HG Holdings, Inc 10-Q for FY2022 Q3
HG Holdings, Inc. (STLY)
About this 10-Q
HG Holdings, Inc filed this 10-Q on November 14, 2022, covering the quarter ended September 30, 2022 (FY2022 Q3).
Headline figures
Quarter ended September 30, 2022, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $5.86M
- up 495.5% from $984K a year earlier
- Net income
- $2.86M
- down 12.7% from net income of $3.28M a year earlier
- Diluted EPS
- $1.00
- down 12.3% from $1.14 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form
(Mark One)
| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to _____.
Commission file number:
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:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| None | NA | NA |
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 Data File required to be submitted pursuant to Rule 405 of Regulation S-T (232.405 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 an 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.
Large accelerated filer ☐ Accelerated filer ☐
Smaller reporting company
If an emerging growth company, indicate by check mark if 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
As of November 13, 2022,
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
HG HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| September 30, | December 31, | |||||||
| 2022 | 2021 | |||||||
|
| (unaudited) | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | $ | ||||||
| Restricted cash | ||||||||
| Investments | ||||||||
| Accounts receivables | ||||||||
| Interest and dividend receivables | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Property, plant and equipment, net | ||||||||
| Lease assets | ||||||||
| Investment in affiliate | ||||||||
| Subordinated notes receivable | ||||||||
| Goodwill | ||||||||
| Intangibles assets, net | ||||||||
| 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 | ||||||||
| Unearned premiums | ||||||||
| 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 earnings/(deficit) | ( | ) | ||||||
| Total stockholders’ equity | ||||||||
| Noncontrolling interests | ||||||||
| Total 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)
(unaudited)
| Three Months |
Nine Months |
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| Ended |
Ended |
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| September 30, |
September 30, |
September 30, |
September 30, |
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| 2022 |
2021 |
2022 |
2021 |
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| Revenues: |
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| Net premiums earned |
$ | $ | $ | $ | ||||||||||||
| Escrow and other title fees |
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| Management fees |
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| Total revenues |
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| Cost of revenues: |
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| Underwriting expenses |
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| Provision for title claim losses |
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| Search and other fees |
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| Total operating expenses |
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| Gross underwriting profit |
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| Operating expenses: |
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| General and administrative expenses |
( |
) |
( |
) |
( |
) |
( |
) |
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| Other income/expenses: |
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| Interest income |
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| Dividend income |
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| Other income |
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| Gain on extinguishment of debt |
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| Gain on remeasurement of equity interest |
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| Gain (loss) on sale of assets |
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| (Loss) gain from affiliate |
( |
) |
( |
) |
( |
) |
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| Loss on impairment |
( |
) |
( |
) | ( |
) |
( |
) | ||||||||
| Income from operations before income taxes |
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| Income tax benefit |
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| Net income |
$ | $ | $ | $ | ||||||||||||
| Net loss attributable to noncontrolling interests |
( |
) |
( |
) |
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| Net income after noncontrolling interests |
$ | $ | $ | $ | ||||||||||||
| Basic and diluted income per share: |
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| Net income – basic |
$ | $ | $ | $ | ||||||||||||
| Net income – diluted |
$ | $ | $ | $ | ||||||||||||
| Weighted average shares outstanding: |
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| Basic |
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| Diluted |
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The accompanying notes are an integral part of the consolidated financial statements.
HG HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| For the Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2022 | 2021 | |||||||
| Net income after noncontrolling interests | $ | $ | ||||||
| Net loss attributable to noncontrolling interests | ( | ) | ||||||
| Net income from operations | ||||||||
| Adjustments to reconcile net income from operations to net cash flows from operating activities: | ||||||||
| Depreciation expense | ||||||||
| Amortization expense | ||||||||
| Stock compensation expense | ||||||||
| Dividends on HC Realty common stock | ||||||||
| Loss from affiliate | ||||||||
| Bargain purchase gain on acquisition of subsidiary | ( | ) | ||||||
| Gain on remeasurement of equity interest | ( | ) | ||||||
| Gain on extinguishment of debt | ( | ) | ||||||
| Gain on sale of assets | ( | ) | ||||||
| Impairment loss on subordinated notes receivable | ||||||||
| Changes in assets and liabilities: | ||||||||
| Prepaid expenses and other current assets | ( | ) | ( | ) | ||||
| Accounts receivable | ( | ) | ||||||
| Income tax receivable | ||||||||
| Deferred tax assets and other assets | ( | ) | ( | ) | ||||
| Accounts payable | ||||||||
| Accrued salaries, wages, and benefits | ||||||||
| Commissions payable | ||||||||
| Escrow liabilities | ( | ) | ||||||
| Reserve for title claims | ||||||||
| Unearned premiums | ||||||||
| 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 | ( | ) | ||||||
| Purchase of investments | ( | ) | ||||||
| Proceeds from sale of assets | ||||||||
| Investment in a business combination | ( | ) | ||||||
| Investment in subsidiaries, net of cash acquired | ||||||||
| Principal payments received on subordinated secured notes receivable | ||||||||
| Net cash (used in) provided by investing activities | ( | ) | ||||||
| Cash flows from financing activities: | ||||||||
| Redemption of fractional shares from stock split | ( | ) | ||||||
| Net cash used in 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 THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
| 1. | Preparation of Interim Unaudited Financial Statements |
The consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). In our opinion, these statements include all adjustments necessary for a fair presentation of the results of all interim periods reported herein. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures prepared in accordance with generally accepted accounting principles in the United States have been either condensed or omitted pursuant to SEC rules and regulations. However, we believe that the disclosures made are adequate for a fair presentation of our results of operations and financial position. Operating results for the interim periods reported herein may not be indicative of the results expected for the year. These consolidated financial statements should be read in conjunction with the financial statements and accompanying notes included in our latest Annual Report on Form 10-K filed with the SEC on March 29, 2022.
All prior period share numbers and per share data appearing in this Quarterly Report on Form 10-Q has been retroactively adjusted to reflect the 1 for 12 reverse stock split of our outstanding shares of common stock, $0.02 par value per share (the “Common Stock”) effective July 15, 2021 (the “Reverse Split”), unless otherwise indicated or unless context suggests otherwise. The Reverse Split 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”).
Description of the Business
Title Insurance
The Company engages in issuing 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.
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.
NCTIC 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. The ability to attract and retain issuing agents is a key determinant of the Company’s growth in title insurance premiums written.
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 rate 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.
Volume is a factor in the Company’s title insurance operation’s profitability due to fixed operating costs that are incurred regardless of title insurance premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on profitability. The Company’s title insurance profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and to minimize risks such as interest rate changes, defaults and impairments of assets.
The Company’s volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes property sales, mortgage financing and mortgage refinancing. Real estate activity, home sales and mortgage lending are cyclical in nature. Real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels, and general United States economic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.
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.
Historically, the title insurance business tends to be seasonal as well as cyclical. Because home sales are typically strongest in periods of favorable weather, the first calendar quarter tends to have the lowest activity levels, while the spring and summer quarters tend to be more active. Mortgage refinance activity tends to be influenced less by seasonality and more by economic cycles, with activity levels increasing during times of falling interest rates.
Real Estate Related
The Company engages in rental real estate through our equity investment in HC Realty. HC Realty is an internally-managed 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”). 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.
As of September 30, 2022, HC Realty owned and operated a portfolio of 29 single-tenant properties leased entirely to the United States of America for occupancy by federal agencies including the Federal Bureau of Investigation, the Drug Enforcement Administration, the Social Security Administration and the Department of Transportation. The Company owns approximately
Reinsurance Related
The Company, through the formation of White Rock USA Cell 47, engaged in providing another insurance company excess-of-loss reinsurance coverage related to catastrophic weather risk in Texas. The current reinsurance contract (refer to Note 7 Reinsurance) expires on December 31, 2022; however, the Company may actively look to provide reinsurance coverage to other carriers as future opportunities arise.
Management Advisory Services Related
The Company, through its wholly-owned subsidiary HGMA, engaged in providing Management Advisory Services including formation, operational, and restructuring services. HGMA was engaged on June 30, 2022 to develop a restructuring plan for an insurance holding company’s non-statutory entity, including identify costs savings and other necessary or advisable steps. Upon approval of such plan by the Board of Directors of the holding company, HGMA will oversee the implementation of such plan. The Company may continue to actively look to provide Management Advisory Services as future opportunities arise.
For information about our reportable segments refer to Note 9 Segment Information.
Developments Impacting Comparison of the Nine Month Periods ended September 30, 2022 and 2021
The following previously disclosed events occurred during or subsequent to period ended September 30, 2021 that impacted the comparison on the nine-month periods ended September 30, 2022 and 2021. 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) 100% of the stock of NCTIC, a Florida title insurer formed in 2017, and (ii) a 100% membership interest in NCTG, which owns a
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
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.
Effective July 1, 2022, the Company formed White Rock USA Protected Cell 47 (the “Protected Cell”). The Protected Cell entered into an Excess Catastrophe Reinsurance Contract (the “Reinsurance Contract”) with Maison Insurance Company (“Maison”) effective July 1, 2022 to provide Maison catastrophic windstorm reinsurance protection on approximately
The Company, through its wholly-owned subsidiary HGMA, engaged in providing Management Advisory Services including formation, operational, and restructuring services. HGMA was engaged on June 30, 2022 to develop a restructuring plan for an insurance holding company’s non-statutory entity, including identify costs savings and other necessary or advisable steps. Upon approval of such plan by the Board of Directors of the holding company, HGMA will oversee the implementation of such plan.
Effective August 1, 2022, Omega acquired substantially all the assets of Omega Title Florida, LLC (“OTF”). In accordance with Topic 805, the Company has determined that the transaction should be accounted for as a business combination. The acquisition allows Omega to expand into additional geographic areas of Florida and expand its footprint.
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.
| 2. | Subordinated Notes Receivable |
The Company received a $
S&L Note
The S&L Note had a principal amount of $
As a result of the Company’s recording of impairment losses in prior quarters, based on current information and events, including the impact of COVID-19 on S&L’s business and its customers, the Company ceased 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. The Company did not receive any interest payments which were recognized as principal reductions during the three and nine month periods ending September 30, 2022. In the three and nine month periods ending September 30, 2021, the Company recognized $
As of September 30, 2022, the Company concluded that 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 $
| 3. | Investment in Affiliate |
HC Realty’s
The following table summarizes the Company’s investment in HC Realty as of September 30, 2022 and December 31, 2021 (in thousands):
| Investment in Affiliate | Loss recorded in the Statements of | |||||||||||||||||||||||||||||||
| Ownership % | Balance | Operations (b) | ||||||||||||||||||||||||||||||
| For the Three | For the Nine | |||||||||||||||||||||||||||||||
| Months Ended | Months Ended | |||||||||||||||||||||||||||||||
| September 30, | September 30, | |||||||||||||||||||||||||||||||
| September 30, | December 31, | September 30, | December 31, | |||||||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||
| HC Realty Series B Stock (a) | % | % | $ | $ | $ | $ | ||||||||||||||||||||||||||
| HC Realty common stock | % | % | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
| Total | % | % | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||||||||||||||
| (a) | Represents investments in shares of HC Realty Series B Stock with a basis of $ |
| (b) | Loss from these investments is included in “Loss from affiliate” in the consolidated statement 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.
| 4. | Investments |
The following table details investments by major investment category, at September 30, 2022:
| Cost or Adjusted/ Amortized Costs | Gross Unrealized Gains | Gross Unrealized Losses | Total | |||||||||||||
| U.S. government and agency securities, held-to-maturity | $ | $ | $ | $ | ||||||||||||
| Common stock | ||||||||||||||||
| Total investments | $ | $ | $ | $ | ||||||||||||
The table below summarizes our fixed maturities at September 30, 2022 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturities of those obligations.
| Cost or Amortized Cost | Percent of Total | Fair Value | Percent of Total | |||||||||||||
| Due in one year or less | $ | % | $ | % | ||||||||||||
| Due after one year through five years | ||||||||||||||||
| Due after five years through ten years | ||||||||||||||||
| Due after ten years | ||||||||||||||||
| Total | $ | % | $ | % | ||||||||||||
Fair value measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Assets and liabilities recorded on our Consolidated Balance Sheets at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
Level 1: Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that we can access.
Level 2: Assets and liabilities whose values are based on the following:
| a. | Quoted prices for similar assets or liabilities in active markets; |
| b. | Quoted prices for identical or similar assets or liabilities in markets that are not active; or |
| c. | Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability. |
Level 3: Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect our estimates of the assumptions that market participants would use in valuing the assets and liabilities.
We estimate the fair value of our investments using the closing prices on the last business day of the reporting period, obtained from active markets such as the NYSE, Nasdaq and NYSE American. For securities for which quoted prices in active markets are unavailable, we use a third-party pricing service that utilizes quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs to estimate the fair value of those securities for which quoted prices are unavailable. Our estimates of fair value reflect the interest rate environment that existed as of the close of business on September 30, 2022. Changes in interest rates subsequent to September 30, 2022 may affect the fair value of our investments.
The fair value of our fixed maturities is initially calculated by a third-party pricing service. Valuation service providers typically obtain data about market transactions and other key valuation model inputs from multiple sources and, through the use of proprietary models, produce valuation information in the form of a single fair value for individual fixed-income and other securities for which a fair value has been requested. The inputs used by the valuation service providers include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, liquidity spreads, currency rates and other information, as applicable. Credit and liquidity spreads are typically implied from completed transactions and transactions of comparable securities. Valuation service providers also use proprietary discounted cash flow models that are widely accepted in the financial services industry and similar to those used by other market participants to value the same financial information. The valuation models take into account, among other things, market observable information as of the measurement date, as described above, as well as the specific attributes of the security being valued, including its term, interest rate, credit rating, industry sector and, where applicable, collateral quality and other issue or issuer specific information. Executing valuation models effectively requires seasoned professional judgment and experience.
All fixed-income securities are classified as held-to-maturity and are reported at amortized cost as of September 30, 2022. The Company performs ongoing impairment evaluations, and we did record any other then temporary impairments during the three or nine month periods ended September 30, 2022.
The following table presents the fair value of our financial instruments measured on a recurring basis by level at September 30, 2022:
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||
| Common stock | $ | $ | $ | $ | ||||||||||||
| Investments, at fair value | ||||||||||||||||
| U.S. government and agency securities, held-to-maturity | ||||||||||||||||
| Total investments | $ | $ | $ | $ | ||||||||||||
| 5. |
Paycheck Protection Program (“PPP”) Loan |
On May 7, 2020, prior to the Company’s acquisitions of NCTIC, NCTG, TAV and Omega, 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, bears 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 provides 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 was included as gain on extinguishment of debt on the Consolidated Statements of Operations during the three months ended September 30, 2021.
| 6. |
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 incurred but not yet reported (“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 September 30, 2022. 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 nine month period ending September 30, 2022 and 2021 is as follows (in thousands):
| September 30, | September 30, | |||||||
| 2022 |
2021 |
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| Beginning Reserves |
$ | $ | ||||||
| Provision for claims related to: |
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| Current year |
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| Prior years |
||||||||
| Total provision for claim losses |
||||||||
| Claims paid related to: |
||||||||
| Current year |
||||||||
| Prior years |
||||||||
| Total title claims paid |
||||||||
| Ending Reserves |
$ | $ | ||||||
At September 30, 2022, there were
For the nine months ended September 30, 2022, 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 September 30, 2022 and 2021 is as follows (in thousands):
| September 30, | September 30, | |||||||
| 2022 |
2021 |
|||||||
| Known title claims |
$ | $ | ||||||
| IBNR title claims |
||||||||
| Total title claims |
||||||||
| Non-title claims |
||||||||
| Total title claims reserves |
$ | $ | ||||||
| 7. | Reinsurance |
|
| |
| Reinsurance obtained from other insurance companies |
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 three and nine month period ended September 30, 2022, NCTIC's reinsurance program consisted of excess of loss reinsurance treaties. The following is a summary of the reinsurance coverage.
Effective January 1, 2022, NCTIC entered into a per risk excess of loss reinsurance agreement that provides coverage of $
Effective January 1, 2022, 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 are as follows:
| Three Months | Nine Months | |||||||||||||||
| Ended | Ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Direct title premiums | $ | $ | $ | $ | ||||||||||||
| Ceded title premiums | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Net title premiums | $ | $ | $ | $ | ||||||||||||
Reinsurance provided to other insurance companies
Effective July 1, 2022, the Company formed the Protected Cell. The Protected Cell entered into the Reinsurance Contract with Maison effective July 1, 2022 to provide Maison catastrophic windstorm reinsurance protection on approximately
The following is a reconciliation of total Reinsurance premiums written to Reinsurance premiums earned for the three and nine months ended September 30, 2022 and 2021 (amounts in thousands):
| Three Months | Nine Months | |||||||||||||||
| Ended | Ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Reinsurance premiums written | $ | $ | $ | $ | ||||||||||||
| Increase in unearned premium reserves | ( | ) | ( | ) | ||||||||||||
| Reinsurance premiums earned | $ | $ | $ | $ | ||||||||||||
| 8. |
Statutory Reporting |
NCTIC's assets, liabilities, and results of operations have been reported in accordance with accounting principles generally accepted in the United States of America (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. The principal differences between SAP and GAAP are that under SAP: (1) certain assets that are not admitted assets are eliminated from the balance sheet, (2) a supplemental reserve for claims is charged directly to unassigned surplus rather than provision for claims under GAAP, and (3) differences may arise in the computation of deferred income taxes. The Company must file with applicable state insurance regulatory authorities an “Annual Statement” which reports, among other items, net income (loss) and stockholders' equity (called “surplus as regards policyholders” in statutory reporting).
| 9. |
Segment Information |
The Company has
Provided below is selected financial information about the Company’s operations by segment for the nine months ending September 30, 2022 (in thousands):
| Title Insurance |
Real Estate Related |
Reinsurance Related |
Management Services 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 |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
Provided below is selected financial information about the Company’s operations by segment for the nine months ending September 30, 2021 (in thousands):
| Title Insurance |
Real Estate Related |
Reinsurance Related |
Management Services 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 |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
Provided below is selected financial information about the Company’s operations by segment for the three months ending September 30, 2022 (in thousands):
| Title Insurance |
Real Estate Related |
Reinsurance Related |
Management Services 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 |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
Provided below is selected financial information about the Company’s operations by segment for the three months ending September 30, 2021 (in thousands):
| Title Insurance |
Real Estate Related |
Reinsurance Related |
Management Services 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 |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||
| 10. | Income taxes |
During the nine months ended September 30, 2022, the Company recorded a non-cash credit to its valuation allowance of $
The Company maintains a valuation allowance against deferred tax assets that currently exceed our deferred tax liabilities. The primary assets covered by this valuation allowance are net operating loss carry-forwards. The valuation allowance was calculated in accordance with the provisions of ASC 740, Income Taxes, which requires an assessment of both positive and negative evidence when measuring the need for a valuation allowance. The Company’s results over the most recent four-year period were heavily affected by business restructuring activities. The Company’s cumulative loss represented sufficient negative evidence to require a valuation allowance. The Company intends to maintain a valuation allowance until sufficient positive evidence exists to support its reversal, resulting in no deferred tax asset balance being recognized. Should the Company determine that it will not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset will be charged to income in the period such determination is made.
As of September 30, 2022, the Company has
The Company’s effective tax rate for the current and prior year nine month periods were effectively due to the change in the valuation allowance.
| 11. | Stockholders’ Equity |
Basic earnings per share of Common Stock are based upon the weighted average shares outstanding. Outstanding stock options and restricted stock are treated as potential common stock for purposes of computing diluted earnings per share. Basic and diluted earnings per share are calculated using the following share data (in thousands):
| Three Months | Nine Months | |||||||||||||||
| Ended | Ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Weighted average shares outstanding for basic calculation | ||||||||||||||||
| Add: Effect of dilutive stock awards | ||||||||||||||||
| Weighted average shares outstanding, adjusted for diluted calculation | ||||||||||||||||
For the three and nine month periods ended September 30, 2022, there were no stock options or restricted awards outstanding. For the three and nine month periods ended September 30, 2021, approximately
The Company will repurchase shares of Common Stock from time to time that are tendered by recipients of restricted stock awards to satisfy tax withholding obligations on vested restricted stock. There were
On the close of business on July 15, 2021, the Company effectuated Reverse Split. In connection with the Reverse Split, the amendment to the Company’s Restated Certificate of Incorporation approved by the Company’s stockholders was effective as of July 15, 2021.
A reconciliation of the activity in Stockholders’ Equity accounts for the three and nine months ended September 30, 2022 is as follows (in thousands):
| Capital in | ||||||||||||||||
| Common | Excess of | Retained | Noncontrolling | |||||||||||||
| Stock | Par Value | Deficit | Interest | |||||||||||||
| Balance at January 1, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net loss | ( | ) | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||||
| Balance at March 31, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net loss | ( | ) | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||||
| Balance at June 30, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net income/(loss) | ( | ) | ||||||||||||||
| Issuance of noncontrolling interest | ||||||||||||||||
| Balance at September 30, 2022 | $ | $ | $ | $ | ||||||||||||
A reconciliation of the activity in Stockholders’ Equity accounts for the three and nine months ended September 30, 2021 is as follows (in thousands):
| Capital in | ||||||||||||||||
| Common | Excess of | Retained | Noncontrolling | |||||||||||||
| Stock | Par Value | Deficit | Interest | |||||||||||||
| Balance at January 1, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net loss | ( | ) | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||||
| Balance at March 31, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net loss | ( | ) | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||||
| Balance at June 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||
| Net income/(loss) | ||||||||||||||||
| Effect of reverse stock split | ( | ) | ||||||||||||||
| Redemption of fractional shares | ( | ) | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||||
| Balance at September 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||
| 12. |
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 September 30, 2022, 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 September 30, 2022 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 September 30, 2022 are as follows (in thousands):
| 2022 |
$ | |||
| 2023 |
||||
| 2024 |
||||
| 2025 |
||||
| Total lease payments, undiscounted |
$ | |||
| Less: present value discount |
( |
) |
||
| Lease liabilities, at present value |
$ |
| 13. |
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 and reinsurance), 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.
Management Advisory Services – The Company recognizes management advisory revenue as services are provided in accordance with the underlying Management Advisory Agreement.
| 14. |
Business Combinations |
On July 20, 2021, the Company completed the Acquisition of NCTIC and NCTG by purchasing
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 was recorded in other income on the Consolidated Statement of Operations during the three months ended September 30, 2021.
On September 1, 2021, the Company acquired the remaining 50% membership interests of TAV for $
The operating results of TAV 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 | ||||
| Property, plant, and equipment | ||||
| Total assets acquired | ||||
| Accrued expenses | ||||
| Management fee payable | ||||
| 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 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. 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.
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, through the date of acquisition:
| Three Months |
Nine Months |
|||||||
| Ended |
Ended |
|||||||
| September 30, |
September 30, |
|||||||
| 2021 |
2021 |
|||||||
| Revenues |
$ | $ | ||||||
| Net income |
$ | ( |
) |
$ | ||||
Effective August 1, 2022, Omega acquired substantially all the assets of Omega Title Florida, LLC (“OTF”). In accordance with Topic 805, the Company has determined that the transaction should be accounted for as a business combination. The assets of OTF at the date of acquisition were as follows (in thousands):
| Title files in progress |
$ | |||
| Property, plant, and equipment |
||||
| Noncompetition agreement |
||||
| Total assets acquired |
$ |
The purchase price paid by Omega for the assets of OTF were as follows (in thousands):
| Cash paid |
$ | |||
| Noncontrolling interest in Omega |
||||
| Total consideration paid |
$ | |||
| Title files in progress | $ | |||
| Fixed assets | ||||
| Noncompetition agreement | ||||
| Total assets acquired | ||||
| Goodwill | $ |
The fair value of assets acquired and liabilities assumed represent a preliminary allocation as our evaluation of facts and circumstances available as of September 30, 2022 is ongoing.
Pursuant to Topic 805, the 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 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 the unaudited pro forma financial information as if OTF had been included in the Company’s financial results as of January 1, 2021 through the date of acquisition:
| Three Months |
Nine Months |
|||||||||||||||
| Ended |
Ended |
|||||||||||||||
| September 30, |
September 30, |
September 30, |
September 30, |
|||||||||||||
| 2022 |
2021 |
2022 |
2021 |
|||||||||||||
| Revenues |
$ | $ | $ | $ | ||||||||||||
| Net income |
$ | ( |
) | $ | $ | ( |
) | $ | ||||||||
| 15. | Goodwill and Intangible Assets |
Goodwill
As of September 30, 2022, the Company recognized $
Intangible Assets
The following is a summary of intangible assets excluding goodwill recorded as intangible assets on our Unaudited Consolidated Balance Sheets:
| September 30, |
December 31, |
|||||||
| 2022 |
2021 |
|||||||
| Intangible assets subject to amortization |
$ | $ | ||||||
| Total |
$ | $ | ||||||
Intangible assets subject to amortization consisted of the following as of September 30, 2022:
| Weighted-average remaining amortization period (in years) |
Gross carrying amount |
Accumulated amortization |
Net carrying amount |
|||||||||||||
| Noncompetition agreement |
$ | $ | ( |
) |
$ | |||||||||||
| Total |
$ | $ | ( |
) |
$ | |||||||||||
Amortization expense of our intangible assets was $
Estimated amortization expense of our intangible assets to be recognized by the Company during the remainder of 2022 and over the next five years is as follows:
| Year ending December 31, |
Estimated Amortization Expense |
|||
| Remaining in 2022 |
$ | |||
| 2023 |
||||
| 2024 |
||||
| 2025 |
||||
| 2026 |
||||
| 2027 |
||||
| Total |
$ | |||
| 16. |
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 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.
As of September 30, 2022, the Company has not experienced any adverse impacts to the payment of HC Realty’s common stock and Series B Stock dividends.
| ITEM 2. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Overview
For a description of our business, including descriptions of segments and recent business developments, see the discussion the notes to the financial statement contained herein including in Note 1 Basis of Financial Statements in the accompanying unaudited Consolidated Financial Statements included in Item 1 of Part I of this Report, which is incorporated by reference into this Part I, Item 2.
As of September 30, 2022, our sources of income include earnings on our title insurance subsidiaries, dividends on HC Realty Series B Stock, premiums earned on reinsurance treaties, management service agreements, and interest paid on our cash deposits and bond portfolio. 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 will continue to pursue acquisition opportunities which will allow us to potentially derive benefit from the Company’s net operating loss carryforwards and also create appropriate risk adjusted returns for shareholders.
Results from Operations
Three and Nine Months Ended September 30, 2022
The Company generated dividend income of $256,000 and $769,000 for both the three and nine month periods ending September 30, 2022 and 2021.
As a result of the Company’s acquisition of the title insurance operations, the Company generated title premium and other title fee revenue of $1.7 million and $5.1 million for the three and nine month periods ended September 30, 2022, respectively, compared to $984,000 for the three and nine months periods ended September 30, 2021. 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 three and nine month periods ended September 30, 2022 was $2.2 million and $6.0 million, respectively, consisting primarily of $1.3 and $3.4 million in wages, $181,000 and $493,000 of rent expense, and $73,000 and $417,000 in professional and legal fees. During the first quarter of 2022, the Company began operations of HGMA to provide management oversight of title operations. The operating expenses incurred at HGMA are included in the operating results of our title insurance segment.
As a result of the Company’s reinsurance provided to other insurance companies, the Company generated reinsurance premiums earned of $3.3 million for both the three and nine month periods ended September 30, 2022. The reinsurance expenses associated with the reinsurance revenue are primarily management service costs associated with the formation and operation of White Rock USA Cell 47. Reinsurance expenses for the three and nine month periods ended September 20, 2022 was $40,000.
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 incurred were $339,000 and $904,000 for the three and nine month periods ending September 30, 2022, respectively, compared to $313,000 and $910,000 for the three and nine month periods ending September 30, 2021. General and administrative expenses for the three and nine month periods ending September 30, 2022 consisted of $64,000 and $252,000 of professional fees, $44,000 and $169,000 of wages and personnel costs, $0 and $41,000 of stock based compensation expense, and $230,000 and $442,000 of other operating expenses, respectively.
Our effective tax rate for the three and nine month periods ended September 30, 2022 and 2021 was effectively 0% due to our net operating loss carryforwards.
Financial Condition, Liquidity and Capital Resources
Sources of liquidity include cash on hand, earnings from our title insurance subsidiaries, earnings from reinsurance provided to other insurance companies, management service agreements, and dividends from our HC Realty common stock 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 September 30, 2022, we had $11.0 million in cash and additional $13.3 million in restricted cash, of which $13.3 million is cash held in escrow for title insurance transactions. A portion of our unrestricted and restricted cash is currently held in savings accounts earning approximately 0.05%. We also received quarterly dividends on our HC Realty common stock 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 provided by operations for the nine month period ended September 30, 2022 of $10.9 million consisted of primarily reinsurance unearned premiums of $3.3 million, increase in title escrow liabilities of $5.3 million, dividends on our HC Realty Series B Stock of $769,000, and management service fees earned; offset by expense from our title operations.
On August 5, 2022, the Board authorized the repurchase of up to $1.5 million of shares of the Company’s common stock. The authorization does not obligate the Company to acquire a specific number of shares during any period and does not have an expiration date, but it may be modified, suspended, or discontinued at any time at the discretion of the Board. Repurchases may be made from time to time in the open market, or through privately negotiated transactions or otherwise, in compliance with applicable laws, rules and regulations, and subject to the Company’s cash requirements for other purposes, and other factors it deems relevant. The Company did not repurchase any of its shares of common stock during the three month period ending September 30, 2022.
Critical Accounting Policies
Our critical accounting policies and estimates are discussed in the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our 2021 Annual Report on Form 10-K. We believe there have been no new critical accounting policies or material changes to our existing critical accounting policies and estimates during the nine months ended September 30, 2022.
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.
| ITEM 3. |
Quantitative and Qualitative Disclosures about Market Risk |
| Not required to be provided by a smaller reporting company. |
| ITEM 4. |
Controls and Procedures |
| (a) |
Evaluation 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-15(e) 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 that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report. |
| (b) |
Changes in internal controls over financial reporting. There were no changes in our internal control over financial reporting that occurred during the second quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |
Part II. OTHER INFORMATION
| Item 1. |
Legal Proceedings |
Hollie Drive Litigation
In November 2019, we received notice that the Company and 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 previously disclosed 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, SFC 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 the relatively low damages amount 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.
| ITEM 6. |
Exhibits |
| 2.1 |
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| 2.2 |
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| 2.3 |
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| 3.1 |
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| 3.2 |
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| 10.1 |
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| 10.2 |
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| 10.3 | Consulting Agreement, dated August 5, 2022, by and between the company and Bradley G. Garner (incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K (Commission File No. 0-14938) filed August 11, 2022) (management contract). | |
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| 31.1 |
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| 31.2 |
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| 32.1 |
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| 32.2 |
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| 101 |
The following financial statements from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2022, formatted in Inline Xtensible Business Reporting Language (“XBRL”): (i) balance sheets, (ii) statements of operations, (iii) statements of cash flows, (iv) the notes to the financial statements, and (v) document and entity information. (1) |
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| 104 |
Cover Page Interactive Data File (formatted in Inline iXBRL and contained in Exhibit 101). |
| (1) |
Filed herewith |
| (2) |
Furnished herewith |
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: November 14, 2022 |
HG HOLDINGS, INC. |
| By: /s/ Justin H. Edenfield |
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| Justin H. Edenfield |
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| Principal Financial and Accounting Officer |
Exhibit 31.1
I, Steven A. Hale II, certify that:
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1. |
I have reviewed this quarterly report on Form 10-Q of HG Holdings, Inc.; |
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2. |
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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3. |
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods in this report. |
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4. |
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) |
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
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| (b) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
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| (c) |
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
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| (d) |
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
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5. |
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function): |
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| (a) |
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) |
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
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Date: November 14, 2022 |
By: /s/ Steven A. Hale II |
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Steven A. Hale II |
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Chairman and Chief Executive Officer |
Exhibit 31.2
I, Justin H. Edenfield, certify that:
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1. |
I have reviewed this quarterly report on Form 10-Q of HG Holdings, Inc.; |
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2. |
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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3. |
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods in this report. |
|
4. |
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) |
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) |
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) |
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
|
5. |
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function): |
| (a) |
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) |
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
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Date: November 14, 2022 |
By: /s/ Justin H. Edenfield |
|
Justin H. Edenfield |
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Principal Financial and Accounting Officer |
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the HG Holdings, Inc. (the “Company”) Quarterly Report on Form 10-Q for the period ended September 30, 2022 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steven A. Hale II, Chief Executive Officer of the Company certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:
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(1). |
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and |
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(2). |
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
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Date: November 14, 2022 |
By: /s/ Steven A. Hale II |
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Steven A. Hale II |
|
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Chairman and Chief Executive Officer |
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the HG Holdings, Inc. (the “Company”) Quarterly Report on Form 10-Q for the period ended September 30, 2022 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Justin H. Edenfield, Principal Financial and Accounting Officer of the Company certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:
|
(1). |
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and |
|
(2). |
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
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Date: November 14, 2022 |
By: /s/ Justin H. Edenfield |
|
Justin H. Edenfield |
|
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Principal Financial and Accounting Officer |