Form 10-Q Heritage Insurance Holdi For: Sep 30

November 6, 2018 4:11 PM

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number

001-36462

 

Heritage Insurance Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

 

Delaware

 

45-5338504

(State of Incorporation)

 

(IRS Employer

Identification No.)

2600 McCormick Drive, Suite 300

Clearwater, Florida 33759

(Address, including zip code, of principal executive offices)

(727) 362-7200

(Registrant’s telephone number, including area code)

 

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. Yes No

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). Yes No

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

 

Non-accelerated filer

 

 

Smaller reporting company

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No

The aggregate number of shares of the Registrant’s Common Stock, $0.0001 par value, outstanding on November 2, 2018 was 26,600,605

 

 

 


HERITAGE INSURANCE HOLDINGS, INC.

Table of Contents

 

 

 

Page

PART I – FINANCIAL INFORMATION

 

 

Item 1 Financial Statements

 

 

Condensed Consolidated Balance Sheets: September 30, 2018 (unaudited) and December 31, 2017

 

2

Condensed Consolidated Statements of Operations and Other Comprehensive (Loss) Income: Three and Nine months ended September 30, 2018 and 2017 (unaudited)

 

3

Condensed Consolidated Statements of Stockholders’ Equity: Nine months ended September 30, 2018 and 2017 (unaudited)

 

4

Condensed Consolidated Statements of Cash Flows: Nine months ended September 30, 2018 and 2017 (unaudited)

 

5

Notes to Unaudited Condensed Consolidated Financial Statements

 

7

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

31

Item 3 Quantitative and Qualitative Disclosures about Market Risk

 

40

Item 4 Controls and Procedures

 

41

PART II – OTHER INFORMATION

 

 

Item 1 Legal Proceedings

 

42

Item 1A Risk Factors

 

42

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

 

42

Item 4 Mine Safety Disclosures

 

42

Item 6 Exhibits

 

42

Signatures

 

44

 

 

 

 


 

FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q (“Form 10-Q”) or in documents incorporated by reference that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements about (i) projections related to the financial impact of Hurricane Michael; (ii) our expectations about our liquidity and capital resources; (iii) estimates and assumptions regarding certain tax and accounting matters, including steps to remediate certain deficiencies; (iv) estimates related to the Tax Cuts and Jobs Act of 2017 and the impact on our effective tax rate; (v) intentions with respect to the sale of certain investments; (vi) access to reinsurance coverage for catastrophic events and layer exhaustion; (vii) expectations to declare and pay dividends; . These statements are based on current expectations, estimates and projections about the industry and market in which we operate, and management’s beliefs and assumptions. Without limiting the generality of the foregoing, words such as “may”, “will”, “expect”, “believe”, “anticipate”, “intend”, “could”, “would”, “estimate”, or “continue” or the negative variations thereof or comparable terminology are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. The risks and uncertainties include, without limitation:

 

the possibility that actual losses may exceed reserves;

 

the concentration of our business in coastal states, which could be impacted by hurricane losses or other significant weather-related events such as northeastern winter storms;

 

our exposure to catastrophic weather events;

 

the fluctuation in our results of operations;

 

increased costs of reinsurance, non-availability of reinsurance, and non-collectability of reinsurance;

 

our failure to effectively manage our growth and integrate acquired companies;

 

increased competition, competitive pressures, and market conditions;

 

our failure to accurately price the risks we underwrite;

 

inherent uncertainty of our models and our reliance on such model as a tool to evaluate risk;

 

the failure of our claims department to effectively manage or remediate claims;

 

low renewal rates and failure of such renewals to meet our expectations;

 

our failure to execute our diversification strategy;

 

failure of our information technology systems and unsuccessful development and implementation of new technologies;

 

a lack of redundancy in our operations;

 

our failure to attract and retain qualified employees and independent agents or our loss of key personnel;

 

our inability to generate investment income;

 

our inability to maintain our financial stability rating;

 

effects of emerging claim and coverage issues relating to legal, judicial, environmental and social conditions;

 

the failure of our risk mitigation strategies or loss limitation methods; and

 

changes in regulations and our failure to meet increased regulatory requirements.

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results.

These forward-looking statements are subject to numerous risks, uncertainties and assumptions about us described in our filings with the Securities and Exchange Commission (the “SEC”). The forward-looking statements we make in our Form 10-Q are valid only as of the date of our Form 10-Q and may not occur in light of the risks, uncertainties and assumptions that we describe from time to time in our filings with the SEC. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from our forward-looking statements is included in the section entitled “Risk Factors” in Part I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2017. Except as required by applicable law, we undertake no obligation and disclaim any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

 


 

 

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Balance Sheets

(Amounts in thousands, except per share and share amounts)

 

 

 

September 30, 2018

 

 

December 31, 2017

 

ASSETS

 

(unaudited)

 

 

 

 

 

Fixed maturity securities, available for sale, at fair value (amortized

   cost of $528,139 and $552,458 in 2018 and 2017, respectively)

 

 

515,541

 

 

$

549,796

 

Equity securities, available for sale, at fair value (cost of $16,906 and $17,548

   in 2018 and 2017, respectively)

 

 

15,709

 

 

 

17,217

 

Total investments

 

 

531,250

 

 

 

567,013

 

Cash and cash equivalents

 

 

221,524

 

 

 

153,697

 

Restricted cash

 

 

12,250

 

 

 

20,833

 

Accrued investment income

 

 

3,753

 

 

 

5,057

 

Premiums receivable, net

 

 

68,621

 

 

 

67,757

 

Reinsurance recoverable on paid and unpaid claims

 

 

324,826

 

 

 

357,357

 

Prepaid reinsurance premiums

 

 

282,649

 

 

 

227,764

 

Income taxes receivable

 

 

36,249

 

 

 

37,338

 

Deferred policy acquisition costs, net

 

 

75,702

 

 

 

41,678

 

Property and equipment, net

 

 

18,480

 

 

 

18,748

 

Intangibles, net

 

 

81,911

 

 

 

101,626

 

Goodwill

 

 

152,459

 

 

 

152,459

 

Other assets

 

 

15,653

 

 

 

19,883

 

Total Assets

 

$

1,825,327

 

 

$

1,771,210

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Unpaid losses and loss adjustment expenses

 

$

421,095

 

 

$

470,083

 

Unearned premiums

 

 

484,680

 

 

 

475,334

 

Reinsurance payable

 

 

217,022

 

 

 

17,577

 

Long-term debt, net

 

 

178,330

 

 

 

184,405

 

Deferred income tax

 

 

11,963

 

 

 

34,333

 

Advance premiums

 

 

33,435

 

 

 

23,648

 

Accrued compensation

 

 

10,486

 

 

 

16,477

 

Accounts payable and other liabilities

 

 

77,760

 

 

 

169,537

 

Total Liabilities

 

$

1,434,771

 

 

$

1,391,394

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

Common stock, $0.0001 par value, 50,000,000 shares authorized, 26,569,804 shares issued and 25,769,804 outstanding at September 30, 2018 and 26,560,004 shares issued and 25,885,004 outstanding at December 31, 2017

 

 

3

 

 

 

3

 

Additional paid-in capital

 

 

295,500

 

 

 

294,836

 

Accumulated other comprehensive loss

 

 

(9,583

)

 

 

(3,064

)

Treasury stock, at cost, 7,214,797 shares at September 30, 2018 and 7,099,597 shares at December 31, 2017

 

 

(89,185

)

 

 

(87,185

)

Retained earnings

 

 

193,821

 

 

 

175,226

 

Total Stockholders' Equity

 

 

390,556

 

 

 

379,816

 

Total Liabilities and Stockholders' Equity

 

$

1,825,327

 

 

$

1,771,210

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

2


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss)

(Unaudited)

(Amounts in thousands, except per share and share amounts)

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written

 

$

233,613

 

 

$

154,355

 

 

$

701,643

 

 

$

455,845

 

Change in gross unearned premiums

 

 

551

 

 

 

(1,292

)

 

 

(9,345

)

 

 

4,180

 

Gross premiums earned

 

 

234,164

 

 

 

153,063

 

 

 

692,298

 

 

 

460,025

 

Ceded premiums

 

 

(115,926

)

 

 

(57,855

)

 

 

(356,748

)

 

 

(182,189

)

Net premiums earned

 

 

118,238

 

 

 

95,208

 

 

 

335,550

 

 

 

277,836

 

Net investment income

 

 

3,847

 

 

 

2,735

 

 

 

9,704

 

 

 

8,210

 

Net realized gains (losses)

 

 

5

 

 

 

365

 

 

 

(307

)

 

 

1,011

 

Other revenue

 

 

3,205

 

 

 

3,466

 

 

 

10,346

 

 

 

10,948

 

Total revenues

 

 

125,295

 

 

 

101,774

 

 

 

355,293

 

 

 

298,005

 

EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

58,695

 

 

 

64,035

 

 

 

177,775

 

 

 

156,728

 

Policy acquisition costs, net of ceding commission income for the three and nine months ended September 30, 2018, of $13,781 and $42,097 respectively

 

 

26,569

 

 

 

20,906

 

 

 

58,167

 

 

 

66,086

 

General and administrative expenses, net of ceding commission income for the three and nine months ended September 30, 2018, of $4,526 and $13,772 respectively

 

 

25,815

 

 

 

15,420

 

 

 

72,167

 

 

 

48,826

 

Total expenses

 

 

111,079

 

 

 

100,361

 

 

 

308,109

 

 

 

271,640

 

Operating income

 

 

14,216

 

 

 

1,413

 

 

 

47,184

 

 

 

26,365

 

Interest expense, net

 

 

5,225

 

 

 

3,751

 

 

 

15,431

 

 

 

8,163

 

Other non-operating income, net

 

 

 

 

 

6,883

 

 

 

(542

)

 

 

6,883

 

Income (loss) before income taxes

 

 

8,991

 

 

 

(9,221

)

 

 

32,295

 

 

 

11,319

 

Provision for income taxes

 

 

3,002

 

 

 

(525

)

 

 

9,068

 

 

 

7,390

 

Net income (loss)

 

$

5,989

 

 

$

(8,696

)

 

$

23,227

 

 

$

3,929

 

OTHER COMPREHENSIVE (LOSS) INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in net unrealized (losses) gains on investments

 

 

(2,895

)

 

 

593

 

 

 

(9,918

)

 

 

8,473

 

Reclassification adjustment for net realized investment (gains) losses

 

 

(5

)

 

 

(365

)

 

 

307

 

 

 

(1,011

)

Income tax (expense) benefit related to items of other comprehensive income

 

 

1,665

 

 

 

(81

)

 

 

3,249

 

 

 

(2,866

)

Total comprehensive (loss) income

 

$

4,754

 

 

$

(8,549

)

 

$

16,865

 

 

$

8,525

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

25,631,871

 

 

 

25,883,267

 

 

 

25,663,415

 

 

 

27,647,146

 

Diluted

 

 

26,046,938

 

 

 

25,883,267

 

 

 

26,340,759

 

 

 

27,647,146

 

Earnings (loss) per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.23

 

 

$

(0.34

)

 

$

0.91

 

 

$

0.14

 

Diluted

 

$

0.23

 

 

$

(0.34

)

 

$

0.88

 

 

$

0.14

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

3


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Stockholders’ Equity

Nine Months Ended September 30, 2018 and 2017

(Unaudited)

(Amounts in thousands, except share amounts)

 

 

 

Common Shares

 

 

Par Value

 

 

Additional

Paid-In

Capital

 

 

Retained

Earnings

 

 

Treasury Shares

 

 

Accumulated

Other Comprehensive Loss

 

 

Total

Stockholders'

Equity

 

Balance at December 31, 2017, as previously reported

 

 

25,885,004

 

 

$

3

 

 

$

294,836

 

 

$

175,226

 

 

$

(87,185

)

 

$

(3,064

)

 

$

379,816

 

Cumulative effect of change in accounting principle (ASU 2016-01), net of tax

 

 

 

 

 

 

 

 

 

 

 

(267

)

 

 

 

 

 

267

 

 

 

 

Balance at December 31, 2017, as adjusted

 

 

25,885,004

 

 

 

3

 

 

 

294,836

 

 

 

174,959

 

 

 

(87,185

)

 

 

(2,797

)

 

 

379,816

 

Stock buy-back

 

 

(115,200

)

 

 

 

 

 

 

 

 

 

 

 

(2,000

)

 

 

 

 

 

(2,000

)

Stock-based compensation

 

 

 

 

 

 

 

 

3,929

 

 

 

 

 

 

 

 

 

 

 

 

3,929

 

Convertible Option debt extinguishment, net of tax

 

 

 

 

 

 

 

 

(4,235

)

 

 

 

 

 

 

 

 

 

 

 

(4,235

)

Reclassification of income taxes upon early adoption of ASU 2018-02

 

 

 

 

 

 

 

 

 

 

 

424

 

 

 

 

 

 

(424

)

 

 

 

Tax effect of warrant reclassification

 

 

 

 

 

 

 

 

970

 

 

 

 

 

 

 

 

 

 

 

 

970

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

(4,789

)

 

 

 

 

 

 

 

 

(4,789

)

Net unrealized change in investments,

   net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,362

)

 

 

(6,362

)

Net income

 

 

 

 

 

 

 

 

 

 

 

23,227

 

 

 

 

 

 

 

 

 

23,227

 

Balance at September 30, 2018

 

 

25,769,804

 

 

$

3

 

 

$

295,500

 

 

$

193,821

 

 

$

(89,185

)

 

$

(9,583

)

 

$

390,556

 

 

 

 

Common Shares

 

 

Par Value

 

 

Additional

Paid-In

Capital

 

 

Retained

Earnings

 

 

Treasury Shares

 

 

Accumulated

Other Comprehensive Loss

 

 

Total

Stockholders'

Equity

 

Balance at December 31, 2016

 

 

28,840,443

 

 

$

3

 

 

$

205,727

 

 

$

182,809

 

 

$

(25,562

)

 

$

(5,018

)

 

$

357,959

 

Stock buy-back

 

 

(5,340,267

)

 

 

(1

)

 

 

 

 

 

 

 

 

(61,623

)

 

 

 

 

 

(61,624

)

Stock-based compensation

 

 

 

 

 

 

 

 

3,611

 

 

 

 

 

 

 

 

 

 

 

 

3,611

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

(6,790

)

 

 

 

 

 

 

 

 

(6,790

)

Net unrealized change in investments,

   net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4,596

 

 

 

4,596

 

Net income

 

 

 

 

 

 

 

 

 

 

 

3,929

 

 

 

 

 

 

 

 

 

3,929

 

Balance at September 30, 2017

 

 

23,500,176

 

 

$

2

 

 

$

209,338

 

 

$

179,948

 

 

$

(87,185

)

 

$

(422

)

 

$

301,681

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

For the Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

$

23,227

 

 

$

3,929

 

Adjustments to reconcile net income to net cash (used in) provided by operating

   activities:

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

3,929

 

 

 

3,611

 

Bond amortization and accretion

 

 

4,935

 

 

 

6,810

 

Amortization of original issuance discount on debt

 

 

3,188

 

 

 

 

Depreciation and amortization

 

 

21,408

 

 

 

5,904

 

Allowance for doubtful accounts

 

 

4,468

 

 

 

 

Net realized gains (losses)

 

 

307

 

 

 

(1,011

)

Change in fair value of long-term debt conversion feature

 

 

 

 

 

6,883

 

Net gain on repurchase of debt

 

 

(542

)

 

 

 

Deferred income taxes

 

 

(17,301

)

 

 

(1,376

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accrued investment income

 

 

1,304

 

 

 

129

 

Premiums receivable, net

 

 

(1,332

)

 

 

7,394

 

Prepaid reinsurance premiums

 

 

(54,885

)

 

 

(47,346

)

Reinsurance premiums receivable and recoverable

 

 

32,531

 

 

 

(370,751

)

Income taxes receivable

 

 

1,089

 

 

 

9,064

 

Deferred policy acquisition costs, net

 

 

(34,024

)

 

 

891

 

Other assets

 

 

230

 

 

 

(7,332

)

Unpaid losses and loss adjustment expenses

 

 

(48,988

)

 

 

349,443

 

Unearned premiums

 

 

9,346

 

 

 

(4,180

)

Reinsurance payable

 

 

199,445

 

 

 

61,455

 

Funds held by company under reinsurance treaties

 

 

 

 

 

61,732

 

Accrued interest

 

 

(757

)

 

 

(1,363

)

Accrued compensation

 

 

(5,991

)

 

 

2,652

 

Advance premiums

 

 

9,787

 

 

 

1,832

 

Other liabilities

 

 

(91,031

)

 

 

9,276

 

Net cash provided by operating activities

 

 

60,343

 

 

 

97,646

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Proceeds from sales and maturities of investments available for sale

 

 

232,666

 

 

 

96,467

 

Purchases of investments available for sale

 

 

(212,107

)

 

 

(11,702

)

Cost of property and equipment acquired

 

 

(1,425

)

 

 

(195

)

Net cash provided by investing activities

 

 

19,134

 

 

 

84,570

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Proceeds from issuance of secured convertible debt

 

 

 

 

 

136,750

 

Debt issuance costs

 

 

 

 

 

(5,105

)

Mortgage loan payments

 

 

(196

)

 

 

 

Repurchase of convertible note

 

 

(13,248

)

 

 

 

Purchase of treasury stock

 

 

(2,000

)

 

 

(61,624

)

Cash dividends paid

 

 

(4,789

)

 

 

(6,790

)

Net cash (used in) provided by financing activities

 

 

(20,233

)

 

 

63,231

 

Increase in cash, cash equivalents, and restricted cash

 

 

59,244

 

 

 

245,447

 

Cash, cash equivalents and restricted cash, beginning of period

 

 

174,530

 

 

 

126,727

 

Cash, cash equivalents and restricted cash, end of period

 

$

233,774

 

 

$

372,174

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

 

Income taxes paid

 

$

25,267

 

 

$

 

Interest paid

 

$

14,265

 

 

$

5,969

 

 

5


 

Reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets.

 

 

 

 

September 30, 2018

 

 

December 31, 2017

 

 

 

(In thousands)

 

Cash and cash equivalents

 

$

221,524

 

 

$

153,697

 

Restricted cash

 

 

12,250

 

 

$

20,833

 

Total cash, cash equivalents and restricted cash shown in the condensed consolidated statements of cash flows

 

$

233,774

 

 

$

174,530

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 


6


 

HERITAGE INSURANCE HOLDINGS, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

 

NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The condensed consolidated financial statements as of and for the three and nine months ended September 30, 2018 and 2017 include Heritage Insurance Holdings, Inc. (“Parent Company”); its property and casualty insurance subsidiaries: Heritage Property & Casualty Insurance Company (“Heritage P&C”), Narragansett Bay Insurance Company (“NBIC”) and Zephyr Insurance Company, Inc. (“Zephyr”); Heritage MGA, LLC, (“HMGA”), the managing general agent that manages substantially all aspects of our Florida insurance subsidiary’s business; Contractors’ Alliance Network, LLC (“CAN”), our claims vendor network manager for Florida that provides restoration, emergency and recovery services; Skye Lane Properties, LLC, our property management subsidiary; First Access Insurance Group, LLC, our retail agency and licensed reinsurance intermediary; Osprey Re Ltd. (“Osprey”), our reinsurance subsidiary that may provide a portion of the reinsurance protection purchased by our insurance subsidiaries; and Heritage Insurance Claims, LLC, an inactive subsidiary reserved for future development.

Through our insurance subsidiaries, Heritage P&C, Zephyr and NBIC, we write personal residential insurance for single-family homeowners and condominium owners, and rental property insurance in the states of Alabama, Connecticut, Florida, Georgia, Hawaii, Massachusetts, New Jersey, New York, North Carolina, Rhode Island and South Carolina. We also provide commercial residential insurance for Florida properties and are also licensed in the states of Maryland, Mississippi, Pennsylvania and Virginia. We are vertically integrated and control or manage substantially all aspects of insurance underwriting, customer service, actuarial analysis, distribution and claims processing and adjusting.

The condensed consolidated financial information included herein as of and for the three and nine months ended September 30, 2018 and 2017 does not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. However, such information reflects all adjustments consisting of normal recurring accruals which are, in the opinion of management, necessary for a fair statement of the financial condition and results of operations for the interim periods. The results for the three and nine months ended September 30, 2018 and 2017 are not indicative of annual results. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The December 31, 2017 consolidated balance sheet was derived from the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017.

For further information, refer to the consolidated financial statements and footnotes thereto included in Heritage Insurance Holdings, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “2017 Form 10-K”). References to “we”, “us”, “our”, or the “Company” refer to Heritage Insurance Holdings, Inc. and its consolidated subsidiaries.

Changes to significant accounting policies

We have made no material changes to our significant accounting policies as reported in our Annual Report on Form 10-K for the year ended December 31, 2017.

Reclassification

We have reclassified certain amounts in the 2017 statement of operations to conform to our 2018 presentation. Additionally, we reclassified certain amounts in the 2017 consolidated statement of cash flows to conform to the 2018 presentation, relating to the presentation of restricted cash and cash equivalents. This reclassification is a result of our adoption of Accounting Standards Update (ASU) 2016-18, Restricted Cash effective January 1, 2018.

Recently Adopted Accounting Pronouncements

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): The amendment allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Act”). In addition, under ASU 2018-02, an entity will be required to provide certain disclosures regarding stranded tax effects. The new guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company early adopted the updated guidance effective January 1, 2018 and elected to reclassify the stranded income tax effects relating to the reduction in the federal corporate income tax rate from accumulated other comprehensive income (“AOCI”) to retained earnings at the beginning of the period of adoption. The net impact of the accounting change resulted in a $0.4 million decrease in AOCI comprised of income taxes associated with net unrealized losses on investments and a corresponding increase in retained earnings.

7


 

In May 2017, the FASB issued ASU No. 2017-09, Compensation–Stock Compensation (Topic 718): Scope of Modification Accounting, clarifying when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. The new guidance requires modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. The new guidance was effective for the Company on a prospective basis beginning on January 1, 2018. This new guidance does not have an impact on the Company’s condensed consolidated financial statements as it is not the Company’s practice to change either the terms or conditions of share-based payment awards once they are granted.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805). Clarifying the Definition of a Business, which provides additional guidance on evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The guidance requires an entity to evaluate if substantially all the fair value of the assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the new guidance would define this as an asset acquisition; otherwise, the entity then evaluates whether the asset meets the requirement that a business include, at a minimum, an input and substantive process that together significantly contribute to the ability to create outputs. The guidance was effective for the Company on a prospective basis beginning on January 1, 2018. The impact of this guidance will be determined by the terms of any future acquisitions.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is a new accounting standard that will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. This updated guidance became effective on January 1, 2018 and requires adoption on a retrospective basis. The Company has not experienced any transactions that are within the scope of this guidance and accordingly will evaluate the effect of this guidance further if and when any such transactions occur.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, which requires entities to include in their cash and cash-equivalent balances in the statement of cash flows those amounts that are deemed to be restricted cash and restricted cash equivalents. The ASU does not define the terms “restricted cash” and “restricted cash equivalents.” To conform to the new guidance, the Company reclassified $20.9 million of restricted cash to the beginning period balance for cash, cash equivalents and restricted cash for the nine months ended September 30, 2017.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU will significantly change the income statement impact of equity investments held by an entity and the recognition of changes in fair value of financial liabilities when the fair value option is elected. The guidance requires equity investments to be measured at fair value with changes in fair value recognized through net income. In February 2018, the FASB issued ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10)” to clarify certain aspects of ASU No. 2016-01. The updated guidance was effective for the quarter ended March 31, 2018. The adoption of this guidance resulted in the recognition of $0.4 million of net pre-tax unrealized loss on equity investments as a cumulative effect adjustment that decreased retained earnings as of January 1, 2018 and increased AOCI by the same amount. The Company elected to report changes in the fair value of equity investments in other revenue.

In May 2014, the FASB issued ASU Topic 2014-09, Revenue from Contracts with Customers. The ASU 2014-09 creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The standard became effective for the Company in the first quarter of 2018. The Company has determined that this pronouncement is not applicable to its insurance contracts and is not material to the Company’s condensed consolidated financial statements.

Accounting Pronouncements Not Yet Adopted

The Company describes below recent pronouncements that may have a significant effect on its consolidated financial statements or on its disclosures upon future adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on, or are unrelated to, its financial condition, results of operations, or related disclosures.

In August 2018, the FASB issued ASU 2018-12, Financial Services – Insurance (Topic 944) Targeted Improvements to the Accounting for Long-Duration Contracts, which amends the accounting and disclosure model for certain long-duration insurance contracts under U.S. GAAP. The goal of the ASU amendments is to (1) improve the timeliness of recognizing changes in the liability for future policy benefits and modify the rate used to discount future cash flows; (2) simplify and improve the accounting for certain market-based or guarantees associated with deposit (or account balances) contracts; (3) simplify the amortization of deferred acquisition costs; and (4) improve the effectiveness of the required disclosures. The amendments in ASU 2018-12 will be effective for the Company in the first quarter of 2021. The Company has determined that this pronouncement is not applicable to its insurance contracts and will not have a material impact on its consolidated financial statements.

8


 

In March 2018, the FASB issued ASU 2018-04, Investments-Debt Securities (Topic 320) and Regulated Operations (Topic 980). Pursuant to SEC Staff Accounting Bulletin No. 177 and SEC Release No 33-9273, the amendment of ASU 2018-04 adds, amends and supersedes various paragraphs that contain SEC guidance in ASC 320, Investments-Debt Securities and ASC 980, Regulated Operations. The Company does not anticipate the adoption of ASU 2018-04 will have a material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other. The amendments in ASU 2017-04 intend to simplify the subsequent measurement of goodwill, eliminating Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The standard is effective for the Company in the first quarter of 2020 on a prospective basis with early adoption permitted. The Company does not expect the adoption of this standard will have a material impact on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses Measurement of Credit Losses on Financial Instruments. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset in order to present the net carrying value at the amount expected to be collected on the financial asset on the consolidated balance sheet. The guidance also amends the current accounting for other-than-temporary impairment model by requiring an estimate of the expected credit loss only when the fair value is below the amortized cost of the asset. The length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer impact the determination of whether a potential credit loss exists. The available-for-sale debt security model will also require the use of a valuation allowance as compared to the current practice of writing down the asset. The standard is effective for the Company in the first quarter of 2020 with early adoption permitted in the first quarter of 2019. The Company does not expect the adoption of this standard will have a material impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02 (as subsequently amended by ASU 2018-01, ASU 2018-10 and ASU 2018-11)Lease Accounting, which requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. As with previous guidance, there continues to be a differentiation between finance leases and operating leases, however this distinction now primarily relates to differences in the manner of expense recognition over time and in the classification of lease payments in the statement of cash flows. Lease assets and liabilities arising from both finance and operating leases will be recognized in the statement of financial position. ASU 2016-02 leaves the accounting for leases by lessors largely unchanged from previous GAAP. The transitional guidance for adopting the requirements of ASU 2016-02 calls for a modified retrospective approach that includes a number of optional practical expedients that entities may elect to apply. In addition, ASU 2018-11 provides for an additional (and optional) transition method by which entities may elect to initially apply the transition requirements in Topic 842 at that Topic’s effective date with the effects of initially applying Topic 842 recognized as a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption and without retrospective application to any comparative prior periods presented.

To date, we have taken an inventory of all our operating leases, which consist primarily of auto, equipment and real estate owned and unowned by the Company, started our review of key lease agreements, including contract review for embedded leases, and are currently evaluating lease terms, lease payments and appropriate discount rates to use in calculating the right-to-use asset and lease liability. At September 30, 2018, the Company estimated its lease obligations subject to the new accounting guidance to be in aggregate of $5.2 million with lease terms ranging from 5 to 10 years.

In addition, we are currently evaluating the transition package of practical expedients permitted within the new standard, which among other things, allows us to use hindsight to determine the reasonably certain lease term for existing leases, and allows for the adoption of the new standard at the effective date without adjusting the comparative prior periods presented. We will be continuously assessing the impact of the new standard and the impact on our systems, processes and controls through January 1, 2019, our planned adoption date.

There are no other recently issued accounting standards that apply to the Company or that are expected to have a material impact on the Company’s results of operations, financial condition, or cash flows.

9


 

NOTE 2. ACQUISITION

Acquisition of NBIC

On November 30, 2017, the Company completed the acquisition of all the outstanding capital stock of NBIC Holdings, Inc., the parent company of Narragansett Bay Insurance Company, a leading specialty underwriter of personal residential insurance products and services in several states in the northeastern United States for $250.0 million, including $210.0 million in cash, plus 2,222,215 shares of the Company’s common stock with an aggregate fair value of $40.0 million. The completion of the NBIC acquisition represents a significant advancement in executing the Company’s geographic diversification strategy by leveraging our combined platform to accelerate growth along the Eastern region. The Company recognized goodwill of $106 million, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes. Refer to our 2017 Form 10-K for additional information on this acquisition.

Unaudited Pro Forma Financial Information

The following unaudited pro forma results of operations assume that the NBIC acquisition occurred at the beginning of the periods presented. The pro forma amounts include certain adjustments, including depreciation and amortization expense and income taxes. The unaudited pro forma information assumes the acquisition had taken place January 1, 2017.

The unaudited pro forma effects for the three and nine months ended September 30, 2017 is as follows:

 

 

For the Three Months Ended September 30, 2017

 

 

For the Nine Months Ended September 30, 2017

 

 

(In thousands, except per share)

 

Revenue

$

176,123

 

 

$

401,061

 

Net (loss) income

$

(2,732

)

 

$

14,662

 

Basic, (loss) earnings per share

$

(0.12

)

 

$

0.49

 

Diluted, (loss) earnings per share

$

(0.12

)

 

$

0.49

 

 

NOTE 3. INVESTMENTS

The following table details the difference between cost or adjusted/amortized cost and estimated fair value, by major investment category, at September 30, 2018 and December 31, 2017:

 

 

 

Cost or Adjusted /

Amortized Cost

 

 

Gross Unrealized

Gains

 

 

Gross Unrealized

Losses

 

 

Fair Value

 

 

 

(In thousands)

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

46,934

 

 

$

2

 

 

$

1,051

 

 

$

45,885

 

States, municipalities and political subdivisions

 

 

61,672

 

 

 

 

 

 

1,527

 

 

 

60,145

 

Special revenue

 

 

261,799

 

 

 

10

 

 

 

6,316

 

 

 

255,493

 

Industrial and miscellaneous

 

 

152,884

 

 

 

27

 

 

 

3,560

 

 

 

149,351

 

Redeemable preferred stocks

 

 

4,850

 

 

 

6

 

 

 

189

 

 

 

4,667

 

Total fixed maturities

 

 

528,139

 

 

 

45

 

 

 

12,643

 

 

 

515,541

 

Nonredeemable preferred stocks

 

 

13,808

 

 

 

17

 

 

 

654

 

 

 

13,171

 

Equity securities

 

 

3,098

 

 

 

37

 

 

 

597

 

 

 

2,538

 

Total equity securities

 

 

16,906

 

 

 

54

 

 

 

1,251

 

 

 

15,709

 

Total investments

 

$

545,045

 

 

$

99

 

 

$

13,894

 

 

$

531,250

 

 

10


 

 

 

Cost or Adjusted /

Amortized Cost

 

 

Gross Unrealized

Gains

 

 

Gross Unrealized

Losses

 

 

Fair Value

 

 

 

(In thousands)

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

39,445

 

 

$

7

 

 

$

572

 

 

$

38,880

 

States, municipalities and political subdivisions

 

 

76,876

 

 

 

104

 

 

 

569

 

 

 

76,411

 

Special revenue

 

 

269,277

 

 

 

524

 

 

 

2,124

 

 

 

267,677