Fortune Brands Home & Security, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Financial statements are unaudited. The company designs, manufactures, and sells branded cabinetry, plumbing, doors, and security and storage products. Simonton windows is reported as a discontinued operation following its sale in September 2014.
Financial performance
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net sales | $1,097.7 million, up 5.0% year over year | $3,073.3 million, up 7.9% |
| Operating income | $136.4 million, up 39.8%; operating margin approximately 12.4% versus 9.3% | $337.6 million, up 27.9%; operating margin approximately 11.0% versus 9.3% |
| Continuing-operations income, net of tax | $88.6 million; diluted EPS $0.54 | $225.1 million; diluted EPS $1.34 |
| Net income (loss) attributable to shareholders | $(21.1) million; diluted EPS $(0.13) | $113.0 million; diluted EPS $0.67 |
| Cash from operating activities | Not separately presented for the quarter | $110.2 million versus $166.2 million |
Gross margin was approximately 34.5% in Q3, compared with 34.3% a year earlier; for the nine-month period it was approximately 34.2%, versus 34.9%. Q3 net loss primarily reflects the $111.8 million loss on the Simonton sale, recorded in discontinued operations. The nine-month discontinued-operations loss was $111.2 million.
Balance sheet, liquidity, and capital allocation
- At September 30, cash and cash equivalents were $175.1 million, total assets $4,081.2 million, and total equity $2,340.6 million. Cash was $241.4 million at December 31, 2013; $161.3 million of September cash was held at non-U.S. subsidiaries, and repatriation could have tax consequences.
- Long-term borrowings under credit facilities were $680.0 million, compared with $350.0 million at year-end 2013; short-term bank notes were $3.5 million. The company amended its facilities, increasing total commitments from $1.0 billion to $1.5 billion: a $975 million revolver and $525 million term loan, both due July 2018. Rates are variable at LIBOR plus 1.0%–2.0%; the company reported covenant compliance.
- Operating cash flow was lower year over year, which management attributed mainly to higher incentive compensation and customer program payments and lower accruals, partly offset by lower working capital needs. Investing used $77.6 million, including the $118.5 million SentrySafe acquisition, partly offset by $130.0 million of Simonton sale proceeds. Financing used $97.3 million, including $411.4 million of treasury-stock purchases and $58.5 million of dividends.
- The company repurchased approximately 10.4 million shares for $411.2 million in the first nine months and authorized an additional $250 million repurchase program in September. Remaining authorization was $328.0 million at quarter-end. It paid a quarterly dividend of $0.12 per share beginning in Q1 2014.
Material changes and management commentary
- Q3 sales growth included approximately $25 million from SentrySafe. Across the first nine months, reported sales also benefited from approximately $100 million from WoodCrafters and $25 million from SentrySafe, higher volume, and pricing. Growth was partly offset by the planned exit from low-margin western U.S. builder-direct cabinet business (approximately $40 million year to date) and unfavorable foreign exchange (approximately $20 million year to date).
- Nine-month operating income growth reflected higher volume, acquisitions, productivity, lower SG&A, and the absence of a $21.2 million Cabinets impairment recorded in 2013. Capacity expansion costs, first-quarter weather-related inefficiencies, and approximately $10 million of unfavorable foreign exchange were offsets.
- Segment sales rose year over year in the first nine months: Cabinets 12.2%, Plumbing 2.7%, Doors 11.1%, and Security & Storage 5.6%. Security & Storage operating income fell 16.7%, reflecting higher raw-material and support costs, restructuring, and weaker tool-storage sales. In Q3, that segment’s operating income declined 8.1% despite 17.4% sales growth, principally due to higher selling and administrative costs.
- Management described the U.S. home-products market as being in the early stages of a multi-year recovery, with prospects dependent on consumer confidence, employment, home prices, and credit availability. It expects operating leverage and strategic investment to support profitable organic growth as markets improve, and identified organic investment, potential acquisitions, dividends, and repurchases as capital-allocation opportunities. The filing provides no specific numeric earnings or revenue guidance.
Risks, contingencies, and unusual items
- Demand is exposed to U.S. new construction and repair-and-remodel activity; other cited risks include economic conditions, competition, customer and supplier concentration, raw-material and transportation costs, supply-chain availability, international operations, and postretirement benefit costs.
- Goodwill and intangible-asset valuations depend significantly on assumptions about U.S. housing recovery and planned cost reductions. Weaker market growth, customer actions, discount-rate volatility, or reduced consumer spending could prompt impairment. No impairment was recorded in the first nine months of 2014.
- The company is involved in ordinary-course litigation and environmental remediation. Management stated these matters were not expected to have a material adverse effect, while noting outcomes and remediation exposures are uncertain.
- Management warned that pension remeasurements may create material income or expense in future periods. It made approximately $2 million of qualified pension contributions in Q3 and expected no further qualified contributions in the remainder of 2014.
- Operating cash flows are seasonal, typically strongest in Q3 and Q4. The company reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether continuing-operations growth persists after separating acquisition contributions, pricing, foreign exchange, and the cabinet business exit.
- The final purchase-price allocation and performance of SentrySafe, acquired for $118.5 million; the allocation was preliminary.
- The cash-flow and balance-sheet effects of the Simonton disposition, including the $111.8 million recorded sale loss and any subsequent adjustments.
- Debt levels, variable-rate exposure, covenant headroom, and the company’s ability to fund repurchases, dividends, acquisitions, and capital expenditures from cash generation.
- Whether housing-market recovery, capacity investments, raw-material costs, and Security & Storage performance develop in line with management’s assumptions.