Fortune Brands Home & Security, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; unaudited. The filing’s registrant name is Fortune Brands Home & Security, Inc. (the company is identified in the request metadata as Fortune Brands Innovations). Figures below are in millions of dollars except per-share amounts.
Business context and financial performance
The company sells branded kitchen and bath cabinetry, plumbing and accessories, windows and door systems, and security and storage products. Results benefited from improving U.S. housing and repair-and-remodel markets, higher sales volume, and the June acquisition of WoodCrafters.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $1,125.1 | $909.1 | $3,055.5 | $2,643.2 |
| Operating income | $98.6 | $60.6 | $261.7 | $154.2 |
| Net income attributable to company | $64.2 | $40.0 | $165.5 | $100.3 |
| Diluted EPS | $0.37 | $0.24 | $0.97 | $0.61 |
| Operating margin | 8.8% | 6.7% | 8.6% | 5.8% |
For the nine-month period, gross margin was approximately 34.7%, versus 32.8% a year earlier. The effective tax rate rose to 33.7% from 31.8%; management cited the non-deductible investment impairment as an unfavorable factor, partly offset by research-credit benefits.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $166.2, up from $119.4. Higher earnings were partly offset by working-capital needs; receivables and inventory increased.
- Investing cash outflow was $355.3, mainly reflecting the $302.0 WoodCrafters acquisition. Capital expenditures were $55.2.
- Cash declined $179.0 to $157.0; $110.5 was held at non-U.S. subsidiaries, and repatriation could have tax consequences.
- At September 30, total debt was $355.6, consisting of $350.0 of term debt and $5.6 of short-term bank borrowings. The $650 million revolving facility had no borrowings. The company reported compliance with credit-facility covenants.
- Current assets were $1,273.6 and current liabilities $707.9. The credit facilities were renewed in July 2013, extending maturity to July 2018. The term loan carries a variable rate based on LIBOR and leverage.
- The company repurchased $42.7 of shares in the first nine months and paid $33.2 in dividends. It reported $98.1 remaining under its $150 million repurchase authorization.
Material changes and unusual items
- Sales increased 23.8% in Q3 and 15.6% for the nine months. WoodCrafters contributed approximately $60 of Q3 sales; its Q3 operating income was approximately $5.
- Q3 operating income increased 62.7%; nine-month operating income increased 69.7%. Growth reflected volume, market improvement, productivity and the acquisition, partly offset by higher strategic and advertising spending.
- Kitchen & Bath Cabinetry recorded a $21.2 noncash impairment after abandoning internally developed software. Management said it would not materially affect current or future cash flow or future operating income.
- A separate $6.2 impairment of a cost-method investment was recorded in Q2 in other expense; the investment was written down to zero, with no further funding obligation.
- WoodCrafters was acquired for approximately $302, funded with cash and borrowings. Purchase-price allocation remained preliminary; goodwill attributable to the acquisition was $141.5 and was tax deductible.
- The company began paying regular quarterly dividends in 2013. It also amended postretirement plans and announced a freeze of an hourly pension plan by the end of 2016; no 2013 pension contribution was expected.
Outlook, commentary and risks
Management said U.S. home-products markets continued to improve, including larger-ticket repair-and-remodel activity, but expected recovery to be gradual and uneven. Demand depends on consumer confidence, employment, home prices and credit availability. The company emphasized organic growth investment and potential add-on acquisitions; the filing provides no specific earnings or revenue guidance.
Key exposures include housing-market dependence, acquisition integration, customer and supplier concentration, raw-material and transportation costs, competitive promotions, pension costs and funding, foreign exchange, and regulatory or environmental changes. Management noted that changes in market assumptions could trigger impairment of goodwill or indefinite-lived tradenames. Pending litigation and environmental remediation were disclosed; the company did not expect them to have a material adverse effect, while noting outcomes and remediation estimates are uncertain.
Important facts for investors to verify
- How much of reported sales and earnings growth reflects underlying volume and market recovery versus WoodCrafters and other one-time effects.
- Whether Cabinetry segment profitability improves after the $21.2 software impairment and as acquisition integration proceeds.
- Working-capital conversion, particularly receivables and inventory growth, and the resulting effect on cash generation.
- Variable-rate debt exposure, liquidity access, and any tax cost associated with moving overseas cash to the U.S.
- Housing-market assumptions supporting goodwill and tradename valuations, plus future pension remeasurement and funding outcomes.