HC2 Holdings, Inc. — Form 10-Q Summary
Entity note: The supplied filing is for HC2 Holdings, Inc. (NYSE: HCHC), not under the name INNOVATE Corp. It covers the quarter and nine months ended September 30, 2017; financial figures are unaudited and in U.S. dollars.
Business context and reporting period
HC2 is a diversified holding company with seven operating segments: Construction, Marine Services, Energy, Telecommunications, Insurance, Life Sciences and Other. Its strategy includes growing existing businesses and pursuing acquisitions. Comparisons below are with the corresponding 2016 periods.
Financial performance and liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net revenue | $406.4 million, down 1.6% from $413.1 million | $1,175.6 million, up 6.5% from $1,104.1 million |
| Operating income (loss) | $10.6 million, versus $6.9 million; operating margin about 2.6% | $0.3 million, versus a $6.4 million loss; operating margin about 0.03% |
| Net loss | $8.3 million, versus $5.4 million | $44.7 million, versus $35.5 million |
| Loss attributable to common and participating preferred stockholders | $6.7 million; $0.16 per share, versus $7.5 million; $0.20 per share | $40.5 million; $0.95 per share, versus $38.1 million; $1.07 per share |
| Adjusted EBITDA | $9.8 million, versus $18.2 million | $31.1 million, versus $33.7 million |
| Operating cash flow | Not presented for the quarter alone | $37.1 million, versus $55.0 million |
Adjusted EBITDA is a non-GAAP measure and excludes the Insurance segment. It should not be treated as a substitute for GAAP results.
At September 30, 2017, cash and cash equivalents were $130.8 million, including $48.5 million at HC2 on a stand-alone basis. Consolidated long-term obligations were $496.6 million net of discounts and financing costs; disclosed gross indebtedness was $503.8 million, compared with $438.4 million at year-end 2016. HC2 stand-alone debt was $400.0 million of 11.0% senior secured notes due 2019. Total assets were $2.97 billion and stockholders’ equity was $81.9 million. Insurance reserves were $1.68 billion; investments totaled $1.52 billion.
For the nine months, investing activities used $67.0 million and financing activities provided $45.4 million. Capital expenditures were $25.3 million. Net cash increased $15.4 million from year-end.
Material changes versus the prior comparable period
- Third-quarter revenue fell mainly because of lower Telecommunications wholesale traffic and reduced Marine Services telecom-installation revenue; Construction growth, including acquired PDC and BDS businesses, partly offset the declines.
- Nine-month revenue rose across all segments. Construction, Insurance, Telecommunications and Energy contributed to growth, including acquisitions and higher investment income.
- Insurance segment operating results improved substantially: lower policy benefits and reserve releases, higher investment income and lower expenses supported the result. The reserve reductions were associated in part with long-term-care rate increases and conditional non-forfeiture elections and terminations.
- Interest expense increased to $39.4 million for the nine months from $31.6 million, reflecting increased 11.0% note principal and refinancing-related costs. The company also issued $93 million of additional 11.0% notes during 2017.
- A $12.9 million third-quarter income tax expense, versus a $1.3 million benefit a year earlier, more than offset pre-tax income of $4.5 million and contributed to the quarterly net loss. Management cited investment appreciation and the mix of income and losses among taxable entities; certain loss-related tax benefits were subject to a full valuation allowance.
- Adjusted EBITDA declined, with Marine Services and Life Sciences among the principal pressures. Life Sciences losses increased with higher research, development and clinical spending.
Outlook, risks, contingencies and unusual items
- Management said it believed liquidity would be sufficient for at least the next 12 months, relying on subsidiary distributions and potential new debt or equity, refinancing, other financing or asset sales. It cautioned that access to these sources is not assured and subsidiary distributions face contractual and regulatory limits.
- The $400 million 11.0% notes carry restrictive covenants, including liquidity and collateral coverage tests. HC2 reported compliance at quarter-end; the collateral coverage ratio was above 2.0x and the notes required six months of debt-service and preferred-dividend liquidity.
- After quarter-end, GMSL agreed, subject to conditions, to acquire Fugro’s trenching and cable-lay business for consideration valued at about $73 million, including a 23.6% equity interest in GMSL’s parent and a secured loan obligation. Management expected the acquisition to be accretive; completion and results were not assured.
- HC2 reported FCC approval for the DTV and Mako LPTV transactions. A separate agreement to buy 14 Three Angels Broadcasting Network stations for $9.6 million remained subject to FCC approval. The company also expected to sign a $75 million bridge loan for LPTV acquisitions; final terms were not yet disclosed in this filing.
- In November 2017, the Insurance subsidiary agreed to acquire Humana’s Kanawha Insurance Company, subject to customary closing conditions and regulatory approvals.
- DBMG backlog was $656.1 million, up from $503.5 million at December 31, 2016; five projects represented 62.2% of backlog, creating concentration risk if projects are cancelled or reduced.
- GMSL’s dispute with ASN involved alleged contract breaches and ASN’s stated damages of $30 million plus $1.2 million in liquidated damages, while $8.9 million of GMSL invoices remained at risk. HC2 disputed the claims. Other disclosed matters included CGI producer litigation and a disputed U.K. VAT assessment; management did not consider the VAT assessment probable.
- Other unusual items included $1.8 million of impairment expense in the Other segment, including goodwill and fixed-asset impairments related to NerVve, and a $6.0 million nine-month gain from reducing the estimated insurance-acquisition contingent consideration liability.
- Risks highlighted include insurance reserve and investment performance, high debt and financing access, foreign exchange and interest rates, project delays and cost overruns, regulatory limits on insurance dividends, and changing incentives and fuel-price economics affecting CNG demand.
Most important facts for investors to verify
- Confirm the issuer identity and corporate name applicable to the intended investment; this filing is HC2 Holdings, Inc. for 2017 Q3.
- Track cash generation, parent-level cash and subsidiary distributions against $400 million of 11.0% notes, preferred dividends and any subsequent bridge borrowing.
- Assess whether Insurance reserve releases and resulting profits are repeatable, and review the reserve adequacy, statutory capital and investment credit quality disclosures.
- Monitor Marine Services’ ASN dispute and unpaid invoices, project execution, and the terms, closing and financing of announced acquisitions.
- Evaluate backlog concentration, Life Sciences cash needs and impairments, and the assumptions behind management’s non-GAAP Adjusted EBITDA measure.