HC2 Holdings, Inc. (now INNOVATE Corp.) — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. The filing was submitted under HC2 Holdings, Inc.; the company name in the request reflects its later name. HC2 is a diversified holding company with Construction, Energy, Telecommunications, Insurance, Life Sciences, Broadcasting and Other operations.
Financial results and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net revenue | $377.0 million | $479.2 million | $821.8 million | $928.2 million |
| Operating income (loss) | $4.9 million | $33.6 million | $(21.9) million | $59.2 million |
| Continuing-operations income (loss) | $28.5 million | $16.9 million | $(12.5) million | $17.2 million |
| Net income (loss) | $28.5 million | $9.2 million | $(72.5) million | $2.9 million |
| Income (loss) attributable to common and participating preferred holders | $12.7 million | $9.0 million | $(70.8) million | $7.4 million |
| Continuing-operations EPS, basic | $0.26 | $0.34 | $(0.56) | $0.42 |
- Q2 net revenue declined $102.2 million year over year, principally from lower Telecommunications and Construction revenue. Six-month net revenue also fell, with Insurance investment losses contributing to the decline.
- Six-month operating performance deteriorated sharply: Insurance operating income fell to $1.6 million from $65.3 million, and Construction operating income fell to $7.1 million from $21.9 million. Energy improved to $3.9 million from a loss of $0.7 million; Telecommunications remained marginally profitable.
- Q2 net income included $64.0 million of other income, primarily a $71.1 million gain on the first tranche of the HMN sale, partly offset by other items and tax. The gain is not indicative of recurring operating earnings.
- Six-month discontinued-operations loss was $60.0 million, including a $39.3 million loss on the GMSL disposal. Six-month investment gains and losses included a net loss of $19.6 million, versus a $4.0 million gain a year earlier.
- Other comprehensive income was $286.9 million in Q2, mainly reflecting unrealized gains on available-for-sale securities; this contributed to comprehensive income of $315.4 million despite operating income of only $4.9 million.
Cash flow, debt and liquidity
- For the first six months, continuing operating cash flow was $48.6 million, versus $33.6 million in 2019. Continuing investing activities provided $145.9 million, largely reflecting GMSL and HMN sale proceeds; continuing financing activities used $220.2 million, including debt repayments and payments to noncontrolling holders. Cash, cash equivalents and restricted cash ended at $205.3 million, down $25.1 million from the start of the year.
- At June 30, consolidated debt principal was $654.6 million ($633.8 million carrying amount after discounts and financing costs), compared with $805.0 million principal at year-end 2019. HC2 repaid $15.0 million on its revolving facility and redeemed $127.5 million of senior secured notes during the first half, funded by asset-sale proceeds; it also drew $15.0 million on a replacement revolver.
- HC2 reported only $0.9 million of stand-alone cash, against $412.4 million of stand-alone debt. Most consolidated cash is held by subsidiaries and may be restricted from distribution. The company depends on subsidiary distributions, financing or refinancing, and further asset sales to meet holding-company obligations.
- Contractual debt payments, including interest, were scheduled at $140.4 million for the remainder of 2020 and $418.6 million in 2021. The company said it was in compliance with debt covenants at June 30, 2020, but noted future compliance could depend on cash management, asset monetizations, financing or other transactions.
Material changes and management commentary
- GMSL was sold on February 28, 2020. The sale generated approximately $144.0 million in net proceeds at the subsidiary level; approximately $98.6 million went to HC2. A first tranche sale of 30% of HMN closed in May, producing $85.5 million cash proceeds and the $71.1 million gain. The remaining 19% interest is subject to a put option exercisable beginning on the second anniversary of the first closing.
- COVID-19 disrupted Construction project execution and increased safety-related costs: $8.4 million in Q2 and $8.8 million in the first half. Broadcasting advertising weakened. Management said the pandemic’s future effects could materially harm revenue growth, profitability, cash flows and liquidity, but could not reliably estimate the impact.
- Insurance’s Q2 results reflected market volatility and a $17.9 million net unrealized investment loss in earnings, primarily from preferred-stock marks; fixed-maturity valuation movements also drove substantial OCI volatility. Management described those fixed-maturity unrealized losses as temporary and said it could hold the securities, subject to issuer credit conditions.
- Management believed liquidity would be sufficient for at least 12 months, relying on subsidiary distributions and potential debt/equity financing, refinancing and asset sales. It cautioned that these sources are not assured, subsidiary distributions are restricted, and holding-company cash is limited.
- No quantified company-wide revenue or earnings guidance was provided. DBMG reported $410.3 million of backlog at June 30, including $96.6 million concentrated in five contracts or commitments; cancellations or scope reductions could materially reduce backlog.
- Subsequent events: on August 6, Energy entered a new M&T credit facility and used proceeds and cash to refinance existing facilities and redeem $14.0 million of 14% preferred stock. On August 10, HC2 and its lender agreed to extend the $15.0 million revolving facility’s maturity to September 1, 2021.
Risks, contingencies and unusual items
- Near-term refinancing and liquidity risk is significant given limited parent-level cash, substantial debt, scheduled 2020–2021 payments and dependence on subsidiary cash transfers and capital markets.
- COVID-19 risks include project delays or cancellations, workforce and supply-chain disruptions, weaker advertising, possible customer payment-term changes, and potential impairment or financing pressures. The company also cited remote-work cybersecurity and operational risks.
- Insurance results depend on long-term-care claims and reserve assumptions, investment performance, interest rates, reinsurer collectability and regulatory capital. Long-term care reserves totaled $4.61 billion; recoverables from reinsurers totaled $958.4 million.
- A proposed settlement framework in the DBMG stockholder litigation contemplated approximately $20.4 million for former tendering shareholders, with insurers expected to contribute $12.34 million and DBMG the balance, plus approximately $1.0 million of HC2-funded payments to current public DBMG holders. Court approval remained uncertain.
- A separate stockholder litigation fee application sought $2.5 million in attorneys’ fees; oral argument was scheduled for August 11, 2020. HC2 also disclosed an ongoing UK VAT assessment dispute involving its telecommunications subsidiary, which it said it did not consider probable, and an ongoing Canadian tax audit with no proposed adjustments at the time.
- Management identified potential future impairment risk at Broadcasting if COVID-related market conditions worsen. No impairment was recorded following its Q1 quantitative test and Q2 qualitative review.
Investor facts to verify
- Whether HC2 can refinance or repay the large 2021 debt maturities and maintain covenant compliance, given only $0.9 million of stand-alone cash.
- How much of reported Q2 earnings came from the one-time HMN disposal gain, and the eventual proceeds and accounting outcome for the remaining HMN stake and put option.
- Whether Construction backlog converts to revenue as expected and whether COVID-related project costs, delays or cancellations persist.
- Developments in Insurance claims and reserve experience, investment portfolio valuations, and the company’s ability to upstream cash from regulated insurance subsidiaries.
- Outcomes and cash exposure from the DBMG settlement, the stockholder fee application, tax matters and other litigation.