Business context and reporting period
This filing is the Fiscal 2013 Form 10-K of Harbinger Group Inc. (HGI), not a standalone Spectrum Brands Holdings filing, for the year ended September 30, 2013. HGI is a diversified holding company with four reporting segments: Consumer Products, Insurance, Energy and Financial Services. HGI owned approximately 59.2% of Spectrum Brands at year-end.
Fiscal 2013 included Spectrum Brands’ HHI Business operations from December 17, 2012, the EXCO/HGI joint venture from February 14, 2013, and the TLM Taiwan acquisition from April 8, 2013.
Key financial metrics
| Metric | Fiscal 2013 | Fiscal 2012 | Change |
|---|---|---|---|
| Consolidated revenue | $5,543.4 million | $4,480.7 million | +23.7% |
| Operating income | $737.4 million | $409.5 million | +80.1% |
| Income before taxes | $118.3 million | $25.4 million | +$92.9 million |
| Net income | $(69.0) million | $110.7 million | Decline of $179.7 million |
| Net loss attributable to common and participating preferred stockholders | $(94.2) million | $29.9 million | Decline of $124.1 million |
| Diluted loss per common share | $(0.67) | $0.15 | Declined from profit to loss |
| Cash provided by operating activities | $522.3 million | $622.5 million | Down $100.2 million |
| Capital expenditures | $100.1 million | $53.5 million | Up $46.6 million |
| Cash and cash equivalents | $1,899.7 million | $1,470.7 million | Up $429.0 million |
| Total debt | $4,896.1 million | $2,167.0 million | Up $2,729.1 million |
| Total stockholders’ equity | $1,133.5 million | $1,598.9 million | Down $465.4 million |
Operating margin was approximately 13.3% in Fiscal 2013 versus 9.1% in Fiscal 2012. The reported net loss was affected by $187.3 million of income tax expense, including a $152.8 million non-cash increase in valuation allowances, $101.6 million of loss from the preferred-stock conversion feature, and $54.3 million of oil and gas impairment charges.
Segment performance
- Consumer Products: Revenue increased to $4,085.6 million from $3,252.4 million, primarily from the HHI Business. Operating income rose to $351.2 million from $301.8 million. Gross margin declined to 34.0% from 34.3%. Adjusted EBITDA was $677.1 million, with a 15.8% margin, unchanged from Fiscal 2012.
- Insurance: Revenue increased to $1,348.4 million from $1,221.8 million. Operating income rose to $522.9 million from $159.9 million, while adjusted operating income increased to $221.4 million from $57.9 million. Results benefited from reserve and assumption changes, investment gains and favorable immediate-annuity mortality experience.
- Energy: The newly formed EXCO/HGI JV generated $90.2 million of revenue and an operating loss of $45.2 million, including the $54.3 million impairment. Adjusted EBITDA was $39.6 million. HGI’s proportionate share of EXCO/HGI JV debt was $271.2 million.
- Financial Services: Revenue increased to $28.9 million from $8.6 million and operating income increased to $10.4 million from $2.5 million. Salus loans outstanding increased to $560.4 million; no loans were delinquent at year-end.
Material changes versus the prior comparable period
- Spectrum Brands acquired the HHI Business for approximately $1.375 billion, including TLM Taiwan, adding residential locksets, builders’ hardware and plumbing products.
- HGI formed the EXCO/HGI JV and acquired conventional oil and gas properties; the JV also acquired shallow Cotton Valley assets for approximately $130.7 million.
- HGI issued $925.0 million aggregate principal amount of 7.875% senior secured notes and retired substantially all of its 10.625% notes.
- Spectrum Brands refinanced debt, assumed $1.09 billion of senior notes in connection with the HHI acquisition, and completed a $1.15 billion term-loan refinancing used partly to retire its 9.5% notes.
- FGH issued $300.0 million of 6.375% senior notes due 2021 and paid a $73.0 million special dividend to HGI from the proceeds.
- HGI’s investment portfolio experienced a significant increase in unrealized losses as interest rates rose. Gross unrealized losses increased to $263.9 million from $30.6 million.
- HGI repurchased 1.7 million common shares for $12.3 million under a $50 million authorization. HGI did not declare common-stock dividends.
Liquidity, debt and outlook
HGI reported approximately $301.2 million of corporate cash, cash equivalents and short-term investments at September 30, 2013, excluding cash held by FGL and Spectrum Brands. Management expected approximately $117.0 million of Fiscal 2014 subsidiary dividends and believed cash on hand and expected distributions would cover corporate interest, preferred dividends and general administrative expenses for at least the next twelve months. Actual upstream distributions remain subject to subsidiary board approval, debt covenants and insurance-regulatory restrictions.
HGI’s direct annual interest burden on its 7.875% notes was approximately $72.8 million, and preferred-stock cash dividends were approximately $32.9 million annually. Spectrum Brands held $207.3 million of cash and expected Fiscal 2014 capital expenditures of approximately $70 million to $75 million. Its ABL facility had approximately $288.9 million of availability, net of reserves and letters of credit.
The EXCO/HGI JV had a $470.0 million borrowing base, $364.0 million drawn, and $105.5 million of unused borrowing capacity at September 30, 2013. Management indicated that distributions to partners would be suspended during the first half of Fiscal 2014 to focus on reducing borrowings. The next borrowing-base redetermination could reduce liquidity.
Management commentary, risks and unusual items
- Management highlighted acquisition-led growth, cost reductions, operating synergies, expansion of Spectrum Brands’ product portfolio, growth in Salus lending and development of the EXCO/HGI JV.
- Major risks include substantial consolidated and subsidiary debt, restrictive covenants, refinancing requirements, dependence on subsidiary distributions, and potential changes in borrowing bases or insurance dividend capacity.
- Spectrum Brands faces integration risk related to the HHI Business, customer concentration, commodity costs, foreign exchange, retailer bargaining power, seasonal demand, environmental liabilities and the scheduled expiration of certain Stanley Black & Decker trademark rights.
- FGL faces interest-rate, credit, equity-market, policyholder surrender, reinsurance-counterparty, insurance-regulatory and financial-strength-rating risks. Wilton Re and Front Street represented approximately $1.5 billion and $1.4 billion, respectively, of reinsurance recoverables.
- FGL’s insurance subsidiaries had a reported RBC ratio of 450% at September 30, 2013, versus 406% at December 31, 2012, but regulatory and rating-agency capital requirements may change.
- The EXCO/HGI JV is exposed to oil and gas price volatility, reserve-estimation risk, production and drilling performance, environmental regulation, pipeline availability and joint-venture dependence on EXCO.
- HGI disclosed a Delaware derivative action concerning the Spectrum Brands acquisition, FGL regulatory and escheatment matters, ongoing market-conduct examinations and litigation concerning the contingent FGL purchase-price reduction. The filing does not indicate that these matters are expected to be material, but outcomes remain uncertain.
- HGI’s CEO Philip Falcone and Harbinger Capital were subject to SEC-related settlement restrictions and insurance-regulatory commitments that limit involvement in certain FGL activities.
Most important facts for investors to verify
- Confirm that the filing is HGI’s consolidated 10-K and distinguish HGI results from Spectrum Brands’ standalone results.
- Reconcile the $4.896 billion consolidated debt balance, maturities, interest obligations and subsidiary-level covenant requirements.
- Assess whether expected Fiscal 2014 subsidiary dividends of approximately $117 million are legally and operationally available to HGI.
- Evaluate the sustainability of Insurance segment earnings excluding investment gains, reserve assumption changes and other unusual items.
- Review Spectrum Brands’ HHI integration progress, realized synergies, margins, customer concentration and trademark-transition requirements.
- Review the EXCO/HGI JV’s borrowing-base redetermination, reserve revisions, impairment risk, hedging positions and planned suspension of distributions.
- Examine FGL’s reinsurance recoverables, statutory capital, RBC ratios, rating-agency actions and regulatory examinations.
- Consider dilution and senior claims associated with preferred stock convertible into approximately 62.0 million common shares.
- Verify the recoverability of deferred tax assets and the $817.2 million consolidated valuation allowance, including Section 382 limitations.
- Review the effect of rising interest rates on FGL’s $15.3 billion fixed-maturity portfolio, which had $263.9 million of gross unrealized losses at year-end.