Business Context and Reporting Period
HRG Group, Inc. filed an unaudited Form 10-Q for the three months ended December 31, 2017. HRG is a holding company whose principal operating asset is a 59.3% controlling interest in Spectrum Brands Holdings, Inc. The report presents two segments: Consumer Products and Corporate and Other. Spectrum Brands operates branded consumer-product businesses across hardware and home improvement, global pet supplies, global auto care, and home and garden control products.
The filing reflects major portfolio changes. HRG completed the sale of its insurance operations, including Fidelity & Guaranty Life and Front Street, on November 30, 2017. Spectrum Brands classified its Global Batteries & Appliances segment as held for sale and discontinued operations effective December 29, 2017.
Key Financial Metrics
| Metric | Three months ended December 31, 2017 | Prior comparable period |
|---|---|---|
| Net sales | $646.5 million | $602.3 million |
| Operating income | $26.6 million | $41.3 million |
| Operating margin | 4.1% | 6.9% |
| Loss before income taxes from continuing operations | $47.9 million | $36.4 million |
| Net income from continuing operations | $78.1 million | $(42.0) million |
| Net income attributable to HRG controlling interest | $507.4 million | $212.2 million |
| Basic EPS | $2.53 | $1.06 |
| Adjusted EBITDA, Consumer Products | $105.7 million | $105.2 million |
- Consumer Products sales increased 7.3% to $646.5 million, driven primarily by hardware and home improvement growth, acquisitions, and favorable foreign exchange.
- Consumer Products operating income declined 44.7% to $34.0 million. Gross profit was $242.7 million, with a 37.5% gross margin versus 39.9% in the prior period.
- Consumer Products Adjusted EBITDA margin declined to 16.3% from 17.5%, despite a slight increase in Adjusted EBITDA.
- Income from discontinued operations was $500.8 million, including $459.9 million from the insurance operations and $40.9 million from the GBA segment. The insurance amount included a $445.9 million reclassification of accumulated other comprehensive income related to FGL.
- Cash used in continuing operating activities was $143.4 million, compared with $91.3 million used in the prior period. Continuing investing activities generated $1.473 billion, primarily from proceeds related to the insurance-operations disposals. Capital expenditures were $17.9 million.
- Cash and cash equivalents totaled $1.648 billion at December 31, 2017, compared with $270.1 million at September 30, 2017. Corporate cash and investments were approximately $1.5 billion.
- Total debt was $5.823 billion, including $934.5 million classified as current. Spectrum Brands had $454.4 million of borrowing availability under its revolving facility, net of letters of credit and other allocations.
- Total assets were $9.080 billion and total liabilities were $7.452 billion at December 31, 2017. HRG shareholders’ equity was $820.4 million, and noncontrolling interest was $807.2 million.
Material Changes Versus the Prior Comparable Period
- Sales increased $44.2 million, or 7.3%. Hardware and home improvement sales rose 12.8%; global pet supplies increased 4.2% on an as-reported basis but declined 11.0% organically; global auto care and home and garden control sales declined slightly.
- Operating income decreased $14.7 million, principally because restructuring charges increased by $18.2 million and the rawhide product safety recall generated $7.3 million of costs.
- Corporate and Other operating loss improved to $7.4 million from $20.2 million, primarily because of lower payroll, bonus, stock-based compensation, asset-management, and loan-loss expenses.
- Continuing-operations results benefited from a provisional $206.7 million tax benefit for revaluation of deferred tax balances under the Tax Cuts and Jobs Act, partly offset by a provisional $78.8 million repatriation-tax expense.
- Cash increased substantially because of approximately $1.490 billion received from the FGL merger and Front Street sale, partially offset by operating cash usage.
- HRG repaid $92.0 million of HGI Energy Notes on December 5, 2017 and redeemed its $864.4 million of 7.875% Senior Secured Notes on January 16, 2018.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- On January 15, 2018, Spectrum Brands agreed to sell its Global Batteries and Lighting business to Energizer for $2.0 billion in cash, subject to customary adjustments and closing conditions. The transaction was expected to close before December 31, 2018, but required antitrust approvals and was not subject to a financing condition.
- Spectrum Brands was actively marketing its Home and Personal Care business for a separate transaction expected to be entered into and completed before December 31, 2018. The filing provides no assurance that either strategic process would be completed on the expected terms or timetable.
- HRG was reviewing strategic alternatives involving the company and/or its assets, including potential transactions involving Spectrum Brands. No definitive schedule or transaction had been established.
- HRG expected approximately $60.7 million of subsidiary dividends during fiscal 2018 and stated that available cash, investments, borrowings, and expected dividends should cover its cash requirements for at least the next twelve months. This depends on subsidiary performance, financing covenants, board approvals, and legal or regulatory restrictions.
- Spectrum Brands expected fiscal 2018 capital expenditures of approximately $110 million to $120 million and intended to fund requirements through cash, operating cash flow, and available revolver capacity.
- Restructuring charges were $20.4 million for the quarter. Future costs for current initiatives were estimated at $16.2 million as of December 31, 2017.
- The rawhide product safety recall generated $7.3 million of quarterly costs. Management stated that the estimate was provisional and could change as customer claims were substantiated or additional claims arose.
- The filing identifies substantial exposure to leverage, interest rates, foreign exchange, commodity prices, major retail customers, competition, seasonal demand, product safety, litigation, cybersecurity, tax-law changes, and the ability to complete planned divestitures.
- HRG expected a preliminary $26.6 million net payment associated with a possible Section 338(h)(10) tax election related to the FGL transaction, but there was no assurance that the election would be made or that the expected payment would be received.
- Management stated that current litigation, environmental matters, product liability, and warranty claims were not expected to have a material effect based on information available at filing. Environmental, product-liability, and warranty accruals were $4.3 million, $4.0 million, and $5.7 million, respectively.
Important Facts for Investors to Verify
- Confirm the closing status, final proceeds, purchase-price adjustments, and antitrust or other conditions for the Energizer transaction.
- Assess post-redemption liquidity and debt maturity exposure after the January 16, 2018 repayment of the $864.4 million HRG notes.
- Reconcile reported net income and EPS to continuing operations, discontinued operations, the FGL accumulated-other-comprehensive-income reclassification, and provisional Tax Cuts and Jobs Act accounting.
- Monitor whether Spectrum Brands can restore gross margins and operating income after restructuring, recall, start-up, and operational-inefficiency costs.
- Evaluate the deterioration in continuing operating cash flow and the reliance on asset-sale proceeds and subsidiary dividends.
- Review the final accounting for the Tax Cuts and Jobs Act, including the $206.7 million deferred-tax benefit and $78.8 million repatriation-tax provision.
- Verify the outcome of the Section 338(h)(10) election and the estimated $26.6 million related payment.
- Review covenant compliance, revolver availability, variable-rate debt exposure, and restrictions on upstreaming cash from Spectrum Brands.