SPB

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended April 3, 2011, and the six-month period ended April 3, 2011, for Harbinger Group Inc. (HGI). HGI is a holding company that acquired a controlling interest (approximately 54.5%) in Spectrum Brands Holdings, Inc. (Spectrum Brands) on January 7, 2011. Spectrum Brands is a diversified global branded consumer products company operating in seven major categories, including consumer batteries, pet supplies, and small appliances. The financial statements reflect Spectrum Brands as the accounting predecessor due to the transaction being treated as a common control transaction.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 30% year-over-year for the quarter and 38% for the six-month period. This growth is primarily driven by the inclusion of Russell Hobbs (acquired in the SB/RH Merger in June 2010), which contributed $158 million in sales for the quarter and $407 million for the six months.
• Profitability: While operating income increased for the six-month period ($87.1 million vs. $64.5 million), the company reported a significant net loss due to high interest expenses and tax provisions. Interest expense surged to $82.7 million for the quarter (up from $48.4 million) and $140.7 million for the six months (up from $97.9 million), largely due to the issuance of HGI's 10.625% Senior Secured Notes and refinancing charges.
• Debt Refinancing: In February 2011, Spectrum Brands refinanced its Term Loan, resulting in non-cash charges of approximately $34.8 million recorded in interest expense (including write-offs of debt issuance costs and prepayment penalties).
• Cash Flow: Net cash used in operating activities was $134.2 million for the six months ended April 3, 2011, compared to $81.0 million in the prior year period. This increase was driven by higher working capital usage and increased cash interest payments. However, financing activities provided $384.9 million, primarily from the issuance of senior secured notes and borrowings under the revolving credit facility.

Guidance, Outlook, and Risks

Management Commentary and Outlook: Management expects net sales to remain higher in the remainder of Fiscal 2011 compared to the prior year due to the full-period effect of the Russell Hobbs acquisition and new distribution gains. However, consolidated SG&A expenses are expected to increase due to the integration of Russell Hobbs, the consolidation of FGL (acquired April 6, 2011), and corporate oversight costs. The company does not expect to receive dividends from Spectrum Brands in the foreseeable future as it intends to retain earnings to pay down debt.

Subsequent Events:

• FGL Acquisition: On April 6, 2011, HGI completed the acquisition of Fidelity & Guaranty Life Holdings, Inc. (FGL) for $350 million. FGL is a provider of fixed annuity products.
• Preferred Stock Issuance: On May 13, 2011, HGI issued 280,000 shares of Series A Participating Convertible Preferred Stock for gross proceeds of $280 million.
• Debt Amendment: On April 21, 2011, Spectrum Brands amended its ABL Revolving Credit Facility, extending the maturity to 2016 and reducing interest margins.

Risks and Contingencies:

• Debt Covenants: Spectrum Brands is subject to limitations under its 12% Notes indenture because its Fixed Charge Coverage Ratio is below 2:1, restricting its ability to make significant acquisitions or incur additional senior debt until the test is satisfied.
• Legal Proceedings: HGI is a defendant in a derivative action regarding the Spectrum Brands Acquisition. Spectrum Brands faces various litigation, including asbestos claims and environmental remediation matters, though reserves are deemed adequate.
• Market Risks: The company is exposed to foreign exchange fluctuations (approx. 44% of sales outside the U.S.), commodity price volatility (specifically zinc), and interest rate changes.

Investor Verification Checklist

• Debt Service Capacity: Verify the company's ability to service its significant debt load ($2.17 billion total) given the current net losses and the restrictions imposed by the Fixed Charge Coverage Ratio covenant on the 12% Notes.
• Integration Costs: Monitor the realization of cost synergies from the SB/RH Merger against the rising SG&A expenses associated with the FGL acquisition and corporate overhead.
• Dividend Policy: Confirm the timeline for potential dividends from Spectrum Brands, as HGI relies on subsidiary distributions to fund its own debt obligations (specifically the 10.625% Notes).
• FGL Integration: Assess the financial impact and regulatory hurdles associated with the newly acquired FGL business, including the requirement to replace the "Reserve Facility" by December 31, 2012.
• Foreign Exchange Exposure: Evaluate the sensitivity of future earnings to currency fluctuations, particularly the Euro and Pound Sterling, given the significant international sales mix.