HG HOLDINGS, INC. The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.
Principles of Consolidation
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in
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 on Form 10-K, which is incorporated by reference into this Item 7 of Part II of this Annual Report on Form 10-K.
COVID-19 Pandemic
Despite the widespread availability of vaccines, COVID-19 (including its variant
strains) continues to impact
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--------------------------------------------------------------------------------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.
See Item 1A of Part I of this Annual Report on Form 10-K for further discussion of risk factors related to COVID-19.
Title Insurance Segment Trends and Conditions
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
As of the
The industry as a whole saw a decline in total real estate transactions in 2022,
largely due to higher mortgage interest rates. Mortgage rates remained
abnormally high after emergency actions taken by the
A shortage in the supply of homes for sale, increasing home prices, rising
mortgage interest rates, inflation and disrupted labor markets created some
volatility in the residential real estate market in 2021 and 2022, which has
continued into 2023. Additionally, geopolitical uncertainties associated with
the war in
Because commercial real estate transactions tend to be generally driven by
supply and demand for commercial space and occupancy rates in a particular area
rather than by interest rate fluctuations, we believe that our commercial real
estate title insurance business is less dependent on the industry cycles
discussed above than our residential real estate title business. Commercial real
estate transaction volume is also often linked to the availability of financing.
Factors including
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. The fourth quarter is typically strong due to the desire of commercial entities to complete transactions by year-end. Seasonality in 2020, 2021 and 2022 deviated from historical patterns due to COVID-19 and the subsequent rapid increase in interest rates. We have noted short-term fluctuations through recent years in resale and refinance transactions as a result of changes in interest rates.
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--------------------------------------------------------------------------------Real Estate Related Segment
The Company currently owns 300,000 shares of HC Common Stock and 1,025,000
shares of HC Series B Stock of
As of
Results of Operations 2022 Compared to 2021
As of
The Company generated interest income of
As a result of the Company's title insurance operations, the Company generated
title premium and other title fee revenue of
As a result of the Company's reinsurance related segment, the Company generated
As a result of the management services related segment, the Company generated
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Corporate general and administrative expenses are not directly allocable to any
of our reporting segments and consist primarily of wages and personnel costs,
legal and professional fees, insurance expense, and stock based compensation.
General and administrative expenses of
Our effective tax rate for the year ended
Financial Condition, Liquidity and Capital Resources
Sources of liquidity include cash on hand, earnings from our title insurance
subsidiaries, reinsurance premiums earned, management service fees earned, and
dividends from our HC Common Stock and HC Series B Stock. We expect cash on hand
to be adequate for ongoing operational expenditures for at least 12 months from
the date of the accompanying consolidated financial statements. At
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 year ended
Net cash used in financing activities of
Net cash used in investing activities stayed relatively flat for the year ended
Recent Accounting Pronouncements
In
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--------------------------------------------------------------------------------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 consolidated 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 consolidated balance sheets. Investments accounted for under the equity method of accounting are initially recorded at cost and the Company 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: Recognition and Measurement of Financial Assets and Financial Liabilities, 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.
Note Receivable - In accordance with FASB ASC Topic 810-40-5, upon the sale of
substantially all of the assets of the Company, 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 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
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The Company concluded, based on current information and events, including the
impact of the COVID-19 pandemic 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
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 consolidated 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 consolidated 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 shares that are expected to vest, over the vesting period. The fair value of stock options is determined using the Black-Scholes option-pricing model. The fair value of restricted stock awards is 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 is 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. 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.
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--------------------------------------------------------------------------------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.
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.
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