Business context and reporting period
The supplied filing is HC2 Holdings, Inc.’s Form 10-K for the fiscal year ended December 31, 2014, filed March 16, 2015. It is not a filing by INNOVATE Corp.; investors should confirm the intended company and filing. HC2 describes itself as a diversified holding company with Manufacturing (Schuff), Marine Services (GMSL), Utilities, Telecommunications (ICS), Life Sciences and Other segments.
HC2 acquired control of Schuff in May 2014, ANG in August and GMSL in September. It completed the sale of the remaining North America Telecom business in July 2014. Consequently, reported 2014 results include Schuff, ANG and GMSL only from their respective acquisition dates.
Financial results and key metrics
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Net revenue | $543.2 million | $230.7 million |
| Operating loss | $14.4 million | $39.1 million |
| Net income (loss) | $(9.5) million | $111.6 million |
| Net income (loss) attributable to HC2 | $(12.1) million | $111.6 million |
| Cash provided by (used in) operating activities | $32.8 million | $(20.3) million |
| Cash and cash equivalents at year-end | $108.0 million | $9.0 million |
| Total debt and other long-term obligations | $343.4 million | None reported |
FY 2014 cost of revenue was $471.5 million, or 86.8% of revenue; the resulting gross profit was approximately $71.7 million, a 13.2% gross margin. Operating margin was approximately negative 2.7%. SG&A was $81.4 million, up from $34.7 million, and included costs associated with the expanded portfolio and acquisitions. HC2 reported a $24.5 million income tax benefit, primarily reflecting valuation-allowance releases; the filing identifies an approximately $4 million non-cash tax-provision adjustment related to a control weakness.
For comparison on a pro forma basis, assuming Schuff and GMSL had been acquired at the start of 2013, MD&A reports revenue of $853.5 million for 2014 versus $801.7 million for 2013, up 6.5%. Pro forma adjusted EBITDA was $69.0 million in 2014, a non-GAAP measure. Schuff’s backlog was $357.0 million at year-end, down from $426.9 million a year earlier; five commitments represented 56.9% of backlog.
Fourth-quarter 2014 revenue was $223.8 million, operating loss was $9.3 million and reported net income was $11.4 million. Quarterly results reflect the changing contribution of recently acquired businesses and should not be read as a standalone run rate.
Investing cash outflow was $216.5 million, principally reflecting acquisitions and investments; financing cash inflow was $284.6 million, including debt and equity proceeds. Reported capital expenditures were $5.8 million; pro forma capital expenditures including acquired businesses were $15.8 million. At year-end, current assets were $331.6 million and current liabilities were $205.6 million. The filing says existing cash was expected to cover fixed obligations and operating needs for at least the next 12 months, while noting reliance on subsidiary distributions and financing restrictions. Corporate-level cash, cash equivalents and short-term investments were approximately $23.5 million.
Changes, outlook, risks and unusual items
- Revenue growth in reported results primarily reflects acquisitions and the shift from a telecommunications-focused business to a diversified portfolio. Pro forma Manufacturing revenue increased 26.4% year over year, while pro forma Marine Services revenue increased 5.6%. Telecommunications revenue fell 29.8%, which management attributed mainly to lower domestic and international terminations.
- HC2 issued $250 million of 11% senior secured notes due 2019 to refinance its acquisition-related September credit facility. The notes are secured by substantially all of HC2’s assets; the filing reports $343.4 million of total debt and obligations at year-end. The notes’ indenture includes financial tests and restrictions on debt, liens, dividends and other actions. HC2 reported compliance at December 31, 2014.
- Preferred stock issued in 2014 carries a 7.5% annualized cumulative cash dividend and quarterly accretion; a further $14 million Series A-2 issuance occurred January 5, 2015. These securities and potential conversions may affect cash needs and dilute common shareholders. HC2 paid no common dividend in 2014 and stated it had no near-term intention to do so.
- Management provided no specific consolidated revenue or earnings guidance. It expects to pursue acquisitions and grow acquired businesses, but stated it has not selected a specific industry or guaranteed future transactions. GMSL planned fleet investment and expected to re-enter offshore power after a non-compete expires in November 2015; it also warned that weaker oil prices and reduced energy-sector spending could constrain growth.
- GMSL’s UK pension recovery plan addresses an approximately GBP 32 million funding shortfall, with scheduled contributions and additional profit- and dividend-related payments. Future valuations could increase required funding and reduce cash available to HC2.
- Schuff recognized revenue on $53.9 million of unapproved change orders. Backlog is concentrated, and contracts may be delayed, reduced or cancelled; fixed-price projects also expose the business to cost overruns. Schuff’s BP-related litigation was settled and dismissed in 2014.
- HC2 disclosed a material weakness in controls over income-tax accounting and concluded internal control over financial reporting was ineffective at year-end. BDO gave an adverse opinion on internal controls, while issuing an unqualified opinion on the financial statements. Controls at businesses acquired in 2014, representing 82% of year-end assets and 70% of annual revenue, were excluded from management’s assessment.
- Other material risks include substantial leverage, foreign-exchange exposure, acquisition integration, subsidiary restrictions on upstream cash, and a Canadian spectrum-license lawsuit seeking $50 million in damages, with a related cross-claim. HC2 said it would defend the claims and did not expect pending matters to have a material adverse effect.
Important facts for investors to verify
- Confirm that HC2 Holdings, Inc. and the December 31, 2014 fiscal year—not INNOVATE Corp. or a 2014 fourth-quarter-only filing—are the intended subject.
- Reconcile reported revenue and pro forma revenue, including acquisition dates, discontinued operations and the differing pro forma figures presented in the filing.
- Review the $24.5 million tax benefit, valuation-allowance release, Section 382 NOL limitations and the disclosed tax-accounting material weakness.
- Assess debt service, the 11% notes’ covenants and collateral, preferred-stock dividend and redemption terms, and the extent to which subsidiaries can distribute cash to HC2.
- Test the quality and concentration of Schuff backlog, collectability of contract receivables, and approval and recovery of unapproved change orders.
- Track GMSL pension contributions, vessel replacement needs, exposure to oil-and-gas spending, and the planned offshore-power market re-entry.
- Monitor remediation of tax controls and integration of acquired-company controls, as well as the status and potential exposure of the pending litigation.