Fortune Brands Home & Security, Inc. — Q3 2015 Form 10-Q
Business context and period: The filing covers the quarter and nine months ended September 30, 2015. The company designs, manufactures and sells branded cabinetry, plumbing products, doors and security products. Results include Norcraft from May 2015; Waterloo, sold in September 2015, and Simonton, sold in 2014, are reported as discontinued operations.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,238.8m | $1,057.7m | $3,354.7m | $2,974.0m |
| Operating income | $160.3m | $129.5m | $355.8m | $324.3m |
| Continuing-operations income, net of tax | $100.0m | $84.5m | $218.9m | $217.1m |
| Net income (loss) attributable to Fortune Brands | $107.5m | ($21.1m) | $227.2m | $113.0m |
| Diluted EPS, continuing operations | $0.61 | $0.52 | $1.34 | $1.29 |
| Diluted EPS, total | $0.66 | ($0.13) | $1.39 | $0.67 |
Q3 sales rose 17.1% and operating income rose 23.8%; operating margin was approximately 12.9%, versus 12.2%. For the nine months, sales rose 12.8% and operating income rose 9.7%; operating margin was approximately 10.6%, versus 10.9%. Continuing-operations net income was nearly flat year to date despite higher sales, reflecting higher interest expense, taxes and other costs.
Q3 growth reflected acquisitions, higher volume, pricing and favorable mix, partly offset by foreign exchange. Norcraft, SentrySafe and Anaheim contributed approximately $125m of Q3 sales and $254m year to date. For Q3, segment sales increased in Cabinets 33.3%, Plumbing 5.3%, Doors 8.2% and Security 1.7%. Security operating income declined 17.8% in the quarter; the other three segments reported higher operating income.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $264.1m, up from $110.2m; capital expenditures were $86.9m. Free cash flow, calculated as operating cash flow less capital expenditures, was approximately $177.2m.
- Investing activities used $725.0m, principally reflecting $652.8m of acquisition spending. Financing activities provided $630.5m. Cash increased $158.7m to $350.6m.
- At September 30, cash was $350.6m and total debt was approximately $1,341.4m, compared with $670.0m at year-end 2014. Cash less debt implies net debt of approximately $990.8m. The company reported $202.4m of cash held by non-U.S. subsidiaries and noted potential tax consequences if certain funds were repatriated.
- Current assets were $1,623.4m and current liabilities $777.7m. The company had no revolver borrowings, $450.0m outstanding on its term loan and $891.4m of senior notes, net of discounts and commissions. It reported compliance with debt covenants.
- The $900m senior-note issuance comprised $400m of 3% notes due 2020 and $500m of 4% notes due 2025. A $975m revolving facility and term loan mature in July 2018; facility rates vary with LIBOR and leverage.
Material changes, outlook and risks
- Norcraft acquisition: Purchased in May for $648.6m, funded with cash and borrowings. The preliminary allocation included $348.8m of goodwill and $335.0m of identifiable intangibles and remains subject to valuation adjustments. Management cited expanded cabinetry offerings and market coverage as expected benefits.
- Waterloo sale: Sold for approximately $14m cash, subject to adjustments. The sale produced a $16.9m pretax loss, partly offset by an estimated $26.5m tax benefit; the reported after-tax discontinued-operations gain was $6.9m. The filing’s discontinued-operations comparison is not like-for-like: 2014 includes Simonton and its $111.8m sale loss.
- Management outlook: Management described the U.S. home-products market as in a multi-year recovery and expects continued recovery to depend on consumer confidence, employment, home prices, mortgage rates and credit availability. It cited potential operating leverage and profitable organic growth as markets recover. The filing provides no specific financial guidance.
- Costs and unusual items: Nine-month restructuring charges were $12.6m, primarily related to facility relocations and severance; Norcraft transaction costs were $15.1m. Foreign exchange reduced sales by approximately $47m year to date. The nine-month effective tax rate rose to 34.0% from 31.5%, affected by tax-audit settlement costs, acquisition-related taxes and nondeductible costs. Management said unrecognized tax benefits could decline by $3m–$7m over the next 12 months.
- Risks and contingencies: Key stated exposures include housing and remodeling demand, economic conditions, acquisition integration, competition, key customers and suppliers, raw-material and transportation costs, foreign exchange, pension costs, regulation and international operations. The company described ordinary-course litigation and environmental remediation matters, while stating it did not expect them to materially affect results, cash flows or financial condition. It also cautioned that pension remeasurements may cause material expense or income.
Important facts for investors to verify
- How much reported sales and earnings growth reflects Norcraft and other acquisitions versus organic volume, pricing and mix.
- Progress and final purchase-price allocation for Norcraft, including goodwill, intangible-asset values and integration performance.
- Debt reduction capacity and interest-cost sensitivity following the increase in debt, including variable-rate exposure and covenant headroom.
- Cash generation and working-capital needs given seasonality, capital spending and cash held outside the U.S.
- The sustainability of the housing-market recovery, segment trends—particularly Security—and effects of foreign exchange, raw materials and restructuring.
- The tax effects and final adjustments related to the Waterloo sale, and the comparability of discontinued-operations results with prior periods.