Fortune Brands Home & Security, Inc. (now identified in the request as Fortune Brands Innovations) — Q2 2015 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2015; financial statements are unaudited. The company designs, manufactures and sells branded cabinetry, plumbing products, entry doors and security products. Results include Norcraft from its May 2015 acquisition. Waterloo tool storage is reported as discontinued operations; Simonton windows was sold in 2014.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $1,165.1 million | $1,027.2 million | $2,115.9 million | $1,916.3 million |
| Operating income | $128.2 million | $125.5 million | $195.5 million | $194.8 million |
| Continuing-operations net income | $78.0 million | $86.3 million | $118.9 million | $132.6 million |
| Diluted EPS, continuing operations | $0.48 | $0.51 | $0.73 | $0.78 |
| Operating cash flow | Not separately provided for the quarter | $41.8 million | $(30.7) million |
Q2 sales increased 13.4%; operating income rose 2.2%. Calculated gross margin was approximately 35.2% in both Q2 periods; operating margin was approximately 11.0% versus 12.2%. For the first half, gross margin was approximately 34.4% versus 34.3%, while operating margin was approximately 9.2% versus 10.2%. Higher interest expense and taxes contributed to lower continuing-operations earnings.
First-half sales rose 10.4%, with reported growth across all segments: Cabinets +9.5%, Plumbing +6.4%, Doors +5.6% and Security +32.5%. Management attributed consolidated sales growth to acquisitions (approximately $129 million for the half), higher volume, pricing and favorable mix; foreign exchange reduced sales by approximately $26 million. First-half operating income was nearly flat: higher volume, pricing, productivity and acquisitions were largely offset by $14.9 million of Norcraft transaction costs and higher restructuring charges. Q2 results showed similar factors, including $13.8 million of Norcraft transaction costs.
Cash, debt and liquidity
At June 30, cash and cash equivalents were $223.5 million, current assets $1,529.9 million and current liabilities $682.3 million. Long-term debt was $1,389.8 million, with no current portion; total debt was therefore approximately $1.39 billion. Net debt was approximately $1.17 billion. The company had $41.8 million of operating cash flow, used $706.7 million in investing activities (including $652.5 million for acquisitions), and generated $700.9 million from financing activities in the first half. Cash increased $31.6 million to $223.5 million.
In June, the company issued $900 million of senior notes: $400 million due 2020 at 3% and $500 million due 2025 at 4%. Proceeds were used to repay revolving-credit borrowings and for general purposes. The $975 million revolving facility had no balance outstanding at June 30; the term loan balance was $498.7 million. Both facilities mature in July 2018, and the company reported compliance with their covenants. First-half dividends were $44.6 million; the remaining share-repurchase authorization was approximately $299 million.
Outlook, commentary and risks
- Management described the U.S. home-products market as in a multi-year recovery, but said continued recovery depends on consumer confidence, employment, home prices, mortgage rates and credit availability. It emphasized organic growth, productivity and strategic investment; no numerical earnings or revenue guidance is provided in the filing.
- Management expected to sell Waterloo by the end of 2015. Waterloo’s first-half discontinued-operations sales were $50.4 million; its net income after tax was $0.8 million.
- Management expects approximately $5 million of pension contributions in 2015 and said it believes liquidity is sufficient for foreseeable minimum pension funding needs. Operating cash flow is seasonal, typically stronger in the third and fourth quarters.
- Risks cited include dependence on North American housing and remodeling activity; acquisition integration; competition and innovation; key customers and suppliers; raw-material and transportation costs; foreign exchange; pension costs; regulatory and tax compliance; and international operations. The filing reports no material change to previously disclosed risk factors.
- The 2015 effective tax rate was 35.0% for the first half versus 30.3% a year earlier, affected by Norcraft-related costs and taxes, restructuring charges and tax adjustments. Unrecognized tax benefits could decrease by $4 million to $8 million within 12 months, principally as tax proceedings conclude.
- Litigation and environmental remediation matters are disclosed; management did not expect them to have a material adverse effect, while noting outcomes and remediation estimates involve uncertainty.
Most important facts for investors to verify
- How much of sales and segment growth reflects acquisitions versus organic volume, pricing and mix, particularly Norcraft and SentrySafe.
- Whether the Norcraft acquisition delivers expected strategic benefits, and how its provisional purchase-price allocation, goodwill and acquired intangible values change when finalized.
- Whether operating cash flow improves beyond the seasonally weaker first half, given working-capital needs and acquisition spending.
- Debt-service capacity and covenant headroom following the increase in debt, including exposure to variable rates on the term loan and revolver.
- Progress on the planned Waterloo sale, tax proceedings and the disclosed litigation and environmental matters.