INNOVATE Corp. annual report, FY2018

Abrir documento

Business context and reporting period

The supplied filing is HC2 Holdings, Inc.’s Form 10-K for the fiscal year ended December 31, 2018, filed March 12, 2019—not an INNOVATE Corp. filing or a quarterly report. The filing covers HC2, a diversified holding company with eight operating segments: Construction, Marine Services, Energy, Telecommunications, Insurance, Life Sciences, Broadcasting and Other.

HC2 reported approximately 4,119 employees. Its strategy is to acquire and grow businesses intended to generate sustainable free cash flow and attractive returns.

Financial performance and liquidity

  • Revenue: Net revenue was $1,976.7 million, up $342.6 million (21%) from 2017. This total includes insurance premiums and investment income; revenue from contracts with customers was $1,774.1 million.
  • Profit: Operating loss was $55.8 million, compared with a $1.1 million loss in 2017. Net income was $179.9 million, and income attributable to common and participating preferred stockholders was $155.6 million, versus a $49.7 million loss in 2017. Basic and diluted earnings per share were $3.14 and $2.90, respectively.
  • Nonrecurring and investment-related items: Results included a $115.4 million bargain purchase gain on the KIC insurance acquisition, a $105.1 million gain on the sale and deconsolidation of businesses (principally the $102.1 million BeneVir sale gain), and $47.0 million of gains from reinsurance recaptures. These items materially contributed to reported net income.
  • Cash flow: Cash from operating activities was $341.4 million, up from $6.6 million in 2017. Management attributed much of the increase to a $314.6 million working-capital change, largely associated with insurance reinsurance recaptures. Investing activities used $224.6 million; financing activities provided $115.2 million. Capital expenditures were $39.7 million.
  • Cash and liquidity: Year-end cash and cash equivalents were $325.0 million ($330.4 million including restricted cash), compared with $97.9 million at year-end 2017. HC2 parent-only cash was just $6.5 million; $283.3 million was held in the Insurance segment. Subsidiary distributions to the parent are subject to financing, regulatory and other restrictions.
  • Debt: Consolidated debt obligations were $781.0 million before unamortized discounts and financing costs; the balance-sheet carrying amount was $743.9 million. HC2 parent debt included $470.0 million of 11.5% secured notes due 2021 and $55.0 million of 7.5% convertible notes due 2022. Interest expense increased to $75.7 million from $55.1 million.
  • Balance sheet and insurance exposure: Total assets were $6,503.8 million, liabilities $6,281.8 million, and total stockholders’ equity $193.7 million. Insurance reserves were $4,562.1 million. The filing reports substantial investment and reinsurance balances; the ability to realize or collect them is subject to market, credit and claims risks.
  • Comprehensive income: Despite net income of $179.9 million, comprehensive income was $19.1 million, reflecting $158.2 million of unrealized losses on available-for-sale securities and other comprehensive items.

Material changes versus 2017

  • Revenue rose 21%, with growth in Construction, Telecommunications, Insurance and Broadcasting. Broadcasting’s results reflected acquisitions and a fuller year of operations.
  • Operating loss widened to $55.8 million. Marine Services recorded a $15.4 million operating loss, partly due to underutilized vessels and project timing; Broadcasting recorded a $24.0 million operating loss as its acquired station and network operations expanded.
  • Insurance operating income declined to $1.8 million from $25.4 million. Higher policy benefits and reserves, including increased claims and lifetime-benefit claims in the acquired KIC block, outweighed higher investment income.
  • Adjusted EBITDA, a company-defined non-GAAP measure that excludes the Insurance segment, was $44.5 million versus $50.8 million. Construction improved, while Marine Services and Broadcasting weakened.
  • Major transactions included the August acquisition of KIC for nominal consideration, the November acquisition of GrayWolf for $139.8 million, and the June sale of BeneVir. HC2 also refinanced its parent-level notes in November and DBMG borrowed $80 million under a TCW term loan for the GrayWolf transaction.
  • DBMG backlog fell to $528.5 million from $723.4 million; GMSL backlog increased to $483.4 million from $445.3 million. Backlog is not guaranteed revenue and may be delayed, reduced or canceled.

Outlook, risks and unusual items

HC2 provided no quantitative consolidated earnings guidance. Management said it expected to meet liquidity needs for at least the next 12 months through subsidiary distributions, additional financing or refinancing, and/or asset sales, while noting there is no assurance these options will be available on acceptable terms.

  • Parent liquidity and leverage: HC2 depends on cash distributions from subsidiaries to service parent obligations; subsidiary debt agreements and insurance regulation may limit distributions. The 11.5% secured notes are secured by substantially all of HC2’s and certain guarantors’ assets. The indenture includes liquidity and collateral coverage tests, and a fixed-charge coverage test begins with fiscal 2019.
  • Insurance reserves and capital: Long-term-care claims, morbidity, persistency, investment returns and regulatory approval of premium increases could require additional reserves or capital. CGI agreed to maintain specified risk-based capital levels following the KIC transaction, potentially requiring HC2 contributions.
  • Marine Services: HC2 said it was exploring strategic alternatives for GMSL, including a potential sale. The segment also faces aging-vessel, utilization, pension-funding and project risks. Its reported UK pension deficit was $18.6 million.
  • Contingencies: In a dispute with Alcatel-Lucent Submarine Networks, GMSL faced claimed damages of $38.2 million plus $1.2 million of liquidated damages, interest and costs; $8.9 million of its invoices remained at risk at year-end. The filing says GMSL disputes the claims. A proposed $1.25 million settlement of CGI producer litigation, payable by former owner GAFRI on behalf of defendants, was subject to court approval after year-end. ICS disputed UK VAT assessments; the filing text does not provide a clear assessed amount.
  • Other risks: The filing highlights acquisition integration, competition, project cost overruns, interest and foreign-exchange movements, regulatory change, cybersecurity, and uncertain alternative-fuel incentives. ANG’s 2018 revenue included $2.6 million of credits for 2017 fuel sales; future AFETC allocations were uncertain.
  • Controls and audit: Management and the auditor reported effective internal control over financial reporting at December 31, 2018. The independent auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

  1. Confirm the issuer and period: the supplied document is HC2 Holdings’ FY2018 Form 10-K, despite the request metadata naming INNOVATE Corp. and “2018 Q4.”
  2. Assess how much of 2018 earnings and operating cash flow came from bargain-purchase, divestiture and reinsurance-recature items, rather than recurring operations.
  3. Review parent-only liquidity, subsidiary distribution restrictions, debt maturities, interest burden and compliance with indenture covenants.
  4. Evaluate the adequacy of long-term-care reserves, CGI’s statutory capital position, and the assumptions underlying potential premium increases.
  5. Track resolution of the GMSL contract dispute, CGI litigation settlement approval and the disputed VAT assessment.
  6. Test whether DBMG and GMSL backlog converts to profitable cash flow, and whether GrayWolf and Broadcasting acquisitions deliver expected results.