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 March 31, 2019
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
Emerging growth company
Non-accelerated filer
Smaller reporting 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 ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.0001 per share
HRTG
New York Stock Exchange
The aggregate number of shares of the Registrant’s Common Stock outstanding on May 5, 2019 was 30,013,018
HERITAGE INSURANCE HOLDINGS, INC.
Table of Contents
Page
PART I – FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Consolidated Balance Sheets: March 31, 2019 (unaudited) and December 31, 2018
2
Condensed Consolidated Statements of Operations and Other Comprehensive Income: Three months ended March 31, 2019 and 2018 (unaudited)
3
Condensed Consolidated Statements of Stockholders’ Equity: Three months ended March 31, 2019 and 2018 (unaudited)
4
Condensed Consolidated Statements of Cash Flows: Three months ended March 31, 2019 and 2018 (unaudited)
5
Notes to Unaudited Condensed Consolidated Financial Statements
7
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3 Quantitative and Qualitative Disclosures about Market Risk
31
Item 4 Controls and Procedures
32
PART II – OTHER INFORMATION
Item 1 Legal Proceedings
33
Item 1A Risk Factors
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 4 Mine Safety Disclosures
Item 6 Exhibits
Signatures
35
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) our ability to meet our investment objectives and to manage and mitigate market risk with respect to our investments; (ii) the adequacy of our reinsurance program and our ability to diversify risk and safeguard our financial position; (iii) our estimates with respect to tax matters; (iv) future dividends, if any; (v) our estimates regarding certain accounting matters; (vi) the sufficiency of our liquidity to pay our insurance company affiliates’ claims and expenses, as well as to satisfy commitments in the event of unforeseen events; (vii) the sufficiency of our capital resources, together with cash provided from our operations, to meet currently anticipated working capital requirements; and (viii) the potential effects of our current legal proceedings.
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 identify suitable acquisition candidates; 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;
our reliance on independent agents to write voluntary insurance policies;
changes in regulations and our failure to meet increased regulatory requirements;
our ability to maintain effective internal controls over financial reporting;
our status as an “emerging growth company”;
the regulation of our insurance operations; and
certain characteristics of our common stock.
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, 2018. 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.
Item 1 – Financial Statements
Condensed Consolidated Balance Sheets
(Amounts in thousands, except per share and share amounts)
March 31, 2019
December 31, 2018
ASSETS
(unaudited)
Fixed maturities, available-for-sale, at fair value (amortized cost of $528,193 and $518,391)
527,940
$
509,649
Equity securities, at fair value (cost of $18,249 and $18,698)
17,375
16,456
Other investments
21,693
2,488
Total investments
567,008
528,593
Cash and cash equivalents
279,720
250,117
Restricted cash
12,257
12,253
Accrued investment income
4,618
4,468
Premiums receivable, net
55,096
57,000
Reinsurance recoverable on paid and unpaid claims
263,266
317,930
Prepaid reinsurance premiums
161,015
233,071
Income taxes receivable
365
35,586
Deferred policy acquisition costs, net
69,883
73,055
Property and equipment, net
21,317
17,998
Intangibles, net
74,757
76,850
Goodwill
152,459
Other assets
15,232
9,333
Total Assets
1,676,993
1,768,713
LIABILITIES AND STOCKHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses
404,484
432,359
Unearned premiums
454,225
472,357
Reinsurance payable
114,263
166,975
Long-term debt, net
132,176
148,794
Deferred income tax
5,967
7,705
Advance premiums
27,892
20,000
Accrued compensation
7,752
9,226
Accounts payable and other liabilities
95,147
85,964
Total Liabilities
1,241,906
1,343,380
Commitments and contingencies (Note 17)
Stockholders’ Equity:
Common stock, $0.0001 par value, 50,000,000 shares authorized, 30,013,018 shares issued and 29,432,217 shares outstanding at March 31, 2019 and 30,083,559 shares issued and 29,477,756 shares outstanding at December 31, 2018
Additional paid-in capital
328,937
325,292
Accumulated other comprehensive loss
(564
)
(6,527
Treasury stock, at cost, 7,562,537 shares at March 31, 2019 and 7,214,797 shares at December 31, 2018
(94,196
(89,185
Retained earnings
200,907
195,750
Total Stockholders' Equity
435,087
425,333
Total Liabilities and Stockholders' Equity
See accompanying notes to unaudited condensed consolidated financial statements.
Condensed Consolidated Statements of Operations and Other Comprehensive Income
(Unaudited)
For the Three Months Ended March 31,
2019
2018
REVENUES:
Gross premiums written
210,348
204,366
Change in gross unearned premiums
18,242
22,797
Gross premiums earned
228,590
227,163
Ceded premiums
(118,899
(121,055
Net premiums earned
109,691
106,108
Net investment income
3,672
3,302
Net realized gains (losses)
1,024
(227
Other revenue
3,874
2,843
Total revenues
118,261
112,026
EXPENSES:
Losses and loss adjustment expenses
62,139
53,091
Policy acquisition costs, net of ceding commission income of $12.9 million and $14.3 million
26,020
12,187
General and administrative expenses, net of ceding commission income of $4.3 million and $4.7 million
18,604
21,931
Total expenses
106,763
87,209
Operating income
11,498
24,817
Interest expense, net
2,117
4,820
Other non-operating (income)/loss, net
48
—
Income before income taxes
19,997
Provision for income taxes
2,369
5,168
Net income
6,964
14,829
OTHER COMPREHENSIVE INCOME
Change in net unrealized gains (losses) on investments
8,036
(6,478
Reclassification adjustment for net realized investment losses
335
227
Income tax (expense) benefit related to items of other comprehensive income
(2,408
1,823
Total comprehensive income
12,927
10,401
Weighted average shares outstanding
Basic
29,540,514
25,727,553
Diluted
29,544,563
26,732,019
Earnings per share
0.24
0.58
0.55
Condensed Consolidated Statements of Stockholders’ Equity
Three Months Ended March 31, 2019 and 2018
(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, 2018
29,477,756
Net unrealized change in investments, net of tax
5,963
Restricted stock vested, net of surrendered shares
17,000
(118
Stock-based compensation on vested restricted stock
1,345
Convertible Option debt extinguishment
(1,840
Stock issued on convertible note conversion
285,201
4,210
Stock buy-back
(347,740
(5,011
Dividends declared on common stock
(1,807
Tax rate change
Balance at March 31, 2019
29,432,217
Balance at December 31, 2017, as previously reported
25,885,006
294,836
175,226
(87,185
(3,064
379,816
Cumulative effective of change in accounting principle (ASU 2016-01), net of tax
(267
267
Balance at December 31, 2017, as adjusted
174,959
(2,797
(115,200
(1,999
Stock-based compensation
1,306
Reclassification of income taxes upon early adoption of ASU 2018-02
424
(424
Tax effect of warrant reclassification
970
(1,601
(4,428
Balance at March 31, 2018
25,769,806
297,112
188,611
(89,184
(7,649
388,893
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Bond amortization and accretion
1,229
1,792
Amortization of original issuance discount on debt
390
871
Depreciation and amortization
2,696
7,041
Net realized (gains) losses
(1,024
Net loss from repurchase of debt
Deferred income taxes
(4,098
(13,260
Changes in operating assets and liabilities:
(150
816
1,904
1,023
72,056
63,703
Reinsurance premiums receivable and recoverable
54,664
(196,466
35,221
19,815
3,171
(12,184
(5,898
(3,019
(27,875
77,652
(18,132
(22,797
(52,712
38,431
Accrued interest
127
3,217
(1,474
(9,219
7,892
14,090
Income taxes payable
5,725
Other liabilities
3,253
Net cash provided by (used in) operating activities
85,322
(12,132
INVESTING ACTIVITIES
Marketable securities sales
25,486
127,328
Marketable securities purchases
(37,203
(71,498
Proceeds from sales of equity securities
2,291
Purchase of equity securities
(1,617
Limited partnership interest
(19,205
Proceeds from sale of assets
71
Cost of property and equipment acquired
(3,994
(83
Net cash (used in) provided by investing activities
(34,171
55,747
FINANCING ACTIVITIES
Repayment of term note
(11,875
Mortgage loan payments
(70
(68
Repurchase of convertible notes
(2,869
Purchase of treasury stock
Tax withholdings on share-based compensation awards
Dividends paid
Net cash used in financing activities
(21,544
(3,668
Increase in cash, cash equivalents, and restricted cash
29,607
39,947
Cash, cash equivalents and restricted cash, beginning of period
262,370
174,530
Cash, cash equivalents and restricted cash, end of period
291,977
214,477
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid
2,977
5,406
Issuance of shares on conversion of convertible notes
Reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets
(in thousands)
Restricted cash primarily presents funds held to meet our contractual obligations related to the catastrophe issued by Citrus Re bonds and certain states in which the Company’s insurance subsidiaries conduct business to meet regulatory requirements.
6
NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements include the accounts of the Heritage Insurance Holdings, Inc. (together with its subsidiaries, the “Company”). These 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. Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted. In the opinion of the Company’s management, all material intercompany transactions and balances have been eliminated and all adjustments consisting of normal recurring accruals which are, necessary for a fair statement of the financial condition and results of operations for the interim periods have been reflected. The accompanying interim consolidated financial statements and related footnotes should be read in conjunction with the Company’s consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”).
Significant accounting policies
Leases
We lease office space as the lessor and tenant and have entered into various other lease agreements in conducting our business. We evaluate each lease agreement to determine whether the lease is an operating or financing lease and effective for the first quarter of 2019, we have established a right-of-use (“ROU”) asset and corresponding lease liability on the balance sheet. As described below under “Recently Adopted Accounting Pronouncements” we adopted the Financial Accounting Standards Update, or ASU, “Leases”, or “FASB 842” as of January 1, 2019. The Company did not recognize an opening adjustment to retained earnings as a result of the adoption of FASB 842. Refer to Note 5-Leases herein for further information.
Reclassification
We have reclassified certain amounts in the 2018 condensed consolidated balance sheet to confirm to our 2019 presentation.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) 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.
We adopted the guidance prospectively during the first quarter of 2019. As part of our adoption, we elected not to reassess historical lease classification, recognize short-term leases on our balance sheet, nor separate lease and non-lease components for our real estate leases. At implementation, we recorded approximately $2.8 million as right-of-use operating and financing leased assets in other assets and approximately $2.8 million of lease liabilities in accounts payable and other liabilities. Adoption of this standard did not materially impact the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income and Statements of Cash Flows. See Note 5 to the Financial Statements.
Accounting Pronouncements Not Yet Adopted
For information regarding accounting standards that the Company has not yet adopted, refer to our Annual Report on Form 10-K, filed on March 12, 2019, the section of Note 1 of the notes to the consolidated financial statements the “Accounting Pronouncement Not Yet Adopted”.
NOTE 2. INVESTMENTS
Securities Available-for-Sale
The following table details the difference between cost or adjusted/amortized cost and estimated fair value, by major investment category, at March 31, 2019 and December 31, 2018:
Cost or Adjusted /
Amortized Cost
Gross Unrealized
Gains
Losses
Fair Value
(In thousands)
Fixed maturity securities, available-for-sale
U.S. government and agency securities (1)
49,547
81
451
49,177
States, municipalities and political subdivisions
65,988
440
151
66,277
Special revenue
244,841
1,463
1,479
244,825
Industrial and miscellaneous
163,514
943
951
163,506
Redeemable preferred stocks
4,303
153
4,155
528,193
2,932
3,185
48,739
40
738
48,041
60,028
46
785
59,289
249,026
210
3,881
245,355
155,678
152,457
4,920
413
4,507
518,391
377
9,119
(1)
U.S. government and agency securities include pledged fixed maturity securities with an estimated fair value of $24 million and $31 million under the terms and condition of the advance agreement entered into with a financial institution as of March 31, 2019 and December 31, 2018, respectively. The Company is permitted to withdraw or exchange any portion of the pledged collateral over the minimum requirement at any time.
The Company calculates the gain or loss realized on the sale of investments by comparing the sales price (fair value) to the cost or adjusted/amortized cost of the security sold. The Company determines the cost or adjusted/amortized cost of the security sold using the specific-identification method. The following tables detail the Company’s net realized gains (losses) by major investment category for the three months ended March 31, 2019 and 2018.
(Losses)
Fair Value at Sale
Fixed maturity securities
24,414
87
50,067
Equity securities
74
Total realized gains
89
50,141
(67
6,141
(218
48,143
(273
513
(98
2,167
Total realized losses
(340
6,654
(316
50,310
Unrealized gains (losses) on equity securities (1)
1,359
Net realized (losses) gains
31,068
100,451
For the three months ended March 31, 2018, the Company recognized $868,700 as unrealized losses on equity securities pursuant to ASC 2016-01, at the time of adoption the Company reported changes in the fair value of equity investments in Other revenue.
8
The table below summarizes the Company’s fixed maturities at March 31, 2019 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of those obligations.
For the Three Months Ended March 31, 2019
Cost or Amortized Cost
Percent of Total
Maturity dates:
Due in one year or less
55,079
10
%
54,993
Due after one year through five years
168,231
168,051
Due after five years through ten years
138,520
26
138,978
Due after ten years
166,363
165,918
100
Equity Securities
The following tables present realized gains and losses from securities included both sales of securities and unrealized gains losses included in net income as of March 31, 2019 and December 31, 2018:
March 31, 2018
Net gains (loss) recognized during the period on equity securities
1,086
(945
Less: Net losses (gains) recognized from equity securities sold
273
76
Unrealized gains (loss) recognized on equity securities still held at reporting date
(869
The following table summarizes the Company’s net investment income by major investment category for the three months ended March 31, 2019 and 2018, respectively:
2,724
2,945
309
307
Cash, cash equivalents and short-term investments
817
157
342
259
4,192
3,668
Investment expenses
520
366
Net investment income, less investment expenses
As of March 31, 2019, the Company evaluated its fixed maturity securities for impairment and determined that none of its investments in fixed maturity securities that reflected an unrealized loss position were other-than-temporarily impaired. The issuers of the fixed maturity securities in which the Company invests continue to make interest payments on a timely basis and have not suffered any credit rating reductions. The Company does not intend to sell, nor is it likely that it would be required to sell, the fixed maturity securities before the Company recovers its amortized cost basis.
Limited Partnerships
The Company has interests in limited partnerships that are not registered or readily tradable on a securities exchange. The investments are private equity funds managed by general partners who make financial policy and operational decisions. The Company is not the primary beneficiary and does not consolidate these partnerships. The Company carries these investments at fair value which is based on the net value of the funds. As of March 31, 2019, the estimated fair value of our investments in the limited partnership interests was $21.7 million. The general partner's objective is to achieve capital appreciation through investments in marketable securities and broad markets, preferred stock, industry-focused and fixed income exchange-traded funds (ETFs). During the first quarter of 2019 and 2018, the Company received total cash distributions of $259,800 and $121,170, respectively, representing return of capital on its investments. The Company incurred no allocated costs in the first quarter of 2019 and $5,000 for the comparable period of 2018.
9
The following tables present an aging of our unrealized investment losses by investment class as of March 31, 2019 and December 31, 2018:
Less Than Twelve Months
Twelve Months or More
Number of Securities
Gross Unrealized Losses
U.S. government and agency securities
49
2,635
59
402
19,792
1
523
150
29,693
54
109
16,848
235
842
70,928
82
13,985
318
1,397
96,391
25
24
1,368
17
129
2,215
Total fixed maturity securities
112
265
35,358
664
2,920
219,019
10,485
66
609
20,488
13
103
12,864
42
682
39,979
214
70,156
232
1,822
70,375
105
1,260
76,335
323
2,621
108,319
55
193
2,541
27
221
1,965
404
3,164
172,381
690
5,955
241,126
The Company is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations.
NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS
For the Company’s investments in U.S. government securities that do not have prices in active markets, agency securities, state and municipal governments, and corporate bonds, the Company obtains the fair values from its third-party valuation service and we evaluate the relevant inputs, assumptions, methodologies and conclusions associated with such valuations. The valuation service calculates prices for the Company’s investments in the aforementioned security types on a month-end basis by using several matrix-pricing methodologies that incorporate inputs from various sources. The model the valuation service uses to price U.S. government securities and securities of states and municipalities incorporates inputs from active market makers and inter-dealer brokers. To price corporate bonds and agency securities, the valuation service calculates non-call yield spreads on all issuers, uses option-adjusted yield spreads to account for any early redemption features, then adds final spreads to the U.S. Treasury curve as of quarter end. The inputs the valuation service uses in their calculations are not quoted prices in active markets, but are observable inputs, and therefore represent Level 2 inputs.
The following table presents information about the Company’s assets measured at fair value on a recurring basis. The Company assesses the levels for the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy. As of March 31, 2019, and December 31, 2018, there were no transfers in or out of Level 1, 2, and 3.
The Company also invests small amounts in equity securities, real estate and private limited partnerships. This investment class has the potential for higher returns but also the potential for higher degrees of risk, including less than stable rates of returns and may provide less liquidity.
Investments excluded from the fair value hierarchy
Limited partnerships carried at fair value, which do not have readily determinable fair value, use NAV (net asset value) provided by the investees and are excluded from the fair value hierarchy. The Company may, as of the last day of each calendar
quarter, upon at least 65 days’ prior written notice, withdrawal all or any portion of the balance in its investment. There is a 3 percent withdrawal fee if made during the first year of investment.
Level 1
Level 2
Level 3
Invested Assets:
Fixed maturity securities, available-for-sale:
359
48,818
4,514
523,426
Common stock
3,825
Non-redeemable preferred stock
13,550
Total equity securities
545,315
21,889
Investments reported at NAV
354
47,687
4,861
504,788
3,686
12,770
526,105
At December 31, 2018, the Company recorded the $2.4 million of limited partnership investments at net asset value and therefore, excluded from the fair value hierarchy.
Non-recurring fair value measurements
Assets and liabilities that are measured at fair value on a non-recurring basis include intangible assets and goodwill which are recognized at fair value during the period in which an acquisition is completed, from updated estimates and assumptions during the measurement period, or when they are considered to be impaired. These non-recurring fair value measurements, primarily for intangible assets acquired, were based on Level 3 unobservable inputs. For the three months ended March 31, 2019 and 2018, these non-recurring fair values inputs consisted of brand, agent relationships, renewal rights, customer relations, trade names, value of business acquired, non-compete and goodwill. To evaluate such assets for a potential impairment, we determine the fair value of the goodwill and intangible assets using a combination of a discounted cash flow approach and market approaches, which contain significant unobservable inputs and therefore is considered a Level 3 fair value measurement. The unobservable inputs in the analysis generally include future cash flow projections and a discount rate.
There were no non-recurring fair value adjustments to intangible assets and goodwill during the first quarter of 2019 and 2018. We record any measurement period adjustments to the fair value of assets acquired and liabilities assumed, with the corresponding offset to goodwill.
11
NOTE 4. OTHER COMPREHENSIVE INCOME
Other comprehensive income (loss) was $6.0 million and $(4.4) million for the three months ended March 31, 2019 and 2018, respectively. The difference between net income as reported and comprehensive income was due to the changes in unrealized gains and losses, net of taxes on fixed maturities securities.
Pre-tax
Tax
After-tax
Other comprehensive income
Change in unrealized losses on investments, net
(2,323
5,713
1,871
(4,607
Reclassification adjustment of realized losses (gains) included in net income
(85
250
(48
179
Effect on other comprehensive income
8,371
(6,251
NOTE 5. LEASES
The Company has entered into operating and financing leases primarily for real estate and vehicles. The Company will determine whether an arrangement is a lease at inception of the agreement. The operating leases have terms of one to ten years, and often include one or more options to renew. These renewal terms can extend the lease term from three to ten years, and are included in the lease term when it is reasonably certain that the Company will exercise the option. The Company considers these options in determining the lease term used in establishing our right-of-use asset and lease obligations. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Because the rate implicit in each operating lease in not readily determinable, the Company uses its incremental borrowing rate to determine present value of the lease payments. The Company used the implicit rates within the finance leases.
Components of our lease costs for the three months ended March 31, 2019 are as follows (in thousands):
Amortization of ROU assets - Finance leases
Interest on lease liabilities - Finance leases
Variable lease cost (cost excluded from lease payments)
111
Operating lease cost (cost resulting from lease payments)
176
Total lease cost
317
New ROU assets - Operating leases
6,955
Supplemental cash flow information and non-cash activity related to our operating and financing leases as of March 31, 2019 are as follows (in thousands):
Finance lease - Operating cash flows
Finance lease - Financing cash flows
Operating lease - Operating cash flows (fixed payments)
171
Operating lease - Operating cash flows (liability reduction)
141
Supplemental balance sheet information related to our operating and financing leases as of March 31, 2019 are as follows (in thousands):
Balance Sheet Classification
Right-of-use assets (1)
7,129
Lease Liability
(8,581
(1) Right-of-use asset is reduced by $1.3 million in lease incentives received in March 2019, for the new February 1, 2019 lease agreement.
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Weighted-average remaining lease term and discount rate for our operating and financing leases as of March 31, 2019 are as follows:
Weighted average lease term - Finance leases
4.12 yrs.
Weighted average lease term - Operating leases
8.48 yrs.
Weighted average discount rate - Finance leases
8.1
Weighted average discount rate - Operating leases
5.3
Maturities of lease liabilities by fiscal year for our operating and financing leases as of March 31, 2019 are as follows (in thousands):
2019 remaining
879
2020
1,437
2021
1,405
2022
1,439
2023
1,254
2024 and thereafter
4,449
Total lease payments
10,863
Less: imputed interest
(2,282
Present value of lease liabilities
8,581
NOTE 6. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following at March 31, 2019 and December 31, 2018:
Land
2,582
Building
11,390
Computer hardware and software
5,163
4,901
Office furniture and equipment
1,855
Tenant and leasehold improvements
7,717
4,477
Vehicle fleet
783
854
Total, at cost
29,490
25,601
Less: accumulated depreciation and amortization
(8,173
(7,603
Depreciation and amortization expense for property and equipment was $571,000 and $414,000 for the three months ended March 31, 2019 and 2018, respectively. The Company’s real estate consists of 15 acres of land and five buildings with a gross area of 229,000 square feet and a parking garage.
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and Intangible Assets
At March 31, 2019 and December 31, 2018 goodwill was $152.5 million and intangible assets were $74.8 million and $76.8 million, respectively. The Company has determined the useful life of the other intangible assets to range between 2.5-15 years. The Company has recorded $1.3 million relating to insurance licenses and classified as an indefinite lived intangible which is subject to annual impairment testing concurrent with goodwill.
Balance as of December 31, 2018
Goodwill acquired
Impairment
Balance as of March 31, 2019
Other Intangible Assets
Our intangible assets resulted primarily from the acquisitions of Zephyr Acquisition Company and NBIC Holdings, Inc. and consist of brand, agent relationships, renewal rights, customer relations, trade names, non-competes and insurance licenses. Finite-lived intangibles assets are amortized over their useful lives from one to fifteen years.
Amortization expense of our intangible assets was $2.1 million and $6.6 million for the three months ended March 31, 2019 and March 31, 2018, respectively. No impairment in the value of amortizing or non-amortizing intangible assets was recognized during the three months ended March 31, 2019 or 2018.
Estimated annual pretax amortization of intangible assets for each of the next five years and thereafter is as follows (in thousands):
Year
Amount
6,115
6,365
6,351
2024
Thereafter
35,558
73,442
Excludes insurance licenses valued at $1.3 million and classified as an indefinite lived intangible which is subject to annual impairment testing and not amortized.
NOTE 8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the periods indicated.
Basic earnings per share:
Net income attributable to common stockholders (000's)
Diluted earnings per share:
Weighted average dilutive shares
4,049
1,004,466
Total weighted average dilutive shares
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NOTE 9. DEFERRED REINSURANCE CEDING COMMISSION
The Company defers reinsurance ceding commission income, which is amortized over the effective period of the related insurance policies. For the three months ended March 31, 2019 and 2018, the Company allocated ceding commission income of $12.9 million and $14.3 million to policy acquisition costs and $4.3 million and $4.7 million to general and administrative expense, respectively.
The table below depicts the activity with regard to deferred reinsurance ceding commission during the three-month periods ended March 31, 2019 and 2018.
Beginning balance of deferred ceding commission income
44,996
51,277
Ceding commission deferred
12,647
15,557
Less: ceding commission earned
(17,169
(18,993
Ending balance of deferred ceding commission income
40,474
47,841
NOTE 10. DEFERRED POLICY ACQUISITION COSTS
The Company defers certain costs in connection with written policies, called deferred policy acquisition costs (“DPAC”), which are amortized over the effective period of the related insurance policies.
The Company anticipates that its DPAC costs will be fully recoverable in the near term. The table below depicts the activity with regard to DPAC during the three-month periods ended March 31, 2019 and 2018.
Beginning Balance
41,678
Policy acquisition costs deferred
35,965
24,371
Amortization
(39,137
(12,187
Ending Balance
53,862
NOTE 11. INCOME TAXES
During the three months ended March 31, 2019 and 2018, the Company recorded $2.4 million and $5.2 million, respectively, of income tax expense which corresponds to an estimated annual effective tax rate of 25.4% and 25.8%, respectively. Effective tax rates are dependent upon components of pre-tax earnings and the related tax effects. The effective tax rate can fluctuate throughout the year as estimates used in the tax provision for the first quarter are updated as more information becomes available throughout the year.
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The table below summarizes the significant components of our net deferred tax assets (liabilities):
Deferred tax assets:
15,264
12,090
Unearned commission
9,657
10,733
Net operating loss
Tax-related discount on loss reserve
2,418
2,329
Unrealized loss
431
2,631
528
297
Accrued expenses
2,050
2,321
Other
1,870
1,443
Total deferred tax asset
32,327
31,953
Deferred tax liabilities:
Deferred acquisition costs
16,735
17,494
Prepaid expenses
65
Property and equipment
533
Note discount
536
710
Basis in purchased investments
149
163
Basis in purchased intangibles
18,509
18,982
1,767
1,533
Total deferred tax liabilities
38,294
39,658
Net deferred tax liability
(5,967
(7,705
In April 2019, the Company was notified by the tax authority that the 2015, 2016 and 2017 tax years federal income tax returns will be examined. The Company does not believe the examination results will have an adverse impact on the condensed consolidated financial statements.
At March 31, 2019 and December 31, 2018, we had no significant uncertain tax positions or unrecognized tax benefits that, if recognized, would impact the effective income tax rate.
NOTE 12. REINSURANCE
The Company’s reinsurance program is designed, utilizing the Company’s risk management methodology, to address its exposure to catastrophes or large non-catastrophic losses. The Company’s program provides reinsurance protection for catastrophes including hurricanes, tropical storms, tornadoes and winter storms. The Company’s reinsurance agreements are part of its catastrophe management strategy, which is intended to provide its stockholders an acceptable return on the risks assumed in its property business, and to reduce variability of earnings, while providing protection to the Company’s policyholders.
We purchase significant reinsurance from third party reinsurers, including the Florida Hurricane Catastrophe Fund, and sponsor catastrophe bonds issued by Citrus Re. Our insurance affiliates may also purchase reinsurance from our captive reinsurer, Osprey Re Ltd. The catastrophe reinsurance may be on an excess of loss or quota share basis. We also purchase reinsurance for non-catastrophe losses on a quota share, per risk or facultative basis. Purchasing a sufficient amount of reinsurance to consider catastrophic losses from single or multiple events or significant non-catastrophe losses is an important part of our risk strategy, and premiums paid (or ceded) to reinsurers is one of our largest cost components. Reinsurance involves transferring, or “ceding”, a portion of the risk exposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss.
Our reinsurance agreements are prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of our new reinsurance agreements. We generally amortize our catastrophe reinsurance premiums over the 12-month contract period on a straight-line basis, which is June 1 through May 31. Our quota share reinsurance is amortized over the 12-month contract period and may be purchased on a calendar or fiscal year basis.
In the event that we incur losses and loss adjustment expenses recoverable under our reinsurance program, we record amounts recoverable from our reinsurers on paid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of our liability for unpaid losses associated with the reinsured policies; therefore, the
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amount changes in conjunction with any changes to our estimate of unpaid losses. As a result, a reasonable possibility exists that an estimated recovery may change significantly in the near term from the amounts included in our consolidated financial statements.
Our insurance regulators require all insurance companies, like us, to have a certain amount of capital and reinsurance coverage in order to cover losses and loss adjustment expenses upon the occurrence of a catastrophic event. Our 2018-2019 reinsurance program provides reinsurance in excess of our state regulator requirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once in every 100 years based on our portfolio of insured risks. The nature, severity and location of the event giving rise to such a probable maximum loss differs for each insurer depending on the insurer’s portfolio of insured risks, including, among other things, the geographic concentration of insured value within such portfolio. As a result, a particular catastrophic event could be a one-in-100-year loss event for one insurance company while having a greater or lesser probability of occurrence for another insurance company. We also purchase reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year. We share portions of our reinsurance program coverage among our insurance company affiliates.
The Company’s reinsurance arrangements had the following effect on certain items in the condensed consolidated statement of income for the three months ended March 31, 2019 and 2018:
Premium written:
Direct
Ceded
(46,842
(57,350
Net
147,016
Premiums earned:
Loss and Loss Adjustment Expenses
112,176
335,729
(50,037
(282,638
NOTE 13. RESERVE FOR UNPAID LOSSES
The Company determines the reserve for unpaid losses on an individual-case basis for all incidents reported. The liability also includes amounts which are commonly referred to as incurred but not reported, or “IBNR”, claims as of the balance sheet date.
The table below summarizes the activity related to the Company’s reserve for unpaid losses:
Balance, beginning of period
470,083
Less: reinsurance recoverable on unpaid losses
250,507
315,353
Net balance, beginning of period
181,852
154,730
Incurred related to:
Current year
62,725
51,361
Prior years
(586
1,730
Total incurred
Paid related to:
8,362
(1,252
45,616
46,737
Total paid
53,978
45,485
Net balance, end of period
190,013
162,336
Plus: reinsurance recoverable on unpaid losses
214,471
385,399
Balance, end of period
547,735
As of March 31, 2019, we reported $190.0 million in unpaid losses and loss adjustment expenses, net of reinsurance which included $143.1 million attributable to IBNR net of reinsurance recoverable, or 75% of net reserves for unpaid losses and loss adjustment expenses.
The Company’s losses incurred for the three months ended March 31, 2019 and 2018 reflect favorable development of $0.6 million and unfavorable development of $1.7 million, respectively, associated with management’s best estimate of the actuarial loss and LAE reserves with consideration given to Company specific historical loss experience. While a portion of the 2018 development includes additional retention for hurricane losses, the majority of the 2018 loss development related to personal lines litigated and AOB claims from 2016 and 2017 accident years.
NOTE 14. LONG-TERM DEBT
Convertible Senior Notes
In August 2017 and September 2017, we issued in aggregate $136.8 million of 5.875% Convertible Senior Notes (“Convertible Notes”) maturing on August 1, 2037, unless earlier repurchased, redeemed or converted. Interest is payable semi-annually in arrears, on February 1, and August 1 of each year, commencing in 2018.
As of March 31, 2019, we have $20.8 million Convertible Notes outstanding, net of issuance and debt discount costs in aggregate of approximately, $2.6 million. For the first quarters of 2019 and 2018, the Company made interest payments of approximately $1.5 million and $3.7 million, respectively on the Convertible Notes.
Debt Extinguishment
On February 19, 2019, the Company reacquired $5.8 million of its outstanding Convertible Notes, payment was made in cash of approximately $2.9 million and issuance of 285,201 shares of the Company’s common stock valued at $4.2 million. The repurchase resulted in a $48,000 non-operating loss.
Senior Secured Credit Facility
In December 2018, the Company entered in to a five-year, $125 million credit agreement (the “Credit Agreement”) with a syndicate of lenders consisting of $75 million senior secured term loan facility (the “Term Loan Facility”) and a $50.0 million senior secured revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”).
Term Loan Facility: The principal amount of the Term Loan Facility amortizes in quarterly installments, beginning with the close of the fiscal quarter ending March 31, 2019, in an amount equal to $1.9 million per quarter, with the remaining balance payable at maturity. As of December 31, 2018, there was $75.0 million in aggregate principal outstanding on the Term Loan Facility. As of March 31, 2019, the balance of the term loan was $73.1 million. For the three months ended March 31, 2019, the Company made interest payments of approximately $1.1 million on the term loan.
Revolving Credit Facility: The Revolving Credit Facility allows for borrowings of up to $50.0 million inclusive of a $5.0 million sublimit for the issuance of letters of credit and a $10.0 million sublimit for swingline loans. As of March 31, 2019, the Company had $10.0 million of borrowings and no letters of credit outstanding under the Revolving Credit Facility. For the three months ended March 31, 2019, the Company made interest payments of approximately $251,700 under the credit facility.
Mortgage Loan
In October 2017, the Company and its subsidiary, Skye Lane Properties LLC, jointly obtained a commercial real estate mortgage loan in the amount of $12.7 million, bearing interest of 4.95% per annum and expiring on October 30, 2027. On October 30, 2022, the interest rate shall adjust to an interest rate equal to the annualized interest rate of the United States 5-year Treasury Notes as reported by Federal Reserve on a weekly average basis plus 3.10%. The Company makes monthly principal and interest payments against the loan. For each of the first quarters of 2019 and 2018, the Company made principal and interest payments of approximately $223,200 on the mortgage loan.
FHLB Loan Agreements
In November 2018, a subsidiary of the Company received a fixed interest rate 3.094% cash loan of $19.2 million from the Federal Home Loan Bank (“FHLB”) Atlanta. In connection with the agreement, the subsidiary became a member of FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased in December 2018 and valued at $1.4 million. Additionally, the transaction required securities be pledged as collateral. As of March 31, 2019, the fair value of the collateralized securities was $24.2 million and the equity investment in FHLB common stock was $1.4 million. As of March 31, 2019, the Company made quarterly interest payments of approximately $148,500 per the terms of the agreement.
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The following table summarizes the Company’s long-term debt as of March 31, 2019 and December 31, 2018:
Convertible debt
23,413
29,163
Mortgage loan
12,324
12,394
Term loan facility
73,125
75,000
Revolving credit facility
10,000
FHLB loan agreement
19,200
Total principal amount
138,062
155,757
Less: unamortized discount and issuance costs
5,886
6,963
Total long-term debt
As of the date of this report, we were in compliance with the applicable terms of all our covenants and other requirements under the Revolving agreement, Term Note, Convertible Debt, cash borrowings and other loans. Our ability to secure future debt financing depend, in part, on our ability to remain in such compliance. As long as there is no default or an event of default exist we are allowed to payout dividends in an aggregate amount not to exceed $10.0 million in any fiscal year.
The schedule of principal payments on long-term debt is as follows:
5,832
7,790
7,806
7,822
74,589
34,223
NOTE 15. ACCOUNTS PAYABLE AND OTHER LIABILITIES
Accounts payable and other liabilities consist of the following as of March 31, 2019 and December 31, 2018:
Description
Deferred ceding commission
Outstanding claim checks
15,624
15,360
Accounts payable and other payables
11,051
8,379
Lease obligations
Accrued interest and issuance costs
697
1,285
Accrued dividends
1,807
1,589
Premium tax
406
2,241
Current income taxes
460
Commission payables
10,782
11,654
Total other liabilities
NOTE 16. STATUTORY ACCOUNTING AND REGULATIONS
State laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as our insurance subsidiaries. The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, restrict insurers’ ability to pay dividends, restrict the allowable investment types and investment mixes, and subject the Company’s insurers to assessments.
The Company’s insurance subsidiaries must maintain capital and surplus ratios or balances as determined by the regulatory authority of the states in which they are domiciled. Heritage P&C is required to maintain capital and surplus equal to the greater of $15 million or 10% of their respective liabilities. Zephyr is required to maintain a deposit of $750,000 in a federally insured financial
19
institution. NBIC is required to maintain capital and surplus of $3.0 million. The combined statutory surplus for Heritage P&C, Zephyr and NBIC was $366.6 million for the three months ended March 31, 2019. The combined statutory surplus for Heritage P&C, Zephyr and NBIC was $376.3 million at December 31, 2018. State law also requires the Company’s insurance subsidiaries to adhere to prescribed premium-to-capital surplus ratios, with which the Company is in compliance. At March 31, 2019, our insurance subsidiaries met the financial and regulatory requirements of the states in which they do business.
NOTE 17. COMMITMENTS AND CONTINGENCIES
The Company is involved in claims-related legal actions arising in the ordinary course of business. The Company accrues amounts resulting from claims-related legal actions in unpaid losses and loss adjustment expenses during the period that it determines an unfavorable outcome becomes probable and it can estimate the amounts. Management makes revisions to its estimates based on its analysis of subsequent information that the Company receives regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) judicial decisions and legal developments in the awarding of damages; and (iv) trends in general economic conditions, including the effects of inflation. When determinable, the Company discloses the range of possible losses in excess of those accrued and for reasonably possible losses.
NOTE 18. RELATED PARTY TRANSACTIONS
The Company has been party to various related party transactions involving certain of its officers, directors and significant stockholders as set forth below. The Company has entered into each of these arrangements without obligation to continue its effect in the future and the associated expense was immaterial to its results of operations or financial position as of March 31, 2019 and 2018.
In January 2017, the Company entered into a consulting agreement with Mrs. Shannon Lucas, the wife of the Chairman and CEO, in which she agreed to provide consulting services related to the Company’s catastrophe reinsurance and risk management program at a rate of $400 per hour. The consulting agreement has no specific term and either party may terminate the agreement upon providing written notice. Additionally, she serves as a director of Heritage P&C with an annual compensation of $150,000. For the three months ended March 31, 2019 and 2018 the Company paid consulting fees to Ms. Lucas of approximately $102,800 and $171,000, respectively
NOTE 19. EMPLOYEE BENEFIT PLANS
The Company provides a 401(k) plan for substantially all employees. The Company provides a matching contribution of 100% on the first 3% of employees’ contribution and 50% on the next 2% of the employees’ contribution to the plan. The maximum match is 4%. For the three-month periods ended March 31, 2019 and 2018, the contributions made to the plan on behalf of the participating employees were approximately $255,700 and $394,200, respectively.
The Company provides for its employees a partially self-insured healthcare plan and benefits. For the three months ended March 31, 2019 and 2018, incurred medical premium costs amounted to an aggregate of $841,400 and $853,000, respectively. An additional liability of approximately $303,000 was recorded for unpaid claims as of March 31, 2019. A stop loss reinsurance policy caps the maximum loss that could be incurred by the Company under the self-insured plan. The Company’s stop loss coverage per employee is $150,000 for which any excess cost would be covered by the reinsurer subject to an aggregate limit for losses in excess of $1.5 million which would provide up to $1.0 million of coverage. Any excess of the $1.5 million retention and the $1 million of aggregate coverage would be borne by the Company. The aggregate stop loss commences once our expenses exceed 125% of the annual aggregate expected claims.
NOTE 20. EQUITY
The total amount of authorized capital stock consists of 50,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of March 31, 2019, the Company had 29,432,217 shares of common stock outstanding, 7,562,537 treasury shares of common stock and 580,801 unvested shares of restricted common stock issued reflecting total paid-in capital of $328.9 million as of such date.
As more fully disclosed in our audited consolidated financial statements for the year ended December 31, 2018, there were, as of December 31, 2018, 29,477,756 shares of common stock outstanding, 7,214,797 treasury shares of common stock and 605,801 unvested shares of restricted common stock, representing $325.3 million of additional paid-in capital.
Common Stock
Holders of common stock are entitled to one vote for each share held on all matters subject to a vote of stockholders, subject to the rights of holders of any outstanding preferred stock. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election, subject to the rights of holders of any outstanding
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preferred stock. Holders of common stock will be entitled to receive ratably any dividends that the board of directors may declare out of funds legally available therefor, subject to any preferential dividend rights of outstanding preferred stock. Upon the Company’s liquidation, dissolution or winding up, the holders of common stock will be entitled to receive ratably its net assets available after the payment of all debts and other liabilities and subject to the prior rights of holders of any outstanding preferred stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of the Company’s capital stock are fully paid and nonassessable.
Stock Repurchase Program
On August 1, 2018, the Company announced that its Board of Directors authorized a stock repurchase program authorizing the Company to repurchase up to $50 million of its common stock through December 31, 2020 under our current Rule 10b5-1 trading plan, which allows the Company to purchase shares below a predetermined price per share. During the first quarter of 2019, the Company purchased 347,740 shares of its common stock for $5.0 million. At March 31, 2019, the Company has the capacity to repurchase $45.0 million of its common shares until December 2020. During the first quarter of 2018, the Company repurchased 115,200 shares of its common stock for $2.0 million.
Dividends
On February 25, 2019, the Company’s Board of Directors declared a $0.06 per share quarterly dividend payable on April 3, 2019, to shareholders of record as of March 15, 2019. The declaration and payment of any future dividends will be subject to the discretion of the Board of Directors and will depend on a variety of factors including the Company’s financial condition and results of operations.
NOTE 21. STOCK-BASED COMPENSATION
Restricted Stock
The Company has adopted the Heritage Insurance Holdings, Inc., Omnibus Incentive Plan (the “Plan”) effective on May 22, 2014. The Plan authorized 2,981,737 shares of common stock for issuance under the Plan for future grants. As of December 31, 2018, all unexercised shares have been forfeited.
At March 31, 2019 there were 1,321,398 shares available for grant under the Plan. The Company recognizes compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards.
In 2018, the Board of Directors granted 155,801 restricted shares vesting over three to five years, to the Company’s executives and other key employees. No restricted stock was granted during quarter ended March 31, 2019.
The Company grants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The options have a maximum term of ten years from the date of grant and vest primarily in equal annual installments over a range of one to five-year periods following the date of grant for employee options. If a participant’s employment relationship ends, the participant’s vested awards will remain exercisable for the shorter of a period of 30 days or the period ending on the latest date on which such award could have been exercisable. The fair value of each option grant is separately estimated for each grant date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company estimates the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense.
The Company has also granted shares of its common stock subject to certain restrictions under the Plan. Restricted stock awards granted to employees vest in equal installments generally over a five-year period from the grant date subject to the recipient’s continued employment. The fair value of restricted stock awards is estimated by the market price at the date of grant and amortized on a straight-line basis to expense over the period of vesting. Recipients of restricted stock awards have the right to receive dividends.
Restricted stock activity for the quarter ended March 31, 2019 is as follows:
Weighted-Average
Grant-Date Fair
Number of shares
Value per Share
Non-vested, at December 31, 2018
605,801
20.41
Granted
Vested
(17,000
14.72
Canceled and surrendered
(8,000
Non-vested, at March 31, 2019
580,801
20.65
21
Awards are being amortized to expense over the three to five-year vesting period. The Company recognized $1.3 million and $1.3 million of compensation expense for the three months ended March 31, 2019 and 2018, respectively. There was approximately $9.6 million of unrecognized compensation expense related to the un-vested restricted stock at March 31, 2019. The Company expects to recognize substantially all of remaining compensation expense over approximately over the next 1.9 years. During the quarter ended March 31, 2019, 25,000 restricted shares were vested and released, all of which had been granted to employees. Of the shares released to employees, 8,000 shares were withheld by the Company to cover withholding taxes of $118,000. During the first quarter of 2018, no shares were vested and released.
NOTE 22. SUBSEQUENT EVENTS
The Company performed an evaluation of subsequent events through the date the financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the financial statements as of March 31, 2019.
On May 6, 2019, the Company announced that its Board of Directors declared a $0.06 per share quarterly dividend payable on July 3, 2019 to stockholders of record as of June 14, 2019.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”). Unless the context requires otherwise, as used in this Form 10-Q, the terms “we”, “us”, “our”, “the Company”, “our company”, and similar references refer to Heritage Insurance Holdings, Inc., a Delaware corporation, and its subsidiaries.
Financial Results Highlights for the Three Months Ended March 31, 2019
Net income was $7.0 million, or $0.24 per diluted share. Investment gains contributed approximately $0.8 million to net income, or $0.03 per diluted share.
Gross premiums written were $210.3 million, up 2.9% year-over-year, including 6.6% growth outside Florida and 0.1% growth in Florida.
Began writing personal residential business in Virginia and launched commercial residential product in New Jersey. Heritage is now actively writing personal residential business in twelve states (licensed in fifteen).
Favorable prior year reserve development of $0.6 million, representing third consecutive quarter of favorable development.
Net current accident year catastrophe losses of $15.0 million, including $10.2 million for Brevard County, FL hailstorm.
Repurchased 347,740 shares for $5.0 million at a 3% discount to first quarter 2019 book value per share, resulting in total capital returned to shareholders of $6.8 million in the quarter, including $0.06 per share regular quarterly dividend.
As previously disclosed, paid down $10.0 million of revolving credit facility debt and repurchased an incremental $5.8 million principal amount of convertible notes ($23.4 million principal amount of convertible notes remain outstanding with third parties), taking the debt-to-capital ratio to 24.1%, down 10.7 points year-over-year and 2.7 points sequentially.
Critical Accounting Policies and Estimates
When we prepare our consolidated financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles (GAAP), we must make estimates and assumptions about future events that affect the amounts we report. Certain of these estimates result from judgments that can be subjective and complex. As a result of that subjectivity and complexity, and because we continuously evaluate these estimates and assumptions based on a variety of factors, actual results could materially differ from our estimates and assumptions if changes in one or more factors require us to make accounting adjustments. During the three months ended March 31, 2019, we reassessed our critical accounting policies and estimates as disclosed within our 2018 Form 10-K; we have made no material changes or additions with regard to such policies and estimates.
Results of Operations
The following table reports our unaudited results of operations for the three months ended March 31, 2019 and 2018:
$ Change
% Change
REVENUE:
5,982
(4,555
(20
)%
1,427
2,156
(2
3,583
370
1,251
NM
1,031
36
Total revenue
6,236
OPERATING EXPENSES:
9,048
Policy acquisition costs
13,833
114
General and administrative expenses
(3,327
(15
Total operating expenses
19,554
(13,319
(54
(2,703
(56
Other non-operating expense, net
(10,663
(53
(2,799
(7,864
Basic net income per share
(0.34
(59
Diluted net income per share
(0.31
(57
NM= Not Meaningful
Comparison of the Three Months Ended March 31, 2019 and 2018
Revenue
Gross premiums written were $210.3 million in first quarter 2019, up 2.9% from $204.4 million in the prior year quarter. The increase reflects further diversification, as gross premiums written grew 6.6% outside Florida, but only 0.1% in Florida. Premiums-in-force were $930.1 million at quarter-end, up 0.7% year-over-year, including 4.7% growth outside Florida and a 2.4% decline in Florida. Sequentially, premiums-in-force increased 0.7%, including 1.8% growth outside Florida and a 0.3% decline in Florida.
Gross premiums earned were $228.6 million in first quarter 2019, up 0.6% from $227.2 million in the prior year quarter. This increase stems from the same items impacting gross premiums written.
Ceded premiums earned
Ceded premiums earned were $118.9 million, down 1.8% from $121.1 million in the prior year quarter. The decrease is primarily attributable to NBIC-related reinsurance synergies and a decline in NBIC’s gross quota share reinsurance program from 18.75% to 8.0%, partially offset by an increase in NBIC’s net quota share reinsurance program from 49.5% to 52%.
Net premiums earned were $109.7 million, up 3.4% from $106.1 million in the prior year quarter. The increase stems from higher gross premiums earned and lower ceded premiums earned, as described above.
Net investment income, inclusive of realized investment gains and unrealized gains on equity securities, was $4.7 million, up $1.6 million year-over-year. The increase relates primarily to unrealized gains on equity securities in the current year quarter.
Other revenue was $3.9 million in the current year quarter, up $1.0 million year-over-year reflecting unrealized loss on equity securities recognized in 2018.
Total revenue was $118.3 million in the current year quarter, up 5.6% year-over-year. The increase primarily stems from higher net premiums earned, net investment income and other revenue, as described above.
Operating Expenses
Losses and loss adjustment expenses (“LAE”) were $62.1 million in the current year quarter, up $9.0 million from $53.1 million in the prior year quarter. The increase stems primarily from a higher net loss ratio in the current year quarter.
Policy acquisition costs were $26.0 million in the current year quarter, up $13.8 million from $12.2 million in the prior year quarter. The increase primarily reflects the favorable impact of NBIC-related purchase accounting on the prior year quarter and reduced ceding commission income in the current year quarter associated with a reduction to NBIC’s gross quota share reinsurance program from 18.75% to 8.0%. The favorable 2018 purchase accounting impact occurred predominantly in the first two quarters and was limited thereafter, as acquisition costs increased with new business.
General and administrative expenses were $18.6 million in the current year quarter, down $3.3 million from $21.9 million in the prior year quarter. The decrease is primarily attributable to lower EBITDA, and consequently, lower compensation accruals for compensation tied to EBITDA, in the current year quarter.
Interest and amortization of debt issuance costs
Interest expense and amortization of debt issuance costs were $2.1 million in the current year quarter, down $2.7 million from $4.8 million in the prior year quarter. The decrease primarily reflects a $53.0 million year-over-year reduction in balance sheet long-term debt and a lower blended interest rate on outstanding debt
Provision for income taxes was $2.4 million and $5.2 million for first quarter 2019 and 2018, respectively. The effective tax rate for the current year quarter is 25.4%, 40 basis points below the prior year quarter’s 25.8% rate. The effective tax rate can fluctuate throughout the year as estimates used in the first quarter’s tax provision are updated with additional information throughout the year.
First quarter 2019 net income was $7.0 million ($0.24 per diluted share) compared to $14.8 million ($0.55 cents per diluted share) in the prior year quarter. The decrease primarily reflects a higher net expense ratio stemming from the favorable impact of purchase accounting on the prior year quarter and a higher net loss ratio.
Ratios
Gross ceded premium ratio
52.0
53.3
Net loss and LAE ratio
56.6
50.0
Net operating expense ratio
40.7
32.2
Net combined ratio
97.3
82.2
The gross ceded premium ratio was 52.0% in first quarter 2019, down 1.3 points from 53.3% in the prior year quarter. The decrease is primarily attributable to NBIC-related reinsurance synergies and a decline in NBIC’s gross quota share reinsurance program from 18.8% to 8.0%, partly offset by an increase in NBIC’s net quota share program from 49.5% to 52.0%.
The net loss and LAE ratio was 56.6% in first quarter 2019, up 6.6 points from 50.0% in the prior year quarter. The increase relates to higher current accident quarter net losses and LAE, partly offset by better reserve development and a lower ceded premium ratio.
The net operating expense ratio was 40.7% in first quarter 2019, up 8.5 points from 32.2% in the prior year quarter. The increase primarily stems from the favorable impact of NBIC-related purchase accounting on the prior year quarter and reduced ceding commission income in the current year quarter associated with an overall reduction to NBIC’s quota share reinsurance programs, partly offset by a lower ceded premium ratio.
The net combined ratio was 97.3% in first quarter 2019, up 15.1 points from 82.2% in the prior year quarter. The increase stems from higher net loss and operating expense ratios, as described above.
Liquidity and Capital Resources
As of March 31, 2019, we had $279.7 million of cash and cash equivalents, which primarily consisted of cash and money market accounts. We generally hold substantial cash balances to meet seasonal liquidity needs including amounts to pay quarterly reinsurance installments as well as meet the collateral requirements of Osprey Re Ltd. (“Osprey”), our captive reinsurance company. In addition, we have $12.3 million in restricted cash to meet our contractual obligations related to the catastrophe bonds issued by Citrus Re Ltd.
Osprey is required to maintain a collateral trust account equal to the risk that it assumes from our insurance company affiliates. At March 31, 2019, approximately $20 million was held in Osprey’s trust account.
Although we can provide no assurances, we believe that we maintain sufficient liquidity to pay our insurance company affiliates’ claims and expenses, as well as to satisfy commitments in the event of unforeseen events such as inadequate premium rates or reserve deficiencies. We maintain a comprehensive reinsurance program at levels management considers adequate to diversify risk and safeguard our financial position.
Although we can provide no assurance, we believe our current capital resources, together with cash provided from our operations, will be sufficient to meet currently anticipated working capital requirements for at least the next twelve months.
Cash Flows
Change
Net cash provided by (used in):
Operating activities
97,454
Investing activities
(89,918
Financing activities
(17,876
Net increase (decrease) in cash and cash equivalents
(10,340
Operating Activities
Net cash provided by operating activities was $85.3 million for the three months ended March 31, 2019 compared to cash used of $12.1 million for the three months ended March 31, 2018. The increase in cash from operating activities relates primarily to collection of reinsurance on catastrophe claims and a reduction of unpaid losses and loss adjustment expenses during the first quarter of 2019 compared to the first quarter of 2018.
Investing Activities
Net cash used in investing activities for the three months ended March 31, 2019 was $34.2 million as compared to cash provided of $55.7 million for the comparable period in 2018. The cash provided by investing activities in the first quarter of 2018 relates to investments sold during the quarter, primarily to fund payments of Hurricane Irma claims pending reinsurance recoveries whereas we increased invested assets during the first quarter of 2019.
Financing Activities
Net cash used in financing activities for the three months ended March 31, 2019 was $21.5 million, as compared to cash used in financing activities of $3.7 million for the comparable period in 2018. The increase in cash used in financing activities is due primarily to stock repurchased under the stock repurchase program in the current year, principal payment on the revolving credit line and purchase of Convertible Senior Notes during the first quarter of 2019.
Credit Facilities
On December 14, 2018, Heritage Insurance Holdings, Inc. (the “Company”), as borrower, entered into a five-year, $125 million credit agreement (the “Credit Agreement”) by and among the Company, certain subsidiaries of the Company from time to time party thereto as guarantors, the lenders from time to time party thereto (the “Lenders”), Regions Bank, as Administrative Agent and Collateral Agent, BMO Harris Bank N.A., as Syndication Agent, Hancock Whitney Bank and Canadian Imperial Bank of Commerce, as Co-Documentation Agents, and Regions Capital Markets and BMO Capital Markets Corp., as Joint Lead Arrangers and Joint Bookrunners.
Pursuant to the Credit Agreement, the participating Lenders agreed to provide (1) a senior secured term loan facility in an aggregate principal amount of $75 million (the “Term Loan Facility”) and (2) a senior secured revolving credit facility in an aggregate principal amount of $50 million (inclusive of a $5 million sublimit for the issuance of letters of credit and a $10 million sublimit for swingline loans) (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”).
At our option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to LIBOR (based on one, two, three or six-month interest periods), adjusted for statutory reserve requirements, plus an applicable margin (equal to 3.25% as of the Closing Date) or (2) a base rate determined by reference to the greatest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the LIBOR index rate applicable for an interest period of one month plus 1.00%, plus an applicable margin (equal to 2.25%).
The applicable margin for loans under the Credit Facilities varies from 3.25% per annum to 3.75% per annum (for LIBOR loans) and 2.25% to 2.75% per annum (for base rate loans) based on our consolidated leverage ratio. Interest payments with respect to the Credit Facilities are required either on a quarterly basis (for base rate loans) or at the end of each interest period (for LIBOR loans) or, if the duration of the applicable interest period exceeds three months, then every three months. As of March 31, 2019, the borrowing under our Credit Facilities were accruing interest at a rate of 5.8125% per annum.
In addition to paying interest on outstanding borrowings under the Revolving Credit Facility, we are required to pay a quarterly commitment fee based on the unused portion of the Revolving Credit Facility, which is determined by our consolidated leverage ratio.
Each of the Revolving Credit Facility and the Term Loan Facility mature on December 14, 2023. The principal amount of the Term Loan Facility amortizes in quarterly installments, beginning with the close of the fiscal quarter ending March 31, 2019, in an amount equal to $1,875,000 per quarter, payable monthly or quarterly, with the balance payable at maturity.
The Company may prepay the loans under the Credit Facilities, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts and reimbursement of certain costs in the case of prepayments of LIBOR loans. In addition, the Company is required to prepay the loan under the Term Loan Facility with the proceeds from certain financing transactions, involuntary dispositions or asset sales (subject, in the case of asset sales, to reinvestment rights).
All obligations under the Credit Facilities are or will be guaranteed by each existing and future direct and indirect wholly-owned domestic subsidiary of the Company, other than all of the Company’s current and future regulated insurance subsidiaries (collectively, the “Guarantors”).
The Company and the Guarantors entered into a Pledge and Security Agreement, on December 14, 2018 (the “Security Agreement”), in favor of Regions Bank, as collateral agent. Pursuant to the Security Agreement, amounts borrowed under the Credit Facilities are secured on a first priority basis by a perfected security interest in substantially all of the present and future assets of the Company and each Guarantor (subject to certain exceptions), including all of the capital stock of the Company’s domestic subsidiaries, other than its regulated insurance subsidiaries.
The Credit Agreement contains, among other things, covenants, representations and warranties and events of default customary for facilities of this type. The Company is required to maintain, as of each fiscal quarter (1) a maximum consolidated leverage ratio of 3.25 to 1.00 for each fiscal quarter ending on or before December 31, 2019, stepping down on each of the three anniversaries thereafter; (2) a minimum consolidated fixed charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth for the Company and its subsidiaries. Events of default include, among other events, (i) nonpayment of principal, interest, fees or other amounts; (ii) failure to perform or observe certain covenants set forth in the Credit Agreement; (iii) breach of any representation or warranty; (iv) cross-default to other indebtedness; (v) bankruptcy and insolvency defaults; (vi) monetary judgment defaults and material nonmonetary judgment defaults; (vii) customary ERISA defaults; (viii) a change of control of the Company; and (ix) failure to maintain specified catastrophe retentions in each of the Company’s regulated insurance subsidiaries.
Convertible Notes
On August 10, 2017, the Company and Heritage MGA, LLC (the “Guarantor”) entered into a purchase agreement (the “Purchase Agreement”) with Citigroup Global Markets Inc., as the initial purchaser (the “Initial Purchaser”), pursuant to which the Company agreed to issue and sell, and the Initial Purchaser agreed to purchase, $125.0 million aggregate principal amount of the Company’s 5.875% Convertible Senior Notes due 2037 (the “Convertible Notes”) in a private placement transaction pursuant to Rule 144A under the Securities Act, as amended (the “Securities Act”) (the “Offering”). The Purchase Agreement contained customary representations, warranties and agreements of the Company and the Guarantor and customary conditions to closing, indemnification rights and obligations of the parties and termination provisions. The net proceeds from the Offering, after deducting discounts and commissions and estimated offering expenses payable by the Company, were approximately $120.5 million. The Offering was completed on August 16, 2017.
The Company issued the Convertible Notes under an Indenture (the “Convertible Note Indenture”), dated August 16, 2017, by and among the Company, as issuer, the Guarantor, as guarantor, and Wilmington Trust, National Association, as trustee (the “Trustee”).
The Convertible Notes bear interest at a rate of 5.875% per year. Interest began accruing on August 16, 2017 and is payable semi-annually in arrears, on February 1 and August 1 of each year, starting on February 1, 2018. The Convertible Notes are senior unsecured obligations of the Company that rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company’s unsecured indebtedness that is not so subordinated; effectively junior to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness or other liabilities incurred by the Company’s subsidiaries other than the Guarantor, which fully and unconditionally guarantee the Convertible Notes on a senior unsecured basis.
The Convertible Notes mature on August 1, 2037, unless earlier repurchased, redeemed or converted.
28
Holders may convert their Convertible Notes at any time prior to the close of business on the business day immediately preceding February 1, 2037, other than during the period from, and including, February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2017, if the closing sale price of the Company’s common stock, for at least 20 trading days (whether or not consecutive) in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price of the Convertible Notes in effect on each applicable trading day; (2) during the ten consecutive business-day period following any five consecutive trading-day period in which the trading price for the Convertible Notes for each such trading day was less than 98% of the closing sale price of the Company’s common stock on such date multiplied by the then-current conversion rate; (3) if the Company calls any or all of the Convertible Notes for redemption, at any time prior to the close of business on the second business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events.
During the period from and including February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, and on or after February 1, 2037 until the close of business on the second business day immediately preceding August 1, 2037, holders may surrender their Convertible Notes for conversion at any time, regardless of the foregoing circumstances.
The conversion rate for the Convertible Notes was initially 67.0264 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $14.92 per share of common stock). The conversion rate is subject to adjustment in certain circumstances, and is subject to increase for holders that elect to convert their Convertible Notes in connection with certain corporate transactions (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture)) that occur prior to August 5, 2022.
Upon the occurrence of a fundamental change (as defined in the Convertible Note Indenture) (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture)), holders of the Convertible Notes may require the Company to repurchase for cash all or a portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.
Except as described below, the Company may not redeem the Convertible Notes prior to August 5, 2022. On or after August 5, 2022 but prior to February 1, 2037, the Company may redeem for cash all or any portion of the Convertible Notes, at the Company’s option, at a redemption price equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Convertible Notes, which means that the Company is not required to redeem or retire the Convertible Notes periodically. Holders of the Convertible Notes are able to cause the Company to repurchase their Convertible Notes for cash on any of August 1, 2022, August 1, 2027 and August 1, 2032, in each case at 100% of their principal amount, plus accrued and unpaid interest to, but excluding, the relevant repurchase date.
The Convertible Note Indenture contains customary terms and covenants and events of default. If an Event of Default (as defined in the Indenture) occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in aggregate principal amount of the Convertible Notes then outstanding by notice to the Company and the Trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be immediately due and payable. In the case of certain events of bankruptcy, insolvency or reorganization (as set forth in the Convertible Note Indenture) with respect to the Company, 100% of the principal of, and accrued and unpaid interest, if any, on, the Notes automatically become immediately due and payable.
In the second quarter of 2018, the Company repurchased $10.6 million principal amount of Convertible Notes for cash. In the fourth quarter of 2018 and first quarter of 2019, the Company exchanged Convertible Notes in the aggregate principal amount of $81.6 million for a combination of cash and the issuance of an aggregate of 3,880,653 shares of the Company’s common stock, leaving $23.4 million in aggregate principal amount outstanding.
In November 2018, a subsidiary of the Company pledged U.S. government and agency fixed maturity securities with an estimated fair value of $31.0 million as collateral and received $19.2 million in a cash loan under an advance agreement with the Federal Home Loan Bank (“FHLB”) Atlanta. The loan originated on December 12, 2018 and bears a fixed interest rate of 3.094% with interest payments due quarterly commencing in March 2019. The principal balance on the loan has a maturity date of December 13, 2023. In connection with the agreement, the subsidiary became a member of FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased on December 31, 2018 and valued at $1.4 million. The subsidiary is permitted to withdraw any portion of the pledged collateral over the minimum collateral requirement at any time, other than in the
29
event of a default by the subsidiary. The proceeds from the loan was used to prepay the Company’s Senior Secured Notes due 2023 (“Senior Notes”) in 2018. The Company does not have any Senior Notes outstanding as of March 31, 2019.
Contractual Obligations
The following table represents our contractual obligations for which cash flows are fixed or determinable as of March 31, 2019:
Less Than 1 Year
1-3 Years
3-5 Years
More than 5 Years
39,575
1,032
2,751
33,041
Note Payable
104,329
9,671
24,552
70,106
21,057
670
1,786
16,815
FHLB agreement
22,066
455
1,206
20,405
11,075
1,091
2,842
2,692
4,450
Other obligations and commitments (1)
169,262
Total Contractual Obligations
367,364
182,181
33,137
97,740
54,306
Represents deposits premiums on reinsurance contracts
Seasonality of our Business
Our insurance business is seasonal as hurricanes typically occur during the period from June 1 through November 30 each year and winter storms generally impact the first and fourth quarters of each year. With our catastrophe reinsurance program effective on June 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insured value of our policy base, will occur and be reflected in our financial results beginning June 1 of each year, subject to certain adjustments.
Off-Balance Sheet Arrangements
We do not have transactions with unconsolidated entities, such as entities often referred to as structured financial or special purpose entities, whereby we have financial guarantees, subordinated retained interest, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities or any other obligation under a variable interest in an unconsolidated entity that provides financial, liquidity, market risk, or credit risk support to us.
Recent Accounting Pronouncements
The information set forth under Note 1 to the condensed consolidated financial statements under the caption “Basis of Presentation and Significant Accounting Policies” is incorporated herein by reference.
JOBS Act
We qualify as an “emerging growth company” under the JOBS Act. Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.
We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, if as an emerging growth company we choose to rely on such exemptions, we may not be required to, among other things, (i) provide an auditor’s attestation report on our systems of internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act, (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis), and (iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer’s compensation to median employee compensation. These exemptions will apply until we no longer meet the requirements of being an emerging growth company. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth
30
anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenue of at least $1.07 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our prior second fiscal quarter, and (2) the date on which we have issued more than $1 billion in non-convertible debt during the prior three-year period.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our investment portfolios at March 31, 2019 included fixed maturity and equity securities, the purposes of which are not for trading or speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet policyholder obligations while minimizing market risk, which is the potential economic loss from adverse fluctuations in securities’ prices. We consider many factors including credit ratings, investment concentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies. Investment securities are managed by a group of nationally recognized asset managers and are overseen by the investment committee appointed by our board of directors. Our investment portfolios are primarily exposed to interest rate risk, credit risk and equity price risk. We classify our fixed maturity securities as available-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income within our stockholders’ equity. We classify our equity securities as available-for-sale and report any unrealized gains or losses in the income statement. As such, any material temporary changes in the fair value of such securities can adversely impact the carrying value of our stockholders’ equity.
Interest Rate Risk
Our fixed maturity securities are sensitive to potential losses resulting from unfavorable changes in interest rates. We manage the risk by analyzing anticipated movement in interest rates and considering our future capital needs.
The following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed maturity securities at March 31, 2019 (in thousands):
Hypothetical Change in Interest rates
Estimated Fair Value After Change
Change In Estimated Fair
Value
Percentage Increase
(Decrease) in Estimated
300 basis point increase
472,832
(55,108
(10
200 basis point increase
491,203
(36,737
(7
100 basis point increase
509,572
(18,368
(3
100 basis point decrease
546,303
18,363
200 basis point decrease
563,473
35,533
300 basis point decrease
572,696
44,756
Credit Risk
Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuer of our fixed maturities. We mitigate this risk by investing in fixed maturities that are generally investment grade and by diversifying our investment portfolio to avoid concentrations in any single issuer or market sector.
The following table presents the composition of our fixed maturity portfolio by rating at March 31, 2019 (in thousands):
Comparable
Rating
Amortized
Cost
% of Total
Estimated
% of total
AAA
49,212
49,151
AA+
176,927
176,004
AA
61,645
61,925
AA-
37,703
37,899
A+
24,164
24,243
A
31,061
31,071
A-
39,492
39,426
BBB+
39,521
39,784
BBB
17,120
17,050
BBB-
4,717
4,647
BB+
720
0
734
BB
414
BB-
101
99
B+
134
131
B
867
NA and NR
44,391
44,496
Equity Price Risk
Our equity investment portfolio at March 31, 2019 consists of common stocks and redeemable and non-redeemable preferred stocks. We may incur potential losses due to adverse changes in equity security prices. We manage this risk primarily through industry and issuer diversification and asset allocation techniques.
The following table illustrates the composition of our equity portfolio at March 31, 2019 (in thousands):
Fair value
Stocks by sector:
Financial
1,602
Energy
2,283
13,489
78
Subtotal
Mutual Funds and ETF By type:
Foreign Currency Exchange Risk
At March 31, 2019, we did not have any material exposure to foreign currency related risk.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Quarterly Report, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of
our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2019.
Changes in Internal Control over Financial Reporting
There has been no change in our internal controls over financial reporting during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We implemented internal controls to ensure we adequately assessed the impact of the new accounting standards related to leases on our financial statements to facilitate their adoption on January 1, 2019. There were no significant changes to our internal control over financial reporting due to the adoption of the new standard.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to claims and legal actions arising routinely in the ordinary course of our business. Although we cannot predict with certainty the ultimate resolution of the claims and lawsuits asserted against us, we do not believe that any currently pending legal proceedings to which we are a party will have a material adverse effect on our consolidated financial position results of operations or cash flow.
Item 1A. Risk Factors
The risk factors disclosed in the section entitled “Risk Factors” in our 2018 Form 10-K set forth information relating to various risks and uncertainties that could materially adversely affect our business, financial condition and operating results. Those risk factors continue to be relevant to an understanding of our business, financial condition and operating results. No material changes have occurred with respect to those risk factors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer purchases of equity securities
During the three months ended March 31, 2019, we purchased 347,740 shares of common stock for an aggregate purchase of $5.0 million under our share repurchase program. A summary of our common stock repurchases during the three months ended March 31, 2019 under our share repurchase program is set forth in the table below (in thousands, except shares):
Total Number of Shares Purchased
Average Price Paid Per Share (1)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)
Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs
January 1, 2019 through January 31, 2019
50,000
February 1, 2019 through February 28, 2019
March 1, 2019 through March 31, 2019
347,740
14.56
44,989
Average price paid per share excludes cash paid for commissions.
(2)
On August 1, 2018, the Company announced that its Board of Directors authorized a stock repurchase program authorizing the Company to repurchase up to $50 million of its common stock through December 31, 2020 under our current Rule 10b5-1 trading plan, which allows the Company to purchase shares below a predetermined price per share.
Item 4. Mine Safety Disclosures
None
Item 6. Exhibits
The information required by this Item 6 is set forth in the Index to Exhibits accompanying this Quarterly Report on Form 10-Q.
Index to Exhibits
Exhibit
Number
3.1
Certificate of Incorporation of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014)
3.2
By-laws of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014)
Form of Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A (File No. 333-195409) filed on May 13, 2014)
4.1
Form of 5.875% Convertible Senior Notes due 2037 (included in Exhibit 4.1), incorporated by reference to 1.1 to our Form 8-K filed on August 16, 2017
4.2
Indenture, date as of August 16, 2017, by and among the Company. Heritage MGA, LLC as guarantor, and Wilmington Trust, National Association, as trustee, incorporated by reference to Exhibit 4.1 to our Form 8-K filed on August 16, 2017
10.8*
Credit Agreement, dated December 14, 2018, among Heritage Insurance Holdings, Inc., certain subsidiaries of Heritage Insurance Holdings, Inc. from time to time party thereto as guarantors, the lenders from time to time party thereto, Regions Bank, as Administrative Agent and Collateral Agent, BMO Harris Bank N.A., as Syndication Agent, Hancock Whitney Bank and Canadian Imperial Bank of Commerce, as Co-Documentation Agents, and Regions Capital Markets and BMO Capital Markets Corp., as Joint Lead Arrangers and Joint Bookrunners
31.1*
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**
Certification of Chief Executive Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**
Certification of Chief Financial Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
101. SCH XBRL Taxonomy Extension Schema.
101.CAL
101. CAL XBRL Taxonomy Extension Calculation Linkbase.
101.DEF
101. DEF XBRL Taxonomy Extension Definition Linkbase.
101.LAB
101. LAB XBRL Taxonomy Extension Label Linkbase.
101.PRE
101. PRE XBRL Taxonomy Extension Presentation Linkbase.
* Filed herewith
** Furnished herewith
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 8, 2019
By:
/s/ BRUCE LUCAS
Bruce Lucas
Chairman and Chief Executive Officer
(Principal Executive Officer and Duly Authorized Officer)
/s/ KIRK LUSK
Kirk Lusk
Chief Financial Officer
(Principal Financial and Accounting Officer)