INNOVATE Corp. quarterly report, Q1 FY2017

Business context and reporting period

This is HC2 Holdings, Inc.’s Form 10-Q for the quarter ended March 31, 2017. The filing identifies the registrant as HC2 Holdings, Inc. (ticker HCHC), not INNOVATE Corp.; investors should confirm the issuer and filing match the requested company. HC2 was a diversified holding company with operations in construction, marine services, energy, telecommunications, insurance, life sciences and other businesses.

Financial results and liquidity

Unless otherwise noted, amounts are U.S. dollars. Income-statement and cash-flow figures are for the three months ended March 31; balance-sheet comparisons are to December 31, 2016.

  • Revenue: Net revenue rose 17.7% to $390.6 million from $331.7 million. Telecommunications revenue increased to $191.7 million from $149.8 million; Construction revenue declined to $112.7 million from $119.1 million.
  • Profit and margins: Operating income was $1.0 million, versus an operating loss of $19.3 million. Net loss was $15.9 million, compared with $31.3 million; loss attributable to common stock and participating preferred stockholders was $15.1 million, or $0.36 per diluted share, versus $31.5 million, or $0.89 per share. Operating margin was approximately 0.2%, compared with approximately negative 5.8%.
  • Adjusted EBITDA: Management’s non-GAAP measure, which excludes the Insurance segment, was $16.7 million versus approximately $0.3 million. The improvement was led by Marine Services and growth in Telecommunications and Energy.
  • Cash flow: Operating activities provided $32.8 million, investing activities used $28.8 million and financing activities provided $6.5 million. Cash increased $11.6 million to $127.0 million. Operating cash flow improvement was attributed principally to better subsidiary collections.
  • Debt and liquidity: Consolidated debt principal was $454.3 million, up from $438.4 million; long-term obligations on the balance sheet, net of discounts and financing costs, were $445.6 million. HC2 issued $55 million of 11.0% senior secured notes, using part of the proceeds to repay $35 million of bridge notes. Consolidated cash was $127.0 million; standalone HC2 cash was $27.0 million. The company reported compliance with its note indenture’s liquidity and collateral coverage covenants.
  • Balance sheet and insurance: Total assets were $2.856 billion and total liabilities were $2.757 billion. Life, accident and health reserves were $1.665 billion; recoverables from reinsurers were $524.8 million, with 63.7% due from Hannover Life Reassurance. Shareholders’ equity was $66.5 million.

Material changes versus the prior comparable period

  • Revenue increased mainly from wholesale telecommunications traffic, Marine Services activity and higher Insurance investment income; Construction was affected by project design-change delays.
  • Operating results improved substantially, including a Marine Services turnaround and lower prior-year project losses. Insurance benefited from lower policy-benefit and reserve expense and a swing in realized investment results from a loss to a gain.
  • Interest expense increased $3.8 million to $14.1 million, reflecting increased note principal and costs associated with refinancing. Other expense included a $3.3 million impairment of a fixed-maturity security.
  • Income from equity investees swung to $7.7 million from a $3.6 million loss, principally due to stronger Marine Services joint-venture results, including HMN.
  • Segment performance was mixed: Construction operating income fell to $5.7 million; Telecommunications operating income rose to $1.6 million; Life Sciences operating loss widened to $3.1 million.

Outlook, management commentary, risks and unusual items

  • Management said it believed available funding sources would meet liquidity requirements and fixed obligations for at least the next 12 months, relying on subsidiary distributions, financing, refinancing and/or asset sales. It cautioned that financing may not be available on acceptable terms and subsidiary distributions face contractual, regulatory and other restrictions. No specific consolidated earnings guidance was provided.
  • DBMG backlog was $497.6 million, down from $503.5 million at year-end; five contracts or commitments represented 59.3% of backlog. Management noted that cancellation or scope reductions could materially reduce backlog. The filing also identifies seasonal softness in Marine Services installation and first-quarter telecommunications activity.
  • GMSL is in a contract dispute with ASN. ASN alleged $30 million in damages and $1.2 million in liquidated damages, plus interest and costs. GMSL disputed the allegations; $4.5 million of issued invoices remained unpaid and at risk at quarter-end. The filing does not provide a clear estimate of the company’s ultimate exposure.
  • ICS disputed a U.K. VAT assessment; management did not consider the assessment probable and expected to prevail. The amount is not stated in the provided filing text.
  • Other risks include significant leverage and 11.0% notes, insurance reserve adequacy and investment-credit risk, foreign exchange exposure, and CNG demand uncertainty following expiration of a fuel tax credit. A Delaware class-action settlement framework was under discussion; no final settlement or court approval was assured.
  • Subsequent events included conversion of a Gaming Nation debenture into a 22.9% equity interest, a May preferred-stock conversion into common shares, and a DBMG dividend expected to provide HC2 $4.6 million. The company early adopted a goodwill impairment accounting update with no reported impact and expected to adopt the new revenue standard in 2018; its impact was still under evaluation.

Most important facts for investors to verify

  • Confirm that this HC2 Holdings filing is the intended issuer and reporting period for the INNOVATE Corp. request.
  • Review debt maturities, the 11.0% coupon, covenant headroom and cash available at the parent company versus regulated or subsidiary-level cash.
  • Track resolution and potential financial effects of the ASN dispute, including collection of the $4.5 million unpaid invoices, and the disputed VAT assessment.
  • Assess whether DBMG can convert concentrated backlog into revenue and cash, given project delays and contract concentration.
  • Evaluate Insurance reserve assumptions, reinsurance counterparty exposure, investment impairments and the effect of long-term-care rate increases.
  • Distinguish recurring operating cash generation from investment gains, asset-sale gains and equity-method income; review the company’s non-GAAP Adjusted EBITDA exclusions.