Fortune Brands Home & Security, Inc. — Q3 2011 Form 10-Q
Filing identity and period: The filing is for the quarter ended September 30, 2011, and is presented under the name Fortune Brands Home & Security, Inc. (the company identified in the request as Fortune Brands Innovations). Results are unaudited and compare the three and nine months ended September 30, 2011 with the corresponding 2010 periods. The company separated from Fortune Brands on October 3, 2011, after quarter-end, and began NYSE trading as FBHS on October 4.
Financial performance
- Revenue: Q3 sales were $848.0 million, up 4.3%; nine-month sales were $2,452.5 million, up 2.6%.
- Profit and margins: Q3 operating income was $49.4 million versus $65.3 million; net income attributable to the company was $20.1 million versus $27.4 million, and EPS was $0.13 versus $0.18. Nine-month operating income was $117.1 million versus $152.8 million; attributable net income was $50.0 million versus $46.9 million, and EPS was $0.32 versus $0.30. Approximate operating margins were 5.8% versus 8.0% for Q3 and 4.8% versus 6.4% for nine months.
- Cash flow: Nine-month operating cash flow was $23.0 million, down from $56.1 million. Capital expenditures were $41.4 million; reported free cash flow was negative $15.0 million versus positive $28.8 million. Cash at September 30 was $127.6 million.
- Liquidity and debt: At September 30, current assets were $1,015.1 million and current liabilities $1,146.2 million. Current liabilities included a $548.9 million dividend payable to Fortune Brands and $56.4 million of short-term loans from Fortune Brands. External debt comprised $3.3 million of bank notes and $16.8 million of long-term debt. On October 4, the company borrowed $510 million under newly arranged facilities: a $650 million five-year revolving credit facility and a $350 million five-year term loan. The facilities carry variable LIBOR-based rates and covenant requirements; the filing reports covenant compliance at September 30.
- Balance sheet: Total assets were $3,840.9 million and total equity $2,128.4 million at September 30. Goodwill was $1,366.5 million and other intangible assets, net, were $792.2 million.
Changes and operating drivers
- Sales growth reflected customer gains, new products, pricing and favorable currency, partly offset by weak housing-related markets, expired U.S. and Canadian tax incentives, and lower customer inventories. Raw-material and transportation costs pressured profitability.
- Nine-month segment sales rose in Kitchen & Bath Cabinetry (5.8%), Plumbing & Accessories (3.0%) and Security & Storage (4.8%); Advanced Material Windows & Door Systems fell 6.6%. Windows & Door Systems recorded a $9.6 million operating loss for the nine months.
- Q3 Plumbing & Accessories operating income increased 23.3%; Cabinetry declined 19.6%, Security & Storage declined 26.2%, and Windows & Door Systems reported a $0.3 million operating loss. Corporate expense also increased.
- Nine-month interest expense to Fortune Brands fell substantially after a $2.7 billion equity contribution capitalized most intercompany loans in Q1. Historical results include allocated parent-company costs and may not represent standalone costs or future results.
Outlook, risks and unusual items
- Management expected a gradual, uneven U.S. home-products recovery and emphasized productivity, pricing, innovation and growth investment. It expected approximately $75 million of higher raw-material and transportation costs for full-year 2011 and planned to offset these with productivity and price increases.
- The company expected approximately $20 million of additional annual costs as a standalone public company. It did not initially expect to pay a dividend; the board would periodically evaluate one.
- Management expected approximately $20 million of restructuring and other costs over the following six months for cabinetry facility consolidation and a windows facility closure, including approximately $14 million of non-cash charges.
- The Q3 tax rate was 57.1% and the nine-month rate 44.6%, including an $8.5 million charge related to foreign dividends remitted in preparation for the separation. Management expected a post-separation effective tax rate of approximately 35%, excluding unusual items.
- A Windows reporting unit had current-year operating losses; management warned that a 10% decline in fair value could trigger impairment of its $87.3 million goodwill and $127.0 million tradename. No impairment was recorded in 2011 through September; annual testing was planned for Q4.
- Other notable items included $2.4 million of non-cash separation-related compensation costs and a pension remeasurement that increased the pension liability by $56.8 million, primarily due to a lower discount rate. The company cited housing-market uncertainty, customer credit risk, commodity and foreign-exchange exposure, and ordinary-course litigation and environmental matters; it did not expect pending litigation or current environmental compliance to have a material adverse effect.
Investor verification points
- Confirm the post-separation debt balance, borrowing costs, covenant headroom and treatment of the $548.9 million dividend payable and subsequent facility borrowings.
- Assess whether operating cash flow and free cash flow can recover amid working-capital needs, elevated capital spending and planned restructuring costs.
- Track the Windows & Door Systems business, including facility closures, market recovery assumptions and potential goodwill or tradename impairment.
- Compare actual standalone overhead and tax rates with management’s approximately $20 million annual incremental-cost estimate and approximately 35% tax-rate outlook.
- Evaluate whether pricing and productivity can offset raw-material, transportation and promotional costs while sustaining sales growth.