and maintain its exposure to loss within its capital resources. For the year ended December 31, 2021, NCTIC's reinsurance program consisted of excess of loss reinsurance treaties. The following is a summary of the reinsurance coverage.
Effective January 1, 2021, NCTIC entered into a per risk excess of loss reinsurance agreement that provided coverage of $
Effective January 1, 2021, NCTIC entered into a reinstatement premium protection reinsurance agreement to reinsure the reinstatement premium payment obligations of NCTIC under the shared per risk excess of loss agreement. The coverage is limited to
NCTIC’s reinsured risks are treated, to the extent of reinsurance, as though they are risks for which the Company is not liable. However, NCTIC remains contingently liable in the event the reinsuring companies do not meet their obligations under these reinsurance contracts. NCTIC uses a broker to place its reinsurance through Lloyd’s syndicates. Chaucer Ltd (“Chaucer”) and Beazley Syndicate (“Beazley”) are each
The effects of reinsurance on premiums written and earned at NCTIC for the period since the Acquisition ending December 31, 2021 are as follows (in thousands):
| 2021 | ||||||||
| Written | Earned | |||||||
| Direct premiums | $ | $ | ||||||
| Ceded premiums | ( | ) | ( | ) | ||||
| Net premiums | $ | $ | ||||||
| 11. | Income Taxes |
The provision for income tax (benefit) expense consists of (in thousands):
| 2021 | 2020 | |||||||
| Current: | ||||||||
| Federal | $ | ( | ) | $ | ( | ) | ||
| State | ||||||||
| Total current | ( | ) | ( | ) | ||||
| Deferred: | ||||||||
| Federal | ||||||||
| State | ||||||||
| Total deferred | ||||||||
| Income tax (benefit) expense from continuing operations | $ | ( | ) | $ | ||||
A reconciliation of the difference between the federal statutory income tax rate and the effective income tax rate follows:
| 2021 | 2020 | |||||||
| Federal statutory rate | % | % | ||||||
| State tax, net of federal benefit | ( | ) | ||||||
| Deferred correction – State NOLs | ( | ) | ||||||
| FIN 48 unrecognized tax benefits | ( | ) | ||||||
| State tax credits true-up | ( | ) | ||||||
| Permanent differences | ( | ) | ||||||
| Valuation allowance increase | ( | ) | ||||||
| Other, net | ( | ) | ||||||
| Effective income tax rate | ( | )% | % | |||||
The income tax effects of temporary differences that comprise deferred tax assets and liabilities at December 31 follow (in thousands):
| 2021 | 2020 | |||||||
| Noncurrent deferred tax assets: | ||||||||
| Equity method investment | $ | $ | ||||||
| Goodwill | ||||||||
| Other accrued expenses | ||||||||
| Notes receivable fair value adjustment | ||||||||
| Employee benefits | ||||||||
| Capital loss carryforward | ||||||||
| AMT credit | ||||||||
| Net operating loss | ||||||||
| Gross non-current deferred tax assets | ||||||||
| Noncurrent deferred tax liabilities: | ||||||||
| Property, tax, and equipment | $ | ( | ) | $ | ( | ) | ||
| Non-taxable dividends | ( | ) | ( | ) | ||||
| Gain on remeasurement of Acquisition | ( | ) | ||||||
| Valuation allowance | ( | ) | ( | ) | ||||
| Gross non-current deferred tax liabilities | ( | ) | ( | ) | ||||
| Net noncurrent deferred tax assets | $ | $ | ||||||
We have U.S. federal net operating loss carryforwards of approximately $
During 2021, we recorded a non-cash credit to our valuation allowance of approximately $
The unrecognized tax benefits activity for the year ended December 31 follows (in thousands):
| 2021 | 2020 | |||||||
| Unrecognized tax benefits balance at January 1 | $ | $ | ||||||
| Gross decrease in tax positions of prior years | ( | ) | ||||||
| Unrecognized tax benefits balance at December 31 | $ | $ | ||||||
Total amount of unrecognized tax benefits that would affect our effective tax rate if recognized is $
| 12. | Stockholders’ Equity |
In addition to common stock, authorized capital includes
Basic and diluted earnings per share are calculated using the following share data (in thousands):
| 2021 | 2020 | |||||||
| Weighted average shares outstanding for basic calculation | ||||||||
| Dilutive effect of restricted stock | ||||||||
| Weighted average shares outstanding for diluted calculation | ||||||||
For the years ended December 31, 2021 and 2020 approximately
In July 2012, the Board authorized the purchase of up to $
In the fourth quarter of 2016, the Board adopted a Rights Agreement designed to protect the Company’s substantial net operating loss carryforwards. Under the Rights Agreement, company stockholders of record as of December 15, 2016 received one preferred share purchase right for each share of common stock they owned on such date. If a person or group acquires beneficial ownership of
The Company entered into Amendment No. 1, dated January 30, 2017, to the Rights Agreement. This amendment amends the definition of Acquiring Person in the Rights Agreement to exclude any member of the Hale Group (Hale Partnership Fund, LP and certain affiliates that are parties to the agreement (Hale Agreement) dated January 30, 2017 with the Company), provided that any purchases made by members of the Hale Group after December 5, 2016 are made in compliance with Section 1(h) of the Hale Agreement. The Company entered into Amendment No 2, dated December 5, 2019, to the Rights Agreement. This amendment amends the definition of “Expiration Time” to provide that, unless otherwise expiring under the terms of the existing definition, the Rights Agreement will expire (i) at the close of business on the day after the Company’s 2020 annual meeting of stockholders unless the Company’s stockholders approve the amendment to the definition of “Expiration Time” in this amendment or (ii) the close of business on December 5, 2022 (unless the Company’s NOLs are utilized prior to that date). At the Company’s 2020 annual meeting of stockholders, the Company’s stockholders approved the amendment to the definition of “Expiration Time” under Amendment No. 2.
If the rights become exercisable, all holders of rights, other than the person or group triggering the rights, will be entitled to purchase Company common stock at a 50% discount. Rights held by the person or group triggering the rights will become void and will not be exercisable. The rights have a de minimis fair value and trade with the Company’s common stock. The Board may amend the Rights Agreement in any way or redeem the rights at any time unless and until the rights are triggered.
The Rights Agreement includes a procedure for the Board to consider requests to exempt a particular transaction from triggering the exercisability of the rights under the Rights Agreement if the transaction (i) does not (x) create a significant risk of the Company’s NOLs being impaired or (y) constitute a default under the change-in-control covenant included in the Company’s credit facility or (ii) is otherwise in the best interests of the Company.
On the close of business on July 15, 2021, the Company effectuated a 1-for-
| 13. | Stock Based Compensation |
The Stanley Furniture Company, Inc. 2012 Incentive Compensation Plan (Incentive Compensation Plan) provides for the granting of performance grants, performance shares, stock options, restricted stock, restricted stock units, and stock appreciation rights to employees and certain service providers. Under this plan, the aggregate number of common shares that may be issued through awards of any form is
Stock Options
The options are issued at market value on the date of grant and have a term of
The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense.
Stock option activity for the two years ended December 31, 2021, follows:
| Number | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in thousands) | |||||||||||||
| Outstanding at January 1, 2020 | $ | |||||||||||||||
| Cancelled/Forfeited | ( | ) | $ | |||||||||||||
| Expired | ( | ) | $ | |||||||||||||
| Outstanding at December 31, 2020 | - | $ | - | - | ||||||||||||
| Outstanding at December 31, 2021 | - | $ | - | - | $ | - | ||||||||||
| Exercisable at December 31, 2021 | - | $ | - | - | $ | - | ||||||||||
Restricted Stock
The restricted stock awards are accounted for as “non-vested equity shares” until the awards vest or are forfeited. In general, restricted stock awards for employees are time vested or performance vested and for non-employee directors vest at the end of their current term on the Board. The fair value of each share of restricted stock is the market price of our stock on the grant date. The fair value of each time vested award is amortized into compensation expense on a straight-line basis between the award date and the vesting date. Performance based awards are amortized into stock compensation expense based on the probability of meeting the performance criteria. In 2021,
The following table summarizes information about restricted stock awards for the two years ended December 31, 2021:
| Number | Weighted-Average Grant Date Fair Value | |||||||
| Outstanding at January 1, 2020 | $ | |||||||
| Vested | ( | ) | ||||||
| Granted | - | - | ||||||
| Cancelled/Forfeited/Expired | - | - | ||||||
| Outstanding at December 31, 2020 | $ | |||||||
| Vested | - | - | ||||||
| Granted | - | - | ||||||
| Cancelled/Forfeited/Expired | - | - | ||||||
| Effect of reverse stock split | ( | ) | - | |||||
| Outstanding at December 31, 2021 | $ | |||||||
As of December 31, 2021, there was $
| 14. | Leases |
Right-of-use assets and lease liabilities related to operating leases under ASC Topic 842 are recorded when the Company and its subsidiaries are party to a contract, which conveys the right for it to control an asset for a specified period of time. Substantially all of our operating lease arrangements relate to rented office space and real estate for our title operations. We generally are not a party to any material contracts considered finance leases. Right-of-use assets and lease liabilities under ASC Topic 842 are recorded as Lease assets and Lease liabilities, respectively, on the Consolidated Balance Sheet.
Our operating leases range in term from to years. As of December 31, 2021, the weighted-average remaining lease term of our operating leases was
Our lease agreements do not contain material variable lease payments, buyout options, residual value guarantees or restrictive covenants.
Most of our leases include one or more options to renew, with renewal terms that can extend the lease term by varying amounts. The exercise of lease renewal options is at our sole discretion. We do not include options to renew in our measurement of lease assets and lease liabilities as they are not considered reasonably assured of exercise.
The lease liability is determined by discounting future lease payments using a discount rate based on our incremental borrowing rate for similar collateralized borrowing. The discount rate is calculated using estimates of capitalization rates and borrowing rates. As of December 31, 2021 the weighted-average discount rate used to determine our operating lease liability was
Lease expense included in general and administrative expense on the Consolidated Statements of Operations was $
Future payments under operating lease arrangements accounted for under ASC Topic 842 as of December 31, 2021 are as follows (in thousands):
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| Total lease payments, undiscounted | $ | |||
| Less: present value discount | ||||
| Lease liabilities, at present value | $ |
| 15. | Commitments and Contingencies |
The company is involved in several legal proceedings. In the Company’s opinion, based on the present status of these proceedings, any potential liability of the Company with respect to these legal proceedings, will not, in the aggregate, be material to the Company’s consolidated financial condition or operations. For further information on the legal proceedings see Item 3 Legal Proceedings.
We currently have letters of credit to cover estimated exposures, most notably with workman’s compensation claims. This agreement requires us to maintain a compensating balance with the issuer for the amounts outstanding. We currently have letters of credit outstanding in the amount of $
The Company and its subsidiaries are parties to claims and lawsuits related to the normal course of business operations. When the Company determines that a loss is both probably and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure is recorded. Actual losses may materially differ from the Company’s estimates. With respect to our title insurance operations, this customary litigation includes but is not limited to a wide variety of cases arising out of or related to title and escrow claims, for which we make provisions through our loss reserves. See Note 9 Reserve for Title Claim. None of these claims and lawsuits, in management’s opinion, will have a material adverse effect on our Consolidated Financial Statements.
In conducting our title insurance operations, our title insurance subsidiaries routinely hold customers’ assets in escrow, pending completion of real estate transactions, and are responsible for the proper disposition of these balances for our customers. Certain of these amounts are maintained in segregated bank accounts. These balances amounted to $
| 16. | Goodwill |
As of December 31, 2021, the Company recognized $
A summary of changes in Goodwill is as follows (in thousands):
| Title Insurance | Real Estate Related | Corporate and Other | Total | |||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | $ | ||||||||||||
| Goodwill associated with acquisitions | ||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | $ | ||||||||||||
For discussion of the Company’s acquisitions, see Note 2 Business Combinations.
| 17. | Segment Information |
The Company has
Provided below is selected financial information about the Company’s operations by segment for the year ended December 31, 2021 (in thousands):
| Title Insurance (a) | Real Estate Related | Corporate and Other | Total | |||||||||||||
| Insurance and other services revenue | $ | $ | $ | $ | ||||||||||||
| Cost of revenues | ( | ) | ( | ) | ||||||||||||
| Gross profit | $ | $ | $ | $ | ||||||||||||
| Operating expenses | ( | ) | ( | ) | ( | ) | ||||||||||
| Other income and expenses | ( | ) | ||||||||||||||
| Income (loss) before income taxes | $ | $ | $ | ( | ) | $ | ||||||||||
| Assets | $ | $ | $ | $ | ||||||||||||
| Goodwill | $ | $ | $ | $ | ||||||||||||
| (a) | Represents operations of the title insurance subsidiaries subsequent to the Acquisition on July 1, 2021 and the Second Acquisition on September 1, 2021. |
Provided below is selected financial information about the Company’s operations by segment year ended December 31, 2020 (in thousands):
| Title Insurance | Real Estate Related | Corporate and Other | Total | |||||||||||||
| Insurance and other services revenue | $ | $ | $ | $ | ||||||||||||
| Cost of revenues | ||||||||||||||||
| Gross profit | $ | $ | $ | $ | ||||||||||||
| Operating expenses | ( | ) | ( | ) | ||||||||||||
| Other income and expenses | ||||||||||||||||
| Income (loss) before income taxes | $ | $ | $ | ( | ) | $ | ||||||||||
| Total assets | $ | $ | $ | $ | ||||||||||||
| 18. | Revenue from Contracts with Customers |
ASC 606, Revenue from Contracts with Customers requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance does not apply to revenue associated with insurance contracts (including title insurance policies), financial instruments and lease contracts; and therefore is primarily applicable to the following Company revenue categories.
Escrow and other title-related fees – The Company’s title insurance segment recognizes commission revenue and fees related to items such as searches, settlements, commitments and other ancillary services. Escrow and other title-related fees are recognized as revenue at the time of the related transactions as the earnings process, or performance obligation, is then considered to be complete.
Non-title services – All non-title service fees, such as management fees, are recognized as revenue as performance obligations are completed.
| 19. | Uncertainties |
On March 11, 2020, the World Health Organization declared the current coronavirus (“COVID-19”) outbreak to be a global pandemic. In response to this declaration and the rapid spread of COVID-19 within the United States, federal, state and local governments throughout the country imposed varying degrees of restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the illness. These measures have had a significant adverse impact upon many sectors of the economy.
As a result of these measures, many non-essential retail commerce across the country experienced significant disruption causing severely reduced sales volume. S&L, who distributes its products through these potentially impacted retail channels, has experienced and may continue to experience a reduction in sales volume as a result of these measures. Whereas most state and local governments have begun to ease restrictions on commercial retail activity, it is possible that a resurgence in COVID-19 cases could prompt a return to tighter restrictions in certain areas of the country. Furthermore, the economic recession brought on by the pandemic may have a continuing adverse impact on consumer demand for S&L’s products. Therefore, uncertainty remains regarding the ongoing impact of the COVID-19 outbreak upon the future results of operations of S&L and its corresponding impact to the collectability of the S&L Note.
Despite the restrictions and measures by federal, state, and local governments in response to COVID-19, many of the U.S. Government tenant agencies of HC Realty’s properties were deemed essential. All of HC Realty’s revenue is generated through the receipt of rental payments from U.S. Government tenant agencies. The extent, however, of future COVID-19 disruption is highly uncertain and cannot be predicted. It is possible that with a resurgence in COVID-19 cases resulting in tighter restriction that risks to HC Realty’s operations become heightened.
The COVID-19 pandemic caused the Company’s title operations at NCTIC and Omega to modify its business practices (including employee travel, employee work locations and cancellation of physical participation in meetings, events and conferences). The COVID-19 pandemic and any of its variants could continue to affect the Company in a number of ways including, but not limited to, the impact on employees becoming ill, quarantined, or otherwise unable to work or travel due to illness or governmental restriction, potential decreases in net premiums written in the future, and future fluctuations in the Company's investment portfolio due to the pandemic and the economic disruption it is causing. Because of the inherent uncertainty regarding the duration and severity of the COVID-19 pandemic (including any of its variants) and its effects on the economy, as well as uncertainty regarding the effects of government measures already taken, and which may be taken or continued in the future, to combat the spread of the virus and any of its variants, and/or provide additional economic stimulus, the Company is currently unable to predict the ultimate impact of the pandemic on the title insurance operations.
The Federal Reserve’s monetary policy and other regulatory changes, such as their guidance for future rate increases, could impact mortgage rates and resultingly real estate transactions. The company is unable to predict the ultimate impact that the Federal Reserve’s monetary policy may have on the title insurance operations.
The Company continues to evaluate the impact of these measures on our operational and financial performance, specifically the impact on S&L, HC Realty, and NCTIC and Omega’s operations. During the third quarter 2021, the Company did not receive its contractual payments on the S&L Note largely as a result of the impacts that COVID-19 had to its operations and its customers. Management used these facts in our analysis of the impairment of the S&L note during the period ended December 31, 2021.
As of December 31, 2021, the Company has not experienced any adverse impacts to the payment of HC Realty’s common and Series B Stock dividends.
| 20. | Subsequent Events |
Effective January 1, 2022, NCTIC elected to not replace First Layer of Reinsurance. NCTIC did replace the Second Layer of Reinsurance and entered into a per risk excess of loss reinsurance agreement that provides coverage of $