10-Q 1 hc2holdings-2017q110q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
FORM 10-Q 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2017
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
Commission File No. 001-35210
HC2 HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
54-1708481
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
450 Park Avenue, 30th Floor, New York, NY
 
10022
(Address of principal executive offices)
 
(Zip Code)
(212) 235-2690
(Registrant’s telephone number, including area code)
____________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.001 per share
 
NYSE MKT LLC
Securities registered pursuant to Section 12(g) of the Act:
N/A
____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 ☐
Accelerated filer
x
Non-accelerated filer
 ☐
Smaller reporting company
 ☐
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.
Emerging Growth Company
 ☐
 
 
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, 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 7(a)(2)(B) of the Securities Act.  ☐
† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes   ☐    No  ý
As of April 30, 2017, 42,155,860 shares of common stock, par value $0.001, were outstanding.

HC2 HOLDINGS, INC.
INDEX TO FORM 10-Q


PART I. FINANCIAL INFORMATION

PART II. OTHER INFORMATION


1
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)


PART I: FINANCIAL INFORMATION

Item 1. Financial Statements
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Services revenue
 
$
235,928

 
$
182,109

Sales revenue
 
118,614

 
120,497

Life, accident and health earned premiums, net
 
19,941

 
19,934

Net investment income
 
15,304

 
14,079

Net realized gains (losses) on investments
 
781

 
(4,875
)
Net revenue
 
390,568

 
331,744

Operating expenses
 
 
 
 
Cost of revenue - services
 
219,612

 
174,873

Cost of revenue - sales
 
94,802

 
99,677

Policy benefits, changes in reserves, and commissions
 
31,487

 
34,020

Selling, general and administrative
 
39,856

 
35,597

Depreciation and amortization
 
7,397

 
5,955

Other operating (income) expenses
 
(3,558
)
 
887

Total operating expenses
 
389,596

 
351,009

Income (loss) from operations
 
972

 
(19,265
)
Interest expense
 
(14,115
)
 
(10,326
)
Loss on contingent consideration
 
(231
)
 
—

Income (loss) from equity investees
 
7,693

 
(3,576
)
Other income (expense), net
 
(4,910
)
 
(714
)
Loss from continuing operations before income taxes
 
(10,591
)
 
(33,881
)
Income tax (expense) benefit
 
(5,291
)
 
2,539

Net loss
 
(15,882
)
 
(31,342
)
Less: Net loss attributable to noncontrolling interest and redeemable noncontrolling interest
 
1,386

 
880

Net loss attributable to HC2 Holdings, Inc.
 
(14,496
)
 
(30,462
)
Less: Preferred stock and deemed dividends from conversions
 
583

 
1,069

Net loss attributable to common stock and participating preferred stockholders
 
$
(15,079
)
 
$
(31,531
)
 
 
 
 
 
Loss per Common Share
 

 

Basic
 
$
(0.36
)
 
$
(0.89
)
Diluted
 
$
(0.36
)
 
$
(0.89
)
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
Basic
 
41,948

 
35,262

Diluted
 
41,948

 
35,262









See notes to consolidated financial statements.

2
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)


 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net loss
 
$
(15,882
)
 
$
(31,342
)
Other comprehensive income (loss)
 
 
 
 
Foreign currency translation adjustment
 
1,125

 
1,823

Unrealized gain (loss) on available-for-sale securities
 
11,976

 
18,617

Other comprehensive income
 
13,101

 
20,440

Comprehensive loss
 
(2,781
)
 
(10,902
)
Less: Net loss attributable to noncontrolling interest and redeemable noncontrolling interest
 
1,386

 
880

Comprehensive loss attributable to HC2 Holdings, Inc.
 
$
(1,395
)
 
$
(10,022
)






















See notes to consolidated financial statements.

3
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)


 
 
March 31,
 
December 31,
 
 
2017
 
2016
Assets
 

 

Investments:
 

 

Fixed maturities, available-for-sale at fair value
 
$
1,302,549

 
$
1,278,958

Equity securities, available-for-sale at fair value
 
51,897

 
51,519

Mortgage loans
 
21,824

 
16,831

Policy loans
 
18,106

 
18,247

Other invested assets
 
80,580

 
62,363

Total investments
 
1,474,956

 
1,427,918

Cash and cash equivalents
 
127,003

 
115,371

Accounts receivable, net
 
228,058

 
267,598

Recoverable from reinsurers
 
524,845

 
524,201

Deferred tax asset
 
440

 
1,108

Property, plant and equipment, net
 
284,304

 
286,458

Goodwill
 
98,086

 
98,086

Intangibles, net
 
38,382

 
39,722

Other assets
 
80,288

 
74,814

Total assets
 
$
2,856,362

 
$
2,835,276

 
 
 
 
 
Liabilities, temporary equity and stockholders’ equity
 

 

Life, accident and health reserves
 
$
1,665,459

 
$
1,648,565

Annuity reserves
 
249,371

 
251,270

Value of business acquired
 
46,509

 
47,613

Accounts payable and other current liabilities
 
236,157

 
251,733

Deferred tax liability
 
15,550

 
15,304

Long-term obligations
 
445,620

 
428,496

Other liabilities
 
98,795

 
92,871

Total liabilities
 
2,757,461

 
2,735,852

Commitments and contingencies
 

 

Temporary equity:
 

 

Preferred stock
 
29,479

 
29,459

Redeemable noncontrolling interest
 
2,958

 
2,526

Total temporary equity
 
32,437

 
31,985

Stockholders’ equity
 

 

Common stock, $.001 par value;
 
42

 
42

Shares authorized: 80,000,000 at March 31, 2017 and December 31, 2016;
 
 
 
 
Shares issued: 42,520,073 and 42,070,675 at March 31, 2017 and December 31, 2016;
 
 
 
 
Shares outstanding: 42,155,860 and 41,811,288 at March 31, 2017 and December 31, 2016, respectively
 
 
 
 
Additional paid-in capital
 
243,698

 
241,485

Treasury stock, at cost; 364,213 and 259,387 shares at March 31, 2017 and December 31, 2016, respectively
 
(1,968
)
 
(1,387
)
Accumulated deficit
 
(188,774
)
 
(174,278
)
Accumulated other comprehensive loss
 
(8,546
)
 
(21,647
)
Total HC2 Holdings, Inc. stockholders’ equity
 
44,452

 
44,215

Noncontrolling interest
 
22,012

 
23,224

Total stockholders’ equity
 
66,464

 
67,439

Total liabilities, temporary equity and stockholders’ equity
 
$
2,856,362

 
$
2,835,276








See notes to consolidated financial statements.

4
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)

 
Common Stock
 
Additional
Paid-In
Capital
 
Treasury
Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Total HC2 Stockholders' Equity
 
Non-
controlling
Interest
Total Stockholders’ Equity
Temporary Equity
 
 
Shares
 
Amount
 
Balance as of December 31, 2016
41,811

 
$
42

 
$
241,485

 
$
(1,387
)
 
$
(174,278
)
 
$
(21,647
)
 
44,215

 
$
23,224

 
$
67,439

 
$
31,985

Share-based compensation expense
—

 
—

 
2,593

 
—

 
—

 
—

 
2,593

 
—

 
2,593

 
—

Fair value adjustment of redeemable noncontrolling interest
—

 
—

 
(275
)
 
—

 
—

 
—

 
(275
)
 
—

 
(275
)
 
275

Preferred stock dividend
—

 
—

 
(563
)
 
—

 
—

 
—

 
(563
)
 
—

 
(563
)
 
—

Preferred stock beneficial conversion feature
—

 
—

 
(20
)
 
—

 
—

 
—

 
(20
)
 
—

 
(20
)
 
20

Issuance of common stock
321

 
—

 
16

 
—

 
—

 
—

 
16

 
—

 
16

 
—

Exercise of stock options
129

 
—

 
462

 
—

 
—

 
—

 
462

 
—

 
462

 
—

Taxes paid in lieu of shares issued for share-based compensation
(105
)
 
—

 
—

 
(581
)
 
—

 
—

 
(581
)
 
—

 
(581
)
 
—

Transactions with noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
331

Net loss
—

 
—

 
—

 
—

 
(14,496
)
 
—

 
(14,496
)
 
(1,212
)
 
(15,708
)
 
(174
)
Comprehensive loss attributable to HC2 Holdings, Inc.
 

—


—


—

 
—


13,101


13,101


—


13,101


—

Balance as of March 31, 2017
42,156


$
42


$
243,698


$
(1,968
)
 
$
(188,774
)

$
(8,546
)

$
44,452


$
22,012


$
66,464


$
32,437

 
Common Stock
 
Additional
Paid-In
Capital
 
Treasury
Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Total HC2 Stockholders' Equity
 
Non-
controlling
Interest
Total Stockholders’ Equity
Temporary Equity
 
 
Shares
 
Amount
 
Balance as of December 31, 2015
35,250

 
$
35

 
$
209,477

 
$
(378
)
 
$
(79,729
)
 
$
(35,375
)
 
$
94,030

 
$
23,494

 
$
117,524

 
$
55,741

Share-based compensation expense
—

 
—

 
2,582

 
—

 
—

 
—

 
2,582

 
—

 
2,582

 
609

Preferred stock dividend and accretion
—

 
—

 
(1,014
)
 
—

 
—

 
—

 
(1,014
)
 
—

 
(1,014
)
 
—

Preferred stock beneficial conversion feature
—

 
—

 
(55
)
 
—

 
—

 
—

 
(55
)
 
—

 
(55
)
 
55

Issuance of common stock
65

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Transactions with noncontrolling interests
—

 
—

 
723

 
—

 
—

 
—

 
723

 
5,444

 
6,167

 
—

Net loss
—

 
—

 
—

 
—

 
(30,462
)
 
—

 
(30,462
)
 
(239
)
 
(30,701
)
 
(641
)
Comprehensive loss attributable to HC2 Holdings, Inc.
—

 
—

 
—

 
—

 
—


20,440

 
20,440

 
—


20,440


—

Balance as of March 31, 2016
35,315

 
$
35


$
211,713


$
(378
)
 
$
(110,191
)

$
(14,935
)

86,244


$
28,699


$
114,943


$
55,764













See notes to consolidated financial statements.

5
HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(15,882
)
 
$
(31,342
)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
 
 
 
 
Provision for doubtful accounts receivable
 
(411
)
 
112

Share-based compensation expense
 
1,519

 
3,191

Depreciation and amortization
 
8,637

 
7,884

Amortization of deferred financing costs and debt discount / premium
 
2,707

 
495

Amortization of discount / premium on investments
 
2,834

 
3,361

(Gain) loss on sale or disposal of assets
 
(3,752
)
 
887

(Income) loss from equity investees
 
(7,693
)
 
3,576

Impairment of investments
 
3,269

 
2,686

Net realized / unrealized (gains) losses on investments
 
(368
)
 
3,067

Loss on contingent consideration
 
231

 
—

Receipt of dividends from equity investees
 
917

 
7,214

Deferred income taxes
 
(4,443
)
 
(12,311
)
Annuity benefits
 
2,172

 
2,256

Other operating activities
 
203

 
112

Changes in assets and liabilities, net of acquisitions:
 
 
 
 
Accounts receivable
 
40,322

 
15,211

Recoverable from reinsurers
 
(644
)
 
3,689

Other assets
 
(5,131
)
 
26,879

Life, accident and health and Annuity reserves
 
18,219

 
20,914

Accounts payable and other current liabilities
 
16,444

 
(42,324
)
Other liabilities
 
(26,374
)
 
1,268

Cash provided by operating activities:
 
32,776

 
16,825

Cash flows from investing activities:
 
 
 
 
Purchase of property, plant and equipment
 
(9,413
)
 
(6,512
)
Disposal of property, plant and equipment
 
161

 
471

Purchase of investments
 
(56,636
)
 
(73,606
)
Sale of investments
 
23,073

 
32,765

Maturities and redemptions of investments
 
24,092

 
18,052

Purchase of equity method investments
 
(10,200
)
 
—

Cash paid for business acquisitions, net of cash acquired
 
—

 
(6,469
)
Other investing activities
 
154

 
172

Cash used in investing activities:
 
(28,769
)
 
(35,127
)
Cash flows from financing activities:
 
 
 
 
Proceeds from long-term obligations
 
53,655

 
2,360

Principal payments on long-term obligations
 
(40,664
)
 
(3,156
)
Annuity receipts
 
873

 
785

Annuity surrenders
 
(6,269
)
 
(5,149
)
Transactions with noncontrolling interests
 
331

 
2,000

Payment of dividends
 
(1,322
)
 
(1,014
)
Other financing activities
 
(117
)
 
—

Cash provided by financing activities:
 
6,487

 
(4,174
)
Effects of exchange rate changes on cash and cash equivalents
 
1,138

 
1,552

Net change in cash and cash equivalents
 
11,632

 
(20,924
)
Cash and cash equivalents, beginning of period
 
115,371

 
158,624

Cash and cash equivalents, end of period
 
$
127,003

 
$
137,700

Supplemental cash flow information:
 
 
 
 
Cash paid for interest
 
$
1,456

 
$
1,465

Cash paid for taxes
 
$
264

 
$
639

Non-cash investing and financing activities:
 
 
 
 
Property, plant and equipment included in accounts payable
 
$
740

 
$
946

Investments in accounts payable
 
$
10,320

 
$
7,180

Dividends payable to shareholders
 
$
563

 
$
988

See notes to consolidated financial statements.

6

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1. Organization and Business

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

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

1.Our Construction segment includes DBM Global Inc. (“DBMG”) and its wholly-owned subsidiaries. DBMG is a fully integrated detailer, BIM modeler, fabricator and erector of structural steel and heavy steel plate. DBMG details, models, fabricates and erects structural steel for commercial and industrial construction projects such as high- and low-rise buildings and office complexes, hotels and casinos, convention centers, sports arenas, shopping malls, hospitals, dams, bridges, mines and power plants. DBMG also fabricates trusses and girders and specializes in the fabrication and erection of large-diameter water pipe and water storage tanks. Through Aitken, DBMG manufactures pollution control scrubbers, tunnel liners, pressure vessels, strainers, filters, separators and a variety of customized products. The Company maintains a 92% controlling interest in DBMG.

2.Our Marine Services segment includes Global Marine Systems Limited ("GMSL"). GMSL is a leading provider of engineering and underwater services on submarine cables. The Company maintains a 95% equity interest in GMSL.

3.Our Energy segment includes American Natural Gas ("ANG"). ANG is a premier distributor of natural gas motor fuel. ANG designs, builds, owns, acquires, operates and maintains compressed natural gas fueling stations for transportation vehicles. The Company maintains effective control of, and a 49.99% ownership interest in ANG.

4.Our Telecommunications segment includes PTGi International Carrier Services, ("ICS"). ICS operates a telecommunications business including a network of direct routes and provides premium voice communication services for national telecommunications operators, mobile operators, wholesale carriers, prepaid operators, Voice over Internet Protocol ("VOIP") service operators and Internet service providers from our International Carrier Services business unit. ICS provides a quality service via direct routes and by forming strong relationships with carefully selected partners. The Company owns 100% of ICS.

5.Our Insurance segment includes Continental General Insurance Company ("CGI" or the "Insurance Company"). CGI provides long-term care, life and annuity coverage that help protect policy and certificate holders from the financial hardships associated with illness, injury, loss of life, or income continuation. The Company owns 100% of the Insurance Company.

6.Our Life Sciences segment includes Pansend Life Sciences, LLC (“Pansend”). Pansend owns a (i) 77% interest in Genovel Orthopedics, Inc. ("Genovel"), which seeks to develop products to treat early osteoarthritis of the knee, (ii) 71% interest in R2 Dermatology Inc. ("R2", f/k/a GemDerm Aesthetics, Inc.), which develops skin lightening technology, and (iii) 80% interest in BeneVir Biopharm, Inc. ("BeneVir"), which focuses on immunotherapy for the treatment of solid tumors. Pansend also invests in other early stage or developmental stage healthcare companies including a 45% interest in Medibeacon Inc., and Triple Ring Technologies, Inc.

7.In our Other segment, we invest in and grow developmental stage companies that we believe have significant growth potential. Among the businesses included in this segment is the Company's 56% ownership interest in 704Games Company ("704Games" f/k/a DMi, Inc.), which owns licenses to create and distribute NASCAR® video games, and the Company's 72% interest in NerVve Technologies, Inc. ("NerVve"), which provides analytics on broadcast TV, digital and social media online platforms.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements of the Company included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of such information. All such adjustments are of a normal recurring nature. Certain information and note disclosures, including a description of significant accounting policies normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), have been condensed or omitted pursuant to such rules and regulations. Certain prior amounts have been reclassified or combined to conform to the current year presentation. These reclassifications and combinations had no effect on previously reported net loss attributable to controlling interest or accumulated deficit. These interim financial statements should be read in conjunction with the Company’s annual consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the SEC on March 9, 2017, as amended by amendment no.1, filed on March 28, 2017 (collectively "Form 10-K"). The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results for any subsequent periods or the entire fiscal year ending December 31, 2017.

7

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED




New Accounting Pronouncements

The Company has implemented all new accounting pronouncements that are in effect and that may impact its Condensed Consolidated Financial Statements and does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial condition, results of operations or liquidity.

Accounting Principles Early Adopted During the Fiscal Year

Testing for Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Topic 350, Intangibles - Goodwill and Other (Topic 350), currently requires an entity that has not elected the private company alternative for goodwill to perform a two-step test to determine the amount, if any, of goodwill impairment. In Step 1, an entity compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the entity performs Step 2 and compares the implied fair value of goodwill with the carrying amount of the goodwill for that reporting unit. An impairment charge equal to the amount by which the carrying amount of goodwill for the reporting unit exceeds the implied fair value of that goodwill is recorded, limited to the amount of goodwill allocated to that reporting unit. To address concerns over the cost and complexity of the two-step goodwill impairment test, the amendments in this ASU remove the second step of the test. An entity will now apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The Company elected to early adopt ASU 2017-04 effective March 31, 2017, resulting in no impact to the Condensed Consolidated Financial Statements.

New Accounting Pronouncements to be Adopted Subsequent to the Fiscal Year

Revenue Recognition

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations, which clarifies the guidance in ASU 2014-09. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, an update on identifying performance obligations and accounting for licenses of intellectual property. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which includes amendments for enhanced clarification of the guidance. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Revenue from Contracts with Customers (Topic 606), which includes amendments of a similar nature to the items typically addressed in the technical corrections and improvements project. Lastly, in February 2017, the FASB issued ASU 2017-05, clarifying the scope of asset derecognition guidance and accounting for partial sales of nonfinancial assets to clarify the scope of ASC 610-20, Other Income - Gains and Losses from Derecognition of Nonfinancial Assets, and provide guidance on partial sales of nonfinancial assets. This ASU clarifies that the unit of account under ASU 610-20 is each distinct nonfinancial or in substance nonfinancial asset and that a financial asset that meets the definition of an “in substance nonfinancial asset” is within the scope of ASC 610-20. This ASU eliminates rules specifically addressing sales of real estate and removes exceptions to the financial asset derecognition model. The ASUs described above are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.

During the three month ended March 31, 2017, the Company continued its evaluation of ASU 2014-09, including the expected impact on its business processes, systems and controls, and potential differences in the timing and/or method of revenue recognition for its contracts. The Company expects to complete its assessment of the cumulative effect of adopting ASU 2014-09 as well as the expected impact of adoption during 2017. The Company will continue its evaluation of ASU 2014-09, including how it may impact new contracts it receives as well as new or emerging interpretations of the standard, through the date of adoption. The Company expects to adopt the revenue recognition ASUs described above in its Consolidated Financial Statements beginning in January 1, 2018 and is currently evaluating the impact the update would have.

Subsequent Events

ASC 855, “Subsequent Events” (“ASC 855”), establishes general standards of accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. ASC 855 requires HC2 to evaluate events that occur after the balance date as of which HC2's financial statements are issued, and to determine whether adjustments to or additional disclosures in the financial statements are necessary. HC2 has evaluated subsequent events through the date these financial statements were issued. See Note 22. Subsequent Events for the summary of the subsequent events.




8

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



3. Business Combinations

Construction Segment

On October 13, 2016, DBMG acquired the detailing and Building Information Modeling (“BIM”) management business of PDC Global Pty Ltd. (“PDC”). The new businesses provide steel detailing, BIM modelling and BIM management services for industrial and commercial construction projects in Australia and North America. On November 1, 2016, DBMG acquired BDS VirCon ("BDS"). BDS provides steel detailing, rebar detailing and BIM modelling services for industrial and commercial projects in Australia, New Zealand, North America and Europe. The aggregate fair value of the consideration paid in connection with the acquisition of PDC and BDS was $25.5 million, including $21.4 million in cash. Both transactions were accounted for as business acquisitions.

The preliminary fair value of consideration transferred and its allocation among the identified assets acquired, liabilities assumed, intangibles and residual goodwill are summarized as follows (in thousands):
Purchase price allocation
 
 
Cash and cash equivalents
 
$
621

Accounts receivable, net
 
5,558

Costs and recognized earnings in excess of billings on uncompleted contracts
 
1,686

Property, plant and equipment, net
 
8,043

Goodwill
 
11,827

Intangibles
 
3,955

Other assets
 
1,209

Total assets acquired
 
32,899

Accounts payable and other current liabilities
 
(5,924
)
Billings in excess of costs and recognized earnings on uncompleted contracts
 
(617
)
Deferred tax liability
 
(169
)
Other liabilities
 
(685
)
Total liabilities assumed
 
(7,395
)
Total net assets acquired
 
$
25,504


The preliminary allocation of the fair value of the acquired businesses was based upon a preliminary valuation. Our estimates and assumptions are subject to change as we obtain additional information for our estimates during the measurement period. The primary areas of preliminary allocation of the fair values of consideration transferred that are not yet finalized relate to the fair values of certain tangible and intangible assets acquired and the residual goodwill. We expect to complete the purchase price allocation for fiscal year 2016 acquisitions during fiscal year 2017.

Goodwill was determined based on the residual differences between fair value of consideration transferred and the value assigned to tangible and intangible assets and liabilities. Among the factors that contributed to goodwill was approximately $2.9 million assigned to the assembled and trained workforce. Goodwill is not amortized and is not deductible for tax purposes.

Acquisition costs incurred by DMBG in connection with the acquisition of PDC and BDS were approximately $2.5 million of which $0.2 million were for the three months ended March 31, 2017, and were included in selling, general and administrative expenses. The acquisition costs were primarily related to legal, accounting and valuation services.

PDC's and BDS' results were included in our Condensed Consolidated Statement of Operations since their respective acquisition dates. Pro forma results of operations for the acquisition of PDC and BDS have not been presented because they are not material to our consolidated results of operations.

Energy Segment

For the year ended December 31, 2016, ANG completed four acquisitions of twenty-one fueling stations in aggregate. The total fair value of the consideration transferred by ANG in connection with the acquisitions was $42.1 million, comprised of $39.2 million in cash and a $2.9 million 4.25% seller note, due in 2022. See Note 12. Long-term Obligations for further details. Two of the transactions were accounted for as an asset acquisition because substantially all of the fair value of the gross assets acquired was concentrated in a group of similar identifiable assets related to acquired stations.


9

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



For the transactions accounted for as a business combination, the fair value of consideration transferred was allocated among the identified assets acquired, liabilities assumed, intangibles and residual goodwill. For the two transactions accounted for as asset acquisitions the preliminary fair value of consideration transferred was preliminarily allocated based on the relative fair value (in thousands):
Purchase price allocation
 
 
Accounts receivable
 
$
1,303

Property, plant and equipment, net
 
42,758

Goodwill
 
1,257

Intangibles
 
4,984

Other assets
 
79

Total assets acquired
 
50,381

Accounts payable and other current liabilities
 
(898
)
Deferred tax liability
 
(7,086
)
Total liabilities assumed
 
(7,984
)
Bargain purchase gain
 
(340
)
Total net assets acquired
 
$
42,057


The preliminary allocation of the fair value of the acquired businesses was based upon a preliminary valuation. Our estimates and assumptions are subject to change as we obtain additional information for our estimates during the measurement period. The primary areas of preliminary allocation of the fair values of consideration transferred that are not yet finalized relate to the fair values of certain property, plant and equipment, deferred tax liability, intangible assets acquired and the residual goodwill. We expect to complete the purchase price allocation for fiscal year 2016 acquisitions during fiscal year 2017.

Approximately $5.0 million of the fair value of consideration transferred has been provisionally assigned to customer contracts with an estimated useful life ranging between four and fifteen years. The multi-period excess earnings method was used to assign fair value to the acquired customer contracts.

Goodwill was determined based on the residual differences between fair value of consideration transferred and the value assigned to tangible and intangible assets and liabilities. Goodwill is not amortized and is not deductible for tax purposes.

Results of operations from the acquired stations since acquisition dates have been included in our Condensed Consolidated Statement of Operations. Pro forma results of operations for ANG's acquisitions have not been presented because they are not material to our consolidated results of operations.

Other Acquisitions

During the year ended December 31, 2016 we completed the acquisition of additional interests in and thereby control of NerVve and BeneVir, and acquired a 60% controlling interest in CWind Limited ("CWind") with an obligation to purchase the remaining 40% in equal amounts on September 30, 2016 and September 30, 2017 (based on agreed financial targets). The total consideration transferred for these acquisitions was $14.9 million, including $9.2 million in cash. On November 1, 2016, we completed the renegotiation of the deferred purchase obligation to purchase the outstanding 40% minority interest of CWind and purchased the remaining 40% on that date. All three transactions were accounted for as business acquisitions.
 
Results of operations from other acquisitions since the respective acquisition dates have been included in our Condensed Consolidated Statement of Operations. Pro forma results of operations for other acquisitions have not been presented because they are not material to our consolidated results of operations.


10

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



The following table summarizes the allocation of the purchase price to the fair value of identifiable assets acquired, liabilities assumed, intangibles and residual goodwill (in thousands):
Purchase price allocation
 
 
Cash and cash equivalents
 
$
2,963

Restricted cash
 
3

Accounts receivable
 
6,400

Inventory
 
528

Property, plant and equipment, net
 
29,896

Goodwill
 
5,541

Intangibles
 
7,082

Other assets
 
2,051

Total assets acquired
 
54,464

Accounts payable and other current liabilities
 
(11,180
)
Deferred tax liability
 
(2,819
)
Long-term obligations
 
(20,813
)
Other liabilities
 
(3
)
Noncontrolling interest
 
(815
)
Total liabilities assumed
 
(35,630
)
Enterprise value
 
18,834

Less fair value of noncontrolling interest
 
3,889

Total net assets acquired
 
$
14,945


4. Investments

Fixed Maturity and Equity Securities Available-for-Sale

The following tables provide information relating to investments in fixed maturity and equity securities (in thousands):
March 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
15,720

 
$
198

 
$
(64
)
 
$
15,854

States, municipalities and political subdivisions
 
375,894

 
7,760

 
(2,944
)
 
380,710

Foreign government
 
6,368

 
—

 
(497
)
 
5,871

Residential mortgage-backed securities
 
129,664

 
5,091

 
(2,498
)
 
132,257

Commercial mortgage-backed securities
 
40,689

 
379

 
(173
)
 
40,895

Asset-backed securities
 
96,593

 
830

 
(916
)
 
96,507

Corporate and other
 
599,602

 
32,924

 
(2,071
)
 
630,455

Total fixed maturity securities
 
$
1,264,530

 
$
47,182

 
$
(9,163
)
 
$
1,302,549

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
$
16,797

 
$
44

 
$
(2,627
)
 
$
14,214

Perpetual preferred stocks
 
37,033

 
701

 
(51
)
 
37,683

Total equity securities
 
$
53,830

 
$
745

 
$
(2,678
)
 
$
51,897

December 31, 2016
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
15,910

 
$
135

 
$
(95
)
 
$
15,950

States, municipalities and political subdivisions
 
374,527

 
4,408

 
(3,858
)
 
375,077

Foreign government
 
6,380

 
—

 
(402
)
 
5,978

Residential mortgage-backed securities
 
136,126

 
2,634

 
(564
)
 
138,196

Commercial mortgage-backed securities
 
48,715

 
427

 
(89
)
 
49,053

Asset-backed securities
 
76,303

 
1,934

 
(572
)
 
77,665

Corporate and other
 
600,458

 
23,635

 
(7,054
)
 
617,039

Total fixed maturity securities
 
$
1,258,419

 
$
33,173

 
$
(12,634
)
 
$
1,278,958

 
 
 
 
 
 
 
 
 

11

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
$
16,236

 
$
—

 
$
(1,371
)
 
$
14,865

Perpetual preferred stocks
 
37,041

 
191

 
(578
)
 
36,654

Total equity securities
 
$
53,277

 
$
191

 
$
(1,949
)
 
$
51,519


The Company has investments in mortgage-backed securities ("MBS") that contain embedded derivatives (primarily interest-only MBS) that do not qualify for hedge accounting. The Company recorded the change in the fair value of these securities within Net realized gains (losses) on investments. These investments had a fair value of $14.7 million and $15.2 million as of March 31, 2017 and December 31, 2016, respectively. The change in fair value related to these securities resulted in a net gain of approximately $0.1 million for the three months ended March 31, 2017 and a net loss of approximately $1.7 million for the three months ended March 31, 2016.

Maturities of Fixed Maturity Securities Available-for-Sale

The amortized cost and fair value of fixed maturity securities available-for-sale as of March 31, 2017 are shown by contractual maturity in the table below (in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date:
 
 
Amortized Cost
 
Fair
 Value
Corporate, Municipal, U.S. Government and Other securities
 
 
 
 
Due in one year or less
 
$
48,251

 
$
48,296

Due after one year through five years
 
112,721

 
117,770

Due after five years through ten years
 
140,161

 
143,746

Due after ten years
 
696,451

 
723,078

Subtotal
 
997,584

 
1,032,890

Mortgage-backed securities
 
170,353

 
173,152

Asset-backed securities
 
96,593

 
96,507

Total
 
$
1,264,530

 
$
1,302,549


Corporate and Other Fixed Maturity Securities

The tables below show the major industry types of the Company’s corporate and other fixed maturity securities (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Amortized Cost
 
Fair
Value
 
% of
Total
 
Amortized Cost
 
Fair
Value
 
% of
Total
Finance, insurance, and real estate
 
$
203,453

 
$
207,732

 
32.9
%
 
$
214,911

 
$
211,834

 
34.3
%
Transportation, communication and other services
 
177,685

 
187,253

 
29.7
%
 
180,647

 
189,163

 
30.7
%
Manufacturing
 
110,413

 
117,647

 
18.7
%
 
112,644

 
118,440

 
19.2
%
Other
 
108,051

 
117,823

 
18.7
%
 
92,256

 
97,602

 
15.8
%
Total
 
$
599,602

 
$
630,455

 
100.0
%
 
$
600,458

 
$
617,039

 
100.0
%

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

A portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities the net amount recognized in the consolidated statements of operations (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The Company recorded a $3.3 million and a $1.0 million impairment, within Other income (expense), net, during the three months ended March 31, 2017 and 2016, respectively, related to one fixed maturity security.


12

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



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

The following table presents the total unrealized losses for the 217 and 269 fixed maturity and equity securities held by the Company as of March 31, 2017 and December 31, 2016, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Unrealized Losses
 
% of
Total
 
Unrealized Losses
 
% of
Total
Fixed maturity and equity securities
 
 
 
 
 
 
 
 
Less than 20%
 
$
(8,016
)
 
67.7
%
 
$
(10,069
)
 
69.0
%
20% or more for less than six months
 
(2,825
)
 
23.9
%
 
(482
)
 
3.3
%
20% or more for six months or greater
 
(1,000
)
 
8.4
%
 
(4,032
)
 
27.7
%
Total
 
$
(11,841
)
 
100.0
%
 
$
(14,583
)
 
100.0
%

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

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

The Company believes it will recover its cost basis in the non-impaired securities with unrealized losses and that the Company has the ability to hold the securities until they recover in value. The Company neither intends to sell nor does it expect to be required to sell the securities with unrealized losses as of March 31, 2017. However, unforeseen facts and circumstances may cause the Company to sell fixed maturity and equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.

The following tables present the estimated fair values and gross unrealized losses for the 217 and 269 fixed maturity and equity securities held by the Company that have estimated fair values below amortized cost as of each of March 31, 2017 and December 31, 2016, respectively. The Company does not have any OTTI losses reported in AOCI. These investments are presented by investment category and the length of time the related fair value has remained below amortized cost (in thousands):
March 31, 2017
 
Less than 12 months
 
12 months of greater
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
5,833

 
$
(64
)
 
$
—

 
$
—

 
$
5,833

 
$
(64
)
States, municipalities and political subdivisions
 
114,135

 
(2,928
)
 
365

 
(16
)
 
114,500

 
(2,944
)
Foreign government
 
—

 
—

 
5,871

 
(497
)
 
5,871

 
(497
)
Residential mortgage-backed securities
 
35,648

 
(2,105
)
 
17,519

 
(393
)
 
53,167

 
(2,498
)
Commercial mortgage-backed securities
 
12,129

 
(56
)
 
2,181

 
(117
)
 
14,310

 
(173
)
Asset-backed securities
 
46,595

 
(442
)
 
11,924

 
(474
)
 
58,519

 
(916
)
Corporate and other
 
85,891

 
(2,017
)
 
3,370

 
(54
)
 
89,261

 
(2,071
)
Total fixed maturity securities
 
$
300,231

 
$
(7,612
)
 
$
41,230

 
$
(1,551
)
 
$
341,461

 
$
(9,163
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
$
12,811

 
$
(2,167
)
 
$
518

 
$
(460
)
 
$
13,329

 
$
(2,627
)
Perpetual preferred stocks
 
4,251

 
(51
)
 
—

 
—

 
4,251

 
(51
)
Total equity securities
 
$
17,062

 
$
(2,218
)
 
$
518

 
$
(460
)
 
$
17,580

 
$
(2,678
)

13

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



December 31, 2016
 
Less than 12 months
 
12 months of greater
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
4,392

 
$
(95
)
 
$
—

 
$
—

 
$
4,392

 
$
(95
)
States, municipalities and political subdivisions
 
207,740

 
(3,858
)
 
—

 
—

 
207,740

 
(3,858
)
Foreign government
 
5,978

 
(402
)
 
—

 
—

 
5,978

 
(402
)
Residential mortgage-backed securities
 
54,385

 
(564
)
 
—

 
—

 
54,385

 
(564
)
Commercial mortgage-backed securities
 
13,159

 
(89
)
 
—

 
—

 
13,159

 
(89
)
Asset-backed securities
 
12,443

 
(572
)
 
—

 
—

 
12,443

 
(572
)
Corporate and other
 
147,653

 
(3,022
)
 
3,579

 
(4,032
)
 
151,232

 
(7,054
)
Total fixed maturity securities
 
$
445,750

 
$
(8,602
)
 
$
3,579

 
$
(4,032
)
 
$
449,329

 
$
(12,634
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
$
14,585

 
$
(1,371
)
 
$
—

 
$
—

 
$
14,585

 
$
(1,371
)
Perpetual preferred stocks
 
20,464

 
(578
)
 
—

 
—

 
20,464

 
(578
)
Total equity securities
 
$
35,049

 
$
(1,949
)
 
$
—

 
$
—

 
$
35,049

 
$
(1,949
)

As of March 31, 2017, investment grade fixed maturity securities (as determined by nationally recognized rating agencies) represented approximately 90.4% of the gross unrealized loss and 95.9% of the fair value. As of December 31, 2016, investment grade fixed maturity securities represented approximately 54.5% of the gross unrealized loss and 83.0% of the fair value.

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

Other Invested Assets

Carrying values of other invested assets accounted for under cost and equity method are as follows (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Cost
Method
 
Equity Method
 
Fair Value
 
Cost
Method
 
Equity Method
 
Fair
Value
Common Equity
 
$
138

 
$
1,083

 
$
—

 
$
138

 
$
1,047

 
$
—

Preferred Equity
 
2,484

 
19,044

 
—

 
2,484

 
9,971

 
—

Derivatives
 
3,097

 
—

 
3,694

 
3,097

 
—

 
3,813

Limited Partnerships
 
—

 
1,007

 
—

 
—

 
1,116

 
—

Joint Ventures
 
—

 
50,033

 
—

 
—

 
40,697

 
—

Total
 
$
5,719

 
$
71,167

 
$
3,694

 
$
5,719

 
$
52,831

 
$
3,813


The Company recognized losses of $0.1 million and $0.7 million on declines in the fair value of derivatives accounted for under ASC 815, "Derivatives and Hedging" during the three months ended March 31, 2017 and 2016, respectively.

Summarized information for the Company's equity method investments as of and for the three months ended March 31, 2017 is as follows (information for two of the investees is reported on a one month lag, in thousands):
Net revenue
 
$
120,862

Gross profit
 
$
38,258

Income (loss) from continuing operations
 
$
(9,243
)
Net income (loss)
 
$
(16,292
)
 
 
 
Current assets
 
$
297,687

Noncurrent assets
 
$
282,415

Current liabilities
 
$
193,848

Noncurrent liabilities
 
$
137,345



14

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Net Investment Income

The major sources of net investment income were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Fixed maturity securities, available-for-sale at fair value
 
$
13,925

 
$
13,266

Equity securities, available-for-sale at fair value
 
675

 
572

Mortgage loans
 
464

 
17

Policy loans
 
298

 
297

Other invested assets
 
4

 
142

Gross investment income
 
15,366

 
14,294

External investment expense
 
(62
)
 
(215
)
Net investment income
 
$
15,304

 
$
14,079


Net Realized Gains (Losses) on Investments

The major sources of net realized gains (losses) on investments were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Realized gains on fixed maturity securities
 
$
961

 
$
321

Realized losses on fixed maturity securities
 
(455
)
 
(2,309
)
Realized gains on equity securities
 
—

 
88

Realized losses on equity securities
 
—

 
(352
)
Net realized gains (losses) on derivative instruments
 
275

 
(2,623
)
Net realized gains (losses)
 
$
781

 
$
(4,875
)

5. Fair Value of Financial Instruments

Assets by Hierarchy Level

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
March 31, 2017
 
 
 
Fair Value Measurement Using:
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
15,854

 
$
5,134

 
$
10,705

 
$
15

States, municipalities and political subdivisions
 
380,710

 
—

 
374,112

 
6,598

Foreign government
 
5,871

 
—

 
5,871

 
—

Residential mortgage-backed securities
 
132,257

 
—

 
78,520

 
53,737

Commercial mortgage-backed securities
 
40,895

 
—

 
4,922

 
35,973

Asset-backed securities
 
96,507

 
—

 
9,347

 
87,160

Corporate and other
 
630,455

 
2,131

 
601,604

 
26,720

Total fixed maturity securities
 
1,302,549

 
7,265

 
1,085,081

 
210,203

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
14,214

 
10,683

 
—

 
3,531

Perpetual preferred stocks
 
37,683

 
9,676

 
28,007

 
—

Total equity securities
 
51,897

 
20,359

 
28,007

 
3,531

Derivatives
 
3,694

 
—

 
—

 
3,694

Total assets accounted for at fair value
 
$
1,358,140

 
$
27,624

 
$
1,113,088

 
$
217,428

Liabilities
 
 
 
 
 
 
 
 
Warrant liability
 
$
4,223

 
$
—

 
$
—

 
$
4,223

Contingent liability
 
11,642

 
—

 
—

 
11,642

Other
 
675

 
—

 
—

 
675

Total liabilities accounted for at fair value
 
$
16,540

 
$
—

 
$
—

 
$
16,540


15

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



December 31, 2016
 
 
 
Fair Value Measurement Using:
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
15,950

 
$
5,140

 
$
10,778

 
$
32

States, municipalities and political subdivisions
 
375,077

 
—

 
369,387

 
5,690

Foreign government
 
5,978

 
—

 
5,978

 
—

Residential mortgage-backed securities
 
138,196

 
—

 
82,242

 
55,954

Commercial mortgage-backed securities
 
49,053

 
—

 
6,035

 
43,018

Asset-backed securities
 
77,665

 
—

 
4,448

 
73,217

Corporate and other
 
617,039

 
2,020

 
594,653

 
20,366

Total fixed maturity securities
 
1,278,958

 
7,160

 
1,073,521

 
198,277

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
14,865

 
10,290

 
—

 
4,575

Perpetual preferred stocks
 
36,654

 
9,312

 
27,342

 
—

Total equity securities
 
51,519

 
19,602

 
27,342

 
4,575

Derivatives
 
3,813

 
—

 
—

 
3,813

Total assets accounted for at fair value
 
$
1,334,290

 
$
26,762

 
$
1,100,863

 
$
206,665

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Warrant liability
 
$
4,058

 
$
—

 
$
—

 
$
4,058

Contingent liability
 
11,411

 
—

 
—

 
11,411

Other
 
816

 
—

 
—

 
816

Total liabilities accounted for at fair value
 
$
16,285

 
$
—

 
$
—

 
$
16,285


The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. There were no transfers between Level 1 and Level 2 during the three months ended March 31, 2017 and $1.1 million corporate and other bonds and $0.5 million preferred stock were transferred from Level 1 into Level 2 during the three months ended March 31, 2016, reflecting the level of market activity in these instruments.

Availability of secondary market activity and consistency of pricing from third-party sources impacts the Company's ability to classify securities as Level 2 or Level 3. The Company’s assessment resulted in no transfers from or into Level 3 during the three months ended March 31, 2017 and net transfers into Level 3 of $2.2 million during the three months ended March 31, 2016.

The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below:

Fixed Maturity Securities - The fair values of the Company’s publicly-traded fixed maturity securities are generally based on prices obtained from independent pricing services. Prices from pricing services are sourced from multiple vendors, and a vendor hierarchy is maintained by asset type based on historical pricing experience and vendor expertise. In some cases, the Company receives prices from multiple pricing services for each security, but ultimately uses the price from the pricing service highest in the vendor hierarchy based on the respective asset type. Consistent with the fair value hierarchy described above, securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.

If the Company ultimately concludes that pricing information received from the independent pricing service is not reflective of market activity, non-binding broker quotes are used, if available. If the Company concludes the values from both pricing services and brokers are not reflective of market activity, it may override the information from the pricing service or broker with an internally developed valuation, however, this occurs infrequently. Internally developed valuations or non-binding broker quotes are also used to determine fair value in circumstances where vendor pricing is not available. These estimates may use significant unobservable inputs, which reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset. Pricing service overrides, internally developed valuations and non-binding broker quotes are generally based on significant unobservable inputs and are reflected as Level 3 in the valuation hierarchy.

The inputs used in the valuation of corporate and government securities include, but are not limited to, standard market observable inputs which are derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer.

For structured securities, valuation is based primarily on matrix pricing or other similar techniques using standard market inputs including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity,

16

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

When observable inputs are not available, the market standard valuation techniques for determining the estimated fair value of certain types of securities that trade infrequently, and therefore have little or no price transparency, rely on inputs that are significant to the estimated fair value but that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs are sometimes based in large part on management judgment or estimation, and cannot be supported by reference to market activity. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what other market participants would use when pricing such securities.

The fair values of private placement securities are primarily determined using a discounted cash flow model. In certain cases these models primarily use observable inputs with a discount rate based upon the average of spread surveys collected from private market intermediaries who are active in both primary and secondary transactions, taking into account, among other factors, the credit quality and industry sector of the issuer and the reduced liquidity associated with private placements. Generally, these securities have been reflected within Level 3. For certain private fixed maturities, the discounted cash flow model may also incorporate significant unobservable inputs, which reflect the Company’s own assumptions about the inputs market participants would use in pricing the security. To the extent management determines that such unobservable inputs are not significant to the price of a security, a Level 2 classification is made. Otherwise, a Level 3 classification is used.

Equity Securities. The balance consists principally of common and preferred stock of publicly and privately traded companies. The fair values of publicly traded equity securities are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. The fair values of preferred equity securities, for which quoted market prices are not readily available, are based on prices obtained from independent pricing services and these securities are generally classified within Level 2 in the fair value hierarchy. The fair value of common stock of privately held companies was determined using unobservable market inputs, including volatility and underlying security values and was classified as Level 3.

Cash Equivalents. The balance consists of money market instruments, which are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1. Various time deposits carried as cash equivalents are not measured at estimated fair value and therefore are excluded from the tables presented.

Derivatives. The balance consists of common stock purchase warrants and call options. The fair values of the call options are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. Depending on the terms, the common stock warrants were valued using either Black-Scholes analysis or Monte Carlo Simulation. Fair value was determined using unobservable market inputs, including volatility and underlying security values, therefore the common stock purchase warrants were classified as Level 3.

Warrant Liability. The balance represents warrants issued in connection with the acquisition of the Insurance business and recorded within other liabilities on the Consolidated Balance Sheets. Fair value was determined using the Monte Carlo Simulation because the adjustments for exercise price and warrant shares represent path dependent features; the exercise price from prior periods needs to be known to determine whether a subsequent sale of shares occurs at a price that is lower than the then current exercise price. The analysis entails a Geometric Brownian Motion based simulation of 100 unique price paths of the Company's stock for each combination of assumptions. Fair value was determined using unobservable market inputs, including volatility, and a range of assumptions regarding a possibility of an equity capital raise each year and the expected size of future equity capital raises. The present value of a given simulated scenario was based on intrinsic value at expiration discounted to the valuation date, taking into account any adjustments to the exercise price or warrant shares issuable. The average present value across all 100 independent price paths represents the estimate of fair value for each combination of assumptions. Therefore, the warrant liability was classified as Level 3.

Contingent Liability. The balance represents the present value of the estimated obligation pursuant to the acquisition of the Insurance business. Fair value was determined using unobservable market inputs, including probability of rate increases as approved by state regulators. The liability was classified as Level 3.


17

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Level 3 Measurements and Transfers

The following tables summarize changes to the Company’s financial instruments carried at fair value and classified within Level 3 of the fair value hierarchy for the three months ended March 31, 2017 and 2016 (in thousands):
 
 
 
Total realized/unrealized gains (losses) included in
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
Net earnings (loss)
Other comp. income (loss)
Purchases and issuances
Sales and settlements
Transfer to Level 3
 
Transfer out of Level 3
 
Balance at March 31, 2017
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
32

 
$
—

 
$
—

 
$
—

 
$
(17
)
 
$
—

 
$
—

 
$
15

States, municipalities and political subdivisions
 
5,690

 
111

 
797

 
—

 
—

 
—

 
—

 
6,598

Residential mortgage-backed securities
 
55,954

 
(595
)
 
889

 
48

 
(2,559
)
 
—

 
—

 
53,737

Commercial mortgage-backed securities
 
43,018

 
234

 
(17
)
 
—

 
(7,262
)
 
—

 
—

 
35,973

Asset-backed securities
 
73,217

 
1,074

 
(1,684
)
 
27,725

 
(13,172
)
 
—

 
—

 
87,160

Corporate and other
 
20,366

 
(3,267
)
 
6,641

 
3,000

 
(20
)
 
—

 
—

 
26,720

Total fixed maturity securities
 
198,277

 
(2,443
)
 
6,626

 
30,773

 
(23,030
)
 
—

 
—

 
210,203

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
4,575

 
—

 
(1,044
)
 
—

 
—

 
—

 
—

 
3,531

Total equity securities
 
4,575

 
—

 
(1,044
)
 
—

 
—

 
—

 
—

 
3,531

Derivatives
 
3,813

 
(119
)
 
—

 
—

 
—

 
—

 
—

 
3,694

Total financial assets
 
$
206,665

 
$
(2,562
)
 
$
5,582

 
$
30,773

 
$
(23,030
)
 
$
—

 
$
—

 
$
217,428

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total realized/unrealized (gains) losses included in
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
Net earnings (loss)
Other comp. income (loss)
Purchases and issuances
Sales and settlements
 
Transfer to Level 3
 
Transfer out of Level 3
 
Balance at March 31, 2017
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Warrant liability
 
$
4,058

 
$
165

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
4,223

Contingent liability
 
11,411

 
231

 
—

 
—

 
—

 
—

 
—

 
11,642

Other
 
816

 
(141
)
 
—

 
—

 
—

 
—

 
—

 
675

Total financial liabilities
 
$
16,285

 
$
255

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
16,540


 
 
 
 
Total realized/unrealized gains (losses) included in
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
Net earnings (loss)
Other comp. income (loss)
Purchases and issuances
Sales and settlements
Transfer to Level 3
Transfer out of Level 3
Balance at March 31, 2016
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
73

 
$
—

 
$
(3
)
 
$
—

 
$
(17
)
 
$
—

 
$
—

 
$
53

States, municipalities and political subdivisions
 
5,659

 
99

 
3

 
—

 
—

 
—

 
—

 
5,761

Residential mortgage-backed securities
 
79,019

 
(1,139
)
 
(156
)
 
—

 
(3,354
)
 
6,387

 
(5,557
)
 
75,200

Commercial mortgage-backed securities
 
60,525

 
(291
)
 
632

 
—

 
(3,814
)
 
385

 
(2,832
)
 
54,605

Asset-backed securities
 
27,653

 
32

 
(420
)
 
14,660

 
(300
)
 
4,911

 
(1,133
)
 
45,403

Corporate and other
 
13,944

 
(18
)
 
(1,395
)
 
—

 
(45
)
 
—

 
—

 
12,486

Total fixed maturity securities
 
186,873

 
(1,317
)
 
(1,339
)
 
14,660

 
(7,530
)
 
11,683

 
(9,522
)
 
193,508

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
4,932

 
—

 
(356
)
 
—

 
—

 
—

 
—

 
4,576

Total equity securities
 
4,932

 
—

 
(356
)
 
—

 
—

 
—

 
—

 
4,576


18

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Derivatives
 
4,211

 
—

 
—

 
(1,124
)
 
—

 
—

 
—

 
3,087

Contingent asset
 
—

 
—

 
—

 
2,992

 
—

 
—

 
—

 
2,992

Total financial assets
 
$
196,016

 
$
(1,317
)
 
$
(1,695
)
 
$
16,528

 
$
(7,530
)
 
$
11,683

 
$
(9,522
)
 
$
204,163

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total realized/unrealized gains (losses) included in
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
Net earnings (loss)
Other comp. income (loss)
Purchases and issuances
Sales and settlements
Transfer to Level 3
Transfer out of Level 3
Balance at March 31, 2016
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives
 
$
4,332

 
$
(1,974
)
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
2,358

Contingent liability
 
—

 
—

 
—

 
2,589

 
—

 
—

 
—

 
2,589

Total financial liabilities
 
$
4,332

 
$
(1,974
)
 
$
—

 
$
2,589

 
$
—

 
$
—

 
$
—

 
$
4,947


Internally developed fair values of Level 3 assets represent less than 1% of the Company’s total assets, any justifiable changes in unobservable inputs used to determine internally developed fair values would not have a material impact on the Company’s financial position.

Fair Value of Financial Instruments Not Measured at Fair Value
    
The Company is required by general accounting principles for Fair Value Measurements and Disclosures to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments, which were not measured at fair value on a recurring basis. The table excludes carrying amounts reported in the Consolidated Balance Sheets for cash, accounts receivable, costs and recognized earnings in excess of billings, accounts payable, accrued expenses, billings in excess of costs and recognized earnings, and other current assets and liabilities approximate fair value due to relatively short periods to maturity (in thousands):
March 31, 2017
 
 
 
 
 
Fair Value Measurement Using:
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
 
 
Mortgage loans
 
$
21,824

 
$
21,825

 
$
—

 
$
—

 
$
21,825

Policy loans
 
18,106

 
18,106

 
—

 
18,106

 
—

Other invested assets
 
5,719

 
4,256

 
—

 
—

 
4,256

Total assets not accounted for at fair value
 
$
45,649

 
$
44,187

 
$
—

 
$
18,106

 
$
26,081

Liabilities
 
 
 
 
 
 
 
 
 
 
Annuity benefits accumulated (1)
 
$
249,276

 
$
246,601

 
$
—

 
$
—

 
$
246,601

Long-term obligations (2)
 
395,576

 
403,533

 
—

 
403,533

 
—

Total liabilities not accounted for at fair value
 
$
644,852

 
$
650,134

 
$
—

 
$
403,533

 
$
246,601


December 31, 2016
 
 
 
 
 
Fair Value Measurement Using:
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
 
 
Mortgage loans
 
$
16,831

 
$
16,832

 
$
—

 
$
—

 
$
16,832

Policy loans
 
18,247

 
18,247

 
—

 
18,247

 
—

Other invested assets
 
5,719

 
4,597

 
—

 
—

 
4,597

Total assets not accounted for at fair value
 
$
40,797

 
$
39,676

 
$
—

 
$
18,247

 
$
21,429

Liabilities
 
 
 
 
 
 
 
 
 
 
Annuity benefits accumulated (1)
 
$
251,270

 
$
249,372

 
$
—

 
$
—

 
$
249,372

Long-term obligations (2)
 
378,780

 
376,081

 
—

 
376,081

 
—

Total liabilities not accounted for at fair value
 
$
630,050

 
$
625,453

 
$
—

 
$
376,081

 
$
249,372

(1) Excludes life contingent annuities in the payout phase.
(2) Excludes certain lease obligations accounted for under ASC 840, "Leases".

Mortgage Loans on Real Estate. The fair value of mortgage loans on real estate is estimated by discounting cash flows, both principal and interest, using current interest rates for mortgage loans with similar credit ratings and similar remaining maturities. As such, inputs include current treasury yields and spreads, which are based on the credit rating and average life of the loan, corresponding to the market spreads. The valuation of mortgage loans on real estate is considered Level 3 in the fair value hierarchy.

19

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Policy Loans. The policy loans are reported at the unpaid principal balance and carry a fixed interest rate. The Company determined that the carrying value approximates fair value because (i) policy loans present no credit risk as the amount of the loan cannot exceed the obligation due upon the death of the insured or surrender of the underlying policy; (ii) there is no active market for policy loans (i.e., there is no commonly available exit price to determine the fair value of policy loans in the open market); (iii) policy loans are intricately linked to the underlying policy liability and, in many cases, policy loan balances are recovered through offsetting the loan balance against the benefits paid under the policy; and (iv) policy loans can be repaid by policyholders at any time, and this prepayment uncertainty reduces the potential impact of a difference between amortized cost (carrying value) and fair value. The valuation of policy loans is considered Level 2 in the fair value hierarchy.

Other Invested Assets. The balance primarily includes common stock purchase warrants. The fair values were derived using Black-Scholes analysis using unobservable market inputs, including volatility and underlying security values; therefore, the common stock purchase warrants were classified as Level 3.

Annuity Benefits Accumulated. The fair value of annuity benefits was determined using the surrender values of the annuities and classified as Level 3.

Long-term Obligations. The fair value of the Company’s long-term obligations was determined using Bloomberg Valuation Service BVAL. The methodology combines direct market observations from contributed sources with quantitative pricing models to generate evaluated prices and classified as Level 2.

6. Accounts Receivable

Accounts receivable consist of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Contracts in progress
 
$
120,488

 
$
121,666

Unbilled retentions
 
33,475

 
35,069

Trade receivables
 
75,963

 
113,380

Other receivables
 
1,340

 
1,102

Allowance for doubtful accounts
 
(3,208
)
 
(3,619
)
Total accounts receivable
 
$
228,058

 
$
267,598


7. Recoverable from Reinsurers

The following table presents information for the Company's recoverable from reinsurers assets (in thousands):
 
 
 
 
March 31, 2017
 
December 31, 2016
Reinsurer
 
A.M. Best Rating
 
Amount
 
% of Total
 
Amount
 
% of Total
Loyal American Life Insurance Co (Cigna)
 
A-
 
$
142,514

 
27.2
%
 
$
139,269

 
26.5
%
Great American Life Insurance Co
 
A
 
47,917

 
9.1
%
 
46,965

 
9.0
%
Hannover Life Reassurance Co
 
A+
 
334,414

 
63.7
%
 
337,967

 
64.5
%
Total
 
 
 
$
524,845

 
100.0
%
 
$
524,201

 
100.0
%

8. Property, Plant and Equipment, net

Property, plant and equipment consist of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Land
 
$
21,029

 
$
21,006

Building and leasehold improvements
 
31,560

 
31,713

Plant and transportation equipment
 
5,302

 
5,551

Cable-ships and submersibles
 
164,660

 
169,034

Equipment, furniture and fixtures, and software
 
104,245

 
101,421

Construction in progress
 
22,633

 
19,889

 
 
349,429

 
348,614

Less: Accumulated depreciation
 
65,125

 
62,156

 
 
$
284,304

 
$
286,458



20

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Depreciation expense was $8.3 million and $7.6 million for the three months ended March 31, 2017 and 2016, respectively. These amounts included $1.2 million and $1.9 million of depreciation expense within cost of revenue for the three months ended March 31, 2017 and 2016, respectively.

As of March 31, 2017 and December 31, 2016, total net book value of equipment under capital leases consisted of $49.5 million and $51.0 million of cable-ships and submersibles, respectively.

9. Goodwill and Intangibles, net

Goodwill

The changes in the carrying amount of goodwill by reporting unit are as follows (in thousands):
 
Construction
Marine Services
 
Energy
 
Telecom
 
Insurance
 
Life Sciences
 
Other
 
Total
Balance at December 31, 2016 and March 31, 2017
 
$
36,317

 
$
2,468

 
$
2,631

 
$
3,378

 
$
47,290

 
$
3,620

 
$
2,382

 
$
98,086


Indefinite-lived Intangible Assets

The acquisition of the Insurance Company resulted in state licenses which are considered indefinite-lived intangible assets not subject to amortization of $2.5 million as of March 31, 2017.

In addition, the consolidation of BeneVir in 2016 resulted in the recording of an in-process research and development intangible asset not subject to amortization of $6.4 million as of March 31, 2017.

Definite Lived Intangible Assets

The changes in the carrying amount of amortizable intangible assets by reporting unit are as follows (in thousands):
 
Construction
Marine Services
 
Energy
 
Life Sciences
 
Other
 
Corporate
 
Total
Trade names
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
$
4,216

 
$
898

 
$
4,777

 
$
—

 
$
—

 
$
—

 
$
9,891

Periodic Amortization
 
(119
)
 
(93
)
 
(320
)
 
—

 
—

 
—

 
(532
)
Balance at March 31, 2017
 
4,097

 
805


4,457

 
—

 
—


—

 
9,359

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
3,438

 
6,344

 
8,889

 
—

 
—


—

 
18,671

Periodic Amortization
 
(353
)
 
(108
)
 
(68
)
 
—

 
—

 
—

 
(529
)
Balance at March 31, 2017
 
3,085

 
6,236

 
8,821

 
—

 
—

 
—

 
18,142

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
—

 
539

 
—

 
—

 
1,003


—

 
1,542

Periodic Amortization
 
—

 
(65
)
 
—

 
—

 
(251
)
 
—

 
(316
)
Balance at March 31, 2017
 
—


474


—

 
—

 
752


—

 
1,226

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
447

 
—

 
91

 
220

 
—


18

 
776

Acquisitions
 
—

 
—

 
8

 
99

 
—

 
—

 
107

Periodic Amortization
 
(68
)
 
—

 
—

 
(1
)
 
—

 
(1
)
 
(70
)
Balance at March 31, 2017
 
379


—


99

 
318

 
—


17

 
813

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Amortizable Intangible Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
8,101

 
7,781

 
13,757

 
220

 
1,003

 
18

 
30,880

Acquisitions
 
—

 
—

 
8

 
99

 
—

 
—

 
107

Periodic Amortization
 
(540
)
 
(266
)
 
(388
)
 
(1
)
 
(251
)
 
(1
)
 
(1,447
)
Balance at March 31, 2017
 
$
7,561

 
$
7,515

 
$
13,377

 
$
318

 
$
752

 
$
17

 
$
29,540



21

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



An interim goodwill impairment test was performed on each reporting units. On a quarterly basis, the Company performs a step 0 analysis. After considering all quantitative and qualitative factors above, the Company has determined that it is more likely than not that the reporting units' fair values exceed carrying values as of the period end, and as such, a more formal “two step” goodwill impairment analysis is not necessary.

10. Life, Accident and Health Reserves

Life, accident and health reserves consist of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Long-term care insurance reserves
 
$
1,422,306

 
$
1,407,848

Traditional life insurance reserves
 
101,870

 
102,077

Other accident and health insurance reserves
 
141,283

 
138,640

Total life, accident and health reserves
 
$
1,665,459

 
$
1,648,565


The following table sets forth changes in the liability for claims for the portion of our long-term care insurance reserves in scope of the ASU 2015-09 disclosure requirements (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Beginning balance
 
$
226,970

 
$
208,150

Less: recoverable from reinsurers 
 
(97,858
)
 
(94,041
)
Beginning balance, net
 
129,112

 
114,109

Incurred related to insured events of:
 
 
 
 
Current year
 
17,641

 
11,482

Prior years
 
(3,678
)
 
672

Total incurred
 
13,963

 
12,154

Paid related to insured events of:
 
 
 
 
Current year
 
(557
)
 
(485
)
Prior years
 
(10,660
)
 
(9,647
)
Total paid
 
(11,217
)
 
(10,132
)
Interest on liability for policy and contract claims
 
1,178

 
1,054

Ending balance, net
 
133,036

 
117,185

Add: recoverable from reinsurers 
 
95,091

 
96,088

Ending balance
 
$
228,127

 
$
213,273


For the three months ended March 31, 2017 the reserve was sufficient by $3.7 million while for the same period last year, the reserve exhibited a deficiency of $0.7 million. The reserve sufficiency is being driven by claim terminations as the result of policyholder deaths that released significant reserves which is attributable to the normal volatility in the reserves, due to the number of claims that are currently open.

11. Accounts Payable and Other Current Liabilities

Accounts payable and other current liabilities consist of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Accounts payable
 
$
60,477

 
$
66,792

Accrued interconnection costs
 
61,551

 
93,661

Accrued payroll and employee benefits
 
23,358

 
28,668

Accrued interest
 
13,334

 
3,056

Accrued income taxes
 
13,757

 
3,983

Accrued expenses and other current liabilities
 
63,680

 
55,573

Total accounts payable and other current liabilities
 
$
236,157

 
$
251,733



22

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



12. Long-term Obligations

Long-term debt consists of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
HC2
 
 
 
 
11.0% Senior Secured Notes, due in 2019

$
362,000


$
307,000

HC22
 
 
 
 
11.0% Senior Secured Bridge Note, due in 2019 (the "11.0% Bridge Notes")
 
—

 
35,000

GMSL
 
 
 
 
Notes payable and revolving lines of credit, various maturity dates
 
16,957

 
17,522

LIBOR plus 3.65% Notes, due in 2019
 
—

 
3,026

Obligations under capital leases
 
50,044

 
49,717

DBMG
 
 
 
 
LIBOR plus 4.0% Notes, due in 2018 and 2019
 
8,764

 
9,439

LIBOR plus 3.0% Line of Credit
 
—

 
—

ANG
 
 
 
 
5.5% Term Loan, due in 2018
 
460

 
501

4.5% Note due in 2022 (1)
 
13,172

 
13,343

4.25% Seller Note, due in 2022
 
2,714

 
2,796

Other
 
158

 
75

Total
 
454,269

 
438,419

Issuance discount or premium and deferred financing costs, net
 
(8,649
)
 
(9,923
)
Total long-term obligations
 
$
445,620

 
$
428,496

(1) ANG refinanced and consolidated all three of its loans with Pioneer during the first quarter of 2017.

HC2 and HC22 11.0% Senior Secured Notes

In January 2017, the Company issued and additional $55.0 million in aggregate principal amount of its 11.0% Senior Secured Notes due 2019 (the “11.0% Notes”). HC2 used a portion of the proceeds from the issuance to repay all $35.0 million in outstanding aggregate principal amount of HC22's 11.0% Bridge Notes. The Company has issued an aggregate of $362.0 million of its 11.0% Notes  pursuant to an indenture dated November 20, 2014, by and among HC2, the guarantors party thereto and U.S. Bank National Association, a national banking association, as trustee (the “11.0% Notes Indenture”). The 11.0% Notes Indenture contains certain covenants limiting, among other things, the ability of the Company and certain subsidiaries of the Company to incur additional indebtedness; create liens; engage in sale-leaseback transactions; pay dividends or make distributions in respect of capital stock and make certain restricted payments; sell assets; engage in transactions with affiliates; or consolidate or merge with, or sell substantially all of its assets to, another person.  The 11.0% Notes Indenture also includes two maintenance covenants: (1) a liquidity covenant; and (2) a collateral coverage covenant. The 11.0% Notes Indenture contains customary events of default.  For additional information the 11.0% Notes and 11.0% Notes Indenture please see our Annual Report on Form 10-K for the year ended December 31, 2016. 

DBMG Credit Facilities

DBMG has a Credit and Security Agreement ("DBMG Facility") with Wells Fargo Credit, Inc. ("Wells Fargo"), pursuant to which Wells Fargo agreed to advance up to a maximum amount of $50 million to DBMG, including up to $14.5 million of letters of credit. The DBMG Facility has a floating interest rate of LIBOR plus 3.0%, requires monthly interest payments, and matures in 2019. The DBMG Facility is secured by a first priority, perfected security interest in all of DBMG’s and its present and future subsidiaries' assets, excluding real estate, and a second priority, perfected security interest in all of DBMG’s real estate. The security agreements pursuant to which DBMG’s assets are pledged prohibit any further pledge of such assets without the written consent of the bank. The DBMG Facility contains various restrictive covenants. At March 31, 2017, DBMG was in compliance with these covenants.

In February 2017 DBMG increased the amount of letters of credit under the DBMG Facility to support increased bonding requirements for anticipated larger projects that will be part of this year's backlog. Under the DBMG Facility as of March 31, 2017 DBMG had $9.0 million in outstanding letters of credit issued, of which $0 has been drawn.

On May 6, 2014, DBMG entered into an amendment to the DBMG Facility, pursuant to which Wells Fargo extended the maturity date of the DBMG Facility to April 30, 2019, lowered the interest rate charged in connection with borrowings under the DBMG Facility and allowed for the issuance of additional loans in the form of notes totaling up to $5.0 million, secured by its real estate as a separate tranche under the DBMG Facility (“Real Estate Term Advance”). At March 31, 2017, DBMG had borrowed $3.2 million under the Real Estate Term Advance. The Real Estate Term Advance has a five year amortization period requiring monthly principal payments and a final balloon payment at maturity. The Real Estate Term Advance has a floating interest rate of LIBOR plus 4.0% and requires monthly interest payments.

23

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



The DBMG Facility allows for the issuance by DBMG of additional loans in the form of notes of up to $10.0 million, secured by its machinery and equipment (“Real Estate Term Advance (M&E)”) and the issuance of a note payable of up to $5.0 million, secured by its real estate (“Real Estate Term Advance (Working Capital)”), each as separate tranches of debt under the DBMG Facility. At March 31, 2017 there was $5.5 million outstanding under the Real Estate Term Advance (M&E) and no borrowings outstanding under the Real Estate Term Advance (Working Capital).

GMSL Capital Leases

GMSL is a party to two leases to finance the use of two vessels: the Innovator (the “Innovator Lease”) and the Cable Retriever (the “Cable Lease,” and together with the Innovator Lease, the “GMSL Leases”). The Innovator Lease was restructured effective May 31, 2016, extending the lease to 2025. The principal amount thereunder bears interest at the rate of approximately 10.4%. The Cable Lease expires in 2023. The principal amount thereunder bears interest at the rate of approximately 4.0%.

As of March 31, 2017, $50.0 million in aggregate principal amount remained outstanding under the GMSL Leases.

ANG Term Loan

In January 2017, ANG refinanced and consolidated all three of its loans with Pioneer. The $13.2 million in aggregate principal balance outstanding shall bear fixed interest annually equal to 4.5%, due in 2022.

For additional information on the Company’s long-term, see Note 13. Long-term Obligations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

13. Income Taxes

Income Tax (Expense) Benefit
       
The Company used the Annual Effective Tax Rate (“ETR”) approach of ASC 740-270, "Interim Reporting," to calculate its 2017 interim tax provision. Income tax was an expense of $5.3 million and a benefit of $2.5 million for the three months ended March 31, 2017 and 2016, respectively. The income tax expense recorded for March 31, 2017 relates to the reversal of taxable temporary differences at the Insurance segment for which no deferred tax benefit is recognized due to a full valuation allowance on the Insurance segment’s net deferred tax assets and to the projected expense as calculated under ASC 740 for other taxpaying entities. Additionally, the tax benefits associated with losses generated by the HC2 Holdings, Inc. U.S. consolidated income tax return and certain other businesses have been reduced by a full valuation allowance as we do not believe it is more-likely-than-not that the losses will be utilized prior to expiration. The income tax benefit recorded for March 31, 2016 relates to losses generated for which we expected to obtain benefits from in the future based on our weighting of all positive and negative evidence that existed at the time. This benefit was partially offset by a valuation allowance recorded against the deferred tax assets of the Insurance segment during the first quarter of 2016.

NOL Limitation

As of December 31, 2016, the Company has a U.S. net operating loss carryforward available to reduce future taxable income in the amount of $95.3 million, of which $77.8 million is subject to an annual limitation under Section 382 of the Internal Revenue Code. Additionally, the Company has $21.6 million of U.S. net operating loss carryforwards from its subsidiaries that do not qualify to be included in the HC2 Holdings, Inc. U.S. consolidated income tax return.

Unrecognized Tax Benefits
 
The Company follows the provision of ASC 740-10, “Income Taxes”, which prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the Company has taken or expects to take on a tax return. The Company is subject to challenge from various taxing authorities relative to certain tax planning strategies, including certain intercompany transactions as well as regulatory taxes.
 
Examinations
 
The Company conducts business globally, and as a result, the Company or one or more of its subsidiaries files income tax returns in the United States federal jurisdiction and various state and foreign jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the world. The open tax years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as they relate to the amount, character, timing or inclusion of revenue and expenses or the applicability of income tax credits for the relevant tax period. Given the nature of tax audits there is a risk that disputes may arise. Tax years 2006 - 2016 remain open for examination.


24

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



14. Commitments and Contingencies

Litigation

The Company is subject to claims and legal proceedings that arise in the ordinary course of business. Such matters are inherently uncertain, and there can be no guarantee that the outcome of any such matter will be decided favorably to the Company or that the resolution of any such matter will not have a material adverse effect upon the Company’s Consolidated Financial Statements. The Company does not believe that any of such pending claims and legal proceedings will have a material adverse effect on its Consolidated Financial Statements. The Company records a liability in its Consolidated Financial Statements for these matters when a loss is known or considered probable and the amount can be reasonably estimated. The Company reviews these estimates each accounting period as additional information is known and adjusts the loss provision when appropriate. If a matter is both probable to result in a liability and the amounts of loss can be reasonably estimated, the Company estimates and discloses the possible loss or range of loss to the extent necessary for the Consolidated Financial Statements not to be misleading. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in its Consolidated Financial Statements.

DBMG Class Action

On November 6, 2014, a putative stockholder class action complaint challenging the tender offer by which HC2 acquired approximately 721,000 of the issued and outstanding common shares of DBMG was filed in the Court of Chancery of the State of Delaware, captioned Mark Jacobs v. Philip A. Falcone, Keith M. Hladek, Paul Voigt, Michael R. Hill, Rustin Roach, D. Ronald Yagoda, Phillip O. Elbert, HC2 Holdings, Inc., and Schuff International, Inc., Civil Action No. 10323 (the “Complaint”).  On November 17, 2014, a second lawsuit was filed in the Court of Chancery of the State of Delaware, captioned Arlen Diercks v. Schuff International, Inc. Philip A. Falcone, Keith M. Hladek, Paul Voigt, Michael R. Hill, Rustin Roach, D. Ronald Yagoda, Phillip O. Elbert, HC2 Holdings, Inc., Civil Action No. 10359.  On February 19, 2015, the court consolidated the actions (now designated as Schuff International, Inc. Stockholders Litigation) and appointed lead plaintiff and counsel.  The currently operative complaint is the Complaint filed by Mark Jacobs.  The Complaint alleges, among other things, that in connection with the tender offer, the individual members of the DBMG Board of Directors and HC2, the now-controlling stockholder of DBMG, breached their fiduciary duties to members of the plaintiff class.  The Complaint also purports to challenge a potential short-form merger based upon plaintiff’s expectation that the Company would cash out the remaining public stockholders of DBMG following the completion of the tender offer.  The Complaint seeks rescission of the tender offer and/or compensatory damages, as well as attorney’s fees and other relief. The defendants filed answers to the Complaint on July 30, 2015. On February 24, 2017, the parties agreed to a framework for the potential settlement of the litigation. On February 28, 2017, the Court entered an order vacating the current scheduling order and directing the parties to submit a stipulation of settlement or status report to the Court by April 21, 2017. In late March 2017, plaintiff’s counsel took three depositions to assess the fairness of the potential settlement framework. On April 24, 2017, plaintiff’s counsel submitted a status report to the Court indicating that they continued to analyze the potential settlement framework and would submit a stipulation of settlement or further status report to the Court by June 8, 2017. There can be no assurance that a settlement will be finalized or that the Court would approve such a settlement even if the parties were to enter into a settlement stipulation or agreement. The Company believes that the settlement under discussion would not have a material effect on the Company's financial condition or operating results.

VAT assessment

On February 20, 2017, the Company's ICS subsidiary received a notice from Her Majesty’s Revenue and Customs office in the U.K. (the “HMRC”) indicating that it was required to pay certain Value-Added Taxes (“VAT”) for the 2015 tax year.  ICS disagrees with HMRC’s assessment on technical and factual grounds and intends to dispute the assessed liabilities and vigorously defend its interests. We do not believe the assessment to be probable and expect to prevail based on the facts and merits of our existing VAT position.

Global Marine Dispute

GMSL is in dispute with Alcatel-Lucent Submarine Networks Limited ("ASN") related to a Marine Installation Contract between the parties, dated March 11, 2016 (the "ASN Contract").  Under the ASN Contract, GMSL's obligations were to install and bury an optical fibre cable in Prudhoe Bay, Alaska.  As of the date hereof, neither party has commenced legal proceedings.  Pursuant to the ASN Contract any such dispute would be governed by English law and would be required to be brought in the English courts in London.  ASN has alleged that GMSL committed material breaches of the ASN Contract, which entitles ASN to terminate the ASN Contract, take over the work themselves, and claim damages for their losses arising as a result of the breaches.  The alleged material breaches include failure to use appropriate equipment and procedures to perform the work and failure to accurately estimate the amount of weather downtime needed.  ASN has indicated to GMSL it has incurred $30 million in damages and $1.2 million in liquidated damages for the period  September 2016 to October 2016, plus interest and costs.  GMSL believes that it has not breached the terms and conditions of the contract and also believes that ASN has not properly terminated the contract in manner that would allow it to make a claim. However, ASN has ceased making payments to GMSL and as of March 31, 2017, the total sum of GMSL invoices raised and issued are $12.6 million, of which $8.1 million were settled by ASN and the balance of $4.5 million are therefore at risk. We believe that the allegations and claims by ASN are without merit, that ASN is required to make all payments under unpaid invoices and we intend to defend our interests vigorously.

Tax Matters

Currently, the Canada Revenue Agency (“CRA”) is auditing a subsidiary previously held by the Company. The Company intends to cooperate in audit matters. To date, CRA has not proposed any specific adjustments and the audit is ongoing.

25

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



15. Employee Retirement Plans

The following table presents the components of net periodic benefit cost for the periods presented (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Service cost - benefits earning during the period
 
$
—

 
$
4

Interest cost on projected benefit obligation
 
1,363

 
1,665

Expected return on assets
 
(1,866
)
 
(1,766
)
Actuarial gain
 
—

 
708

Foreign currency gain (loss)
 
7

 
(56
)
Net periodic benefit cost (income)
 
$
(496
)
 
$
555


The Company previously disclosed in its financial statements for the year ended December 31, 2016 that it expected to contribute $8.8 million to its pension plans in 2017. As of March 31, 2017, $3.0 million contributions have been made. The Company anticipates contributing the remaining balance expected to its pension plans in 2017.

16. Share-based Compensation

On April 11, 2014, HC2’s Board of Directors adopted the HC2 Holdings, Inc. 2014 Omnibus Equity Award Plan (the “Omnibus Plan”), which was approved by our stockholders at the annual meeting of stockholders held on June 12, 2014. The Omnibus Plan provides that no further awards will be granted pursuant to the Company’s Management Compensation Plan, as amended (the “Prior Plan”). However, awards that had been previously granted pursuant to the Prior Plan will continue to be subject to and governed by the terms of the Prior Plan.

The Compensation Committee of HC2's Board of Directors administers HC2's Omnibus Plan and the Prior Plan and has broad authority to administer, construe and interpret the plans.

The Omnibus Plan provides for the grant of awards of non-qualified stock options, incentive (qualified) stock options, stock appreciation rights, restricted stock awards, restricted stock units, other stock based awards, performance compensation awards (including cash bonus awards) or any combination of the foregoing. The Company typically issues new shares of common stock upon the exercise of stock options, as opposed to using treasury shares. The Omnibus Plan authorizes the issuance of up to 5,000,000 shares of the Company’s common stock, subject to adjustment as provided in the Omnibus Plan.

The Company follows guidance which addresses the accounting for share-based payment transactions whereby an entity receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The guidance generally requires that such transactions be accounted for using a fair-value based method and share-based compensation expense be recorded, based on the grant date fair value, estimated in accordance with the guidance, for all new and unvested stock awards that are ultimately expected to vest as the requisite service is rendered.

The Company granted 70,740 and 6,848 options during the three months ended March 31, 2017 and 2016, respectively. Of the total options granted during the three months ended March 31, 2016, 6,848 options were granted to Philip Falcone, pursuant to a standalone option agreement entered in connection with Mr. Falcone’s appointment as Chairman, President and Chief Executive Officer of the Company, and not pursuant to the Omnibus Plan. The anti-dilution protection provision contained in such standalone option agreement was canceled in April 2016 and replaced with an award consisting solely of 1,500,000 premium stock options issued under the Omnibus Plan.

The weighted average fair value at date of grant for options granted during the three months ended March 31, 2017, and 2016 was $2.60 and $3.02, respectively, per option. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions shown as a weighted average for the year:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Expected option life (in years)
 
5.75
 
4.70
Risk-free interest rate
 
2.22%
 
1.27%
Expected volatility
 
48.29%
 
39.58%
Dividend yield
 
—%
 
—%

Total share-based compensation expense recognized by the Company and its subsidiaries under all equity compensation arrangements was $1.5 million and $3.2 million for the three months ended March 31, 2017 and 2016, respectively. All grants are time based, and vest either immediately or over a period of up to 3 years. The Company recognizes compensation expense for equity awards, reduced by actual forfeitures, using the straight-line basis.


26

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Restricted Stock

A summary of HC2’s restricted stock activity is as follows:
 
 
Shares
 
Weighted Average Grant Date Fair Value
Unvested - December 31, 2016
 
115,921

 
$
5.59

Granted
 
320,859

 
$
5.50

Vested
 
(287,655
)
 
$
5.39

Forfeited
 
—

 
$
—

Unvested - March 31, 2017
 
149,125

 
$
5.79


As of March 31, 2017, the unvested restricted stock represented $0.7 million of compensation expense that is expected to be recognized over the weighted average remaining vesting period of approximately 1.6 years. The number of shares of unvested restricted stock expected to vest is 149,125.

Stock Options

A summary of HC2’s stock option activity is as follows:
 
 
Shares
 
Weighted Average Exercise Price
Outstanding - December 31, 2016
 
6,829,097

 
$
6.58

Granted
 
70,740

 
$
5.50

Exercised
 
(128,539
)
 
$
3.50

Forfeited
 
—

 
$
—

Expired
 
—

 
$
—

Outstanding - March 31, 2017
 
6,771,298

 
$
6.62

 
 
 
 
 
Eligible for exercise
 
4,887,017

 
$
5.40


As of March 31, 2017, intrinsic value and average remaining life of the Company's outstanding and exercisable options, respectively, were $6.2 million and $6.1 million and approximately 7.79 and 7.42 years, respectively.

As of March 31, 2017, the unvested stock options outstanding, which represented $1.9 million of compensation expense, are expected to be recognized over the weighted average remaining vesting period of 1.48 years. The number of unvested stock options expected to vest is 1,884,281 shares, with a weighted average remaining life of 8.75 years, a weighted average exercise price of $9.80, and an intrinsic value of $0.

17. Equity

Series A Preferred Stock, Series A-1 Preferred Stock and Series A-2 Preferred Stock

The Company’s preferred shares authorized, issued and outstanding consisted of the following:
 
 
March 31, 2017
 
December 31, 2016
Series A
 
 
 
 
Shares authorized, $0.01 par value
 
20,000,000

 
20,000,000

Series A Shares issued and outstanding
 
14,808

 
14,808

Series A-1 Shares issued and outstanding
 
1,000

 
1,000

Series A-2 Shares issued and outstanding
 
14,000

 
14,000


In connection with the issuance of the Series A Convertible Preferred Stock, the Company originally designated the Series A Preferred Stock pursuant to a Certificate of Designation of Series A Convertible Participating Preferred Stock adopted on May 29, 2014 (the “Series A Certificate”). In connection with the issuance of the Series A-1 Preferred Stock on September 22, 2014, the Company adopted the Certificate of Designation of Series A-1 Convertible Participating Preferred Stock (the “Series A-1 Certificate”) and also amended and restated the Series A Certificate. In connection with the issuance of the Series A-2 Preferred Stock on January 5, 2015, the Company adopted the Certificate of Designation of Series A-2 Convertible Participating Preferred Stock (the “Series A-2 Certificate”) and also amended and restated the Series A Certificate and the Series A-1 Certificate. On August 10, 2015, the Company adopted certain Certificates of Correction of the Certificates of Amendment to the Certificates of Designation of the Series A Certificate, the Series A-1 Certificate and the Series A-2 Certificate, and on June 24, 2016 the Company adopted

27

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



certain amendments to the Series A-1 Certificate of Designation. The Series A Certificate, the Series A-1 Certificate and the Series A-2 Certificate together, as amended, are referred to as the “Certificates of Designation.”
The following summary of the terms of the Preferred Stock and the Certificates of Designation is qualified in its entirety by the complete terms of the Certificates of Designation.
Dividends. The Preferred Stock accrues a cumulative quarterly cash dividend at an annualized rate of 7.50%. The accrued value of the Preferred Stock will accrete quarterly at an annualized rate of 4.00% that is reduced to 2.00% or 0.00% if the Company achieves specified rates of growth measured by increases in its net asset value; provided, that the accreting dividend rate will be 7.25% in the event that (i) the daily volume weighted average price (“VWAP”) of the common stock is less than a certain threshold amount, (ii) the common stock is not registered under Section 12(b) of the Securities Exchange Act of 1934, as amended, (iii) following May 29, 2015, the common stock is not listed on certain national securities exchanges or (iv) the Company is delinquent in the payment of any cash dividends. The Preferred Stock is also entitled to participate in cash and in-kind distributions to holders of shares of common stock on an as-converted basis.
Optional Conversion. Each share of Preferred Stock may be converted by the holder into common stock at any time based on the then applicable conversion price. Pursuant to the Series A-1 Certificate, each share of Series A-1 Preferred Stock is currently convertible at a conversion price of $4.25. Pursuant to the Series A-2 Certificate, each share of Series A-2 Preferred Stock is currently convertible at a conversion price of $7.80. Pursuant to the Series A Certificate, each share of Series A Preferred Stock is currently convertible at a conversion price of $4.25. Such conversion prices are subject to adjustment for dividends, certain distributions, stock splits, combinations, reclassifications, reorganizations, mergers, recapitalizations and similar events, as well as in connection with issuances of equity or equity-linked or other comparable securities by the Company at a price per share (or with a conversion or exercise price or effective issue price) that is below the applicable conversion price (which adjustment shall be made on a weighted average basis).
Redemption by the Holders / Automatic Conversion. On May 29, 2021, holders of the Preferred Stock are entitled to cause the Company to redeem the Preferred Stock at the accrued value per share plus accrued but unpaid dividends (to the extent not included in the accrued value of Preferred Stock). Each share of Preferred Stock that is not so redeemed will be automatically converted into shares of common stock at the conversion price then in effect. Upon a change of control (as defined in the Certificates of Designation) holders of the Preferred Stock are entitled to cause the Company to redeem their Preferred Stock at a price per share of Preferred Stock equal to the greater of (i) the accrued value of the Preferred Stock, which amount would be multiplied by 150% in the event of a change of control occurring on or prior to May 29, 2017, plus any accrued and unpaid dividends (to the extent not included in the accrued value of Preferred Stock), and (ii) the value that would be received if the share of Preferred Stock were converted into common stock immediately prior to the change of control.
Redemption by the Company. At any time after May 29, 2017, the Company may redeem the Preferred Stock, in whole but not in part, at a price per share generally equal to 150% of the original accrued value or on that date, plus accrued but unpaid dividends (to the extent not included in the accrued value of Preferred Stock), subject to the holder’s right to convert prior to such redemption.
Forced Conversion. After May 29, 2017, the Company may force conversion of the Preferred Stock into common stock if the common stock’s thirty-day VWAP exceeds 150% of the then-applicable Conversion Price and the common stock’s daily VWAP exceeds 150% of the then applicable Conversion Price for at least twenty trading days out of the thirty trading day period used to calculate the thirty-day VWAP. In the event of a forced conversion, the holders of Preferred Stock will have the ability to elect cash settlement in lieu of conversion if certain market liquidity thresholds for the common stock are not achieved.
Liquidation Preference. The Series A Preferred Stock ranks at parity with the Series A-1 Preferred Stock and the Series A-2 Preferred Stock. In the event of any liquidation, dissolution or winding up of the Company (any such event, a “Liquidation Event”), the holders of Preferred Stock are entitled to receive per share the greater of (i) the accrued value of the Preferred Stock, which amount would be multiplied by 150% in the event of a Liquidation Event occurring on or prior to May 29, 2017, plus any accrued and unpaid dividends (to the extent not included in the accrued value of Preferred Stock), and (ii) the value that would be received if the share of Preferred Stock were converted into common stock immediately prior to such occurrence. The Preferred Stock will rank junior to any existing or future indebtedness but senior to the common stock and any future equity securities other than any future senior or pari passu preferred stock issued in compliance with the Certificates of Designation.
Voting Rights. Except as required by applicable law, the holders of the shares of each series of Preferred Stock are entitled to vote on an as-converted basis with the holders of the other series of Preferred Stock (on an as-converted basis) and holders of the Company’s common stock on all matters submitted to a vote of the holders of common stock. Certain series of Preferred Stock are entitled to vote with the holders of certain other series of Preferred Stock on certain matters, and separately as a class on certain limited matters. Subject to maintenance of certain ownership thresholds by the initial purchasers of the Series A Preferred Stock and the initial purchasers of the Series A-1 Preferred Stock (collectively, the “Series A and Series A-1 Preferred Purchasers”), the holders of the shares of Preferred Stock also have the right to vote shares of Preferred Stock as a separate class for at least one director, as discussed below under “- Board Rights.”
Consent Rights. For so long as any of the Preferred Stock is outstanding, consent of the holders of shares representing at least 75% of certain of the Preferred Stock then outstanding is required for certain material actions.
Board Rights. For so long as the Series A and Series A-1 Preferred Purchasers own at least a 15% interest in the Company on an as-converted basis and at least 80% of the shares of Preferred Stock issued to the Series A and Series A-1 Preferred Purchasers on an as-converted basis, the Series A and Series A-1 Preferred Purchasers will have the right to appoint and elect (voting as a separate class) a percentage of HC2's Board of Directors that is no more than 5% less than the Series A and Series A-1 Preferred Purchasers’ as-converted equity percentage of the common stock (but no fewer than one director). One such elected director (as designated by the holders of shares representing at least 75% of the Preferred Stock then outstanding) shall be entitled to be a member of each committee of the board of directors of the Company, provided, that such director membership on any such committee will be dependent upon such director meeting the qualification, and if applicable, independence criteria

28

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



deemed necessary to so comply in accordance with any listing requirements of the exchanges on which the Company’s capital stock is then listed. For so long as the Director Election Condition is satisfied, if a specified breach event shall occur with respect to the Preferred Stock (defined for such purposes to include the failure to timely pay required dividends for two or more consecutive quarters or the occurrence and continuation of certain breaches of covenants contained in the Certificates of Designation), the holders of the Preferred Stock shall be entitled to appoint the number of additional directors to the board of directors of the Company that will cause a majority of the board of directors to be comprised of directors appointed by the holders of the Preferred Stock and independent directors until the cure of such specified breach event.
Participation Rights. Pursuant to the securities purchase agreements entered into with the initial purchasers of the Series A Preferred Stock, the Series A-1 Preferred Stock and the Series A-2 Preferred Stock, subject to meeting certain ownership thresholds, certain purchasers of the Series A Preferred Stock, the Series A-1 Preferred Stock and the Series A-2 Preferred Stock are entitled to participate, on a pro rata basis in accordance with their ownership percentage, determined on an as-converted basis, in issuances of equity and equity linked securities by the Company. In addition, subject to meeting certain ownership thresholds, certain initial purchasers of the Series A Preferred Stock, the Series A-1 Preferred Stock and the Series A-2 Preferred Stock will be entitled to participate in issuances of preferred securities and in debt transactions of the Company.

Preferred Share Conversions

Luxor and Corrib Conversions

On August 2, 2016, the Company entered into separate agreements with each of Corrib Master Fund, Ltd. (“Corrib”), then a holder of 1,000 shares of Series A Preferred Stock, and certain investment entities managed by Luxor Capital Group, LP ( “Luxor”), that together then held 9,000 shares of Series A-1 Preferred Stock, that govern their respective Preferred Share Conversions. In the Corrib Preferred Share Conversion (i) Corrib converted 1,000 shares of Series A Preferred Stock into 238,492 shares of the Company’s common stock, and (ii) in consideration of Corrib making such conversion, HC2 issued 15,318 newly issued shares of common stock to Corrib (such shares, the “Corrib Conversion Share Consideration”). In the Luxor Preferred Share Conversion, (i) Luxor converted 9,000 shares of Series A-1 Preferred Stock into 2,119,765 shares of the common stock and (ii) in consideration of Luxor making such conversion, HC2 issued 136,149 newly issued shares of common stock to Luxor (such shares, the “Luxor Conversion Share Consideration” and, together with the Corrib Conversion Share Consideration, the “Conversion Share Consideration”). The fair value of the Conversion Share Consideration was $0.7 million on the date of issuance and was recorded within Preferred stock and deemed dividends from conversion line item of the Consolidated Statements of Operations as a deemed dividend.

The Company also agreed to provide the following two forms of additional consideration for as long as the Preferred Stock remained entitled to receive dividend payments (the "Additional Share Consideration").

The Company agreed that in the event that Corrib and Luxor would have been entitled to any Participating Dividends payable, had they not converted the Preferred Stock (as defined in the respective Series A and Series A-1 Certificate of Designation), after the date of their Preferred Share conversion, then the Company will issue to Corrib and Luxor, on the date such Participating Dividends become payable by the Company, in a transaction exempt from the registration requirements of the Securities Act the number of shares of common stock equal to (a) the value of the Participating Dividends Corrib or Luxor would have received pursuant to Sections (2)(c) and (2)(d) of the respective Series A and Series A-1 Certificate of Designation, divided by (b) the Thirty Day VWAP (as defined in the respective Series A and Series A-1 Certificate of Designation) for the period ending two business days prior to the underlying event or transaction that would have entitled Corrib or Luxor to such Participating Dividend had Corrib’s or Luxor’s Preferred Stock remain unconverted.

Further, the Company agreed that it will issue to Corrib and Luxor, on each quarterly anniversary commencing May 29, 2017 (or, if later, the date on which the corresponding dividend payment is made to the holders of the outstanding Preferred Stock), through and until the Maturity Date (as defined in the respective Series A and Series A-1 Certificate of Designation), in a transaction exempt from the registration requirements of the Securities Act the number of shares of common stock equal to (a) 1.875% the Accrued Value (as defined in the respective Series A and Series A-1 Certificate of Designation) of Corrib’s or Luxor’s Preferred Stock as of the Closing Date (as defined in applicable Voluntary Conversion Agreements) divided by (b) the Thirty Day VWAP (as defined in the respective Series A and Series A-1 Certificate of Designation) for the period ending two business days prior to the applicable Dividend Payment Date (as defined in the respective Series A and Series A-1 Certificate of Designation).

The fair value of the Additional Share Consideration was valued by the Company at $1.5 million on the date of issuance and was recorded within Preferred stock and deemed dividends from conversion line item of the Consolidated Statements of Operations as a deemed dividend.

Hudson Bay Conversion

On October 7, 2016, the Company entered into an agreement with Hudson Bay Absolute Return Credit Opportunities Master Fund, LTD. ("Hudson") to convert and exchange all of Hudson's 12,500 shares of the Company's Series A Convertible Participating Preferred Stock into a total of 3,751,838 shares of the Company's common stock.

Pursuant to the terms of the Series A Voluntary Conversion Agreement, HC2 and Hudson mutually agreed that on the closing date of the voluntary conversion, (i) Hudson voluntarily converted 12,499 of the 12,500 shares of Series A Preferred Stock it held into 2,980,912 shares of HC2’s common stock pursuant to the terms of the Certificate of Designation of Series A Convertible Participating Preferred Stock (the “Series A Certificate of Designation”), with such amount representing the number of shares of common stock into which the 12,499 shares of Series A Preferred Stock held by Hudson convertible pursuant to the terms of the Series A Certificate of Designation and (ii) in consideration of the

29

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



conversion referenced in clause (i) above, the Company issued to the Series A holder in exchange for the single remaining share of Series A Preferred Stock held, in an exchange transaction exempt from the registration requirements of the Securities Act of 1933 and all of the rules and regulations promulgated thereunder (the “Securities Act”) under Section 3(a)(9) of the Securities Act, 770,926 shares of common stock. The fair value of the 770,926 shares was $4.4 million on the date of issuance and was recorded within Preferred stock and deemed dividends from conversion line item of the Consolidated Statements of Operations as a deemed dividend.

Preferred Share Dividends

During 2017, HC2's Board of Directors declared cash dividends with respect to HC2’s issued and outstanding Preferred Stock, as presented in the following table (in thousands):
Declaration Date
 
March 31, 2017

Holders of Record Date
 
March 31, 2017

Payment/Accrual Date
 
April 17, 2017

Total Dividend
 
$
563


18. Related Parties

HC2
    
In January 2015, the Company entered into a services agreement (the “Services Agreement”) with Harbinger Capital Partners, a related party of the Company, with respect to the provision of services that may include providing office space and operational support and each party making available their respective employees to provide services as reasonably requested by the other party, subject to any limitations contained in applicable employment agreements and the terms of the Services Agreement. The Company recognized $1.0 million and $0.7 million of expenses under the Services Agreement for the three months ended March 31, 2017 and 2016, respectively.

GMSL

The parent company of GMSL, Global Marine Holdings, LLC, incurred management fees of $0.18 million and $0.16 million for the three months ended March 31, 2017 and 2016, respectively.

GMSL also has investments in various entities for which it exercises significant influence. A summary of transactions with such entities and balances outstanding are as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net revenue
 
$
7,396

 
$
5,275

Operating expenses
 
$
3,751

 
$
1,230

Interest expense
 
$
347

 
$
370

Dividends received
 
$
632

 
$
418

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Accounts receivable
 
$
7,212

 
$
5,172

Long-term obligations
 
$
35,501

 
$
38,966

Accounts payable
 
$
4,343

 
$
354

 

19. Operating Segment and Related Information

The Company currently has two primary reportable geographic segments - United States and United Kingdom. The Company has seven reportable operating segments based on management’s organization of the enterprise - Construction, Marine Services, Energy, Telecommunications, Insurance, Life Sciences, Other, and a non-operating Corporate segment. Net revenue and long-lived assets by geographic segment is reported on the basis of where the entity is domiciled. All inter-segment revenues are eliminated. The Company has no single customer representing greater than 10% of its revenues.

30

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



Summary information with respect to the Company’s geographic and operating segments is as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net Revenue by Geographic Region
 
 
 
 
United States
 
$
342,105

 
$
226,365

United Kingdom
 
34,692

 
104,017

Other
 
13,771

 
1,362

Total
 
$
390,568

 
$
331,744

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net revenue
 
 
 
 
Construction
 
$
112,721

 
$
119,081

Marine Services
 
44,179

 
32,288

Energy
 
4,287

 
1,207

Telecommunications
 
191,749

 
149,821

Insurance
 
36,026

 
29,138

Other
 
1,606

 
209

Total net revenue
 
390,568

 
331,744

 
 
 
 
 
Income (loss) from operations
 
 
 
 
Construction
 
5,731

 
8,155

Marine Services
 
5,729

 
(4,554
)
Energy
 
(175
)
 
(72
)
Telecommunications
 
1,585

 
177

Insurance
 
270

 
(8,585
)
Life Sciences
 
(3,123
)
 
(2,337
)
Other
 
(1,513
)
 
(1,738
)
Non-operating Corporate
 
(7,532
)
 
(10,311
)
Total income (loss) from operations
 
972

 
(19,265
)
 
 
 
 
 
Interest expense
 
(14,115
)
 
(10,326
)
Loss on contingent consideration
 
(231
)
 
—

Income (loss) from equity investees
 
7,693

 
(3,576
)
Other income (expense), net
 
(4,910
)
 
(714
)
Loss from continuing operations before income taxes
 
(10,591
)
 
(33,881
)
Income tax (expense) benefit
 
(5,291
)
 
2,539

Net loss
 
(15,882
)
 
(31,342
)
Less: Net loss attributable to noncontrolling interest and redeemable noncontrolling interest
 
1,386

 
880

Net loss attributable to HC2 Holdings, Inc.
 
(14,496
)
 
(30,462
)
Less: Preferred stock and deemed dividends from conversions
 
583

 
1,069

Net loss attributable to common stock and participating preferred stockholders
 
$
(15,079
)
 
$
(31,531
)

31

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



 
 
Three Months Ended March 31,
 
 
2017
 
2016
Depreciation and Amortization
 
 
 
 
Construction
 
$
1,640

 
$
529

Marine Services
 
5,085

 
5,155

Energy
 
1,248

 
429

Telecommunications
 
97

 
106

Insurance (1)
 
(1,057
)
 
(619
)
Life Sciences
 
38

 
19

Other
 
330

 
336

Non-operating Corporate
 
16

 
—

Total
 
$
7,397

 
$
5,955

(1) Balance represents amortization of negative VOBA, which increases net income.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Capital Expenditures (2)
 
 
 
 
Construction
 
$
3,814

 
$
2,095

Marine Services
 
2,629

 
2,634

Energy
 
2,650

 
1,659

Telecommunications
 
30

 
22

Insurance
 
278

 
—

Life Sciences
 
51

 
102

Other
 
(37
)
 
—

Non-operating Corporate
 
(2
)
 
—

Total
 
$
9,413

 
$
6,512

(2) The above capital expenditures exclude assets acquired under terms of capital lease and vendor financing obligations.
 
 
March 31,
 
December 31,
 
 
2017
 
2016
Investments
 
 
 
 
Marine Services
 
$
50,034

 
$
40,698

Insurance
 
1,433,030

 
1,407,996

Life Sciences
 
22,176

 
13,067

Other
 
6,153

 
6,778

Eliminations
 
(36,437
)
 
(40,621
)
Total
 
$
1,474,956

 
$
1,427,918

 
 
March 31,
 
December 31,
 
 
2017
 
2016
Property, Plant and Equipment—Net
 
 
 
 
United States
 
$
139,704

 
$
136,905

United Kingdom
 
137,650

 
141,946

Other
 
6,950

 
7,607

Total
 
$
284,304

 
$
286,458


32

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



 
 
March 31,
 
December 31,
 
 
2017
 
2016
Total Assets
 
 
 
 
Construction
 
$
289,969

 
$
295,246

Marine Services
 
283,657

 
275,660

Energy
 
84,075

 
84,602

Telecommunications
 
90,789

 
125,965

Insurance
 
2,063,966

 
2,027,059

Life Sciences
 
38,330

 
28,868

Other
 
8,878

 
10,914

Non-operating Corporate
 
33,135

 
27,583

Eliminations
 
(36,437
)
 
(40,621
)
Total
 
$
2,856,362

 
$
2,835,276


20. Backlog

DBMG’s backlog was $497.6 million ($457.3 million under contracts or purchase orders and $40.3 million under letters of intent) at March 31, 2017. DBMG’s backlog increases as contract commitments, letters of intent, notices to proceed and purchase orders are obtained, decreases as revenues are recognized and increases or decreases to reflect modifications in the work to be performed under the contracts, notices to proceed, letters of intent or purchase orders. DBMG’s backlog can be significantly affected by the receipt, or loss, of individual contracts. Approximately $295.1 million, representing 59.3% of DBMG’s backlog at March 31, 2017, was attributable to five contracts, letters of intent, notices to proceed or purchase orders. If one or more of these large contracts or other commitments are terminated or their scope reduced, DBMG’s backlog could decrease substantially.

DBMG’s backlog at December 31, 2016 was $503.5 million ($441.1 million under contracts or purchase orders and $62.4 million under letters of intent).

21. Basic and Diluted Loss Per Common Share

Earnings per share ("EPS") is calculated using the two-class method, which allocates earnings among common stock and participating securities to calculate EPS when an entity's capital structure includes either two or more classes of common stock or common stock and participating securities. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities. As such, shares of any unvested restricted stock of the Company are considered participating securities. The dilutive effect of options and their equivalents (including non-vested stock issued under stock-based compensation plans), is computed using the “treasury” method.

The Company had no dilutive common share equivalents during the three months ended March 31, 2017 and 2016 due to the results of operations being a loss from continuing operations, net of tax. The Company issued a warrant, Preferred Stock, as well as outstanding stock options and unvested RSUs granted under the Prior Plan and Omnibus Plan, each of which were potentially dilutive but were excluded from the calculation of diluted loss per common share due to their antidilutive effect.

The following table presents a reconciliation of net income (loss) used in basic and diluted EPS calculations (in thousands, except per share amounts):

33

HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED



 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net loss attributable to common stock and participating preferred stockholders
 
$
(15,079
)
 
$
(31,531
)
 
 
 
 
 
Earnings allocable to common shares:
 
 
 
 
 
 
 
 
 
Participating shares at end of period:
 
 
 
 
Weighted-average Common stock outstanding
 
41,948

 
35,262

 
 
 
 
 
Numerator for basic and diluted earnings per share
 
 
 
 
Percentage of loss allocated to:
 
 
 
 
Common Stock
 
100
%
 
100
%
Preferred Stock
 
—
%
 
—
%
 
 
 
 
 
Loss attributable to common shares - basic and diluted
 
 
 
 
Net Loss
 
$
(15,079
)
 
$
(31,531
)
 
 
 
 
 
Denominator for basic and diluted earnings per share
 
 
 
 
Weighted average common shares outstanding - basic and diluted
 
41,948

 
35,262

 
 
 
 
 
Basic and Diluted earnings per share
 
 
 
 
Net loss attributable to common stock and participating preferred stockholders - basic and diluted
 
$
(0.36
)
 
$
(0.89
)

22. Subsequent Events

On April 6, 2017, Gaming Nation Inc. announced the conversion of the convertible debenture held by the Company. The Company made an investment in Gaming Nation pursuant to the purchase of an unsecured convertible debenture issued by Gaming Nation (the "Debenture") on April 6, 2015 in the principal amount of CDN$20 million. The Debenture earned 6% interest in-kind and converted into Gaming Nation Inc. common shares as of the maturity date of April 6, 2017. Pursuant to the conversion of the principal amount and accrued interest, the Company acquired 9,987,556 fully paid common shares equal to a conversion rate of $2.25 per Common Share, which amount equals 22.9% of the Gaming Nation's issued and outstanding common shares as of the conversion date. The Company will apply fair value method to account for its investment in Gaming Nation Inc. subsequent to the conversion. All changes in fair value will be recognized in earnings.

On May 2, 2017, the Company entered into an agreement with DG Value Partners, LP and DG Value Partners II Master Funds LP, holders (collectively, the "DG Value") of the Company's Series A and Series A-1 Convertible Participating Preferred Stock, to convert and exchange all of DG Value's 2,308 Series A and 1,000 Series A-1 Convertible Participating Preferred Stock into a total of 803,469 shares of the Company's common stock.

On May 9, 2017, DBMG declared a cash dividend of $1.29 per share payable to stockholders of record at the close of business on May 19, 2017 and payable on June 5, 2017. The Company will receive $4.6 million of the total dividend payout.


34


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of HC2 Holdings, Inc. (“HC2,” “we,” “us,” “our” and, collectively with its subsidiaries, the “Company”) should be read in conjunction our unaudited Condensed Consolidated Financial Statements and the notes thereto included herein, as well as our audited Consolidated Financial Statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2016. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section in our Form 10-K for the year ended December 31, 2016, filed with the SEC on March 9, 2017, as well as the section below entitled “Special Note Regarding Forward-Looking Statements” for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Our Business

We are a diversified holding company with principal operations conducted through seven operating platforms or reportable segments: Construction ("DBMG"), Marine Services ("GMSL"), Energy ("ANG"), Telecommunications ("ICS"), Insurance ("CIG"), Life Sciences ("Pansend"), and Other, which includes businesses that do not meet the separately reportable segment thresholds.

We continually evaluate acquisition opportunities, as well as monitor a variety of key indicators of our underlying platform companies in order to maximize stakeholder value. These indicators include, but are not limited to, revenue, cost of revenue, operating profit, Adjusted EBITDA and free cash flow. Furthermore, we work very closely with our subsidiary platform executive management teams on their operations and assist them in the evaluation and diligence of asset acquisitions, dispositions and any financing or operational needs at the subsidiary level. We believe that this close relationship allows us to capture synergies within the organization across all platforms and strategically position the Company for ongoing growth and value creation.

The potential for additional acquisitions and new business opportunities, while strategic, may result in acquiring assets unrelated to our current or historical operations. As part of any acquisition strategy, we may raise capital in the form of debt and/or equity securities (including preferred stock) or a combination thereof. We have broad discretion and experience in identifying and selecting acquisition and business combination opportunities and the industries in which we seek such opportunities. Many times, we face significant competition for these opportunities, including from numerous companies with a business plan similar to ours. As such, there can be no assurance that any of the past or future discussions we have had or may have with candidates will result in a definitive agreement and, if they do, what the terms or timing of any potential agreement would be. As part of our acquisition strategy, we may utilize a portion of our available cash to acquire interests in possible acquisition targets. Any securities acquired are marked to market and may increase short-term earnings volatility as a result.

We believe our track record, our platform and our strategy will enable us to deliver strong financial results, while positioning our Company for long-term growth. We believe the unique alignment of our executive compensation program, with our objective of increasing long-term stakeholder value, is paramount to executing our vision of long-term growth, while maintaining our disciplined approach. Having designed our business structure to not only address capital allocation challenges over time, but also maintain the flexibility to capitalize on opportunities during periods of market volatility, we believe the combination thereof positions us well to continue to build long-term stakeholder value.

Our Operations

Refer to Note 1. Organization and Business to our unaudited Condensed Consolidated Financial Statements included elsewhere in this Report on Form 10-Q for additional information.

Seasonality
 
Other than as described below our businesses are not materially affected by seasonality.

Marine Services

Net revenue within our Marine Services segment can fluctuate depending on the season. Revenues are relatively stable for our Marine Services maintenance business as the core driver is the annual contractual obligation. However, this is not the case with our installation business (other than for long-term charter arrangements), in which revenues show a degree of seasonality.  Revenues in our Marine Services installation business are driven by our customers’ need for new cable installations.  Generally, weather downtime, and the additional costs related to downtime, is a significant factor in customers determining their installation schedules, and most installations are therefore scheduled for the warmer months.  As a result, installation revenues are generally lower towards the end of the fourth quarter and throughout the first quarter, as most business is concentrated in the northern hemisphere.

Telecommunications

Net revenue within the wholesale telecommunications business can fluctuate throughout the year due to seasonal events.  The first quarter of the year is typically the softest quarter, increasing through the remainder of the year as religious holidays along with typical end-of-year revenue increases are realized. While seasonality is a factor, the wholesale telecommunications business relies heavily on its sales efforts and customers relationships to drive sales and net margin throughout the year.

35



Recent Developments

Debt Issuance

In January 2017, the Company issued an additional $55.0 million in aggregate principal amount of its 11.0% Senior Secured Notes due 2019 (the “11.0% Notes”). HC2 used a portion of the proceeds from the issuance to repay all $35.0 million in outstanding aggregate principal amount of HC22’s 11.0% Bridge Note due 2019. The Company has issued an aggregate of $362.0 million of its 11.0% Notes  pursuant to an indenture dated November 20, 2014, by and among HC2, the guarantors party thereto and U.S. Bank National Association, a national banking association, as trustee (the “11.0% Notes Indenture”).

Preferred Share Conversion

On May 2, 2017, the Company entered into an agreement with DG Value Partners, LP and DG Value Partners II Master Funds LP, holders (collectively, the "DG Value") of the Company's Series A and Series A-1 Convertible Participating Preferred Stock, to convert and exchange all of DG Value's 2,308 Series A and 1,000 Series A-1 Convertible Participating Preferred Stock into a total of 803,469 shares of the Company's common stock.

Dividends

On May 9, 2017, DBMG declared a cash dividend of $1.29 per share payable to stockholders of record at the close of business on May 19, 2017 and payable on June 5, 2017. The Company will receive $4.6 million of the total dividend payout.

Financial Presentation Background

In the below section within this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we compare, pursuant to U.S. GAAP and SEC disclosure rules, the Company’s results of operations for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016.

Results of Operations

Three months ended March 31, 2017 compared to the three months ended March 31, 2016

Presented below is a disaggregated table that summarizes our results of operations and a comparison of the change between the periods presented (in thousands):
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
 
 
 
 
 
Construction
 
$
112,721

 
$
119,081

 
$
(6,360
)
Marine Services
 
44,179

 
32,288

 
11,891

Energy
 
4,287

 
1,207

 
3,080

Telecommunications
 
191,749

 
149,821

 
41,928

Insurance
 
36,026

 
29,138

 
6,888

Other
 
1,606

 
209

 
1,397

Total net revenue
 
390,568

 
331,744

 
58,824

 
 
 
 
 
 
 
Income (loss) from operations
 
 
 
 
 
 
Construction
 
5,731

 
8,155

 
(2,424
)
Marine Services
 
5,729

 
(4,554
)
 
10,283

Energy
 
(175
)
 
(72
)
 
(103
)
Telecommunications
 
1,585

 
177

 
1,408

Insurance
 
270

 
(8,585
)
 
8,855

Life Sciences
 
(3,123
)
 
(2,337
)
 
(786
)
Other
 
(1,513
)
 
(1,738
)
 
225

Non-operating Corporate
 
(7,532
)
 
(10,311
)
 
2,779

Total income (loss) from operations
 
972

 
(19,265
)
 
20,237

 
 
 
 
 
 
 
Interest expense
 
(14,115
)
 
(10,326
)
 
(3,789
)

36


Loss on contingent consideration
 
(231
)
 
—

 
(231
)
Income (loss) from equity investees
 
7,693

 
(3,576
)
 
11,269

Other income (expense), net
 
(4,910
)
 
(714
)
 
(4,196
)
Loss from continuing operations before income taxes
 
(10,591
)
 
(33,881
)
 
23,290

Income tax (expense) benefit
 
(5,291
)
 
2,539

 
(7,830
)
Net loss
 
(15,882
)
 
(31,342
)
 
15,460

Less: Net loss attributable to noncontrolling interest and redeemable noncontrolling interest
 
1,386

 
880

 
506

Net loss attributable to HC2 Holdings, Inc.
 
(14,496
)
 
(30,462
)
 
15,966

Less: Preferred stock and deemed dividends from conversions
 
583

 
1,069

 
(486
)
Net loss attributable to common stock and participating preferred stockholders
 
$
(15,079
)
 
$
(31,531
)
 
$
16,452


Net revenue: Net revenue for the three months ended March 31, 2016 increased $58.8 million, or 17.7%, to $390.6 million from $331.7 million for the three months ended March 31, 2016. This increase was due primarily to a revenue increase in our Telecommunications segment as a result of growth in wholesale traffic volumes, an increase in revenue in our Marine Services segment driven by increased offshore power installation revenues, and an increase in revenues associated with our Insurance segment driven by increased investment income earned from investments in fixed maturity securities and mortgage loans, and net realized gains driven by the sales of fixed maturity securities. The increases were offset by a decrease in revenue in our Construction segment driven by delays caused by design changes of existing projects in backlog.
 
Income (loss) from operations: Income from operations for the three months ended March 31, 2017 increased $20.2 million to income of $1.0 million from a loss of $19.3 million for the three months ended March 31, 2016. The increase was due in part to the results of the Marine Services segment driven by the increases in revenues, and a loss recognized on a telecom project in the prior year which was not recurring in 2017. The increase in income from operations also resulted from the increase in higher yielding fixed investments and reduced losses realized from sales of fixed maturity securities by our Insurance segment.

Interest expense: Interest expense for the three months ended March 31, 2017 increased $3.8 million to $14.1 million from $10.3 million for the three months ended March 31, 2016. The increase was attributable to the portion of original issue discount and deferred financing fees expensed in the 2017 period through the refinancing date of the 11.0% Bridge Note, and due to the additional interest expense associated with increase in the principal of our 11.0% Notes compared to the previous period.

Income (loss) from equity investees: Income (loss) from equity investees for the three months ended March 31, 2017 increased $11.3 million to income of $7.7 million from a loss of $3.6 million for the three months ended March 31, 2016. The increase in income was driven by an increase in joint venture income in our Marine Services segment, principally from its equity interests in Huawei Marine Networks ("HMN") which realized significant increase in earnings compared to the prior period. This was offset in part by increased non-cash losses of our equity investment in MediBeacon. Additionally, we did not recognize losses from our Inseego investment in the current period as our basis is zero.

Other income (expense), net: Other (expense) for the three months ended March 31, 2017 increased $4.2 million to $4.9 million versus $0.7 million for the three months ended March 31, 2016. The Company recorded a $3.3 million impairment expense in the first quarter of 2017 on one fixed maturity security.

Income tax (expense) benefit: Income tax benefit (expense) was an expense of $5.3 million and a benefit of $2.5 million for the three months ended March 31, 2017 and 2016, respectively. The income tax expense recorded for March 31, 2017 relates to the reversal of taxable temporary differences at the Insurance segment for which no deferred tax benefit is recognized due to a full valuation allowance on the Insurance segment’s net deferred tax assets and to the projected expense as calculated under ASC 740 for other taxpaying entities. Additionally, the tax benefits associated with losses generated by the HC2 Holdings, Inc. U.S. consolidated income tax return and certain other businesses have been reduced by a full valuation allowance as we do not believe it is more-likely-than-not that the losses will be utilized prior to expiration. The income tax benefit recorded for March 31, 2016 relates to losses generated for which we expected to obtain benefits from in the future based on our weighting of all positive and negative evidence that existed at the time. This benefit was partially offset by a valuation allowance recorded against the deferred tax assets of the Insurance segment during the first quarter of 2016.
    
Preferred stock dividends and deemed dividends from conversions: Preferred stock dividends and deemed dividends for the three months ended March 31, 2017 decreased $0.5 million to $0.6 million from $1.1 million for the three months ended March 31, 2016. Our outstanding Preferred shares at March 31, 2017 decreased compared to March 31, 2016 as a result of the conversion, by certain holders of Preferred Stock after March 31, 2016, of shares of Preferred Stock into common stock, reducing the preferred share dividends paid on a quarterly basis.

Segment Results of Operations

In the Company's Condensed Consolidated Financial Statements, other operating (income) expense includes (i) (gain) loss on sale or disposal of assets, (ii) lease termination costs and (iii) asset impairment expense. Each table summarizes the results of operations of our operating segments and compares the amount of the change between the periods presented (in thousands).


37


Construction Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
$
112,721

 
$
119,081

 
$
(6,360
)
 
 
 
 
 
 
 
Cost of revenue
 
91,112

 
97,933

 
(6,821
)
Selling, general and administrative expenses
 
14,486

 
11,560

 
2,926

Depreciation and amortization
 
1,640

 
529

 
1,111

Other operating (income) expense
 
(248
)
 
904

 
(1,152
)
Income (loss) from operations
 
$
5,731

 
$
8,155

 
$
(2,424
)

Net revenue: Net revenue from our Construction segment for the three months ended March 31, 2017 decreased $6.4 million, or 5.3%, to $112.7 million from $119.1 million for the three months ended March 31, 2016. The decrease was driven by delays caused by design changes of existing projects in backlog.

Cost of revenue: Cost of revenue from our Construction segment for the three months ended March 31, 2017 decreased $6.8 million, or 7.0%, to $91.1 million from $97.9 million for the three months ended March 31, 2016. The decrease was primarily due to the decreases in revenue.

Selling, general and administrative expenses: Selling, general and administrative expenses from our Construction segment for the three months ended March 31, 2017 increased $2.9 million, or 25.3%, to $14.5 million from $11.6 million for the three months ended March 31, 2016. The increase was due primarily to the additional operating costs associated with the acquisition of BDS Vircon ("BDS") and PDC Global Pty Ltd. ("PDC") in the fourth quarter of 2016.

Depreciation and amortization: Depreciation and amortization from our Construction segment for the three months ended March 31, 2017 increased $1.1 million, to $1.6 million from $0.5 million for the three months ended March 31, 2016. This was due primarily to the expense associated with the assets acquired through the acquisitions of BDS and PDC in the fourth quarter of 2016.

Other operating (income) expense: Other operating (income) expense from our Construction segment for the three months ended March 31, 2017 increased by $1.2 million to income of $0.2 million from an expense of $0.9 million for the three months ended March 31, 2016. The increase was primarily driven by assets sold at a loss in the prior year period as opposed to a gain in the current year.

Marine Services Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
$
44,179

 
$
32,288

 
$
11,891

 
 
 
 
 
 
 
Cost of revenue
 
31,829

 
27,213

 
4,616

Selling, general and administrative expenses
 
4,842

 
4,491

 
351

Depreciation and amortization
 
5,085

 
5,155

 
(70
)
Other operating (income) expense
 
(3,306
)
 
(17
)
 
(3,289
)
Income (loss) from operations
 
$
5,729

 
$
(4,554
)
 
$
10,283


Net revenue: Net revenue from our Marine Services segment for the three months ended March 31, 2017 increased $11.9 million to $44.2 million from $32.3 million for the three months ended March 31, 2016. The increase was largely driven by revenue contribution from CWind which was acquired at the end of the first quarter of 2016 and increased offshore power installation revenues from existing customers, partially offset by a decrease in telecom install revenues when compared to the prior year.

Cost of revenue: Cost of revenue from our Marine Services segment for the three months ended March 31, 2017 increased $4.6 million to $31.8 million from $27.2 million for the three months ended March 31, 2016. The increase was driven by the increases in revenue, offset in part by a loss recognized on a telecom project in the prior year which was not recurring in 2017.

Other operating (income) expense: Other operating (income) expense from our Marine Services segment for the three months ended March 31, 2017 increased $3.3 million compared to the three months ended March 31, 2016 driven by the current period gain on the sale of a maintenance vessel.


38


Energy Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
$
4,287

 
$
1,207

 
$
3,080

 
 
 
 
 
 
 
Cost of revenue
 
2,507

 
499

 
2,008

Selling, general and administrative expenses
 
711

 
351

 
360

Depreciation and amortization
 
1,248

 
429

 
819

Other operating (income) expense
 
(4
)
 
—

 
(4
)
Income (loss) from operations
 
$
(175
)
 
$
(72
)
 
$
(103
)
    
Net revenue: Net revenue from our Energy segment for the three months ended March 31, 2017 increased $3.1 million to $4.3 million from $1.2 million for the three months ended March 31, 2016. The increase was driven by acquisitions in 2016 subsequent to the first quarter, which added twenty-one stations, and the impact of stations commissioned subsequent to the comparable quarter in the prior year. This was partially offset by tax credits which expired on December 31, 2016 and were not renewed in the first quarter of 2017.

Cost of revenue: Cost of revenue from our Energy segment for the three months ended March 31, 2017 increased $2.0 million to $2.5 million from $0.5 million for the three months ended March 31, 2016. The increase was driven by the increased revenues along with an increase in repairs and maintenance expenses, both associated with the new stations acquired in fourth quarter 2016.

Selling, general and administrative expenses: Selling, general and administrative expenses from our Energy segment for the three months ended March 31, 2017 increased $0.4 million to $0.7 million from $0.4 million for the three months ended March 31, 2016, driven by an increase in office rent and compensation and benefits expense driven by the growth of the business.

Depreciation and amortization: Depreciation and amortization from our Energy segment for the three months ended March 31, 2017 increased $0.8 million to $1.2 million from $0.4 million for the three months ended March 31, 2016. The increase was primarily due to new stations acquired and commissioned.

Telecommunications Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
$
191,749

 
$
149,821

 
$
41,928

 
 
 
 
 
 
 
Cost of revenue
 
187,542

 
147,660

 
39,882

Selling, general and administrative expenses
 
2,525

 
1,878

 
647

Depreciation and amortization
 
97

 
106

 
(9
)
Income (loss) from operations
 
$
1,585

 
$
177

 
$
1,408

    
Net revenue: Net revenue from our Telecommunications segment for the three months ended March 31, 2017 increased $41.9 million, or 28.0%, to $191.7 million from $149.8 million for the three months ended March 31, 2016. The increase was due primarily to growth in wholesale traffic volumes driven by the changing regulatory environment throughout the European market, combined with continued business growth driven by new routing and growing relationships with existing customers.

Cost of revenue: Cost of revenue from our Telecommunications segment for the three months ended March 31, 2017 increased $39.9 million, or 27.0%, to $187.5 million from $147.7 million for the three months ended March 31, 2016. The increase was directly correlated to the growth in wholesale traffic volumes at improved margins.

Selling, general and administrative: Selling, general and administrative expenses from our Telecommunications segment for the three months ended March 31, 2017 increased $0.6 million, or 34.5%, to $2.5 million from $1.9 million for the three months ended March 31, 2016. The increase was due primarily to an increase in salaries and commissions expense as a result of improved sales force performance, as well as from an increase in operational support costs.


39


Insurance Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Life, accident and health earned premiums, net
 
$
19,941

 
$
19,934

 
$
7

Net investment income
 
15,304

 
14,079

 
1,225

Net realized gains (losses) on investments
 
781

 
(4,875
)
 
5,656

Net revenue
 
36,026

 
29,138

 
6,888

 
 
 
 
 
 


Policy benefits, changes in reserves, and commissions
 
31,487

 
34,020

 
(2,533
)
Selling, general and administrative
 
5,326

 
4,322

 
1,004

Depreciation and amortization
 
(1,057
)
 
(619
)
 
(438
)
Income (loss) from operations
 
$
270

 
$
(8,585
)
 
$
8,855


Net investment income: Net investment income from our Insurance segment for the three months ended March 31, 2017 increased $1.2 million to $15.3 million from $14.1 million for the three months ended March 31, 2016. The increase was primarily to an increase in higher yielding fixed investments.

Net realized gains (losses) on investments: Net realized gains (losses) on investments from our Insurance segment for the three months ended March 31, 2017 increased $5.7 million to a $0.8 million gain from a $4.9 million loss for the three months ended March 31, 2016. The increase was due to the sales of low yield fixed maturity securities and fixed maturity securities with a risk of credit downgrades during the three months ended March 31, 2016 due to the initial repositioning of the investment portfolio following the acquisition.

Policy benefits, changes in reserves, and commissions: Policy benefits, changes in reserves, and commissions for the three months ended March 31, 2017 decreased $2.5 million to $31.5 million from $34.0 million for the three months ended March 31, 2016. The decrease was primarily due to the implemented long term care rate increases which generated significant conditional non-forfeiture options activity during the three months ended March 31, 2017. This was not experienced during the three months ended March 31, 2016 significantly reducing the increase in reserves from the prior year.

Selling, general and administrative: Selling, general and administrative expenses from our Insurance segment for the three months ended March 31, 2017 increased $1.0 million to $5.3 million from $4.3 million for the three months ended March 31, 2016. The increase was due to additional staffing and training along with higher consulting and audit fees, which were offset by lower premium tax.

Life Sciences Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Selling, general and administrative expenses
 
$
3,085

 
$
2,318

 
$
767

Depreciation and amortization
 
38

 
19

 
19

Income (loss) from operations
 
$
(3,123
)
 
$
(2,337
)
 
$
(786
)
    
Selling, general and administrative expenses: Selling, general and administrative expenses from our Life Sciences segment for the three months ended March 31, 2017 increased $0.8 million, or 33.1%, to $3.1 million from $2.3 million for the three months ended March 31, 2016. The increase was primarily due to progress driven increases in clinical expenses and research and development at both BeneVir and R2 Dermatology.

Other Segment
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net revenue
 
$
1,606

 
$
209

 
$
1,397

 
 
 
 
 
 
 
Cost of revenue
 
1,424

 
1,047

 
377

Selling, general and administrative expenses
 
1,365

 
564

 
801

Depreciation and amortization
 
330

 
336

 
(6
)
Income (loss) from operations
 
$
(1,513
)
 
$
(1,738
)
 
$
225

    
Net revenue: Net revenue from our Other segment for the three months ended March 31, 2017 increased $1.4 million, to $1.6 million from $0.2

40


million for the three months ended March 31, 2016. The increase was primarily driven by the results of 704Games Company ("704Games") through its sales of the NASCAR® Heat Evolution game, which outperformed its predecessor NASCAR '15.

Cost of revenue: Cost of revenue from our Other segment for the three months ended March 31, 2017 increased $0.4 million, or 36.0%, to $1.4 million from $1.0 million for the three months ended March 31, 2016. The increase was driven by an increase in royalties, disc manufacturing, and game development costs of 704Games driven by its sales of the NASCAR® Heat Evolution game.

Selling, general and administrative: Selling, general and administrative expenses from our Other segment for the three months ended March 31, 2017 increased $0.8 million to $1.4 million from $0.6 million for the three months ended March 31, 2016. The increase was due to compensation, marketing and advertising expenses associated with the release of console and PC versions of the NASCAR® Heat Evolution game, and the costs associated with NerVve Technologies, Inc., which was consolidated in August 2016.

Non-operating Corporate
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Selling, general and administrative expenses
 
$
7,516

 
$
10,311

 
$
(2,795
)
Depreciation and amortization
 
16

 
—

 
16

Income (loss) from operations
 
$
(7,532
)
 
$
(10,311
)
 
$
2,779


Selling, general and administrative expenses: Selling, general and administrative expenses from our Non-operating Corporate segment for the three months ended March 31, 2017 decreased $2.8 million to $7.5 million from $10.3 million for the three months ended March 31, 2016. The decrease was primarily attributable to a reduction in share-based compensation expense as a result of 2015 equity awards, which fully vested in the first quarter of 2016 and minimal grants in 2016 due to under-achievement of performance goals in the 2015 year. In addition, there was a decrease in professional fees and acquisition fees, as well as costs incurred related to the restatement of 2014 results in the first quarter of 2016, which were not present in the current period.

Income (loss) from Equity Investments
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Marine Services
 
$
8,793

 
$
(477
)
 
$
9,270

Life Sciences
 
(1,082
)
 
(306
)
 
(776
)
Other
 
(19
)
 
(2,793
)
 
2,774

Income (loss) from equity investments
 
$
7,692

 
$
(3,576
)
 
$
11,268

    
Marine Services: Income from equity investments in our Marine Services segment for the three months ended March 31, 2017 increased $9.3 million to $8.8 million from $0.5 million for the three months ended March 31, 2016. The increase in income was due to growth in our Marine Services segment joint venture income, largely driven by HMN. Our Marine Services segment's other joint ventures combined for a slight increase.

Life Sciences: Loss from equity investments from our Life Sciences segment for the three months ended March 31, 2017 increased $0.8 million to a loss of $1.1 million from a loss of $0.3 million for the three months ended March 31, 2016. The increase was largely due to higher equity method losses recorded from our investment in MediBeacon Inc. ("MediBeacon") as a result of our increased ownership and additional expenses following successful completion of development and clinical milestones, including the successful completion of the Pilot Two clinical study.

Other: Loss from equity investments from our Other segment for the three months ended March 31, 2017 decreased $2.8 million to a loss of $19.0 thousand from a loss of $2.8 million for the three months ended March 31, 2016. The change was driven by Inseego, as the Company did not recognize losses from our investment in the current period as our basis is zero.

Non-GAAP Financial Measures and Other Information

Adjusted EBITDA

Adjusted EBITDA is not a measurement recognized under U.S. GAAP. In addition, other companies may define Adjusted EBITDA differently than we do, which could limit its usefulness.

Management believes that Adjusted EBITDA provides investors with meaningful information for gaining an understanding of our results as it is frequently used by the financial community to provide insight into an organization’s operating trends and facilitates comparisons between peer companies, since interest, taxes, depreciation, amortization and the other items listed in the definition of Adjusted EBITDA below can differ greatly between organizations as a result of differing capital structures and tax strategies. Adjusted EBITDA can also be a useful measure of a

41


company’s ability to service debt. While management believes that non-U.S. GAAP measurements are useful supplemental information, such adjusted results are not intended to replace our U.S. GAAP financial results. Using Adjusted EBITDA as a performance measure has inherent limitations as an analytical tool as compared to net income (loss) or other U.S. GAAP financial measures, as this non-GAAP measure excludes certain items, including items that are recurring in nature, which may be meaningful to investors. As a result of the exclusions, Adjusted EBITDA should not be considered in isolation and does not purport to be an alternative to net income (loss) or other U.S. GAAP financial measures as a measure of our operating performance. Adjusted EBITDA excludes the results of operations of our Insurance segment.

The calculation of Adjusted EBITDA, as defined by us, consists of Net income (loss) as adjusted for depreciation and amortization; amortization of equity method fair value adjustments at acquisition; (gain) loss on sale or disposal of assets; lease termination costs; asset impairment expense; interest expense; net gain (loss) on contingent consideration; loss on early extinguishment or restructuring of debt; other (income) expense, net; foreign currency transaction (gain) loss included in cost of revenue; income tax (benefit) expense; (gain) loss from discontinued operations; noncontrolling interest; bonus to be settled in equity; share-based compensation expense; acquisition and non-recurring items and other costs.

Our Adjusted EBITDA was $16.7 million and $0.3 million for the three months ended March 31, 2017 and 2016, respectively. The increase was primarily due to improvements in our Marine Services segment driven by increased business opportunities and equity method income particularly in our joint venture investment in HMN, organic growth in our Telecommunications segment, and acquisition driven growth in our Energy segment. These increases were offset by our Construction segment due to decreases in revenues driven by delays caused by design changes of existing projects in backlog and increased losses from our Life Sciences segment as our early stage companies continue to develop their businesses and meet major milestones.
 

Three Months Ended March 31, 2017
 
 
Core Operating Subsidiaries
 
Early Stage & Other
 
 
 
HC2
 
Construction
Marine Services
 
Energy
 
Telecom
 
Life Sciences
Other and Eliminations
Non-operating Corporate
 
Net Income (loss) attributable to HC2 Holdings, Inc.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
(14,496
)
Less: Net Income (loss) attributable to HC2 Holdings Insurance Segment

 
 
 
 
 
 
 
 
 
 
 
 
 
 
(761
)
Net Income (loss) attributable to HC2 Holdings, Inc., excluding Insurance Segment

$
3,203

 
$
11,152

 
$
(697
)
 
$
1,502

 
$
(3,410
)
 
$
(5,430
)
 
$
(20,055
)
 
$
(13,735
)
Adjustments to reconcile net income (loss) to Adjusted EBITDA:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization

1,640

 
5,085

 
1,248

 
97

 
38

 
330

 
16

 
8,454

Depreciation and amortization (included in cost of revenue)

1,240

 
—

 
—

 
—

 
—

 
—

 
—

 
1,240

Amortization of equity method fair value adjustment at acquisition

—

 
(325
)
 
—

 
—

 
—

 
—

 
—

 
(325
)
(Gain) loss on sale or disposal of assets

(248
)
 
(3,500
)
 
(4
)
 
—

 
—

 
—

 
—

 
(3,752
)
Lease termination costs

—

 
194

 
—

 
—

 
—

 
—

 
—

 
194

Interest expense

207

 
1,302

 
136

 
9

 
—

 
2,391

 
10,070

 
14,115

Net loss on contingent consideration
 
—

 
—

 
—

 
—

 
—

 
—

 
231

 
231

Other (income) expense, net

(21
)
 
1,065

 
1,120

 
74

 
(4
)
 
2,115

 
44

 
4,393

Foreign currency (gain) loss (included in cost of revenue)

—

 
24

 
—

 
—

 
—

 
—

 
—

 
24

Income tax (benefit) expense

2,079

 
510

 
13

 
—

 
—

 
—

 
2,177

 
4,779

Noncontrolling interest

263

 
494

 
(747
)
 
—

 
(791
)
 
(605
)
 
—

 
(1,386
)
Share-based payment expense
 
—

 
345

 
91

 
—

 
92

 
29

 
962

 
1,519

Acquisition and nonrecurring items

245

 
—

 
—

 
—

 
—

 
—

 
693

 
938

Adjusted EBITDA

$
8,608

 
$
16,346

 
$
1,160

 
$
1,682

 
$
(4,075
)
 
$
(1,170
)
 
$
(5,862
)
 
$
16,689

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Core Operating Subsidiaries
 
$
27,796

 
 
 
 
 
 
 
 
 
 
 
 
 
 


42




Three Months Ended March 31, 2016
 
 
Core Operating Subsidiaries
 
Early Stage & Other
 
 
 
HC2
 
Construction
Marine Services
 
Energy
 
Telecom
 
Life Sciences
Other and Eliminations
Non-operating Corporate
 
Net Income (loss) attributable to HC2 Holdings, Inc.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
(30,462
)
Less: Net Income (loss) attributable to HC2 Holdings Insurance Segment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(7,496
)
Net Income (loss) attributable to HC2 Holdings, Inc., excluding Insurance Segment
 
$
4,384

 
$
(5,918
)
 
$
(27
)
 
$
1,202

 
$
1,298

 
$
(10,494
)
 
$
(13,409
)
 
$
(22,966
)
Adjustments to reconcile net income (loss) to Adjusted EBITDA:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
 
529

 
5,155

 
429

 
106

 
19

 
336

 
—

 
6,574

Depreciation and amortization (included in cost of revenue)
 
1,933

 
—

 
—

 
—

 
—

 
—

 
—

 
1,933

Amortization of equity method fair value adjustment at acquisition
 
—

 
(358
)
 
—

 
—

 
—

 
—

 
—

 
(358
)
(Gain) loss on sale or disposal of assets
 
904

 
(17
)
 
—

 
—

 
—

 
—

 
—

 
887

Interest expense
 
310

 
1,070

 
9

 
—

 
—

 
—

 
8,937

 
10,326

Other (income) expense, net
 
(44
)
 
612

 
(31
)
 
(1,025
)
 
(3,221
)
 
6,005

 
(1,611
)
 
686

Foreign currency (gain) loss (included in cost of revenue)
 
—

 
(147
)
 
—

 
—

 
—

 
—

 
—

 
(147
)
Income tax (benefit) expense
 
3,445

 
(640
)
 
—

 
—

 
—

 
(1
)
 
(4,226
)
 
(1,422
)
Noncontrolling interest
 
61

 
(155
)
 
(22
)
 
—

 
(720
)
 
(44
)
 
—

 
(880
)
Share-based payment expense
 
—

 
609

 
14

 
—

 
22

 
160

 
2,386

 
3,191

Acquisition and nonrecurring items
 
—

 
266

 
27

 
—

 
—

 
1

 
2,201

 
2,495

Adjusted EBITDA
 
$
11,522

 
$
477

 
$
399

 
$
283

 
$
(2,602
)
 
$
(4,038
)
 
$
(5,722
)
 
$
319

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Core Operating Subsidiaries
 
$
12,681

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Construction: Adjusted EBITDA income from our Construction segment for the three months ended March 31, 2017 decreased $2.9 million to $8.6 million from $11.5 million for the three months ended March 31, 2016. The decrease was driven by delays caused by design changes of existing projects in backlog.

Marine Services: Adjusted EBITDA income from our Marine Services segment for the three months ended March 31, 2017 increased $15.9 million to $16.3 million from $0.5 million for the three months ended March 31, 2016. The increase was driven by revenue contribution from CWind which was acquired at the end of the first quarter of 2016, revenues from offshore power installation and maintenance projects, equity method income through our joint venture investment in HMN, and a loss recognized on a telecom project in the prior year which was not recurring in 2017.

Energy: Adjusted EBITDA income from our Energy segment for the three months ended March 31, 2017 increased $0.8 million to $1.2 million from $0.4 million for the three months ended March 31, 2016 due to the impact of sales by stations acquired and commissioned subsequent to the comparable quarter in the prior year.

Telecommunications: Adjusted EBITDA income from our Telecommunications segment for the three months ended March 31, 2017 increased $1.4 million to $1.7 million from $0.3 million for the three months ended March 31, 2016. The increase was due primarily to volume-driven revenue growth, in part resulting from the changing regulatory environment throughout the European market combined with continued business growth driven by new routing and growing relationships with existing customers.

Life Sciences: Adjusted EBITDA loss from our Life Sciences segment for the three months ended March 31, 2017 increased $1.5 million to a loss of $4.1 million from a loss of $2.6 million due to a progress driven increase in costs at early stage consolidating subsidiaries, principally BeneVir and R2 Dermatology, and an increase in equity method losses recorded for MediBeacon as a result of increased expenses following successful completion of development and clinical milestones, including the successful completion of the Pilot Two clinical study.

Other and Eliminations: Adjusted EBITDA loss from the Other segment and eliminations for the three months ended March 31, 2017 decreased $2.9 million to $1.2 million from $4.0 million for the three months ended March 31, 2016. The decrease in loss was due to a reduction in losses recognized from our equity method investments, principally Inseego, as the Company did not recognize losses from our investment in the three months ended March 31, 2017 as our basis is zero. This was further decreased by lower losses at 704Games as a result of increased sales of the NASCAR® Heat Evolution game, which outperformed its predecessor.

Non-operating Corporate: Adjusted EBITDA loss from our Non-operating Corporate segment for the three months ended March 31, 2017 increased $0.1 million to $5.9 million from $5.7 million for the three months ended March 31, 2016. The increase was primarily due to the

43


continued growth in the company including rent expense.

Adjusted Operating Income - Insurance

Adjusted Operating Income for the Insurance segment (“Insurance AOI”) is a non-U.S. GAAP financial measure frequently used throughout the insurance industry and is an economic measure the Insurance segment uses to evaluate its financial performance. Management believes that Insurance AOI measures provide investors with meaningful information for gaining an understanding of certain results and provides insight into an organization’s operating trends and facilitates comparisons between peer companies. However, Insurance AOI has certain limitations and we may not calculate it the same as other companies in our industry. It should therefore be read together with the Company's results calculated in accordance with U.S. GAAP.
 
Similarly to Adjusted EBITDA, using Insurance AOI as a performance measure has inherent limitations as an analytical tool as compared to income (loss) from operations or other U.S. GAAP financial measures, as this non-U.S. GAAP measure excludes certain items, including items that are recurring in nature, which may be meaningful to investors. As a result of the exclusions, Insurance AOI should not be considered in isolation and does not purport to be an alternative to income (loss) from operations or other U.S. GAAP financial measures as a measure of our operating performance.

Management defines Insurance AOI as Net income (loss) for the Insurance segment adjusted to exclude the impact of net investment gains (losses), including other-than-temporary impairment losses recognized in operations; asset impairment; intercompany elimination and acquisition and non-recurring items. Management believes that Insurance AOI provides a meaningful financial metric that helps investors understand certain results and profitability. While these adjustments are an integral part of the overall performance of the Insurance segment, market conditions impacting these items can overshadow the underlying performance of the business. Accordingly, we believe using a measure which excludes their impact is effective in analyzing the trends of our operations.

The table below shows the adjustments made to the reported net (loss) income of the Insurance segment to calculate Insurance AOI (in thousands). Refer to the analysis of the fluctuations within the results of operations section:
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Net loss - Insurance segment
 
$
(761
)
 
$
(7,496
)
 
$
6,735

Effect of investment (gains) losses
 
(781
)
 
4,875

 
(5,656
)
Asset impairment expense
 
522

 
—

 
522

Insurance AOI
 
$
(1,020
)
 
$
(2,621
)
 
$
1,601


Liquidity and Capital Resources

Short- and Long-Term Liquidity Considerations and Risks

HC2 is a holding company and its liquidity needs are primarily for interest payments on its 11.0% Notes and dividend payments on our Preferred Stock. We also have liquidity needs related to recurring operational expenses. 

As of March 31, 2017, we had $127.0 million of cash and cash equivalents compared to $115.4 million as of December 31, 2016. On a stand-alone basis, as of March 31, 2017, HC2 had cash and cash equivalents of $27.0 million compared to $21.7 million at December 31, 2016. At March 31, 2017, cash and cash equivalents in our Insurance segment was $34.7 million compared to $24.5 million at December 31, 2016.

Our subsidiaries' principal liquidity requirements arise from cash used in operating activities, debt service, and capital expenditures, including purchases of steel Construction equipment and subsea cable equipment, fueling stations, network equipment (such as switches, related transmission equipment and capacity), and service infrastructure, liabilities associated with insurance products, development of back-office systems, operating costs and expenses, and income taxes.
    
As of March 31, 2017, we had $454.3 million of indebtedness on a consolidated basis compared to $438.4 million as of December 31, 2016. On a stand-alone basis, as of March 31, 2017, HC2 had $362.0 million of indebtedness compared to $307.0 million as of December 31, 2016.

As of March 31, 2017, we had $29.5 million in liquidation value of outstanding Preferred Stock, no change from December 31, 2016.  HC2 is required to make semi-annual interest payments on our outstanding 11.0% Notes on June 1st and December 1st of each year.  We are required to make dividend payments on our outstanding Preferred Stock on January 15th, April 15th, July 15th, and October 15th of each year.

In January 2017, the Company issued $55.0 million in aggregate principal amount of 11.0% Notes. The new notes were issued as additional notes under the 11.0% Notes pursuant to which we previously issued $307.0 million aggregate principal amount of the 11.0% Notes. The net proceeds from these new 11.0% Notes were used to refinance all $35 million in aggregate principal amount of the 11.0% Bridge Note, for working capital, and for general corporate purposes (including the financing of potential future acquisitions and investments). The new notes constitute part of a single class of securities with the 11.0% Notes for all purposes and have the same terms as the 11.0% Notes.

44



In the first quarter of 2017, the Company received $9.2 million and $2.0 million in dividends from our Construction and Telecommunications segments, respectively.

We have financed our growth and operations to date, and expect to finance our future growth and operations, through public offerings and private placements of debt and equity securities, credit facilities, vendor financing, capital lease financing and other financing arrangements, as well as cash generated from the operations of our subsidiaries. In the future, we may also choose to sell assets or certain investments to generate cash.

At this time, we believe that we will be able to continue to meet our liquidity requirements and fund our fixed obligations (such as debt services and operating leases) and other cash needs for our operations for at least the next twelve months through a combination of distributions from our subsidiaries and from raising of additional debt or equity, refinancing of certain of our indebtedness or Preferred Stock, other financing arrangements and/or the sale of assets and certain investments. Historically, we have chosen to reinvest cash and receivables into the growth of our various businesses, and therefore have not kept a large amount of cash on hand at the holding company level, a practice which we expect to continue in the future. The ability of HC2’s subsidiaries to make distributions to HC2 is subject to numerous factors, including restrictions contained in each subsidiary’s financing agreements, regulatory requirements, availability of sufficient funds at each subsidiary and the approval of such payment by each subsidiary’s board of directors, which must consider various factors, including general economic and business conditions, tax considerations, strategic plans, financial results and condition, expansion plans, any contractual, legal or regulatory restrictions on the payment of dividends, and such other factors each subsidiary’s board of directors considers relevant. Our ability to sell assets and certain of our investments to meet our existing financing needs may also be limited by our existing financing instruments. Although the Company believes that it will be able to raise additional equity capital, refinance indebtedness or Preferred Stock, enter into other financing arrangements or engage in asset sales and sales of certain investments sufficient to fund any cash needs that we are not able to satisfy with the funds expected to be provided by our subsidiaries, there can be no assurance that it will be able to do so on terms satisfactory to the Company if at all. Such financing options, if pursued, may also ultimately have the effect of negatively impacting our liquidity profile and prospects over the long-term. In addition, the sale of assets or the Company’s investments may also make the Company less attractive to potential investors or future financing partners.

Indebtedness

See Note 12. Long-term Obligations, to the Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for a description of our long-term debt.

Restrictive Covenants
 
The 11.0% Notes Indenture contains certain covenants limiting, among other things, the ability of the Company and certain subsidiaries of the Company to incur additional indebtedness; create liens; engage in sale-leaseback transactions; pay dividends or make distributions in respect of capital stock and make certain restricted payments; sell assets; engage in transactions with affiliates; or consolidate or merge with, or sell substantially all of its assets to, another person.  These covenants are subject to a number of important exceptions and qualifications.
 
The 11.0% Notes Indenture also includes two maintenance covenants:  (1) a liquidity covenant; and (2) a collateral coverage covenant. 

The liquidity covenant provides that the Company will not permit the aggregate amount of all unrestricted cash and cash equivalents of the Company and the subsidiary guarantors of the 11.0% Notes (the "Guarantors") to be less than the Company’s obligations to pay interest on the 11.0% Notes and all other debt of the Company and the Guarantors, plus mandatory cash dividends on the Company’s Preferred Stock, for the next (i) 6 months if our collateral coverage ratio is greater than 2.0x or (ii) 12 months if our collateral coverage ratio is less than 2.0x. As of March 31, 2017, our collateral coverage ratio was greater than 2.0x and therefore the liquidity covenant requires the Company to maintain 6 months of debt service and preferred dividend obligations. If the collateral coverage ratio subsequently becomes lower than 2:1 in the future, the maintenance of liquidity requirement under the 11.0% Notes will be increased back to 12 months of debt service and preferred dividend obligations. As of March 31, 2017, the Company was in compliance with this covenant.

The collateral coverage covenant provides that the Company’s Collateral Coverage Ratio (defined in the 11.0% Notes Indenture as the ratio of (i) the Loan Collateral to (ii) Consolidated Secured Debt (each as defined therein)) calculated on a pro forma basis as of the last day of each fiscal quarter may not be less than 1.25:1. As of March 31, 2017, the Company was in compliance with this covenant.

The instruments governing the Company’s Preferred Stock also limit the Company’s and its subsidiaries ability to take certain actions, including, among other things, to incur additional indebtedness; issue additional Preferred Stock; engage in transactions with affiliates; and make certain restricted payments. These limitations are subject to a number of important exceptions and qualifications.


45


Summary of Consolidated Cash Flows

Presented below is a table that summarizes the cash provided or used in our activities and the amount of the respective increases or decreases in cash (used in) provided by those activities between the fiscal periods (in thousands):
 
 
Three Months Ended March 31,
Increase / (Decrease)
 
 
2017
 
2016
 
2017 vs 2016
Operating activities
 
$
32,776

 
$
16,825

 
$
15,951

Investing activities
 
(28,769
)
 
(35,127
)
 
6,358

Financing activities
 
6,487

 
(4,174
)
 
10,661

Effect of exchange rate changes on cash and cash equivalents
 
1,138

 
1,552

 
(414
)
Net (decrease) increase in cash and cash equivalents
 
$
11,632

 
$
(20,924
)
 
$
32,556


Operating Activities

Cash provided by operating activities totaled $32.8 million for the three months ended March 31, 2017 as compared to $16.8 million for three months ended March 31, 2016. The $16.0 million increase was the result of an increase in working capital driven by improved cash collections at our consolidated subsidiaries.

Investing Activities

Cash used in investing activities totaled $28.8 million for the three months ended March 31, 2017 as compared to $35.1 million for three months ended March 31, 2016. The $6.4 million decrease was driven by a reduction in cash used for acquisitions and purchases of investments, offset by an increase of cash used for purchases of fixed assets.

Financing Activities

Cash provided by financing activities totaled $6.5 million for the three months ended March 31, 2017 as compared to cash used in financing activities of $4.2 million for the three months ended March 31, 2016. The $10.7 million increase was driven by additional borrowings under our 11% Notes, offset by repayments on outstanding long-term obligations.

Other Invested Assets

Carrying values of other invested assets accounted for under cost and equity method are as follows (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Cost
Method
 
Equity Method
 
Fair Value
 
Cost
Method
 
Equity Method
 
Fair
Value
Common Equity
 
$
138

 
$
1,083

 
$
—

 
$
138

 
$
1,047

 
—

Preferred Equity
 
2,484

 
19,044

 
—

 
2,484

 
9,971

 
—

Derivatives
 
3,097

 
—

 
3,694

 
3,097

 
—

 
3,813

Limited Partnerships
 
—

 
1,007

 
—

 
—

 
1,116

 
—

Joint Ventures
 
—

 
50,033

 
—

 
—

 
40,697

 
—

Total
 
$
5,719

 
$
71,167

 
$
3,694

 
$
5,719

 
$
52,831

 
$
3,813


Construction

Cash Flows

Cash flows from operating activities are the principal source of cash used to fund DBMG’s operating expenses, interest payments on debt, and capital expenditures. DBMG's short-term cash needs are primarily for working capital to support operations including receivables, inventories, and other costs incurred in performing its contracts. DBMG attempts to structure the payment arrangements under its contracts to match costs incurred under the project. To the extent it is able to bill in advance of costs incurred, DBMG generates working capital through billings in excess of costs and recognized earnings on uncompleted contracts. DBMG relies on its credit facilities to meet its working capital needs. DBMG believes that its existing borrowing availability together with cash from operations will be adequate to meet all funding requirements for its operating expenses, interest payments on debt and capital expenditures for the foreseeable future.

DBMG is required to make monthly or quarterly interest payments on all of its debt. Based upon the March 31, 2017 debt balance, DBMG anticipates that its interest payments will be approximately $0.1 million each quarter.


46


DBMG estimates that its capital expenditures for 2017 will be approximately $7.5 million. It believes that its available funds, cash generated by operating activities and funds available under its bank credit facilities will be sufficient to fund these capital expenditures and its working capital needs. However, DBMG may expand its operations through future acquisitions and may require additional equity or debt financing.

Marine Services

Cash Flows

Cash flows from operating activities are the principal source of cash used to fund GMSL’s operating expenses, interest payments on debt, and capital expenditures. GMSL's short-term cash needs are primarily for working capital to support operations including receivables, inventories, and other costs incurred in performing its contracts. GMSL attempts to structure the payment arrangements under its contracts to match costs incurred under the project. To the extent it is able to bill in advance of costs incurred, GMSL generates working capital through billings in excess of costs and recognized earnings on uncompleted contracts. GMSL believes that its existing borrowing availability together with cash from operations will be adequate to meet all funding requirements for its operating expenses, interest payments on debt and capital expenditures for the foreseeable future.

GMSL is required to make monthly and quarterly interest and principal payments depending on the structure of each individual debt agreement.

Market Environment

GMSL earns revenues in a variety of currencies including the US dollar, the Singapore dollar and the British pound. The exchange rates between the US dollar, the Singapore dollar and the British pound have fluctuated in recent periods and may fluctuate substantially in the future. Any material appreciation or depreciation of these currencies against each other may have a negative impact on GMSL's results of operations and financial condition.

Insurance

Cash flows

CIG’s principal cash inflows from its operating activities relate to its premiums, annuity deposits and insurance, investment product fees and other income. CIG’s principal cash inflows from its invested assets result from investment income and the maturity and sales of invested assets. The primary liquidity concern with respect to these cash inflows relates to the risk of default by debtors and interest rate volatility. Additional sources of liquidity to meet unexpected cash outflows in excess of operating cash inflows and current cash and equivalents on hand include selling short-term investments or fixed maturity securities.

CIG's principal cash outflows relate to the payment of claims liabilities, interest credited and operating expenses. CIG’s management believes its current sources of liquidity are adequate to meet its cash requirements for the next 12 months.

Market environment

As of March 31, 2017, CIG was in a position to hold any investment security showing an unrealized loss until recovery, provided it remains comfortable with the credit of the issuer. CIG does not rely on short-term funding or commercial paper and to date it has experienced no liquidity pressure, nor does it anticipate such pressure in the foreseeable future. CIG projects its reserves to be sufficient and believes its current capital base is adequate to support its business.

Dividend Limitations

CIG is subject to Texas and Ohio statutory provisions that restrict the payment of dividends. The dividend limitations on CIG are based on statutory financial results and regulatory approval. Statutory accounting practices differ in certain respects from accounting principles used in financial statements prepared in conformity with U.S. GAAP. Significant differences include the treatment of deferred income taxes, required investment reserves, reserve calculation assumptions and surplus notes.

The ability of CIG’s subsidiaries to pay dividends and to make such other payments is limited by applicable laws and regulations of the states in which its subsidiaries are domiciled, which subject its subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, CIG’s insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay.  Along with solvency regulations, the primary driver in determining the amount of capital used for dividends is the level of capital needed to maintain desired financial strength in the form of its subsidiaries Risk-Based Capital (“RBC”) ratio. CIG monitors its insurance subsidiaries’ compliance with the RBC requirements specified by the National Association of Insurance Commissioners. As of December 31, 2016, each of CIG’s insurance subsidiaries exceeds the minimum RBC requirements. CIG’s insurance subsidiaries paid no dividends to CIG in fiscal year 2016 and have further each agreed with each of their respective state regulators to not pay dividends for three years following the completion of the acquisition on December 24, 2015.


47


Other

The Company has an agreement with the Texas Department of Insurance ("TDOI") that, for five years following the acquisition, the Company will contribute to Continental General Insurance Company ("CGI" or the "Insurance Company") cash or marketable securities acceptable to the TDOI to the extent required for CGI’s total adjusted capital to be not less than 400% of CGI’s authorized control level risk-based capital (each as defined under Texas law and reported in CGI’s statutory statements filed with the TDOI).

Additionally, CGI entered into a capital maintenance agreement with Financial Resources, Inc. ("Great American"). Under the agreement, if the applicable acquired company’s total adjusted capital reported in its annual statutory financial statements is less than 400% of its authorized control level risk-based capital, Great American has agreed to pay cash or assets to the applicable acquired company as required to eliminate such shortfall (after giving effect to any capital contributions made by the Company or its affiliates since the date of the relevant annual statutory financial statement). Great American’s obligation to make such payments is capped at $35.0 million under the capital maintenance agreement. The capital maintenance agreements will remain in effect from January 1, 2016 to January 1, 2021 or until payments by Great American under the applicable agreement equal the applicable cap. Pursuant to the purchase agreement, the Company is required to indemnify Great American for the amount of any payments made by Great American under the capital maintenance agreements.

Asset Liability Management

CIG’s insurance subsidiaries maintain investment strategies intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with longer durations, such as long-term care insurance, are matched with investments such as long-term fixed maturity securities. Shorter-term liabilities are matched with fixed maturity securities that have short- and medium-term fixed maturities.  The types of assets in which CIG may invest are influenced by state laws, which prescribe qualified investment assets applicable to insurance companies.  Within the parameters of these laws, CIG invests in assets giving consideration to four primary investment objectives: (i) maintain robust absolute returns; (ii) provide reliable yield and investment income; (iii) preserve capital and (iv) provide liquidity to meet policyholder and other corporate obligations. The Insurance segment’s investment portfolio is designed to contribute stable earnings and balance risk across diverse asset classes and is primarily invested in high quality fixed income securities. In addition, at any given time, CIG’s insurance subsidiaries could hold cash, highly liquid, high-quality short-term investment securities and other liquid investment grade fixed maturity securities to fund anticipated operating expenses, surrenders and withdrawals.

Investments

At March 31, 2017 and December 31, 2016, CIG’s investment portfolio is comprised of the following (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Fair Value
 
Percent
 
Fair Value
 
Percent
U.S. Government and government agencies
 
$
15,854

 
1.1
%
 
$
15,950

 
1.1
%
States, municipalities and political subdivisions
 
380,710

 
26.6
%
 
375,077

 
26.6
%
Foreign government
 
5,871

 
0.4
%
 
5,978

 
0.4
%
Residential mortgage-backed securities
 
132,257

 
9.2
%
 
138,196

 
9.8
%
Commercial mortgage-backed securities
 
40,895

 
2.9
%
 
49,053

 
3.5
%
Asset-backed securities
 
96,507

 
6.7
%
 
77,665

 
5.5
%
Corporate and other
 
630,455

 
44.1
%
 
617,039

 
44.0
%
Common stocks (*)
 
49,340

 
3.4
%
 
53,892

 
3.8
%
Perpetual preferred stocks
 
37,683

 
2.6
%
 
36,654

 
2.6
%
Mortgage loans
 
21,824

 
1.5
%
 
16,831

 
1.2
%
Policy loans
 
18,106

 
1.3
%
 
18,247

 
1.3
%
Other invested assets
 
3,528

 
0.2
%
 
3,415

 
0.2
%
Total
 
$
1,433,030

 
100.0
%
 
$
1,407,997

 
100.0
%
(*) Balance includes fair value of certain securities held by the Company, which are either eliminated on consolidation or reported within other invested assets.


48


Credit Quality

Insurance statutes regulate the type of investments that CIG is permitted to make and limit the amount of funds that may be used for any one type of investment.  In light of these statutes and regulations, and CIG's business and investment strategy, CIG generally seeks to invest in (i) securities rated investment grade by established nationally recognized statistical rating organizations (each, a nationally recognized statistical rating organization (“NRSRO”)), (ii) U.S. Government and government-sponsored agency securities, or (iii) securities of comparable investment quality, if not rated.

The following table summarizes the credit quality, by NRSRO rating, of CIG's fixed income portfolio (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Fair Value
 
Percent
 
Fair Value
 
Percent
AAA, AA, A
 
$
817,672

 
62.8
%
 
$
738,509

 
57.8
%
BBB
 
357,247

 
27.4
%
 
382,555

 
29.9
%
Total investment grade
 
1,174,919

 
90.2
%
 
1,121,064

 
87.7
%
BB
 
28,293

 
2.2
%
 
37,093

 
2.9
%
B
 
18,595

 
1.4
%
 
20,214

 
1.6
%
CCC, CC, C
 
37,962

 
2.9
%
 
35,021

 
2.7
%
D
 
14,494

 
1.1
%
 
17,075

 
1.3
%
NR
 
28,286

 
2.2
%
 
48,491

 
3.8
%
Total non-investment grade
 
127,630

 
9.8
%
 
157,894

 
12.3
%
Total
 
$
1,302,549

 
100.0
%
 
$
1,278,958

 
100.0
%

Foreign Currency

Foreign currency translation can impact our financial results. During the three months ended March 31, 2017 and 2016, approximately 12.4% and 22.0% respectively, of our net revenue from continuing operations was derived from sales and operations outside the U.S. The reporting currency for our Consolidated Financial Statements is the United States dollar (“USD”). The local currency of each country is the functional currency for each of our respective entities operating in that country.

In the future, we expect to continue to derive a portion of our net revenue and incur a portion of our operating costs from outside the U.S., and therefore changes in exchange rates may continue to have a significant, and potentially adverse, effect on our results of operations. Our risk of loss regarding foreign currency exchange rate risk is caused primarily by fluctuations in the USD/British pound sterling (“GBP”) exchange rate. Changes in the exchange rate of USD relative to the GBP could have an adverse impact on our future results of operations. We have agreements with certain subsidiaries for repayment of a portion of the investments and advances made to these subsidiaries. As we anticipate repayment in the foreseeable future, we recognize the unrealized gains and losses in foreign currency transaction gain (loss) on the Consolidated Financial Statements. The exposure of our income from operations to fluctuations in foreign currency exchange rates is reduced in part because a majority of the costs that we incur in connection with our foreign operations are also denominated in local currencies.

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows of our international subsidiaries and may distort comparisons from year to year. By way of example, when the USD strengthens compared to the GBP, there could be a negative or positive effect on the reported results for our Telecommunications segment, depending upon whether such businesses are operating profitably or at a loss. More profits in GBP are required to generate the same amount of profits in USD and a greater loss in GBP to generate the same amount of loss in USD, and vice versa. For instance, when the USD weakens against the GBP, there is a positive effect on reported profits and a negative effect on reported losses.

Off-Balance Sheet Arrangements

DBMG

DBMG’s off-balance sheet arrangements at March 31, 2017 included letters of credit of $9.0 million under Credit and Security Agreements and performance bonds of $219.9 million.

DBMG’s contract arrangements with customers sometimes require DBMG to provide performance bonds to partially secure its obligations under its contracts. Bonding requirements typically arise in connection with public works projects and sometimes with respect to certain private contracts. DBMG’s performance bonds are obtained through surety companies and typically cover the entire project price.


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New Accounting Pronouncements

For a discussion of our New Accounting Pronouncements, refer to Note 2. Summary of Significant Accounting Policies to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Critical Accounting Policies

There have been no significant changes in our critical accounting policies since December 31, 2016.

Related Party Transactions

For a discussion of our Related Party Transactions, refer to Note 18. Related Parties to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Corporate Information

HC2, a Delaware corporation was incorporated in 1994. The Company’s executive offices are located at 450 Park Avenue, 30th Floor, New York, NY, 10022. The Company’s telephone number is (212) 235-2690. Our Internet address is www.hc2.com. We make available free of charge through our Internet website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information on our website is not a part of this Quarterly Report on Form 10-Q.

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains or incorporates a number of “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based on current expectations, and are not strictly historical statements. In some cases, you can identify forward-looking statements by terminology such as “if,” “may,” “should,” “believe,” “anticipate,” “future,” “forward,” “potential,” “estimate,” “opportunity,” “goal,” “objective,” “growth,” “outcome,” “could,” “expect,” “intend,” “plan,” “strategy,” “provide,” “commitment,” “result,” “seek,” “pursue,” “ongoing,” “include” or in the negative of such terms or comparable terminology. These forward-looking statements inherently involve certain risks and uncertainties and are not guarantees of performance, results, or the creation of shareholder value, although they are based on our current plans or assessments which we believe to be reasonable as of the date hereof.

Factors that could cause actual results, events and developments to differ include, without limitation: the ability of our subsidiaries (including, target businesses following their acquisition) to generate sufficient net income and cash flows to make upstream cash distributions, capital market conditions, our and our subsidiaries’ ability to identify any suitable future acquisition opportunities, efficiencies/cost avoidance, cost savings, income and margins, growth, economies of scale, combined operations, future economic performance, conditions to, and the timetable for, completing the integration of financial reporting of acquired or target businesses with HC2 or the applicable subsidiary of HC2, completing future acquisitions and dispositions, litigation, potential and contingent liabilities, management’s plans, changes in regulations and taxes.

We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all forward-looking statements.

Forward-looking statements are not guarantees of performance. You should understand that the following important factors, in addition to those discussed under the section entitled “Risk Factors” in this Quarterly Report and in the documents incorporated by reference, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in the forward-looking statements. You should also understand that many factors described under one heading below may apply to more than one section in which we have grouped them for the purpose of this presentation. As a result, you should consider all of the following factors, together with all of the other information presented herein, in evaluating our business and that of our subsidiaries.

HC2 Holdings, Inc. and Subsidiaries

Actual results or other outcomes may differ from those expressed or implied by forward-looking statements contained or incorporated herein due to a variety of important factors, including, without limitation, the following:

•
limitations on our ability to successfully identify any strategic acquisitions or business opportunities and to compete for these opportunities with others who have greater resources;
•
our possible inability to generate sufficient liquidity, margins, earnings per share, cash flow and working capital from our operating segments;
•
our dependence on distributions from our subsidiaries to fund our operations and payments on our obligations;
•
the impact on our business and financial condition of our substantial indebtedness and the significant additional indebtedness and other financing obligations we may incur;
•
the impact of covenants in the Certificates of Designation governing the Preferred Stock, the 11.0% Notes Indenture, the Credit and Security Agreement governing the DBMG Facility, the CWind line of credit with Barclays (“CWind Facility”), the ANG term loans and notes with

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Signature Financial and Pioneer Savings Bank (“ANG Facilities”), and future financing agreements, on our ability to operate our business and finance our pursuit of acquisition opportunities;
•
our dependence on certain key personnel, in particular, our Chief Executive Officer, Philip Falcone;
•
the potential for, and our ability to, remediate future material weaknesses in our internal controls over financial reporting;
•
uncertain global economic conditions in the markets in which our operating segments conduct their businesses;
•
the ability of our operating segments to attract and retain customers;
•
increased competition in the markets in which our operating segments conduct their businesses;
•
our expectations regarding the timing, extent and effectiveness of our cost reduction initiatives and management’s ability to moderate or control discretionary spending;
•
management’s plans, goals, forecasts, expectations, guidance, objectives, strategies and timing for future operations, acquisitions, synergies, asset dispositions, fixed asset and goodwill impairment charges, tax and withholding expense, selling, general and administrative expenses, product plans, performance and results;
•
management’s assessment of market factors and competitive developments, including pricing actions and regulatory rulings;
•
the impact of additional material charges associated with our oversight of acquired or target businesses and the integration of our financial reporting;
•
the impact of expending significant resources in considering acquisition targets or business opportunities that are not consummated;
•
the possibility of indemnification claims arising out of divestitures of businesses;
•
tax consequences associated with our acquisition, holding and disposition of target companies and assets;
•
the effect any interests our officers, directors, stockholders and their respective affiliates may have in certain transactions in which we are involved;
•
the impact on the holders of HC2’s common stock if we issue additional shares of HC2 common stock or preferred stock;
•
the impact of decisions by HC2’s significant stockholders, whose interest may differ from those of HC2’s other stockholders, or their ceasing to remain significant stockholders;
•
our ability to effectively increase the size of our organization, if needed, and manage our growth;
•
our possible inability to raise additional capital when needed or refinance our existing debt, on attractive terms, or at all; and
•
our possible inability to hire and retain qualified executive management, sales, technical and other personnel.

Construction / DBM Global Inc.

Actual results or other outcomes of DBMG, f/k/a Schuff International, Inc. and thus, our Construction segment, may differ from those expressed or implied by forward-looking statements contained or incorporated herein due to a variety of important factors, including, without limitation, the following:

•
its ability to realize cost savings from expected performance of contracts, whether as a result of improper estimates, performance, or otherwise;
•
uncertain timing and funding of new contract awards, as well as project cancellations;
•
cost overruns on fixed-price or similar contracts or failure to receive timely or proper payments on cost-reimbursable contracts, whether as a result of improper estimates, performance, disputes, or otherwise;
•
risks associated with labor productivity, including performance of subcontractors that DBMG hires to complete projects;
•
its ability to settle or negotiate unapproved change orders and claims;
•
changes in the costs or availability of, or delivery schedule for, equipment, components, materials, labor or subcontractors;
•
adverse impacts from weather affecting DBMG’s performance and timeliness of completion of projects, which could lead to increased costs and affect the quality, costs or availability of, or delivery schedule for, equipment, components, materials, labor or subcontractors;
•
fluctuating revenue resulting from a number of factors, including the cyclical nature of the individual markets in which our customers operate;
•
adverse outcomes of pending claims or litigation or the possibility of new claims or litigation, and the potential effect of such claims or litigation on DBMG’s business, financial condition, results of operations or cash flow; and lack of necessary liquidity to provide bid, performance, advance payment and retention bonds, guarantees, or letters of credit securing DBMG’s obligations under bids and contracts or to finance expenditures prior to the receipt of payment for the performance of contracts.

Marine Services / Global Marine Systems Limited

Actual results or other outcomes of Global Marine Systems Limited (“GMSL”), and thus, our Marine Services segment, may differ from those expressed or implied by forward-looking statements contained or incorporated herein due to a variety of important factors, including, without limitation, the following:

•
the possibility of global recession or market downturn with a reduction in capital spending within the targeted market segments in which the business operates;
•
project implementation issues and possible subsequent overruns;
•
risks associated with operating outside of core competencies when moving into different market segments;
•
possible loss or severe damage to marine assets;
•
vessel equipment aging or reduced reliability;
•
risks associated with operating two joint ventures in China;
•
risks related to noncompliance with a wide variety of anti-corruption laws;

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•
changes to the local laws and regulatory environment in different geographical regions;
•
loss of key senior employees;
•
difficulties attracting enough skilled technical personnel;
•
foreign exchange rate risk;
•
liquidity risk; and
•
potential for financial loss arising from the failure by customers to fulfill their obligations as and when these obligations come due.

Telecommunications / PTGi International Carrier Services, Inc.

Actual results or other outcomes of PTGi International Carrier Services, Inc. (“ICS”), and thus, our Telecommunications segment, may differ from those expressed or implied by forward-looking statements contained or incorporated herein due to a variety of important factors, including, without limitation, the following:

•
our expectations regarding increased competition, pricing pressures and usage patterns with respect to ICS’s product offerings;
•
significant changes in ICS’s competitive environment, including as a result of industry consolidation, and the effect of competition in its markets, including pricing policies;
•
its compliance with complex laws and regulations in the U.S. and internationally;
•
further changes in the telecommunications industry, including rapid technological, regulatory and pricing changes in its principal markets; and
•
an inability of ICS’s suppliers to obtain credit insurance on ICS in determining whether or not to extend credit.

Insurance / Continental Insurance Group Ltd.

Actual results or other outcomes of Continental Insurance Group Ltd. (“CIG”), the parent operating company of CGI (and the formerly separate operating subsidiary UTA, which merged into CGI on December 31, 2016), and together comprise our Insurance segment, may differ from those expressed or implied by forward-looking statements contained or incorporated herein due to a variety of important factors, including, without limitation, the following:

•
our Insurance segment’s ability to maintain statutory capital and maintain or improve their financial strength;
•
our Insurance segment’s reserve adequacy, including the effect of changes to accounting or actuarial assumptions or methodologies;
•
the accuracy of our Insurance segment’s assumptions and estimates regarding future events and ability to respond effectively to such events, including mortality, morbidity, persistency, expenses, interest rates, tax liability, business mix, frequency of claims, severity of claims, contingent liabilities, investment performance, and other factors related to its business and anticipated results;
•
availability, affordability and adequacy of reinsurance and credit risk associated with reinsurance;
•
extensive regulation and numerous legal restrictions on our Insurance segment;
•
our Insurance segment’s ability to defend itself against litigation, inherent in the insurance business (including class action litigation) and respond to enforcement investigations or regulatory scrutiny;
•
the performance of third parties, including distributors and technology service providers, and providers of outsourced services;
•
the impact of changes in accounting and reporting standards;
•
our Insurance segment’s ability to protect its intellectual property;
•
general economic conditions and other factors, including prevailing interest and unemployment rate levels and stock and credit market performance which may affect, among other things, our Insurance segment’s ability to access capital resources and the costs associated therewith, the fair value of our Insurance segment’s investments, which could result in impairments and other-than-temporary impairments, and certain liabilities;
•
our Insurance segment’s exposure to any particular sector of the economy or type of asset through concentrations in its investment portfolio;
•
the ability to increase sufficiently, and in a timely manner, premiums on in-force long-term care insurance policies and/or reduce in-force benefits, as may be required from time to time in the future (including as a result of our Insurance segment’s failure to obtain any necessary regulatory approvals or unwillingness or inability of policyholders to pay increased premiums);
•
other regulatory changes or actions, including those relating to regulation of financial services affecting, among other things, regulation of the sale, underwriting and pricing of products, and minimum capitalization, risk-based capital and statutory reserve requirements for our Insurance segment, and our Insurance segment’s ability to mitigate such requirements;
•
our Insurance segment’s ability to effectively implement its business strategy or be successful in the operation of its business;
•
our Insurance segment’s ability to retain, attract and motivate qualified employees;
•
interruption in telecommunication, information technology and other operational systems, or a failure to maintain the security, confidentiality or privacy of sensitive data residing on such systems;
•
medical advances, such as genetic research and diagnostic imaging, and related legislation; and
•
the occurrence of natural or man-made disasters or a pandemic.

We caution the reader that undue reliance should not be placed on any forward-looking statements, which speak only as of the date of this document. Neither we nor any of our subsidiaries undertake any duty or responsibility to update any of these forward-looking statements to reflect events or circumstances after the date of this document or to reflect actual outcomes.


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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk Factors

Market risk is the risk of the loss of fair value resulting from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying financial instruments are traded. We are exposed to market risk with respect to our investments and foreign currency exchange rates. Through DBMG, we have market risk exposure from changes in interest rates charged on its borrowings and from adverse changes in steel prices. Through GMSL and ANG, we have market risk exposure from changes in interest rates charged on their respective borrowings. We do not use derivative financial instruments to mitigate a portion of the risk from such exposures.

Equity Price Risk

HC2 is exposed to market risk primarily through changes in fair value of available-for-sale fixed maturity and equity securities. HC2 follows an investment strategy approved by the HC2 Board of Directors which sets certain restrictions on the amount of securities that HC2 may acquire and its overall investment strategy.

Market prices for fixed maturity and equity securities are subject to fluctuation, as a result, and consequently the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions. Because HC2’s fixed maturity and equity securities are classified as available-for-sale, the hypothetical decline would not affect current earnings except to the extent that the decline reflects other-than-temporary impairments.

A means of assessing exposure to changes in market prices is to estimate the potential changes in market values on the fixed maturity and equity securities resulting from a hypothetical decline in equity market prices. As of March 31, 2017, assuming all other factors are constant, we estimate that a 10.0%, 20.0%, and 30.0% decline in equity market prices would have an $135.4 million, $270.9 million, and $406.3 million adverse impact on HC2’s portfolio of fixed maturity and equity securities, respectively.

Foreign Currency Exchange Rate Risk

GMSL and ICS are exposed to market risk from foreign currency price changes that could have a significant and potentially adverse impact on gains and losses as a result of translating the operating results and financial position of our international subsidiaries into USD.

We translate the local currency statements of operations of our foreign subsidiaries into USD using the average exchange rate during the reporting period. Changes in foreign exchange rates affect the reported profits and losses and cash flows of our international subsidiaries and may distort comparisons from year to year. For example, when the USD strengthens compared to the GBP, there could be a negative or positive effect on the reported results for our Telecommunications segment, depending upon whether such businesses are operating profitably or at a loss. More profits in GBP are required to generate the same amount of profits in USD and, similarly, a greater loss in GBP is required to generate the same amount of loss in USD, and vice versa. For instance, when the USD weakens against the GBP, there is a positive effect on reported profits and a negative effect on reported losses.

Interest Rate Risk

GMSL, DBMG, and ANG are exposed to the market risk from changes in interest rates through their borrowings, which bear variable rates based on LIBOR. Changes in LIBOR could result in an increase or decrease in interest expense recorded. A 100, 200, and 300 basis point increase in LIBOR based on our floating rate borrowings outstanding as of March 31, 2017 of $25.7 million, would result in an increase in the recorded interest expense of $0.3 million, $0.5 million, and $0.8 million per year.

Commodity Price Risk

DBMG is exposed to the market risk from changes in the price of steel. For large orders the risk is mitigated by locking the general contractors into the price at the mill at the time work is awarded. In the event of a subsequent price increase by the mill, DBMG has the ability to pass the higher costs on to the general contractor. DBMG does not hedge or enter into any forward purchasing arrangements with the mills. The price negotiated at the time of the order is the price paid by DBMG.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2017, our disclosure controls and procedures were effective. Disclosure controls and procedures mean our controls and other procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time

53


periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control.

There have been no changes in our internal control over financial reporting that occurred during the fiscal quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II
Item 1. Legal Proceedings

The Company is subject to claims and legal proceedings that arise in the ordinary course of business. Such matters are inherently uncertain, and there can be no guarantee that the outcome of any such matter will be decided favorably to the Company or that the resolution of any such matter will not have a material adverse effect upon the Company’s Condensed Consolidated Financial Statements. The Company does not believe that any of such pending claims and legal proceedings will have a material adverse effect on its Condensed Consolidated Financial Statements. The Company records a liability in its Condensed Consolidated Financial Statements for these matters when a loss is known or considered probable and the amount can be reasonably estimated. The Company reviews these estimates each accounting period as additional information is known and adjusts the loss provision when appropriate. If a matter is both probable to result in a liability and the amounts of loss can be reasonably estimated, the Company estimates and discloses the possible loss or range of loss to the extent necessary for the Condensed Consolidated Financial Statements not to be misleading. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in its Condensed Consolidated Financial Statements. See Note 14. Commitments and Contingencies to our unaudited financial statements included elsewhere in this Quarterly Report on Form 10-Q.     

Item 1A. Risk Factors

Utilities

The adoption, modification or repeal in environmental, tax, government regulations, and other programs and incentives that encourage the use of clean fuel and alternative vehicles, may impact our business.

Programs and regulations that have the effect of encouraging the use of CNG as a vehicle fuel are subject to change, and could expire or be repealed or amended as a result of changes in federal, state or local political, social or economic conditions. For example, the results of the recent U.S. presidential election have created increased uncertainty regarding the future of these programs and regulations. In particular, the Volumetric Excise Tax Credit (the “VETC”), which expired on December 31, 2016 and may not be available in any subsequent period, provided a tax credit worth $0.50 per gasoline gallon equivalent of compressed natural gas, or diesel gallon equivalent of liquefied natural gas, which our subsidiary ANG claimed for a portion of its fuel sales each year.  The VETC tax credit had been used as an incentive for fleet operators to adopt natural gas vehicles, as it helped offset the incremental cost of a natural gas vehicle versus a similar gas- or diesel-powered version. The termination, modification or repeal of federal, state and local government tax credits, rebates, grants and similar programs and incentives that promote the use of CNG as a vehicle fuel and various government programs that make available grant funds for the purchase and construction of natural gas vehicles and stations may have an adverse impact on our business.

Demand for natural gas vehicles may decline with advances in other alternative technologies and fuels, or with improvements in gasoline, diesel or hybrid engines.
 
The market for CNG vehicles may diminish with technological advances in gasoline, diesel or other alternative fuels that may be considered more cost-effective or otherwise more advantageous than CNG. Operators may perceive an inability to timely recover the additional costs of natural gas vehicles if CNG fuel is not offered at a lower price than gasoline and diesel. In addition, the adoption of CNG as a fuel for vehicle may be slowed or limited if the low prices and over-supply of gasoline and diesel continue or deteriorate further or if natural gas prices increases without corresponding increases in prices of gasoline and diesel. Advances or improvements in fuel efficiency also may offer more economical choice and deter consumers to convert their vehicles to natural gas. Growth in the use of electric commercial vehicles likewise may reduce demand for natural gas vehicles and renewable diesel, hydrogen and other alternative fuels may prove to be more economical alternatives to gasoline and diesel than natural gas, which could have an adverse impact on our business.

If there are advances in other alternative vehicle fuels or technologies, or if there are improvements in gasoline, diesel or hybrid engines, demand for natural gas vehicles may decline.
 
Technological advances in the production, delivery and use of gasoline, diesel or other alternative fuels that are, or are perceived to be, cleaner, more cost-effective, more readily available or otherwise more attractive than CNG, may slow or limit adoption of natural gas vehicles. For example, advances in gasoline and diesel engine technology, including efficiency improvements and further development of hybrid engines, may offer a cleaner, more cost-effective option and make fleet customers less likely to convert their vehicles to natural gas. Additionally, technological advances related to ethanol or biodiesel, which are used as an additive to, or substitute for gasoline and diesel fuel, may slow the need to diversify fuels and affect the growth of the natural gas vehicle fuel market.
 
Further, use of electric commercial vehicles, or the perception that such vehicles may soon be widely available and provide satisfactory performance at an acceptable cost, may reduce demand for natural gas vehicles. In addition, renewable diesel, hydrogen and other alternative fuels may prove to be cleaner, more cost-effective alternatives to gasoline and diesel than natural gas. Advances in technology that reduce demand for natural gas as a vehicle fuel or the failure of natural gas vehicle technology to advance at an equal pace could slow or curtail the growth of natural gas vehicle purchases or conversions, which would have an adverse effect on our business.
 

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Increases, decreases and general volatility in oil, gasoline, diesel and natural gas prices could adversely affect our business.
 
In recent years, the prices of oil, gasoline, diesel and natural gas have been volatile, and this volatility may continue. Additionally, prices for crude oil in recent years have been low, due in part to over-production and increased supply without a corresponding increase in demand. Market adoption of CNG (which can be delivered in the form of CNG) as vehicle fuels could be slowed or limited if the low prices and over-supply of gasoline and diesel, today’s most prevalent and conventional vehicle fuels, continue or worsen, or if the price of natural gas increases without equal and corresponding increases in prices of gasoline and diesel. Any of these circumstances could decrease the market's perception of a need for alternative vehicle fuels generally and could cause the success or perceived success of our industry and our business to materially suffer. In addition, low gasoline and diesel prices contribute to the differential between the cost of natural gas vehicles and gasoline or diesel-powered vehicles. Generally, natural gas vehicles cost more initially than gasoline or diesel powered vehicles, as the components needed for a vehicle to use natural gas add to the vehicle’s base cost. Operators seek to recover the additional costs of acquiring or converting to natural gas vehicles over time through the lower costs of fueling natural gas vehicles; however, operators may perceive an inability to timely recover these additional costs if we do not offer CNG fuel at prices lower than gasoline and diesel. Our ability to offer our customers an attractive pricing advantage for CNG and maintain an acceptable margin on our sales becomes more difficult if prices of gasoline and diesel decrease or if prices of natural gas increase. These pricing conditions exacerbate the cost differential between natural gas vehicles and gasoline or diesel powered vehicles, which may lead operators to delay or refrain from purchasing or converting to natural gas vehicles at all. Any of these outcomes would decrease our potential customer base and harm our business prospects. Further, fluctuations in natural gas prices affect the cost to us of the natural gas commodity. High natural gas prices adversely impact our operating margins in cases where we cannot pass the increased costs through to our customers. Conversely, lower natural gas prices reduce our revenue in cases where the commodity cost is passed through to our customers. As a result, these fluctuations in natural gas prices can have a significant and adverse impact on our operating results.
 
Factors that can cause fluctuations in gasoline, diesel and natural gas prices include, among others, changes in supply and availability of crude oil and natural gas, government regulations and political conditions, inventory levels, consumer demand, price and availability of other alternative fuels, weather conditions, negative publicity surrounding drilling, production or importing techniques and methods for oil or natural gas, economic conditions and the price of foreign imports.
 
With respect to natural gas supply and use as a vehicle fuel, there have been recent efforts to place new regulatory requirements on the production of natural gas by hydraulic fracturing of shale gas reservoirs and other means and on transporting, dispensing and using natural gas. Hydraulic fracturing and horizontal drilling techniques have resulted in a substantial increase in the proven natural gas reserves in the United States. Any changes in regulations that make it more expensive or unprofitable to produce natural gas through these techniques or others, as well as any changes to the regulations relating to transporting, dispensing or using natural gas, could lead to increased natural gas prices.
 
If pricing conditions worsen, or if all or some combination of factors causing further volatility in natural gas, oil and diesel prices were to occur, our business and our industry would be materially harmed.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None

Item 6. Exhibits and Financial Statement Schedule

(a) Exhibits (see Exhibit Index following signature page below)


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
HC2 Holdings, Inc.
 
 
 
Date: May 10, 2017
By:
/s/ Michael J. Sena
 
 
Michael J. Sena
 
 
Chief Financial Officer
 
 
(Principal Financial and Accounting Officer)


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Please note that the agreements included as exhibits to this Form 10-Q are included to provide information regarding their terms and are not intended to provide any other factual or disclosure information about HC2 Holdings, Inc. or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement that have been made solely for the benefit of the other parties to the applicable agreement and may not describe the actual state of affairs as of the date they were made or at any other time.
Exhibit
Number
 
Description
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (filed herewith).
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
 
 
 
32*
 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 
 
 
101
 
The following materials from the registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2017 and 2016, formatted in extensible business reporting language (XBRL); (i) Condensed Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016, (ii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2017 and 2016 (iii) Condensed Consolidated Balance Sheets at March 31, 2017 and 2016, (iv) Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2017 and 2016, (v) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016, and (vi) Notes to Condensed Consolidated Financial Statements (filed herewith).
*
These certifications are being “furnished” and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically incorporates it by reference.


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