INNOVATE Corp. quarterly report, Q2 FY2014

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HC2 Holdings, Inc. (now identified in the request as INNOVATE Corp.) — Q2 2014 Form 10-Q

Filing identity and period: The supplied filing is for HC2 Holdings, Inc., formerly PTGi Holding, Inc.; it reports the quarter and six months ended June 30, 2014. HC2 changed its name and ticker to HCHC in April 2014. Unless otherwise noted, amounts below are in millions of U.S. dollars. Schuff’s results are consolidated only from its May 29 acquisition, so comparisons are affected by the changed business mix.

Business context and key financial metrics

  • Business: HC2 reported Telecommunications (ICS), Life Sciences (Genovel), and Manufacturing (Schuff) segments. It acquired a 70% interest in steel fabricator Schuff for approximately $85 million, funded with debt and equity. The remainder of North America Telecom was sold on July 31, 2014, after quarter-end regulatory approval.
  • Q2 revenue: $96.6 million, up 64.8% from $58.6 million. Schuff contributed $54.5 million; Telecommunications revenue fell 28.2% to $42.1 million.
  • Q2 profitability: Cost of revenue was $82.9 million, or 85.8% of revenue, implying gross margin of approximately 14.2%. Operating loss was $1.1 million; loss from continuing operations attributable to HC2 was $3.8 million. Net loss attributable to HC2 was $3.6 million, or $0.22 per share.
  • First six months: Revenue was $139.9 million, up 19.2%. Cost of revenue was $124.0 million (88.6% of revenue); operating loss was $5.2 million and loss from continuing operations attributable to HC2 was $8.0 million. Net loss attributable to HC2 was $8.5 million, or $0.55 per share.
  • Cash flow, six months: Operating activities provided $9.1 million, investing activities used $90.8 million, and financing activities provided $113.7 million. Cash increased $31.8 million to $40.8 million.
  • Balance sheet and liquidity: At June 30, cash was $40.8 million, current assets $269.4 million, and current liabilities $192.1 million. Debt totaled $86.0 million ($36.8 million current; $49.2 million long-term). Preferred stock was recorded as temporary equity at $29.1 million.
  • Operating scale: Schuff reported $386.9 million of backlog, including $366.9 million under contracts or purchase orders. Five commitments represented $208.2 million, or 53.8%, of backlog.

Material changes versus the prior comparable period

  • Revenue growth primarily reflects the Schuff acquisition; Telecommunications revenue declined amid lower domestic and international call terminations.
  • HC2’s Q2 2014 net loss contrasts with Q2 2013 net income of $137.4 million. The 2013 period included a $135.0 million gain on the sale of discontinued operations and a $14.8 million gain from contingent value rights valuation; these were not recurring operating results.
  • Debt, property and equipment, receivables, inventory, and goodwill increased substantially following the Schuff acquisition and new financing. Debt was zero at December 31, 2013 and $86.0 million at June 30, 2014.
  • Six-month operating cash flow improved from an $9.0 million use in 2013 to $9.1 million provided in 2014. Investing cash flow shifted from $159.4 million provided in 2013, which included business-sale proceeds, to $90.8 million used in 2014, principally for Schuff.
  • Share count rose: 20.5 million common shares were outstanding at June 30, 2014, versus 14.2 million at year-end 2013. The company also issued $30 million of preferred stock and $6 million of common stock to help fund the acquisition.

Outlook, commentary, risks, contingencies, and unusual items

  • Liquidity outlook: Management stated that cash on hand was expected to fund fixed obligations and operating needs for at least the next 12 months. Subsequent to quarter-end, HC2 received $19.5 million from the BLACKIRON sale escrow and $3.0 million associated with the North America Telecom sale; a majority of these proceeds was used to repay the credit facility.
  • Debt and covenants: HC2’s $80 million senior secured term loan had an 18-month term, floating interest starting at 7.50% for base-rate loans or 8.50% for LIBOR loans, with margins increasing 25 basis points quarterly. The facility includes collateral coverage and Schuff EBITDA requirements and restrictive covenants. HC2 and Schuff reported covenant compliance at June 30.
  • Contract estimates: Schuff recognized revenue on $27.7 million of unapproved change orders; customer approval is not assured. Fixed-price project cost overruns, payment timing, and contract revisions can affect results and cash flow.
  • Concentration: More than half of Schuff backlog was concentrated in five commitments; cancellation, scope reduction, delays, or cost overruns could materially reduce expected revenue or profitability.
  • Tax: HC2 determined an ownership change occurred on May 29, 2014. The estimated annual Section 382 limit on use of U.S. net operating loss carryforwards is $3.58 million for the first five years and $2.16 million thereafter, subject to the filing’s stated assumptions.
  • Other risks: The filing highlights construction-cycle exposure, steel and labor costs, subcontractor performance, bonding and working-capital needs, foreign-exchange movements, telecommunications competition, and Genovel’s early-stage product development and regulatory risks. Management reported no formal financial guidance in the supplied filing text.
  • Contingencies and subsequent events: Two Schuff-related lawsuits were settled; the BP Refinery settlement contribution was funded by insurers. Other claims remain subject to ordinary-course uncertainty. Schuff finalized the sale of an aircraft and related equipment in July 2014.

Most important facts for investors to verify

  1. Confirm the filing entity and reporting period: the source is HC2 Holdings, Inc.’s Q2 2014 Form 10-Q, despite the request metadata naming INNOVATE Corp.
  2. Review the Schuff acquisition accounting, final purchase-price allocation, and whether the acquired business sustains its reported margins and cash generation.
  3. Track Schuff’s backlog conversion, the five large concentrated commitments, and collection or approval of the $27.7 million in unapproved change orders.
  4. Check debt maturity and amortization requirements, rising interest margins, covenant headroom, collateral exposure, and application of post-quarter escrow proceeds to debt.
  5. Assess the effect of the Section 382 ownership change on HC2’s ability to use its tax-loss carryforwards.
  6. Separate recurring operating performance from 2013 sale gains and other unusual items, and monitor continuing declines in Telecommunications revenue.