STLY Stanley Furniture Company Inc (QB)

HG HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENT

Principles of Consolidation and Basis of Presentation

The accompanying Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles in the United States ("GAAP") and include our accounts as well as our wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. In our title segment, our investments in unconsolidated subsidiaries and affiliates are accounted for using the equity method until such time that they become wholly or majority-owned.

All prior period share numbers, stock option numbers, exercise prices and per share data appearing in this Annual Report on Form 10-K has been retroactively adjusted to reflect the reverse stock split effective July 15, 2021, unless otherwise indicated or unless context suggests otherwise. As previously stated in our proxy statement, the Reverse Stock Split (as defined in Note 12 herein) did not affect the par value of our common stock, which remained $0.02 per share of common stock. As a result, upon effectiveness of the Reverse Split, the stated capital on our consolidated balance sheet attributable to the common stock was reduced in proportion to the fraction by which the number of shares of common stock was reduced, and the additional paid-in capital account was credited with the amount by which the stated capital was reduced. The per share net income or loss and net book value of our common stock will be increased because there will be fewer shares of our common stock outstanding.

HG Holdings, Inc, together with its consolidated subsidiaries (the “Company”), operates through its wholly owned subsidiaries National Consumer Title Insurance Company (“NCTIC”), National Consumer Title Group, LLC (“NCTG”), Title Agency Ventures, LLC (“TAV”), HG Managing Agency, LLC (“HGMA”), and Omega National Title Agency, LLC (“Omega”) and through an affiliated investment in HC Government Realty Trust, Inc., a Maryland corporation (“HC Realty”).

Cash

We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Restricted Cash

Restricted cash includes collateral deposits required under the Company’s letter of credit agreement, which expires in June 2022, to guarantee the Company’s workers compensation insurance policy, and cash held in escrow under escrow agreements. As of December 31, 2021, there was no outstanding balance on the letter of credit agreement. Cash held by the Company in escrow was approximately $8.1 million as of December 31, 2021. The company records an offsetting escrow liability reflecting that we are liable for the disposition of these escrowed funds.

Concentration of Credit Risk

The Company place its cash and restricted cash with financial institutions and, at times, cash held in depository accounts may exceed the Federal Deposit Insurance Corporation insured limit.

Interest Income

Interest income is recorded on an accrual basis based on the effective interest rate method and includes the accretion of fair value adjustments/discounts. Fair value adjustments to par value are accreted/amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of fair value adjustments, if any.

Other revenues are recognized when contractual obligations are fulfilled or as services are provided.

Payment-in-Kind Interest

The Company has a subordinated secured notes receivable that may contain payment-in-kind (“PIK”) provisions. The PIK interest, computed at the contractual rate specified in the loan agreement, is added to the principal balance of the loan and recorded as interest income.

Variable Interest Entities

As a result of the September 6, 2018 sale of certain of Stanley Furniture Company, LLC’s, formerly known as Churchill Downs, LLC (the “Buyer”) assets, including certain inventory and the Stone & Leigh tradename (the “S&L Asset Sale”) to Stone & Leigh, LLC (“S&L”), we have a variable interest in one entity that has been determined to be variable interest entity ("VIE"). If we conclude that we are the primary beneficiary of a VIE, we are required to consolidate it. To determine if we are the primary beneficiary, we evaluate whether we have the power to direct the activities that most significantly impact the VIE's economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our evaluation includes identification of significant activities and an assessment of our ability to direct those activities based on governance provisions and arrangements to provide or receive product and process technology, product supply, operations services, equity funding, financing, and other applicable agreements and circumstances. Our assessments of whether we are the primary beneficiary of our VIE requires significant assumptions and judgments. We have concluded that we are not the primary beneficiary of the three VIEs as we do not have the power to direct the activities that most significantly impact the VIEs’ economic performance and therefore are not required to consolidate these entities.

Fair Value of Assets Acquired and Liabilities Assumed in Business Combinations

FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations, requires an acquirer to recognize, separately from goodwill, the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree, and to measure these items generally at their acquisition date fair values. Goodwill is recorded as the residual amount by which the purchase price exceeds the fair value of the net assets acquired. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, we are required to report provisional amounts in the financial statements for the items for which the accounting is incomplete. Adjustments to provisional amounts initially recorded that are identified during the measurement period are recognized in the reporting period in which the adjustment amounts are determined. This includes any effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. During the measurement period, we are also required to recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends the sooner of one year from the acquisition date or when we receive the information we were seeking about facts and circumstances that existed as of the acquisition date or learn that more information is not obtainable. Contingent consideration liabilities or receivables recorded in connection with business acquisitions must also be adjusted for changes in fair value until settled.

Leases

The Company enters into lease agreements that are primarily used for office space, and all current leases are accounted for as operating leases. Amounts related to operating leases are included in lease assets and lease liabilities on the Consolidated Balance Sheets. Lease assets represent the Company’s right to use an underlying asset for the stated lease term. Lease liabilities represent the Company’s obligation to make lease payments arising from an operating lease. Lease assets and liabilities are recognized at the date of the lease commencement, and are based on the present value of lease payments over the lease term. The Company's current leases do not provide an implicit interest rate, thus the Company calculated a discount rate using estimates of our incremental borrowing rate for similar collateralized borrowings and capitalizations rates in determining the present value of lease payments. A portion of the Company's current leases includes an option to extend or cancel the lease term. The exercise of such an option is solely at the Company's discretion. The operating lease liability recorded in the Consolidated Balance Sheets includes lease payments related to options to extend or cancel the lease term if the Company determined at the date of adoption that the lease was expected to be renewed or extended. A lease expense is recognized on a straight-line basis over the lease term. Adjustments for straight-line rental expense for the periods presented are not material and as such, the lease expense recognized was reflected in cash used in operating activities for the respective periods. For further information on the Company’s Leasing arrangements see Note 14.

Goodwill

Goodwill represents the excess of cost over fair value of identifiable net assets acquired and assumed in a business combination. Goodwill and other intangible assets with indefinite useful lives are reviewed for impairment at the reporting unit level on an annual basis or more frequently if circumstances indicate potential impairment, through a comparison of fair value to the carrying amount. In evaluating the recoverability of goodwill, we perform an annual goodwill impairment analysis based on a review of qualitative factors to determine if events and circumstances exist, which will lead to a determination that the fair value of a reporting unit is greater than its carrying amount, prior to performing a full fair-value assessment. For the year ended  December 31, 2021, we determined there were no events or circumstances which indicated that the carrying value of a reporting unit exceeded the fair value.

Subordinated Notes Receivable

As of the date of the September 6, 2018 sale of certain of the Buyer’s assets, including certain inventory and the Stone & Leigh tradename (the “S&L Asset Sale’) to Stone & Leigh, LLC (“S&L”) and resulting assignment and transfer of the note from the Buyer to S&L, the S&L Note was measured based on their fair value in accordance with Emerging Issues Task Force (EITF) – Creditors Accounting for Modification or Exchange of Debt Instruments. The discounts resulting from the fair value adjustments for the S&L Note were recorded as a direct reduction to the original principal balance and amortized to interest income using the effective interest method. When impairment is determined to be probable, the measurement will be based on the fair value of the collateral securing the notes. The determination of impairment involves management’s judgment and the use of market and third-party estimates regarding collateral values. During 2021 and 2020 management determined that S&L Note was other than temporarily impaired and recorded an impairment loss of $701,000 and $833,000, respectively.

Property, Plant and Equipment

Depreciation of property, plant and equipment is computed using the straight-line method based upon the estimated useful lives. Depreciation expense is charged to general and administrative expenses. Gains and losses related to dispositions and retirements are included in income. Maintenance and repairs are charged to expense as incurred; renewals and betterments are capitalized. Assets are reviewed for possible impairment when events indicate that the carrying amount of an asset may not be recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of property, plant and equipment, which could result in impairment charges in future periods. Our depreciation policy reflects judgments on the estimated useful lives of assets. Our long-lived assets were tested for impairment at December 31, 2021 and determined that the long-lived assets were not impaired.

Equity Investments

Long-term investments consist of investments in equity securities where our ownership is less than 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 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 a readily determinable fair value, the Company made an accounting policy election for a measurement alternative. Per 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 changes resulting from observable price changes in orderly transaction for the identical or a similar investment of the same issuer. The Company reviews its equity securities without readily determinable fair values on a regular basis to determine if the investment is impaired. For purposes of this assessment, the Company considers the investee’s cash position, liquidity, earnings and revenue outlook, equity position, and ownership, among other factors, in its review. If management’s assessment indicates that an impairment exists, the Company estimates the fair value of the equity investment and recognizes in current earnings an impairment loss that is equal to the difference between the fair value of the equity investment and its carrying amount.

Income Taxes

Deferred income taxes are determined based on the difference between the financial statement and income tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax expense represents the change in the deferred tax asset/liability balance. Income tax credits are reported as a reduction of income tax expense in the year in which the credits are generated. A valuation allowance is recorded when it is more likely than not that a deferred tax asset will not be realized. Interest and penalties on uncertain tax positions are recorded as income tax expense.

Fair Value of Financial Instruments

Accounting for fair value measurements requires disclosure of the level within the fair value hierarchy in which fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3). The fair value of receivables and payables approximate the carrying amount because of the short maturity of these instruments.

Earnings per Common Share

Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share includes any dilutive effect of outstanding stock options and restricted stock calculated using the treasury stock method.

Reserve for Claim Losses

The total reserve for all reported and unreported losses the Company incurred is represented by the reserve for claims. The Company's reserve for unpaid losses and loss adjustment expenses (LAE) is established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders that may be reported in the future (incurred but not reported, or "IBNR"). The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.

Reinsurance

The accompanying consolidated balance sheets reflect reserves for claims gross of reinsurance ceded. The accompanying consolidated statements of operations reflect premiums and provision for claims net of reinsurance ceded. The reinsurance arrangements allow management to control exposure to potential claims arising from large risks and catastrophic events. Amounts recoverable from reinsurers are estimated in a manner consistent with the reserves associated with the reinsured policies. Reinsurance premiums, losses, and LAE are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance agreements.

Stock-Based Compensation

We record share-based payment awards at fair value on the grant date of the awards, based on the estimated number of awards that are expected to vest, over the vesting period. The fair value of stock options was determined using the Black-Scholes option-pricing model. The fair value of the restricted stock awards was based on the closing price of the Company’s common stock on the date of the grant. For awards with performance conditions, we recognize compensation cost over the expected period to achieve the performance conditions, provided achievement of the performance conditions are deemed probable.

Premiums Written and Commissions to Agents

Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of the issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and a provision for future claims are recognized concurrent with recognition of related premium revenue. Fee income related to escrow and other closing services is recognized when the related services have been performed and completed. Rather than making estimates that could be subject to significant variance from actual premium and fee production, the Company recognizes revenues from those sources upon receipt. Such receipts can reflect up to a three to four month lag relative to the effective date of the underlying title policy, and are offset concurrently by production expenses and claim reserve provisions.

Quarterly, the Company evaluates the collectability of receivables. Write-offs of receivables have not been material to the Company.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Changes in such estimates may affect amounts reported in future periods.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The amendments in ASU 2016-13 require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendment is effective for public entities for annual reporting periods beginning after December 15, 2022, however early application is permitted for reporting periods beginning after December 15, 2018. The Company does not anticipate the adoption of ASU 2016-13 to have a material impact to the consolidated financial statements.

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 100% of the stock of NCTIC and 100% of the membership interest in NCTG for $5.463 million, adjusted for a customary post-closing working capital adjustment (the “Purchase Price”). Pursuant to the mechanics in the First Purchase Agreement, the Purchase Price was determined at closing by taking the $5.5 million purchase price originally agreed to under the First Purchase Agreement, subtracting the debt of NCTIC and NCTG, adding payment for $75,000 of the transaction expenses of the Sellers and, adding a closing related working capital adjustment. The Company funded the Purchase Price from cash on hand. Also at closing, the Company and Sellers agreed that the economic benefits and burdens of the ownership of the equity, including for accounting and tax purposes, be transferred as of 12:01 am on July 1, 2021. For all other purposes, the effective time of the transfer remained July 20, 2021.

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 50% non-controlling membership interest in TAV, and by virtue thereof, owns 50% of the membership interest in Omega, also a Florida based title agency. NCTIC provides title insurance, closing and/or escrow services and similar or related services in the state of Florida in connection with residential real estate transactions. Omega operates 10 title agency locations in Florida providing title agency services for residential and commercial real estate transactions.

On September 1, 2021, the Company entered into a Membership Interests Purchase Agreement (the “Second Purchase Agreement”) with TAV and Fidelis US Holdings, Inc., a Delaware corporation (“Second Agreement Seller”). On such date, pursuant to the Second Purchase Agreement and in an immediate sign-and-close transaction, the Company purchased 50% of the membership interests of TAV from Second Agreement Seller (the “Second Acquisition”) for $2.2 million (the “Second Acquisition Purchase Price”).

Combined with the Acquisition by the Company in July 2021 of a 100% membership interest in NCTG, which owns a 50% membership interest in TAV, the Company now is the sole owner of TAV, and by virtue thereof, owns all of the membership interests in Omega. The 50% non-controlling membership interest in TAV was accounted for under the equity method of accounting until the Second Acquisition.

The purchase price allocation for NCTIC and NCTG is as follows (in thousands):

A bargain purchase gain is recognized in current earnings when the aggregate fair value of the consideration transferred and any noncontrolling interest in the acquiree is less than the fair value of the identifiable net assets acquired. The bargain purchase gain was primarily driven by differences in NCTIC’s statutory surplus and GAAP surplus at the date of acquisition. The Company believes that the Sellers wanted to exit the business relatively quickly and there were a limited number of potential buyers due to factors inherent to the property and casualty market, which resulted in a bargain purchase gain. The bargain purchase gain is recorded in other income on the Consolidated Statement of Operations.

On September 1, 2021, the Company acquired the remaining 50% membership interests of TAV for $2.2 million. This acquisition, combined with the July 2021 Acquisition of a 100% membership interest in NCTG, which owns a 50% membership interest in TAV, made the Company the sole owner of TAV.

The operating results of TAV are included in the Company’s consolidated statements of operations beginning September 1, 2021. TAV’s results are included in the title insurance segment.

The final purchase price allocation for TAV at fair value is as follows (in thousands):

The acquisition date fair value of the Company’s previously held equity interest in TAV was $3.6 million with a fair value primarily estimated through an income approach valuation. The Company recorded a gain of $3.3 million on the fair value remeasurement of our previously held equity interest in TAV on the consolidated statements of operations for the year ended December 31, 2021.

The acquisition of the remaining equity interest was accounted for as a step-transaction in accordance with FASB Accounting Standards Codification Topic 805, Business Combinations ("Topic 805"). The Second Acquisition Purchase Price has been allocated to TAV's assets acquired and liabilities assumed based on our best estimates of the fair values as of the acquisition date. Due to the close proximity in timing of the Second Acquisition and our filing of this Annual Report on Form 10-K, the fair value of assets acquired and liabilities assumed represent a preliminary allocation as our evaluation of facts and circumstances available as of December 31, 2021 is ongoing. Goodwill has been recorded based on the amount that the purchase price exceeds the fair value of the net assets acquired. Goodwill consists primarily of intangible assets that do not qualify for separate recognition.

Pursuant to Topic 805, the consolidated financial statements will not be retrospectively adjusted for any provisional amount changes that occur in subsequent periods. Rather, we will recognize any provisional adjustments as we obtain information not available as of the completion of this preliminary fair value calculation as determined within the measurement period. We will also be required to record, in the same period as the consolidated financial statements, the effects to any income statement captions, if any, as a result of any change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. We expect to finalize the purchase price allocation as soon as practicable, but no later than one year from the acquisition date.

The following table presents unaudited pro forma financial information as if NCTIC, NCTG, and TAV had been included in the Company’s financial results as of January 1, 2021 and 2020:

The Company received a $7.4 million subordinated secured promissory note from the Buyer as partial consideration for the sale of substantially all of our assets during the first quarter of 2018. On September 6, 2018, the Buyer sold certain of its assets, including certain inventory and the Stone & Leigh tradename to S&L, which is owned by a group which includes Matthew W. Smith, the Company’s former interim Chief Executive Officer. As a part of the S&L Asset Sale, the Buyer assigned to S&L certain of its rights and obligations under the original $7.4 million subordinated secured promissory note. In connection with the assignment, the Company entered into an Amended and Restated Subordinated Secured promissory note with the Buyer (the “A&R Note”) and the S&L Note. The A&R Note had a principal amount as of the assignment date of $3.3 million.

A&R Note

On October 31, 2019, the Company entered into a Forbearance Agreement (“Forbearance Agreement”) with the Buyer and certain affiliates (the “Loan Parties”) pursuant to which the Company agreed, subject to certain conditions, to forbear until February 24, 2020 from exercising its rights and remedies under the Second Amended and Restated Subordinated Secured Promissory Note (the “Second A&R Note”) issued by Buyer to the Company. On February 24, 2020, the Company and the Loan Parties entered into a letter agreement (the “Forbearance Extension Letter Agreement”) extending the outside termination date for the forbearance period under the Forbearance Agreement from February 24, 2020 to February 26, 2020. The other terms and conditions of the Forbearance Agreement remained the same. The forbearance period terminated on February 26, 2020 under the terms of the Forbearance Extension Letter Agreement and Forbearance Agreement.

The Company received payments on January 31, 2020, February 28, 2020, and March 4, 2020 of $130,000, $200,000 and $350,000, respectively, of the principal amount on the Second A&R Note from the Buyer.

On March 6, 2020, the Company and the Loan Parties entered into a letter agreement (the “Second Forbearance Extension Letter Agreement”) extending, subject to certain conditions, the outside termination date from February 26, 2020 to March 17, 2020. The extension of the outside termination and the effectiveness of the Second Forbearance Extension Letter Agreement was conditioned on Buyer making payments to be applied to the outstanding principal balance of the Second A&R Note of $250,000 on or before March 12, 2020 and $750,000 on or before March 13, 2020. The Second Forbearance Extension Letter Agreement also required the Buyer to make an additional $391,970 payment on or before March 17, 2020 to be applied to the outstanding principal balance of the Second A&R Note. The other terms and conditions of the Forbearance Agreement remained the same.

On March 12 and 13, 2020, the Company received payments from Buyer of $250,000 and $750,000, respectively, pursuant to the Second Forbearance Extension Letter Agreement which payments were applied to the outstanding principal amount of the Second A&R Note.

On March 16, 2020, the Company received payment of $392,000 from the Buyer resulting in satisfaction in full of the Second A&R Note pursuant to the terms of the Forbearance Agreement as amended. As a result of the payments received from Buyer in January, February, and March of 2020 on the Second A&R Note, the Company recognized a gain of $1.3 million on the payoff of the Second A&R Note during the first quarter of 2020.

S&L Note

The S&L Note had a principal amount of $4.4 million as of the assignment date. The S&L Note matures on March 2, 2023, at which time the total principal amount is due. Interest on the S&L Note accrues at a fixed rate of 10% per annum. No cash interest payments were accrued or received during the year ended December 31, 2021. Cash interest payments of $252,000 were accrued or received during the year ended December 31, 2020.  During the years ended December 31, 2021 and 2020, the Company received $190,000 and $58,000 of principal payments on the S&L Note, respectively.

At the assignment date, the Company evaluated the fair value of the S&L Note. As a result of the Company’s recording of impairment losses, based on current information and events, including the impact of COVID-19 on S&L’s business and its customers, the Company ceased accruing interest and accreting interest income on the fair value discount of the S&L Note on the date in the third quarter of 2020 the Company determined the note was other than temporarily impaired.  As such, the Company did not record accreted interest income on the fair value adjustment of the S&L Note for the year ended December 31, 2021. The company recorded accreted interest income of $104,000 for the year ended December 31, 2020.

The Company recognized interest payments of $190,000 and $58,000 received during the years ended December 31, 2021 and 2020, respectively, as reductions of the principal balance of the S&L Note.

During 2021, the Company concluded that the S&L would not have adequate cash required to repay the carrying value of the S&L Note. Given the facts and circumstances, the Company recorded an impairment loss of $701,000 for the year ended December 31, 2021. The Company’s estimated fair value of the S&L Note is based upon the estimated fair value of the collateral securing the note, namely cash, accounts receivables, and inventory. The determination of fair value involves management’s judgment, including analysis of the impact of COVID-19 on S&L’s business and its customers, and the use of market and third-party estimates regarding collateral values. These collateral value estimates are based on the three-level valuation hierarchy for fair value measurement and represent Level 1 and 2 inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

A reconciliation of the activity in the S&L Note for the years ended December 31, 2021 and 2020 is as follows (in thousands):

On March 19, 2019, the Company, together with certain other Lenders, entered into a loan agreement (the “Loan Agreement”) with HC Realty’s operating partnership, and HCM Agency, LLC, as collateral agent (the “Agent”), pursuant to which the Lenders provided HC Realty’s operating partnership with a $10,500,000 senior secured term loan (the “Initial Term Loan”), of which $2,000,000 was provided by the Company.

On August 14, 2020, pursuant to the terms of the Loan Agreement, HC Realty’s operating partnership repaid the loan in full, including all accrued interest and make whole interest. Interest earned for the year ended December 31, 2020 was $204,000.

On March 19, 2019, the Company entered into subscription agreements with HC Realty, pursuant to which it purchased (i) 200,000 shares of HC Realty’s 10.00% Series B Cumulative Convertible Preferred Stock (the “Series B Stock”) for an aggregate purchase price of $2,000,000 and (ii) 300,000 shares of HC Realty’s common stock for an aggregate purchase price of $3,000,000. Certain investors affiliated with HPCM purchased an additional 850,000 shares of Series B Stock for an aggregate purchase price of $8,500,000. On April 3, April 9, and June 29, 2020, the Company entered into subscription agreements with HC Realty, pursuant to which we purchased 100,000, 250,000, and 475,000 shares of Series B Stock, respectively, for an aggregate purchase price of $8,250,000. While some of these investors have other investments with HPCM, each of these investors made a separate and direct investment in HC Realty and HPCM does not receive management fees, performance fees, or any other economic benefits with respect to these investors’ investment in HC Realty’s Series B Stock.

The Series B Stock is not deemed to be in-substance common stock and is accounted for using the measurement alternative for equity investments with no readily determinable fair value. The Series B Stock will be reported at cost, adjusted for impairments or any observable price changes in ordinary transactions with identical or similar investments issued by HC Realty.

The following table summarizes the Company’s investment in HC Realty as of the two years ended December 31, 2021 (in thousands):

The Company’s investment in HC Realty common stock is accounted for under the equity method of accounting. For portions of the year ended December 31, 2020, the Company owned less than 20% of the fully diluted shares outstanding. The Company determined that accounting for the investment in HC Realty common stock under the equity method was appropriate for the portion of time the Company owned less than 20% because the Company holds significant influence of HC Realty.

On May 7, 2020, prior to the Company’s acquisitions, Omega entered into a loan agreement with Wells Fargo, N.A. in the aggregate amount of $544,842 (the “Loan”), pursuant to the PPP under the CARES Act. The Loan was necessary to support ongoing operations due to the economic uncertainty resulting from the COVID-19 pandemic and lack of access to alternative sources of liquidity.

The Loan was scheduled to mature five years from the date on which Omega applies for loan forgiveness under the CARES Act, bore interest at a rate of 1% per annum and is subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration (“SBA”) under the CARES Act. The PPP provided that the use of the Loan amount shall be limited to certain qualifying expenses and may be partially or wholly forgiven in accordance with the requirements set forth in the CARES Act. Omega used all of the PPP proceeds toward qualifying expenses.

On September 16, 2021, Omega received notice from the SBA that the full amount of the loan was forgiven. The forgiveness of the loan is included as gain on extinguishment of debt on the Consolidated Statements of Operations.

NCTIC's assets, liabilities, and results of operations have been reported in accordance with GAAP, which varies from statutory accounting practices (SAP) prescribed or permitted by insurance regulatory authorities. Prescribed SAP are found in a variety of publications of the National Association of Insurance Commissioners (NAIC), state laws and regulations, as well as through general practices. Statutory accounting principles differ in some respects from GAAP, and these differences include, but are not limited to, non-admission of certain assets (principally limitations on deferred tax assets, goodwill, capitalized furniture and equipment, investment in subsidiaries and affiliates, real estate, capitalized software, and premiums and other receivables 90 days past due), reporting of bonds at amortized cost, recognition of credit losses against unassigned surplus, deferred income taxes, changes in the fair values of marketable equity securities, amortization of goodwill, deferral of premiums received as statutory premium reserve, supplemental reserve and exclusion of the incurred but not reported claims reserve. The Company must file with applicable state insurance regulatory authorities an “Annual Statement” which reports, among other items, net income or loss and stockholders' equity (called “surplus as regards policyholders” in statutory reporting).

Capital and surplus on a statutory basis was $5.1 million as of December 31, 2021. Net income on a statutory basis was $95,000 for the year ended December 31, 2021. As of December 31, 2021, approximately all of consolidated shareholders’ equity represents net assets of NCTIC that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior insurance department approval. During 2022, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $40,000 plus any earnings and capital gains derived in 2022.

NCTIC’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy claims that have been IBNR. Despite the variability of such estimates, management believes that the total reserve for claims is adequate to cover claim losses which might result from pending and future claims under title insurance policies issued through December 31, 2021. We continually update loss reserve estimates as new information becomes known, new loss patterns emerge or as other contributing factors are considered and incorporated into the analysis of reserve for claim losses. Due to the uncertainty inherent in the process and to the judgment used by management, the ultimate liability may be greater or less than our current reserves. If actual claims loss development varies from what is currently expected and is not offset by other factors, it is possible that additional reserve adjustments may be required in future periods in order to maintain our recorded reserve within a reasonable range of our actuary's central estimate.

A reconciliation of the activity in the reserves account for the period since the Acquisition ending December 31, 2021 is as follows (in thousands):

At December 31, 2021, there were no reinsurance recoverables on paid claims or unpaid reserves.

For the period subsequent to the Acquisition ending December 31, 2021, there was no development of the net provision for claims attributable to insured events of the prior year as a result of estimation of the reserve for claims. Original estimates are decreased or increased as additional information becomes known regarding individual claims.

A summary of the Company’s loss reserves at December 31, 2021 is as follows (in thousands):

Certain premiums and benefits at NCTIC are ceded to other insurance companies under various reinsurance agreements. The reinsurance agreements provide NCTIC with increased capacity to write more risk and maintain its exposure to loss within its capital resources. For the year ended December 31, 2021, NCTIC's reinsurance program consisted of excess of loss reinsurance treaties. The following is a summary of the reinsurance coverage.

Effective January 1, 2021, NCTIC entered into a per risk excess of loss reinsurance agreement that provided coverage of $650,000 in excess of $350,000 (“First Layer of Reinsurance”) on each and every risk. The contract allows for one full reinstatement at 100% additional premium as to time and pro rata as to amount. The agreement expired on December 31, 2021. Effective January 1, 2021, NCTIC entered into a per risk excess of loss reinsurance agreement that provides coverage of $4,000,000 in excess of $1,000,000 (“Second Layer of Reinsurance”) on each and every risk. The contract allows for one full reinstatement at 100% additional premium as to time and pro rata as to amount. This per risk agreement is shared with other non-affiliated companies. Each company pays its share of the reinsurance cost based on separate company earned premiums. The agreement expired on December 31, 2021. Effective January 1, 2022, the Company replaced the expiring treaty on the Second Layer of Reinsurance, but elected to not replace the expiring treaty on the First Layer of Reinsurance.

Effective January 1, 2021, NCTIC entered into a reinstatement premium protection reinsurance agreement to reinsure the reinstatement premium payment obligations of NCTIC under the shared per risk excess of loss agreement. The coverage is limited to 100% of the original contracted reinsurance placement. This agreement is shared with the other nonaffiliated companies. Each company pays its share of the reinsurance cost based on separate company earned premiums. The agreement expired on December 31, 2021. Effective January 1, 2022, the Company replaced the expiring reinstatement premium protection reinsurance treaty.

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 50% participants in the Lloyd’s syndicate. As such, NCTIC has a concentration of reinsurance risk with these third party reinsurers that could have a material impact on NCTIC’s financial position in the event that either of these reinsurers fail to perform their obligations under the reinsurance treaty. As of December 31, 2021, both reinsurers had an A-issuer credit rating from AM Best, an AA- from Fitch, and an A+ from S&P. The Company monitors both the financial condition of individual reinsurers and risk concentration arising from similar activities and economic characteristics of reinsurers to attempt to reduce the risk of default by such reinsurers. Given the quality of the reinsurers, management believes this possibility to be remote. See Note 9 for recoveries due from reinsurers relating to paid and unpaid claims under these treaties.

The effects of reinsurance on premiums written and earned at NCTIC for the period since the Acquisition ending December 31, 2021 are as follows (in thousands):

The provision for income tax (benefit) expense consists of (in thousands):

A reconciliation of the difference between the federal statutory income tax rate and the effective income tax rate follows:

The income tax effects of temporary differences that comprise deferred tax assets and liabilities at December 31 follow (in thousands):

We have U.S. federal net operating loss carryforwards of approximately $36.4 million which are available to reduce future taxable income. The federal net operating loss will begin expiring in 2033. We have combined state net operating loss carryforwards of $23.7 million that will expire at various times beginning in 2027.

During 2021, we recorded a non-cash credit to our valuation allowance of approximately $275,000 against our December 31, 2021 deferred tax assets.  The primary assets which are covered by this valuation allowance are employee benefits and net operating losses in excess of the amounts which can be carried back to prior periods. 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.  Our results over the most recent four-year period were heavily affected by our business restructuring activities. Our cumulative loss during that period represented sufficient negative evidence to require a valuation allowance.  We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal, resulting in no deferred tax asset balance being recognized.  Should we determine that we will not be able to realize all or part of our 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. 

The unrecognized tax benefits activity for the year ended December 31 follows (in thousands):

Total amount of unrecognized tax benefits that would affect our effective tax rate if recognized is $31,000 and $157,000 at December 31, 2021 and 2020, respectively. The 2014 through 2020 tax years remain open to examination by major taxing jurisdictions.

In addition to common stock, authorized capital includes 1,000,000 shares of “blank check” preferred stock. None was outstanding during the two years ended December 31, 2021. The Board of Directors (“Board”) is authorized to issue such stock in series and to fix the designation, powers, preferences, rights, limitations and restrictions with respect to any series of such shares. Such “blank check” preferred stock may rank prior to common stock as to dividend rights, liquidation preferences or both, may have full or limited voting rights and may be convertible into shares of common stock.

Basic and diluted earnings per share are calculated using the following share data (in thousands):

For the years ended December 31, 2021 and 2020 approximately 35,000 stock awards were included in the diluted per share calculation as they are dilutive.

In July 2012, the Board authorized the purchase of up to $5.0 million of our common stock. These repurchases may be made from time to time in the open market, in privately negotiated transactions, or otherwise, at prices the Company deems appropriate. No repurchases of our common stock were made in 2021 or 2020. The Board does not intend to repurchase any additional shares of our common stock under this authorization as it is now stale but if a new authorization is made such authorization will be separately announced and reported..

In the fourth quarter of 2016, the Board adopted a Rights Agreement designed to protect the Company’s substantial net operating loss carryforwards. Under the Rights Agreement, company stockholders of record as of December 15, 2016 received one preferred share purchase right for each share of common stock they owned on such date. If a person or group acquires beneficial ownership of 4.9% or more of the Company’s outstanding common stock (subject to certain specified exceptions), the rights will become exercisable. The rights will also become exercisable if a person or group that already owns 4.9% or more of the Company’s outstanding common stock acquires an additional 1% or more of the Company’s outstanding common stock.

The Company entered into Amendment No. 1, dated January 30, 2017, to the Rights Agreement. This amendment amends the definition of Acquiring Person in the Rights Agreement to exclude any member of the Hale Group (Hale Partnership Fund, LP and certain affiliates that are parties to the agreement (Hale Agreement) dated January 30, 2017 with the Company), provided that any purchases made by members of the Hale Group after December 5, 2016 are made in compliance with Section 1(h) of the Hale Agreement. The Company entered into Amendment No 2, dated December 5, 2019, to the Rights Agreement. This amendment amends the definition of “Expiration Time” to provide that, unless otherwise expiring under the terms of the existing definition, the Rights Agreement will expire (i) at the close of business on the day after the Company’s 2020 annual meeting of stockholders unless the Company’s stockholders approve the amendment to the definition of “Expiration Time” in this amendment or (ii) the close of business on December 5, 2022 (unless the Company’s NOLs are utilized prior to that date). At the Company’s 2020 annual meeting of stockholders, the Company’s stockholders approved the amendment to the definition of “Expiration Time” under Amendment No. 2.

If the rights become exercisable, all holders of rights, other than the person or group triggering the rights, will be entitled to purchase Company common stock at a 50% discount. Rights held by the person or group triggering the rights will become void and will not be exercisable. The rights have a de minimis fair value and trade with the Company’s common stock. The Board may amend the Rights Agreement in any way or redeem the rights at any time unless and until the rights are triggered.

The Rights Agreement includes a procedure for the Board to consider requests to exempt a particular transaction from triggering the exercisability of the rights under the Rights Agreement if the transaction (i) does not (x) create a significant risk of the Company’s NOLs being impaired or (y) constitute a default under the change-in-control covenant included in the Company’s credit facility or (ii) is otherwise in the best interests of the Company.

On the close of business on July 15, 2021, the Company effectuated a 1-for-12 reverse stock split of its outstanding shares of Common Stock (“Common Stock”) such that every holder of Common Stock receives one share of Common Stock for every twelve shares of Common Stock held (the “Reverse Stock Split”). The amendment to the Company’s Restated Certificate of Incorporation approved by the Company’s stockholders was effective as of such record date.

No fractional shares of common stock were issued as a result of the Reverse Stock Split. Instead, in lieu of any fractional shares to which a stockholder of record would otherwise be entitled as a result of the Reverse Stock Split, the Company paid cash (without interest) equal to such fractional share multiplied by $0.70 which was the 90-day Volume Weighted Average Price (“VWAP”) of our common stock on the OTCQB for the period immediately preceding the Effective Time (with such average closing sales prices being adjusted to give effect to the Reverse Stock Split). After the Reverse Stock Split, a stockholder otherwise entitled to a fractional interest will not have any voting, dividend or other rights with respect to such fractional interest except to receive payment as described above. Stockholders owning fractional shares were paid out in cash for such fractional shares.

The Stanley Furniture Company, Inc. 2012 Incentive Compensation Plan (Incentive Compensation Plan) provides for the granting of performance grants, performance shares, stock options, restricted stock, restricted stock units, and stock appreciation rights to employees and certain service providers. Under this plan, the aggregate number of common shares that may be issued through awards of any form is 1.6 million. As of December 2021, there are 1.2 million shares remaining available for future issuance under equity compensation plans.

Stock Options         

The options are issued at market value on the date of grant and have a term of 10 years from the grant date. In general, employee grants vest ratably over a four to five-year period and Director grants vest after one year. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. We have estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes pricing valuation model.

The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense. No options were granted or exercised in 2021 or 2020.

Stock option activity for the two years ended December 31, 2021, follows:

Restricted Stock         

The restricted stock awards are accounted for as “non-vested equity shares” until the awards vest or are forfeited. In general, restricted stock awards for employees are time vested or performance vested and for non-employee directors vest at the end of their current term on the Board. The fair value of each share of restricted stock is the market price of our stock on the grant date. The fair value of each time vested award is amortized into compensation expense on a straight-line basis between the award date and the vesting date. Performance based awards are amortized into stock compensation expense based on the probability of meeting the performance criteria. In 2021, no restricted stock awards vested and were released. In 2020, 12,931 of restricted stock awards vested and were released.

The following table summarizes information about restricted stock awards for the two years ended December 31, 2021: