HC2 Holdings, Inc. Form 10-Q — quarter ended September 30, 2018
Entity identification: The supplied filing is for HC2 Holdings, Inc. (ticker HCHC), not INNOVATE Corp. Confirm that this is the intended filing before relying on this summary.
Business context and reporting period
HC2 is a diversified holding company with businesses in construction, marine services, energy, telecommunications, insurance, life sciences, broadcasting and other activities. Results cover the three and nine months ended September 30, 2018, compared with the same 2017 periods. Broadcasting became a separately reported segment in 2018; acquisitions, dispositions and deconsolidations also affect comparability.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Consolidated net revenue | $501.4 million | $406.4 million | $1,451.8 million | $1,175.6 million |
| Income (loss) from operations | $(24.4) million | $10.6 million | $(43.6) million | $0.3 million |
| Net income (loss) | $151.5 million | $(8.3) million | $192.5 million | $(44.7) million |
| Net income (loss) attributable to HC2 | $153.5 million | $(6.0) million | $173.8 million | $(38.4) million |
| Adjusted EBITDA | $13.7 million | $9.8 million | $29.4 million | $31.1 million |
Net revenue increased about 23% in both comparison periods. Operating margin, calculated as operating income or loss divided by net revenue, was approximately negative 4.9% in Q3 2018 versus positive 2.6% in Q3 2017, and negative 3.0% for the first nine months of 2018 versus approximately zero in 2017. Reported net income is not a clean measure of ongoing profitability because it includes substantial transaction and investment-related gains. Adjusted EBITDA is a non-GAAP measure that excludes the Insurance segment.
- Cash flow, nine months: Operating activities provided $136.7 million, versus $37.3 million in 2017; investing activities provided $525.4 million, versus $67.0 million used; financing activities provided $75.7 million, versus $45.4 million. Cash and cash equivalents rose to $831.6 million from $97.9 million at year-end 2017. Including restricted cash, period-end cash was $836.2 million.
- Balance sheet at September 30: Total assets were $6.73 billion, total liabilities $6.40 billion, and total stockholders’ equity $292.5 million. Investments were $3.38 billion, while life, accident and health reserves were $4.71 billion.
- Debt and liquidity: Consolidated debt obligations were $706.6 million gross ($702.2 million net of issuance discounts and financing costs), up from $601.1 million gross at December 31, 2017. HC2 standalone debt was $510 million of 11.0% senior secured notes due 2019. Management said the company was compliant with debt covenants and believed it could meet liquidity needs for at least 12 months, relying in part on subsidiary distributions and potential financing or asset sales. Much of the cash increase was associated with the Insurance segment; it should not be assumed that all cash is freely available to the parent.
Material changes versus prior periods
- Q3 net revenue growth reflected construction project activity, higher telecommunications traffic, KIC acquisition-related insurance premiums and investment income, and broadcasting operations acquired mainly in late 2017.
- Operating results weakened despite revenue growth. Management cited higher insurance policy benefits and reserves, marine project cost overruns and underutilized vessel costs, and broadcasting operating expenses.
- Interest expense rose to $17.5 million in Q3 from $13.2 million, and to $54.0 million for nine months from $39.4 million, reflecting higher debt and the Broadcasting bridge loan earlier in 2018.
- Cash, assets, investments and insurance reserves increased substantially following the August acquisition of KMG America/Kanawha Insurance Company (KIC). Broadcasting acquisitions and the sale of BeneVir also changed the business mix.
Outlook, commentary, risks and unusual items
- Unusual gains: The filing reports a $109.1 million bargain-purchase gain from the KIC acquisition, a $102.1 million gain on the BeneVir sale during the first half of 2018, a $44.2 million gain when HC2’s Inseego investment moved from equity-method accounting to fair value, and a $17.7 million gain from recapturing a KIC reinsurance treaty. The KIC bargain gain is accounting income, not acquisition cash proceeds. These items materially affect reported earnings.
- Insurance performance and risk: Insurance pretax Adjusted Operating Income was a loss of $11.3 million in Q3 and $8.7 million for nine months, compared with income of $17.0 million and $20.6 million, respectively, in 2017. Management cited increased long-term-care claims, more claims with lifetime benefits, and unfavorable prior-year reserve development of $6.1 million. Reserve adequacy, policyholder behavior, investment performance and reinsurance recoverability remain important uncertainties.
- Debt and planned transactions: On October 22, 2018, HC2 announced a private offering of $535 million of senior secured notes due 2023; the supplied filing describes commencement of the offering, not its completion. DBMG agreed to acquire GrayWolf Industrial for $135 million, subject to customary conditions, and ICS agreed to acquire Go2Tel, also subject to conditions. HC2 also announced it would explore strategic alternatives for GMSL, including a potential sale.
- Contingencies: In a dispute with Alcatel-Lucent Submarine Networks, the counterparty asserted $38.2 million in damages plus $1.2 million in liquidated damages, interest and costs. GMSL disputed the allegations; $8.9 million of its invoices remained unpaid and at risk. A CGI producer class action had a tentative settlement subject to a formal agreement and court approval. The filing also describes other litigation and a disputed UK VAT assessment.
- Other risks and outlook: Management provided no clear quantitative earnings guidance in the supplied filing text. It highlights acquisition and integration execution, subsidiary cash distribution limits, substantial debt and refinancing needs, insurance reserves, project costs and cancellations, foreign exchange, interest rates, steel prices, regulation and litigation. Construction and marine activity can be seasonal and project-driven. Management said lease-accounting adoption was expected to materially increase balance-sheet assets and liabilities, though the impact was not quantified.
Most important facts for investors to verify
- Confirm that HC2 Holdings’ 2018 Q3 filing, rather than an INNOVATE Corp. filing, is the intended source.
- Separate recurring operating performance from the KIC bargain gain, BeneVir disposal gain, Inseego fair-value gain and reinsurance recapture gain; review the non-GAAP reconciliations and Insurance results.
- Assess the quality and availability of cash, particularly cash held in the regulated Insurance subsidiary, and verify the outcome and terms of the announced $535 million notes offering and 2019 refinancing needs.
- Track long-term-care reserve assumptions, claim trends, statutory capital requirements, and reinsurance counterparties and recoverables.
- Monitor the GMSL dispute and unpaid invoices, CGI litigation settlement approval, and the status, financing and integration of announced acquisitions and the proposed GMSL strategic review.