HC2 Holdings, Inc. — Q2 2019 Form 10-Q
Business context and period: The filing is for the quarter and six months ended June 30, 2019. HC2 is a diversified holding company with operations in construction, marine services, energy, telecommunications, insurance, life sciences and broadcasting. The request identifies INNOVATE Corp., but the filing itself names HC2 Holdings, Inc. as the registrant (NYSE: HCHC).
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net revenue | $518.6 million | $496.8 million | $1,010.0 million | $950.5 million |
| Operating income (loss) | $30.9 million | ($5.5 million) | $52.5 million | ($19.3 million) |
| Net income | $9.2 million | $79.8 million | $2.9 million | $40.9 million |
| Net income attributable to HC2 | $9.4 million | $55.4 million | $6.6 million | $20.4 million |
| Interest expense | $23.0 million | $17.2 million | $45.3 million | $36.5 million |
| Adjusted EBITDA | $27.7 million | $22.7 million | $30.5 million | $15.8 million |
Adjusted EBITDA is a non-GAAP measure that excludes the Insurance segment; it should not be read as a substitute for GAAP results. GAAP operating margin was approximately 6.0% in Q2 2019, compared with negative 1.1% in Q2 2018.
- Cash flow: Six-month operating cash flow was $36.8 million, versus cash used of $41.2 million in 2018. Investing activities used $154.6 million; financing activities provided $69.0 million. Cash, cash equivalents and restricted cash declined $48.5 million to $281.9 million; balance-sheet cash and equivalents were $280.4 million.
- Liquidity and debt: Consolidated debt principal was $861.4 million, up from $781.0 million at year-end 2018; reported debt obligations, net of discounts and financing costs, were $828.2 million. HC2 parent-only cash was $2.8 million, compared with $6.5 million at year-end; Insurance held $226.5 million of cash. HC2 reported compliance with its specified senior-note covenants at June 30.
- Balance sheet and investments: Total assets were $6.88 billion and total stockholders’ equity was $430.8 million. Total investments were $4.20 billion, including $3.81 billion of available-for-sale fixed maturities. Unrealized gains on those securities contributed to six-month other comprehensive income of $229.8 million.
Material changes versus the prior comparable period
- Q2 net revenue rose 4.4%; six-month net revenue rose 6.3%. Growth chiefly reflected Insurance, including the KIC acquisition, and Construction, including GrayWolf. Marine Services and Telecommunications were weaker.
- Operating results improved from losses to income in both comparison periods. Insurance operating income increased substantially, supported by KIC, higher investment income and favorable claims-reserve development. Broadcasting losses narrowed with cost reductions.
- Net income was much lower than in 2018, when the second-quarter comparison included a $102.1 million gain on the BeneVir sale. Higher interest expense also weighed on 2019 results.
- Six-month Telecommunications revenue fell to $344.8 million from $392.8 million, attributed to customer mix, wholesale traffic volumes and market pressure. Marine Services revenue fell to $81.8 million from $105.1 million, reflecting fewer and smaller installation and repair projects.
- Debt principal increased, including a $28.0 million Energy term loan used to finance the ampCNG acquisition and $15.0 million drawn under HC2’s new revolving facility. ANG acquired 20 CNG fueling stations for $41.2 million.
Outlook, risks and unusual items
- Management gave no specific earnings or revenue guidance. It said it expects to meet liquidity needs for at least 12 months using subsidiary distributions, financing, refinancing and/or asset sales, while cautioning that these sources are not assured. Parent-company liquidity depends substantially on distributions from subsidiaries, which may be restricted.
- Key risks include substantial debt and interest costs, refinancing and capital-raising uncertainty, dependence on subsidiary cash distributions, cyclical and seasonal project activity, telecommunications pricing and volume pressure, investment-market exposure, and insurance reserve, reinsurance and regulatory risks. A 100-basis-point increase in rates on $185.9 million of floating-rate borrowings would increase annual interest expense by an estimated $1.9 million.
- Insurance reserves were $4.54 billion and reinsurance recoverables were $961.4 million. The company reported $41.2 million of favorable prior-year long-term-care claims development for the first half; reserve estimates and reinsurer collectability remain important sensitivities.
- GMSL disclosed a dispute in which ASN alleged $38.2 million of damages and $1.2 million of liquidated damages. After quarter-end, on July 25, the parties settled: ASN agreed to pay GMSL $3.5 million and both parties released claims under the contract. A separate producer class settlement involving a $1.25 million payment remained subject to final court approval; its hearing was scheduled for September 17, 2019. HC2 also disclosed an ongoing UK VAT dispute and other litigation.
- Adoption of lease accounting added $67.1 million of right-of-use assets and $74.1 million of lease liabilities; an approximately $5.1 million impairment was recorded at adoption. Management was evaluating upcoming credit-loss and long-duration insurance accounting standards and anticipated operational and reporting changes.
- HC2 reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the registrant identity: this filing is for HC2 Holdings, Inc. (HCHC), not a registrant named INNOVATE Corp.
- Assess parent-only liquidity and upcoming debt service, particularly the $470 million 11.5% senior secured notes due 2021, convertible notes due 2022, and the short-dated Broadcasting notes whose maturity was extended to August 31, 2019.
- Evaluate whether operating cash generation and subsidiary distributions can sustain corporate obligations, given the parent’s $2.8 million cash balance and limits on subsidiary distributions.
- Track Marine Services and Telecommunications performance, Construction backlog concentration, and the extent to which Insurance earnings depend on investment income and reserve assumptions.
- Review the status and financial consequences of disclosed legal matters, insurance capital requirements, reinsurance recoverables, and the planned implementation of new accounting standards.