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EX-10.3 - EXHIBIT 10.3 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit103.htm
EX-31.1 - EXHIBIT 31.1 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit311.htm
EX-10.2 - EXHIBIT 10.2 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit102.htm
EX-31.2 - EXHIBIT 31.2 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit312.htm
EX-10.1 - EXHIBIT 10.1 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit101.htm
EX-32 - EXHIBIT 32 - HC2 HOLDINGS, INC.a2016-q1form10xqexhibit32.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________________________________________________________________________
FORM 10-Q
_________________________________________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission File No. 001-35210 
_________________________________________________________________________________________
HC2 HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
_________________________________________________________________________________________

Delaware
 
54-1708481
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
505 Huntmar Park Drive, Suite 325
 
 
Herndon, VA
 
20170
(Address of principal executive offices)
 
(Zip Code)
 
(703) 865-0700
(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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding as of April 30, 2016
Common Stock, $0.001 par value
35,520,967
 




HC2 HOLDINGS, INC.
INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION
 
 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 

2


HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)


PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

 
Three Months Ended March 31,
 
2016
 
2015
Services revenue
$
182,109

 
$
73,718

Sales revenue
120,497

 
128,090

Life, accident and health earned premiums, net
19,934

 

Net investment income
14,079

 

Realized losses on investments
(4,875
)
 

Net revenue
331,744

 
201,808

Operating expenses
 
 
 
Cost of revenue - services
174,873

 
61,920

Cost of revenue - sales
99,677

 
110,536

Policy benefits, changes in reserves, and commissions
34,139

 

Selling, general and administrative
36,302

 
23,512

Depreciation and amortization
5,597

 
5,255

Loss on sale or disposal of assets
887

 
473

Total operating expenses
351,475

 
201,696

Income (loss) from operations
(19,731
)
 
112

Interest expense
(10,326
)
 
(8,700
)
Other income (expense), net
110

 
(227
)
Loss from equity investees
(3,934
)
 
(2,688
)
Loss from continuing operations before income taxes
(33,881
)
 
(11,503
)
Income tax benefit
2,539

 
6,014

Loss from continuing operations
(31,342
)
 
(5,489
)
Loss from discontinued operations

 
(9
)
Net loss
(31,342
)
 
(5,498
)
Less: Net income attributable to noncontrolling interest and redeemable noncontrolling interest
880

 
261

Net loss attributable to HC2 Holdings, Inc.
(30,462
)
 
(5,237
)
Less: Preferred stock dividends and accretion
1,069

 
1,088

Net loss attributable to common stock and participating preferred stockholders
$
(31,531
)
 
$
(6,325
)
Basic loss per common share:
 
 
 
Loss from continuing operations
$
(0.89
)
 
$
(0.26
)
Loss from discontinued operations

 

Net loss attributable to common stock and participating preferred stockholders
$
(0.89
)
 
$
(0.26
)
Diluted loss per common share:
 
 
 
Loss from continuing operations
$
(0.89
)
 
$
(0.26
)
Loss from discontinued operations

 

Net loss attributable to common stock and participating preferred stockholders
$
(0.89
)
 
$
(0.26
)
Weighted average common shares outstanding:
 
 
 
Basic
35,262

 
24,146

Diluted
35,262

 
24,146

See accompanying notes to condensed consolidated financial statements.

3


HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (INCOME) LOSS
(in thousands)
(Unaudited)



 
Three Months Ended March 31,
 
2016
 
2015
Net loss
$
(31,342
)
 
$
(5,498
)
Other comprehensive income (loss)
 

 
 

Foreign currency translation adjustment
1,823

 
(4,361
)
Unrealized gain (loss) on available-for-sale securities, net of tax
18,617

 
149

Less: Comprehensive income attributable to the noncontrolling interest and redeemable noncontrolling interest
880

 
261

Comprehensive loss attributable to HC2 Holdings, Inc.
$
(10,022
)
 
$
(9,449
)
See accompanying notes to condensed consolidated financial statements.

4


HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(Unaudited)


 
March 31, 2016
 
December 31, 2015
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities, available-for-sale at fair value
$
1,278,031

 
$
1,231,841

Equity securities, available-for-sale at fair value
47,557

 
49,682

Mortgage loans
1,145

 
1,252

Policy loans
18,360

 
18,476

Other invested assets
46,009

 
53,119

Total investments
1,391,102

 
1,354,370

Cash and cash equivalents
137,700

 
158,624

Restricted cash
589

 
538

Accounts receivable (net of allowance for doubtful accounts of $1,621 and $794 at March 31, 2016 and December 31, 2015, respectively)
192,607

 
210,853

Costs and recognized earnings in excess of billings on uncompleted contracts
33,143

 
39,310

Inventory
10,636

 
12,120

Recoverable from reinsurers
526,251

 
522,562

Accrued investment income
16,420

 
15,300

Deferred tax asset
44,245

 
52,511

Property, plant and equipment, net
241,848

 
214,466

Goodwill
83,766

 
61,178

Intangibles
37,539

 
29,409

Other assets
44,142

 
65,206

Assets held for sale
4,976

 
6,065

Total assets
$
2,764,964

 
$
2,742,512

Liabilities, temporary equity and stockholders’ equity
 
 
 
Life, accident and health reserves
$
1,614,244

 
$
1,593,330

Annuity reserves
258,644

 
259,460

Value of business acquired
51,130

 
50,761

Accounts payable and other current liabilities
193,137

 
225,389

Billings in excess of costs and recognized earnings on uncompleted contracts
24,643

 
21,201

Deferred tax liability
18,249

 
4,281

Long-term obligations
394,242

 
371,876

Pension liability
22,982

 
25,156

Other liabilities
16,986

 
17,793

Total liabilities
2,594,257

 
2,569,247

Commitments and contingencies

 

Temporary equity:
 
 
 
Preferred stock, $.001 par value - 20,000,000 shares authorized; Series A - 29,172 shares issued and outstanding at March 31, 2016 and December 31, 2015; Series A-1 - 10,000 shares issued and outstanding at March 31, 2016 and December 31, 2015; Series A-2 - 14,000 shares issued and outstanding at March 31, 2016 and December 31, 2015
52,674

 
52,619

Redeemable noncontrolling interest
3,090

 
3,122

Total temporary equity
55,764

 
55,741

Stockholders’ equity:
 
 
 
Common stock, $.001 par value - 80,000,000 shares authorized; 35,346,536 and 35,281,375 shares issued and 35,314,910 and 35,249,749 shares outstanding at March 31, 2016 and December 31, 2015, respectively
35

 
35

Additional paid-in capital
211,713

 
209,477

Accumulated deficit
(110,191
)
 
(79,729
)
Treasury stock, at cost
(378
)
 
(378
)
Accumulated other comprehensive loss
(14,935
)
 
(35,375
)
Total HC2 Holdings, Inc. stockholders’ equity before noncontrolling interest
86,244

 
94,030

Noncontrolling interest
28,699

 
23,494

Total stockholders’ equity
114,943

 
117,524

Total liabilities, temporary equity and stockholders’ equity
$
2,764,964

 
$
2,742,512

See accompanying notes to condensed consolidated financial statements.

5


HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(Unaudited)


 
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Non- controlling Interest
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance as of December 31, 2014
 
23,813

 
$
24

 
$
141,948

 
$
(378
)
 
$
(44,164
)
 
$
(18,243
)
 
$
25,208

 
$
104,395

Share-based compensation expense
 

 

 
2,694

 

 

 

 

 
2,694

Preferred stock dividends and accretion
 

 

 
(1,088
)
 

 

 

 

 
(1,088
)
Issuance of common stock
 
2

 

 

 

 

 

 

 

Issuance of restricted stock
 
1,436

 
1

 

 

 

 

 

 
1

Conversion of preferred stock to common stock
 
118

 

 
500

 

 

 

 

 
500

Acquisition of noncontrolling interest
 

 

 

 

 

 

 
(271
)
 
(271
)
Excess book value over fair value of purchased noncontrolling interest
 

 

 
34

 

 

 

 
(34
)
 

Net (loss) income
 

 

 

 

 
(5,237
)
 

 
(261
)
 
(5,498
)
Foreign currency translation adjustment
 

 

 

 

 

 
(4,361
)
 

 
(4,361
)
Unrealized gain (loss) on available-for-sale securities, net of tax
 

 

 

 

 

 
149

 

 
149

Balance as of March 31, 2015
 
25,369

 
$
25

 
$
144,088

 
$
(378
)
 
$
(49,401
)
 
$
(22,455
)
 
$
24,642

 
$
96,521


 
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Non- controlling Interest
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance as of December 31, 2015
 
35,250

 
$
35

 
$
209,477

 
$
(378
)
 
$
(79,729
)
 
$
(35,375
)
 
$
23,494

 
$
117,524

Share-based compensation expense
 

 

 
2,582

 

 

 

 
609

 
3,191

Preferred stock dividend and accretion
 

 

 
(1,014
)
 

 

 

 

 
(1,014
)
Preferred stock beneficial conversion feature
 

 

 
(55
)
 

 

 

 

 
(55
)
Issuance of common stock
 
65

 

 

 

 

 

 

 

Acquisition of noncontrolling interest
 

 

 

 

 

 

 
822

 
822

Sale of controlling interest
 

 

 

 

 

 

 
5,345

 
5,345

Excess fair value over book value of noncontrolling interest sold
 

 

 
723

 

 

 

 
(723
)
 

Net (loss) income
 

 

 

 

 
(30,462
)
 

 
(880
)
 
(31,342
)
Net income (loss) attributable to noncontrolling interest and redeemable noncontrolling interest
 

 

 

 

 

 

 
32

 
32

Foreign currency translation adjustment
 

 

 

 

 

 
1,823

 

 
1,823

Unrealized gain (loss) on available-for-sale securities, net of tax
 

 

 

 

 

 
18,617

 

 
18,617

Balance as of March 31, 2016

35,315


$
35


$
211,713


$
(378
)

$
(110,191
)

$
(14,935
)

$
28,699

 
$
114,943

See accompanying notes to condensed consolidated financial statements.

6


HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)


 
Three Months Ended March 31,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(31,342
)
 
$
(5,498
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
 

 
 

Provision for doubtful accounts receivable
112

 
95

Share-based compensation expense
3,191

 
2,694

Depreciation and amortization
7,526

 
7,130

Amortization of deferred financing costs and debt discount
495

 
421

Amortization of fixed maturities discount/premium
3,361

 

(Gain) loss on sale or disposal of assets
887

 
473

Realized (gain) loss on investments
4,649

 
(515
)
Unrealized (gain) loss on investments
(1,582
)
 

Impairment of investments
2,686

 

Equity investment (income)/loss
3,934

 
2,688

Deferred income taxes
(12,311
)
 
(568
)
Receipt of dividends from equity investees
7,214

 

Other
2,368

 
172

Changes in assets and liabilities, net of acquisitions:
 

 
 

(Increase) decrease in accounts receivable
18,900

 
(45,764
)
(Increase) decrease in costs and recognized earnings in excess of billings on uncompleted contracts
6,167

 
3,468

(Increase) decrease in inventory
2,012

 
(2,355
)
(Increase) decrease in other assets
18,700

 
(3,614
)
Increase (decrease) in life, accident and health reserves
20,914

 

Increase (decrease) in accounts payable, current and other liabilities
(42,324
)
 
3,455

Increase (decrease) in billings in excess of costs and recognized earnings on uncompleted contracts
3,442

 
(10,116
)
Increase (decrease) in pension liability
(2,174
)
 
(1,125
)
Net change in cash due to operating activities
16,825

 
(48,959
)
Cash flows from investing activities:
 

 
 

Purchase of property, plant and equipment
(6,512
)
 
(3,124
)
Sale of property and equipment and other assets
471

 
998

Purchase of investments
(73,606
)
 
(18,558
)
Sale of investments
51,040

 
1,026

Cash paid for business acquisitions, net of cash acquired
(6,469
)
 

Purchase of noncontrolling interest

 
(222
)
Sale of controlling interest
2,000

 

(Increase) decrease in restricted cash
(51
)
 
(893
)
Net change in cash due to investing activities
(33,127
)
 
(20,773
)
Cash flows from financing activities:
 

 
 

Proceeds from long-term obligations
2,360

 
50,250

Principal payments on long-term obligations
(2,538
)
 
(2,082
)
Borrowings on line of credit, net
(618
)
 
29,445

Payment of deferred financing costs

 
(1,136
)
Annuity receipts
785

 

Annuity surrenders
(5,149
)
 

Proceeds from sale of preferred stock, net

 
14,032

Payment of dividends
(1,014
)
 


7



Net change in cash due to financing activities
(6,174
)
 
90,509

Effects of exchange rate changes on cash and cash equivalents
1,552

 
117

Net change in cash and cash equivalents
(20,924
)
 
20,894

Cash and cash equivalents, beginning of period
158,624

 
107,978

Cash and cash equivalents, end of period
$
137,700

 
$
128,872

Supplemental cash flow information:
 

 
 

Cash paid for interest
$
1,465

 
$
1,287

Cash paid for taxes
$
639

 
$
112

Preferred stock dividends and accretion
$
55

 
$
67

Non-cash investing and financing activities:
 

 
 

Purchases of property, plant and equipment under financing arrangements
$

 
$
1,808

Property, plant and equipment included in accounts payable
$
946

 
$
1,632

Conversion of preferred stock to common stock
$

 
$
500

See accompanying notes to condensed consolidated financial statements.

8

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. Organization and Business

HC2 Holdings, Inc. (“HC2” and, together with its subsidiaries, the “Company”, “we” and “our”) is a diversified holding company which seeks to acquire and grow attractive businesses that it believes can generate long-term sustainable free cash flow and attractive returns. While the Company generally intends to acquire controlling equity interests in its operating subsidiaries, the Company also invests to a more limited extent in a variety of debt instruments or noncontrolling equity interest positions. The Company’s shares of common stock trade on the NYSE MKT LLC under the symbol “HCHC”.

The Company currently has seven reportable segments based on management’s organization of the enterprise—Manufacturing, Marine Services, Insurance, Utilities, Telecommunications, Life Sciences and Other which includes operations that do not meet the separately reportable segment thresholds.

1.Our Manufacturing segment includes Schuff International, Inc. ("Schuff") and its wholly-owned subsidiaries. Schuff is an integrated fabricator and erector of structural steel and heavy steel plates with headquarters in Phoenix, Arizona. Schuff has operations in Arizona, Georgia, Texas, Kansas and California, with its construction projects primarily located in the aforementioned states. In addition, Schuff has construction projects in select international markets, primarily Panama through, Schuff Hopsa Engineering, Inc., a Panamanian joint venture with Empresas Hopsa, S.A. that provides steel fabrication services. The Company maintains a 91% controlling interest in Schuff.

2.Our Marine Services segment includes Global Marine Systems Limited ("GMSL"). GMSL is a leading provider of engineering and underwater services on submarine cables. In conjunction with the acquisition of GMSL, approximately 3% of the Company’s interest in GMSL was purchased by a group of individuals. The Company maintains a 97% controlling interest in GMSL.

3.Our Insurance segment includes United Teacher Associates Insurance Company ("UTA") and Continental General Insurance Company ("CGI", and together with UTA, "CII" or the "Insurance Companies"). Insurance Companies provide long-term care, life and annuity coverage to approximately 99,000 individuals. The benefits provided help protect our policy and certificate holders from the financial hardships associated with illness, injury, loss of life, or income continuation.

4.Our Utilities segment includes American Natural Gas ("ANG"). ANG is a premier distributor of natural gas motor fuel headquartered in the Northeast. ANG designs, builds, owns, acquires, operates and maintains compressed natural gas fueling stations for transportation vehicles. ANG’s team is comprised of industry, legal, construction, engineering and entrepreneurial experts who are working directly with the leading natural gas companies to seek out opportunities for building successful natural gas fueling stations. Vehicle manufacturers and fleet operators are pursuing natural gas vehicles in the US markets to reduce carbon emissions and environmental impacts while providing a cost-effective alternative to foreign crude oil. The Company maintains a 55% controlling interest in ANG.

5.In our Telecommunications segment, we operate a telecommunications business including a network of direct routes and provide premium voice communication services for national telecom operators, mobile operators, wholesale carriers, prepaid operators, Voice over Internet Protocol service operators and Internet service providers from our International Carrier Services ("ICS") business unit. We provide premium voice communications services for National Telecom operators, Mobile operators, wholesale carriers, Prepaid operators, VARS & VOIP service operators. ICS provides a quality service via direct routes & by forming strong relationships with carefully selected partners.

6.Our Life Sciences segment includes Pansend Life Sciences, LLC (“Pansend”). Pansend owns (i) a 77% interest in Genovel Orthopedics, Inc., which seeks to develop products to treat early osteoarthritis of the knee, (ii) a 61% interest in R2 Dermatology (f/k/a GemDerm Aesthetics, Inc.), which develops skin lightening technology, (iii) a 60% interest in Benevir Biopharm, Inc., which focuses on immunotherapy for the treatment of solid tumors and invests in other early stage or developmental stage healthcare companies.

7.In our Other segment, we invest in and grow developmental stage companies where we believe growth potential is significant. In this segment, we currently have a 72% ownership interest in DMi, Inc. ("DMi"), which owns licenses to create and distribute NASCAR® video games. See footnotes 17. Related Parties and 21. Subsequent Events.




9

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2. Summary of Significant Accounting Policies

Basis of Presentation - The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial reporting and Securities and Exchange Commission (“SEC”) regulations. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such principles and regulations. In the opinion of management, the financial statements reflect all adjustments (all of which are of a normal and recurring nature), which are necessary to present fairly the financial position, results of operations, cash flows and comprehensive income (loss) for the interim periods. The results for the Company’s three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s most recently filed Annual Report on Form 10-K.

Principles of Consolidation - The condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and all other subsidiaries over which the Company exerts control. All intercompany profits, transactions and balances have been eliminated in consolidation. As of March 31, 2016, the Company has a 100% interest in the Insurance Companies, a 97% interest in GMSL, a 91% interest in Schuff, a 55% interest in ANG and a 72% interest in DMi, Inc. Through its subsidiary, Pansend, the Company has a 77% interest in Genovel Orthopedics, Inc., a 61% interest in R2 Dermatology and a 60% interest in Benevir Biopharm, Inc. The results of each of these entities are consolidated with the Company’s results from and after their respective acquisition dates based on guidance from the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 810, “Consolidation” (“ASC 810”). The remaining interests not owned by the Company are presented as a noncontrolling interest component of total equity. Schuff uses a 4-4-5 week quarterly cycle, which for the first quarter of 2016 ended on April 2, 2016.

Reclassification - Certain previous year amounts have been reclassified to conform with current year presentations related to the reporting of new financial statement line items.

Newly Adopted Accounting Principles

In September 2015, the FASB issued Accounting Standards Update ("ASU") 2015-16, “Business Combination Topic No. 805: Simplifying the Accounting for Measurement - Period Adjustments”, which requires adjustments to provisional amounts that are identified during the measurement period to be 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. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In August 2015, the FASB issued ASU 2015-15, “Interest - Imputation of Interest Subtopic No. 835-30: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”, which codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line-of-credit arrangements as assets, rather than as a direct offset to the liability as is required now under ASU 2015-03. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In July, 2015, the FASB issued ASU 2015-12, "(Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient". Part I of this ASU is related to one area of several potential simplifications for employee benefit plans and designates contract value as the only required measure for fully benefit-responsive investment contracts, which maintains the relevant information while reducing the cost and complexity of reporting for fully benefit responsive investment contracts. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In May, 2015, the FASB has issued ASU 2015-9, "Disclosures About Short-Duration Contracts". This ASU requires insurance entities to disclose for annual reporting periods the certain information the liability for unpaid claims and claim adjustment expenses. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In May 2015, the FASB issued ASU 2015-8, “Business Combinations Topic No. 805: Pushdown Accounting-Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115 (SEC Update)”, which rescinds certain SEC guidance in order

10

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

to confirm with ASU 2014-17, “Pushdown Accounting” (“ASU 2014-17”). ASU 2014-17 was issued in November 2014 and provides a reporting entity that is a business or nonprofit activity (an “acquiree”) the option to apply pushdown accounting to its separate financial statements when an acquirer obtains control of the acquiree. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In May 2015, the FASB issued ASU 2015-07, "Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)". The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In February 2015, the FASB issued ASU 2015-2, “Amendments to the Consolidation Analysis”, which amends the consolidation requirements in ASC 810 and significantly changes the consolidation analysis required under U.S. GAAP relating to whether or not to consolidate certain legal entities. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

In January 2015, the FASB issued ASU 2015-1, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items”, which eliminates the concept from U.S. GAAP the concept of an extraordinary item. Under the ASU, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. On January 1, 2016, the Company adopted this update, which did not have a material impact on the condensed consolidated financial statements.

New Accounting Pronouncements

In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" (Topic 718), which introduces targeted amendments intended to simplify the accounting for stock compensation. Specifically, the ASU requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) to be recognized as income tax expense or benefit in the income statement. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company is currently evaluating the impact of the accounting update on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, "Principal versus Agent Considerations" (Topic 606), which updates the new revenue standard by clarifying the principal versus agent implementation guidance. Early adoption is permitted. The Company's effective date for adoption is January 1, 2018. The Company is currently evaluating the impact of the accounting update on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-07, "Simplifying the Transition to the Equity Method of Accounting" (Topic 323), which requires an investor to initially apply the equity method of accounting from the date it qualifies for that method, i.e., the date the investor obtains significant influence over the operating and financial policies of an investee. The ASU eliminates the previous requirement to retroactively adjust the investment and record a cumulative catch up for the periods that the investment had been held, but did not qualify for the equity method of accounting. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company is currently evaluating the impact of the accounting update on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-06, "Contingent Put and Call Options in Debt Instruments" (Topic 815), which addresses how an entity should assess whether contingent call (put) options that can accelerate the payment of debt instruments are clearly and closely related to their debt hosts. This assessment is necessary to determine if the option(s) must be separately accounted for as a derivative. The ASU clarifies that an entity is required to assess the embedded call (put) options solely in accordance with a specific four-step decision sequence. This means entities are not also required to assess whether the contingency for exercising the option(s) is indexed to interest rates or credit risk. For example, when evaluating debt instruments puttable upon a change in control, the event triggering the change in control is not relevant to the assessment. Only the resulting settlement of debt is subject to the four-step decision sequence. Early adoption is permitted. The Company's effective date for adoption is January

11

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1, 2017. The Company is currently evaluating the impact of the accounting update on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-05, "Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships" (Topic 815), which requires an entity to discontinue a designated hedging relationship in certain circumstances, including termination of the derivative hedging instrument or if the entity wishes to change any of the critical terms of the hedging relationship. ASU 2016-05 amends Topic 815 to clarify that novation of a derivative (replacing one of the parties to a derivative instrument with a new party) designated as the hedging instrument would not, in and of itself, be considered a termination of the derivative instrument or a change in critical terms requiring discontinuation of the designated hedging relationship. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company is currently evaluating the impact of the accounting update on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, "Leases" (Topic 842), which applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. The ASU requires a lessor to classify leases as either sales-type, direct financing or operating, similar to existing U.S. GAAP. Classification depends on the same five criteria used by lessees plus certain additional factors. The new leases standard addresses other considerations including identification of a lease, separating lease and nonlease components of a contract, sale and leaseback transactions, modifications, combining contracts, reassessment of the lease term, and remeasurement of lease payments. Early adoption is permitted. The Company’s effective date for adoption is January 1, 2019. The Company is currently evaluating the impact of this accounting update on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities" (Topic 825-10) which, among other things, will require all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income instead of accumulated other comprehensive income. Certain provisions of the ASU are eligible for early adoption. The Company’s effective date for adoption is January 1, 2018. The Company is currently evaluating the impact of this accounting update on its consolidated financial statements.
 
3. Business Combinations

The Company’s acquisitions were accounted for using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date. Estimates of fair value included in the condensed consolidated financial statements, in conformity with ASC No. 820, “Fair Value Measurements and Disclosures” (“ASC 820”), represent the Company’s best estimates and valuations developed with the assistance of independent appraisers and, where such valuations have not yet been completed or are not available, industry data and trends and by reference to relevant market rates and transactions. The following estimates and assumptions are inherently subject to significant uncertainties and contingencies beyond the control of the Company. Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially.

Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill. In accordance with ASC 805 “Business Combinations”, if additional information is obtained about these assets and liabilities within the measurement period (not to exceed one year from the date of acquisition), including finalization of asset appraisals, the Company will refine its estimates of fair value to allocate the purchase price more accurately.

Insurance Companies

On December 24, 2015, the Company completed the acquisitions of 100% of the interests in the Insurance Companies as well as all assets owned by the sellers of the Insurance Companies or their affiliates that are used exclusively or primarily in the business of the Insurance Companies, subject to certain exceptions. The operations of the Insurance Companies were consolidated into our insurance operating segment, with a plan to leverage their existing platform and industry expertise to identify strategic growth opportunities for managing closed blocks of long-term care business.


12

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The aggregate consideration provided in connection with the acquisition of the Insurance Companies and related transactions and agreements was valued at $18.6 million and consisted of $7.0 million of cash, $2.0 million in aggregate principal amount of the Company’s 11.0% Senior Secured Notes due 2019, 1,007,422 shares of the Company's common stock and five years warrants to purchase 2,000,000 shares of the Company's common stock at an exercise price of $7.08 per share (subject to customary adjustments upon stock splits or similar transactions) exercisable on or after February 3, 2016 (the "Warrant").

Purchase Price Allocation

The preliminary fair values of identified assets acquired, liabilities assumed, residual goodwill and consideration transferred are summarized as follows (in thousands):
Fair value of consideration transferred
 
 
Cash
 
$
6,981

Company’s Senior Secured Notes
 
1,879

Company's common stock
 
5,380

Warrant
 
4,332

Total fair value of consideration transferred
 
$
18,572

 
 
 
Purchase price allocation
 
 
Fixed maturities, available for sale at fair value
 
$
1,230,038

Equity securities, available for sale at fair value
 
35,697

Mortgage loans
 
1,252

Policy loans
 
18,354

Other investments
 
183

Cash and cash equivalents
 
48,525

Recoverable from reinsurers
 
523,076

Accrued investment income
 
14,417

Goodwill
 
46,448

Intangibles
 
4,850

Other assets
 
12,869

Total assets acquired
 
1,935,709

Life, accident and health reserves
 
(1,592,722
)
Annuity reserves
 
(259,675
)
Value of business acquired
 
(51,870
)
Deferred tax liability
 
(1,704
)
Other liabilities
 
(11,166
)
Total liabilities assumed
 
(1,917,137
)
Total net assets acquired
 
$
18,572


The values of intangibles, life, accident and health reserves, annuity reserves, and value of business acquired are estimates and might change.

The acquisition of the Insurance Companies resulted in goodwill of approximately $46.4 million. Goodwill was the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. The Insurance Companies were recognized as a new stand-alone reporting unit. Goodwill is not amortized and is not deductible for tax purposes.

The Value of Business Acquired ("VOBA")

The VOBA was derived using a “Becker-ized” Present Value of Distributable Earnings (“PVDE”) method. The PVDE was derived using the statutory after tax profits. The VOBA was valued at $51.9 million and is amortized over the anticipated remaining

13

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

future lifetime of the acquired long term care blocks of business.  VOBA is amortized in relation to the projected future premium of the acquired long term care blocks of business.

Reinsurance Recoverable

The reinsurance recoverable balance represents amounts recoverable from third party. U.S. GAAP requires insurance reserves and reinsurance recoverable balances to be presented on a gross basis, as opposed to U.S. statutory accounting principles, where reserves are presented net of reinsurance. Accordingly, the Company grossed up the fair value of the net insurance contract liability for the amount of reinsurance of approximately $515.9 million, to arrive at a gross insurance liability, and recognized an offsetting reinsurance recoverable amount of approximately $515.9 million. As part of this process, management considered reinsurance counterparty credit risk and considers it to have an immaterial impact on the reinsurance fair value gross-up. To mitigate this risk substantially all reinsurance is ceded to companies with investment grade S&P ratings.
    
Amounts recoverable from reinsurers were estimated in a manner consistent with the liability associated with the reinsured policies and were an estimate of the reinsurance recoverable on paid and unpaid losses, including an estimate for losses incurred but not reported. Reinsurance recoverable represents expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. Reinsurance recoverable includes the balances due from reinsurers under the terms of the reinsurance agreements for these ceded balances as well as settlement amounts currently due.

Contingent Liability

Pursuant to the purchase agreement, the Company also agreed to pay to the sellers, on an annual basis with respect to the years 2015 through 2019, the amount, if any, by which the Insurance Companies’ cash flow testing and premium deficiency reserves decrease from the amount of such reserves as of December 31, 2014. Such payments are capped at $13.0 million. The balance is calculated based on the fluctuation of the statutory cash flow testing and premium deficiency reserves annually following each of the Insurance Companies' filing with its domiciliary insurance regulator of its annual statutory statements for each calendar year ending December 31, 2015 through and including December 31, 2019. Based on the 2015 statutory statements, the Company does not have a payment due. Further, the Company's current estimate is that the obligation will not be incurred up through the year ended December 31, 2019. This expectation is primarily driven by the following factors (i) less confidence that treasury rates will be increasing back to historical averages any time soon; (ii) uncertainty around future operating expenses historically performed by sellers; and (iii) the premium deficiency reserve as reported at December 31, 2015 increased by approximately $8.0 million and because the balance is cumulative over the period, a decrease of approximately $8.0 million would be required first before there would be any obligation to the sellers. The Company will re-perform this assessment at each reporting period through December 31, 2019 or until the $13.0 million is paid in full.

Control Level Risk-Based Capital

In connection with the consummation of the acquisition, the Company has agreed with the Ohio Department of Insurance ("ODOI") that, for five years following the closing of the transaction, it will contribute to CGI cash or marketable securities acceptable to the ODOI to the extent required for CGI’s total adjusted capital to be not less than 400% of CGI’s authorized control level risk-based capital (each as defined under Ohio law and reported in CGI’s statutory statements filed with the ODOI). Similarly, the Company has agreed with the Texas Department of Insurance ("TDOI") that, for five years following the closing of the transaction, it will contribute to UTA cash or other admitted assets acceptable to the TDOI to the extent required for UTA’s total adjusted capital to be not less than 400% of UTA’s authorized control level risk-based capital (each as defined under Texas law and reported in UTA’s statutory statements filed with the TDOI).

Also in connection with the consummation of the acquisition, each of the Insurance Companies entered into a capital maintenance agreement with Great American Financial Resources, Inc., ("GAFRI") (each, a “Capital Maintenance Agreement”, and collectively, the “Capital Maintenance Agreements”). Under each Capital Maintenance Agreement, if the applicable Insurance Company's total adjusted capital reported in its annual statutory statements is less than 400% of its authorized control level risk-based capital, GAFRI will pay cash or assets to the applicable Insurance Company as required to eliminate such shortfall (after giving effect to any capital contributions made by the Company or its affiliates since the date of the relevant annual statutory statement). GAFRI’s obligation to make such payments is capped at $25.0 million under the Capital Maintenance Agreement with UTA and $10.0 million under the Capital Maintenance Agreement with CGI. Each of the Capital Maintenance Agreements will remain in effect from January 1, 2016 to January 1, 2021 or until payments by GAFRI thereunder equal $35.0 million. Pursuant

14

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

to the purchase agreement, the Company will indemnify GAFRI for the amount of any payments made by it under the Capital Maintenance Agreements.

Through March 31, 2016, total capital and surplus to be reported in the Insurance Companies’ quarterly statutory statements, decreased by less than $1.0 million and remains in excess of 400% of the authorized control level risk-based capital.

Pro Forma Adjusted Summary

The results of operations for the Insurance Companies have been included in the consolidated financial statements subsequent to their acquisition dates.

The following schedule presents unaudited consolidated pro forma results of operations data as if the acquisition of the Insurance Companies had occurred on January 1, 2015. This information neither purports to be indicative of the actual results that would have occurred if the acquisitions had actually been completed on the date indicated, nor is it necessarily indicative of the future operating results or the financial position of the combined company (in thousands, except per share amounts): 
 
 
Three Months Ended
March 31, 2015
Net revenue
 
$
237,612

 
 
 
Net income (loss) from continuing operations
 
(8,142
)
Gain (loss) from discontinued operations
 
(9
)
 
 
 
Net income (loss) attributable to HC2
 
$
(8,151
)
 
 
 
Per share amounts:
 
 
Income (loss) from continuing operations
 
$
(0.34
)
Gain (loss) from discontinued operations
 

 
 
 
Net income (loss) attributable to HC2
 
$
(0.34
)
 
Transaction costs incurred in connection with the Insurance Companies acquisition were $0.5 million and zero during the three months ended March 31, 2016 and 2015 and were included within selling, general and administrative expenses. The Company recorded net revenue of $29.1 million and net loss of $12.3 million from the Insurance Companies for the three month ended March 31, 2016.

Other Acquisitions

On February 1, 2016, Pansend, acquired an additional 1,000 shares of preferred stock of BeneVir Biopharm, Inc (“BeneVir”), increasing it's ownership to 60% and obtaining control of the company ("Step Acquisition"). The results of BeneVir's operations since February 1, 2016 are included in the Company’s Condensed Consolidated Statements of Operations. The Company applied equity method to account for its investment in BeneVir prior to the Step Acquisition.

On February 3, 2016, GMSL acquired a 60% majority interest in CWind Limited ("CWind") for $7.8 million with a commitment to purchase the remaining 40% in equal amounts on September 30, 2016 and September 30, 2017 based on agreed upon financial targets. The results of CWind's operations since February 3, 2016 are included in the Company’s Condensed Consolidated Statements of Operations. GMSL performed a preliminary valuation of the acquired assets, assumed liabilities, and a contingent liability at February 3, 2015.








15

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table summarizes the preliminary consideration paid for the Other Acquisitions (in thousands):
 
 
Benevir
 
CWind
Consideration
 
 
 
 
Cash
 
$
1,000

 
$
7,783

Fair value of previously held interest
 
4,272

 

Contingent asset
 

 
(2,992
)
Deferred consideration
 

 
2,589

Total fair value of consideration transferred
 
$
5,272

 
$
7,380

 
 
 
 
 
Purchase price allocation
 
 
 
 
Cash and cash equivalents
 
$
1,122

 
$
1,188

Accounts receivable
 

 
6,397

Inventory
 

 
528

Property, plant and equipment, net
 
187

 
27,675

Goodwill
 
3,633

 
1,528

Intangibles
 
6,392

 
2,626

Other assets
 
37

 
2,298

Total assets acquired
 
11,371

 
42,240

Accounts payable and other current liabilities
 
(161
)
 
(10,891
)
Deferred tax liability
 
(2,580
)
 
(2,341
)
Long-term obligations
 

 
(20,813
)
Other liabilities
 
(12
)
 

Noncontrolling interest
 

 
(815
)
Total liabilities assumed
 
(2,753
)
 
(34,860
)
Enterprise value
 
8,618

 
7,380

Less fair value of noncontrolling interest
 
3,346

 

Purchase price attributable to controlling interest
 
$
5,272

 
$
7,380

 
There were no Other Acquisitions that were significant individually or in aggregate.

4. Investments

Fixed Maturity and Equity Securities Available-for-Sale

The following tables provide information relating to investments in fixed maturity and equity securities as of March 31, 2016 and December 31, 2015 (in thousands):
March 31, 2016
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
17,819

 
$
412

 
$
(4
)
 
$
18,227

States, municipalities and political subdivisions
 
383,829

 
11,485

 
(198
)
 
395,116

Foreign government
 
6,415

 

 
(183
)
 
6,232

Residential mortgage-backed securities
 
158,353

 
1,214

 
(1,398
)
 
158,169

Commercial mortgage-backed securities
 
68,653

 
901

 
(129
)
 
69,425

Asset-backed securities
 
56,955

 
184

 
(662
)
 
56,477

Corporate and other
 
563,929

 
18,332

 
(7,876
)
 
574,385

Total fixed maturity securities
 
$
1,255,953

 
$
32,528

 
$
(10,450
)
 
$
1,278,031

Equity securities
 
 
 
 
 
 
 
 

16

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Common stocks
 
$
17,369

 
$
794

 
$
(831
)
 
$
17,332

Perpetual preferred stocks
 
30,912

 
156

 
(843
)
 
30,225

Total equity securities
 
$
48,281

 
$
950

 
$
(1,674
)
 
$
47,557

December 31, 2015
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
17,131

 
$
1

 
$
(49
)
 
$
17,083

States, municipalities and political subdivisions
 
387,427

 
60

 
(1,227
)
 
386,260

Foreign government
 
6,426

 
3

 

 
6,429

Residential mortgage-backed securities
 
166,324

 
579

 
(588
)
 
166,315

Commercial mortgage-backed securities
 
74,898

 
233

 
(96
)
 
75,035

Asset-backed securities
 
34,396

 
106

 
(51
)
 
34,451

Corporate and other
 
553,487

 
318

 
(7,537
)
 
546,268

Total fixed maturity securities
 
$
1,240,089

 
$
1,300

 
$
(9,548
)
 
$
1,231,841

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
$
19,935

 
$
1

 
$
(1,311
)
 
$
18,625

Perpetual preferred stocks
 
30,901

 
162

 
(6
)
 
31,057

Total equity securities
 
$
50,836

 
$
163

 
$
(1,317
)
 
$
49,682


The Company has investments in mortgage backed securities ("MBS") that contain embedded derivatives (primarily interest-only MBS) that do not qualify for hedge accounting. The Company records the entire change in the fair value of these securities in earnings at period end. These investments had a fair value of $18.1 million and $21.0 million as of March 31, 2016 and December 31, 2015, respectively. The change in fair value related these securities resulted in a loss of approximately $1.7 million and $0 for the three months ended March 31, 2016 and 2015, respectively.

Maturities of Fixed Maturity Securities Available-for-Sale

The amortized cost and fair value of fixed maturity securities available-for-sale at March 31, 2016 are shown by contractual maturity in the table below (dollars in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date (in thousands).
 
 
Amortized
 
Fair
 
 
Cost
 
Value
Corporate, Municipal, U.S. Government and Other securities
 
 
 
 
Due in one year or less
 
$
12,085

 
$
12,096

Due after one year through five years
 
140,767

 
135,432

Due after five years through ten years
 
166,554

 
170,593

Due after ten years
 
652,586

 
675,839

Subtotal
 
971,992

 
993,960

Mortgage-backed securities
 
227,006

 
227,594

Asset-backed securities
 
56,955

 
56,477

Total
 
$
1,255,953

 
$
1,278,031


Corporate Fixed Maturity Securities

The tables below show the major industry types of the Company’s Corporate and other fixed maturity holdings as of March 31, 2016 and December 31, 2015 (in thousands):


17

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
March 31, 2016
 
December 31, 2015
 
 
Amortized
 
Fair
 
% of
 
Amortized
 
Fair
 
% of
 
 
Cost
 
Value
 
Total
 
Cost
 
Value
 
Total
Finance, insurance, and real estate
 
$
218,523

 
$
214,873

 
37.4
%
 
$
223,144

 
$
217,377

 
39.8
%
Transportation, communication and other services
 
156,501

 
162,155

 
28.2
%
 
156,022

 
155,175

 
28.4
%
Manufacturing
 
102,979

 
108,113

 
18.8
%
 
95,138

 
94,792

 
17.4
%
Other
 
85,926

 
89,244

 
15.5
%
 
79,183

 
78,924

 
14.4
%
Total
 
$
563,929

 
$
574,385

 
100.0
%
 
$
553,487

 
$
546,268

 
100.0
%

Other-Than-Temporary Impairments - Fixed Maturity and Equity Securities

A portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities the net amount recognized in the Condensed Consolidated Statements of Operations (“credit loss impairments”) represent the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The Company recorded a $1.0 million impairment related to one fixed maturity security during the three months ended March 31, 2016 within other income (expense). The Company did not record any impairments on fixed maturity or equity securities during the three months ended March 31, 2015.

Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale

The following table presents the total unrealized losses for the 228 and 528 fixed maturity and equity securities as of March 31, 2016 and December 31, 2015, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (in thousands):
 
 
March 31, 2016
 
December 31, 2015
 
 
Unrealized
 
% of
 
Unrealized
 
% of
 
 
Losses
 
Total
 
Losses
 
Total
Fixed maturity securities
 
 
 
 
 
 
 
 
Less than 20%
 
$
(4,613
)
 
38.0
%
 
$
(5,667
)
 
52.2
%
20% or more for less than six months
 
(70
)
 
0.6
%
 

 
%
20% or more for six months or greater
 
(7,441
)
 
61.4
%
 
(5,198
)
 
47.8
%
Total
 
$
(12,124
)
 
100.0
%
 
$
(10,865
)
 
100.0
%

The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include (a) whether the unrealized loss is credit-driven or a result of changes in market interest rates (b) the extent to which fair value is less than cost basis (c) cash flow projections received from independent sources (d) historical operating, balance sheet and cash flow data contained in issuer SEC filings and news releases (e) near-term prospects for improvement in the issuer and/or its industry (f) third party research and communications with industry specialists (g) financial models and forecasts (h) the continuity of dividend payments, maintenance of investment grade ratings and hybrid nature of certain investments (i) discussions with issuer management, and (j) ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value.

The Company analyzes its MBS for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data.

The Company believes it will recover its cost basis in the non impaired securities with unrealized losses and that the Company has the ability to hold the securities until they recover in value. The Company neither has an intention to sell nor does it expect to be required to sell the securities with unrealized losses as of March 31, 2016 and December 31, 2015, respectively. However, unforeseen facts and circumstances may cause the Company to sell fixed maturity and equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.

18

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables present the estimated fair values and gross unrealized losses for 228 and 528 fixed maturity and equity securities that have estimated fair values below amortized cost as of March 31, 2016 and December 31, 2015, respectively. The Company does not have any other-than-temporary impairment losses reported in AOCI. These investments are presented by investment category and the length of time the related fair value has remained below amortized cost (in thousands):
March 31, 2016
 
Less than 12 months
 
12 months of greater
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
53

 
$
(4
)
 
$

 
$

 
$
53

 
$
(4
)
States, municipalities and political subdivisions
 
7,978

 
(198
)
 

 

 
7,978

 
(198
)
Foreign government
 
6,232

 
(183
)
 

 

 
6,232

 
(183
)
Residential mortgage-backed securities
 
93,363

 
(1,398
)
 

 

 
93,363

 
(1,398
)
Commercial mortgage-backed securities
 
16,857

 
(129
)
 

 

 
16,857

 
(129
)
Asset-backed securities
 
38,407

 
(662
)
 

 

 
38,407

 
(662
)
Corporate and other
 
92,922

 
(7,876
)
 

 

 
92,922

 
(7,876
)
Total fixed maturity securities
 
$
255,812

 
$
(10,450
)
 
$

 
$

 
$
255,812

 
$
(10,450
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
$
7,891

 
$
(831
)
 
$

 
$

 
$
7,891

 
$
(831
)
Perpetual preferred stocks
 
18,078

 
(843
)
 

 

 
18,078

 
(843
)
Total equity securities
 
$
25,969

 
$
(1,674
)
 
$

 
$

 
$
25,969

 
$
(1,674
)
December 31, 2015
 
Less than 12 months
 
12 months of greater
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
15,409

 
$
(49
)
 
$

 
$

 
$
15,409

 
$
(49
)
States, municipalities and political subdivisions
 
294,105

 
(1,227
)
 

 

 
294,105

 
(1,227
)
Residential mortgage-backed securities
 
77,695

 
(588
)
 

 

 
77,695

 
(588
)
Commercial mortgage-backed securities
 
44,618

 
(96
)
 

 

 
44,618

 
(96
)
Asset-backed securities
 
22,550

 
(51
)
 

 

 
22,550

 
(51
)
Corporate and other
 
466,293

 
(7,537
)
 

 

 
466,293

 
(7,537
)
Total fixed maturity securities
 
$
920,670

 
$
(9,548
)
 
$

 
$

 
$
920,670

 
$
(9,548
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
$
13,657

 
$
(1,311
)
 
$

 
$

 
$
13,657

 
$
(1,311
)
Perpetual preferred stocks
 
7,378

 
(6
)
 

 

 
7,378

 
(6
)
Total equity securities
 
$
21,035

 
$
(1,317
)
 
$

 
$

 
$
21,035

 
$
(1,317
)

At March 31, 2016, investment grade fixed maturity securities (as determined by nationally recognized rating agencies) represented approximately 20.3% of the gross unrealized loss and 56.9% of the fair value. At December 31, 2015, investment grade fixed maturity securities represented approximately 33.2% of the gross unrealized loss and 88.3% of the fair value.

Certain risks are inherent in connection with fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates, and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.

Other Invested Assets

Other invested assets represent approximately 3.3% and 3.9% of the Company’s total investments as of March 31, 2016 and December 31, 2015, respectively. Carrying values of other invested assets as of March 31, 2016 and December 31, 2015 are as follows (in thousands):

19

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
March 31, 2016
 
December 31, 2015
 
 
Cost Method
 
Equity Method
 
Cost Method
 
Equity Method
Common Equity
 
$
138

 
$
3,986

 
$
249

 
$
6,475

Preferred Equity
 
1,655

 
5,109

 
1,655

 
7,522

Warrants
 
3,097

 

 
3,880

 

Limited Partnerships
 

 
1,111

 

 
1,171

Joint Ventures
 

 
27,568

 

 
27,324

Total
 
$
4,890

 
$
37,774

 
$
5,784

 
$
42,492


Additionally, of March 31, 2016 and December 31, 2015, other invested assets include common stock purchase warrants and call options accounted for under the ASC 815 (in thousands):
March 31, 2016
 
Cost
 
Gains
 
Losses
 
Fair Value
Warrants
 
$
6,384

 
$
270

 
$
(3,567
)
 
$
3,087

Call Options
 
911

 

 
(653
)
 
258

Total
 
$
7,295

 
$
270

 
$
(4,220
)
 
$
3,345

December 31, 2015
 
Cost
 
Gains
 
Losses
 
Fair Value
Warrants
 
$
6,383

 
$
428

 
$
(2,600
)
 
$
4,211

Call Options
 
1,680

 

 
(1,048
)
 
632

Total
 
$
8,063

 
$
428

 
$
(3,648
)
 
$
4,843


Net Investment Income

For the three months ended March 31, 2016, the major sources of net investment income in the accompanying Condensed Consolidated Statements of Operations were as follows (in thousands):
 
 
2016
Fixed maturities, available-for-sale at fair value
 
$
13,266

Equity securities, available-for-sale at fair value
 
572

Mortgage loans
 
17

Policy loans
 
297

Other invested assets
 
142

Gross investment income
 
14,294

External investment expense
 
(215
)
Net investment income
 
$
14,079


Net investment (losses) gains

For the three months ended March 31, 2016, the major sources of net investment income in the accompanying Condensed Consolidated Statements of Operations were as follows (in thousands):
 
 
2016
Realized gains on fixed maturity available-for-sale securities
 
$
321

Realized losses on fixed maturity available-for-sale securities
 
(2,309
)
Realized gains on equity securities
 
88

Realized losses on equity securities
 
(352
)
Realized gains on certain derivative instruments
 
41

Realized losses on certain derivative instruments
 
(2,664
)
Net realized loss
 
$
(4,875
)

20

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5. Fair Value of Financial Instruments

Assets by Hierarchy Level

Assets and liabilities measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 are summarized below (in thousands):
March 31, 2016
 
 
 
Fair Value Measurement Using:
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
18,227

 
$
6,688

 
$
11,486

 
$
53

States, municipalities and political subdivisions
 
395,116

 

 
389,355

 
5,761

Foreign government
 
6,232

 

 
6,232

 

Residential mortgage-backed securities
 
158,169

 

 
82,969

 
75,200

Commercial mortgage-backed securities
 
69,425

 

 
14,820

 
54,605

Asset-backed securities
 
56,477

 

 
11,074

 
45,403