Filing scope and business context
The provided filing is a Form 10-Q for Harbinger Group Inc. (HGI), not a standalone Spectrum Brands Holdings, Inc. filing. It covers the three and six months ended March 31, 2013, compared with April 1, 2012, and includes Spectrum Brands as HGI’s 57.4%-owned Consumer Products subsidiary. HGI also reports Insurance, Energy and Financial Services segments.
During the period, HGI completed or advanced several major transactions: Spectrum Brands acquired Stanley Black & Decker’s Hardware and Home Improvement business; HGI formed the EXCO/HGI oil and gas partnership; FGL issued senior notes and entered into a related-party reinsurance arrangement; and Salus completed a collateralized loan obligation securitization.
Key financial metrics
| Metric | Three months ended March 31, 2013 | Prior comparable period | Six months ended March 31, 2013 | Prior comparable period |
|---|---|---|---|---|
| Total revenues | $1,411.9 million | $1,105.7 million | $2,634.2 million | $2,271.7 million |
| Operating income | $134.0 million | $95.9 million | $349.4 million | $207.7 million |
| Income from continuing operations before tax | $15.5 million | $16.7 million | $148.0 million | $101.7 million |
| Net income | $(50.5) million | $(0.2) million | $17.6 million | $45.3 million |
| Net income attributable to controlling interest | $(33.3) million | $12.0 million | $40.8 million | $51.5 million |
| Net income attributable to common and participating preferred stockholders | $(45.5) million | $(3.9) million | $16.5 million | $19.9 million |
| Diluted EPS attributable to controlling interest | $(0.33) | $(0.03) | $0.06 | $0.10 |
| Net cash provided by operating activities | Not separately reported for the quarter | Not separately reported for the quarter | $(87.4) million | $106.3 million |
The quarterly operating margin was approximately 9.5%, compared with approximately 8.7% in the prior-year quarter. The six-month operating margin was approximately 13.3%, compared with approximately 9.1%.
- Consumer Products revenue increased 32.4% in the quarter and 16.5% for six months, primarily from the Hardware Acquisition. Consumer Products operating income declined to $52.3 million from $55.2 million in the quarter and to $120.4 million from $138.9 million for six months.
- Consumer Products gross margin declined to 32.7% from 34.8% in the quarter and to 32.9% from 34.1% for six months, largely because acquired HHI inventory was revalued to fair value and expensed as sold.
- Insurance revenue increased to $402.7 million from $359.1 million in the quarter and to $746.3 million from $676.3 million for six months. Insurance operating income increased to $109.4 million from $55.8 million in the quarter and to $273.0 million from $91.0 million for six months.
- Insurance net investment gains were $206.7 million in the quarter and $353.2 million for six months, including gains on securities and derivatives. These gains are volatile and are not representative of recurring operating performance.
- FGL’s reported net investment spread was 1.24% in the quarter and 1.10% for six months, versus 1.20% and 1.27%, respectively, in the prior periods.
- Energy contributed $16.7 million of revenue and $0.5 million of operating income from inception of the EXCO/HGI Partnership through March 31, 2013.
- Financial Services operating income was $5.2 million in the quarter and $12.5 million for six months, compared with losses of $0.8 million and $1.0 million, respectively.
Balance sheet, debt and liquidity
- Total assets were $27.7 billion at March 31, 2013, compared with $25.2 billion at September 30, 2012. Cash and cash equivalents were $1.475 billion; HGI separately reported corporate cash, cash equivalents and investments of approximately $208.5 million.
- Total debt increased to $4.597 billion from $2.167 billion, primarily because of acquisition and refinancing activity. Total liabilities were $25.791 billion and permanent equity was $1.599 billion.
- HGI issued $700.0 million of 7.875% senior secured notes and retired its remaining 10.625% notes. The refinancing generated $58.9 million of interest expense, including $13.0 million of non-cash debt-cost write-offs.
- Spectrum Brands had $795.0 million outstanding under its new term loan, $2.34 billion of senior notes, $76.5 million drawn under its ABL facility and approximately $238.4 million of ABL borrowing availability after reserves and letters of credit.
- FGL issued $300.0 million of 6.375% senior notes due 2021 and paid a $73.0 million special dividend to HGI from the proceeds.
- The EXCO/HGI Partnership had $374.0 million drawn under its credit agreement, with HGI’s proportionate share of $278.6 million. Its borrowing base was $470.0 million, leaving $96.0 million of unused borrowing base before cash.
- HGI received $101.1 million of subsidiary dividends during the first six months, including $93.0 million from FGL, $7.4 million from Spectrum Brands and $0.7 million from Salus. Management expected approximately $34 million of additional dividends during the remainder of fiscal 2013.
Material changes versus the prior comparable period
- Revenue and operating income increased substantially because of the HHI acquisition, higher Insurance investment gains, the new Energy partnership and expanded Salus activity.
- Net income attributable to common and participating preferred stockholders fell to a quarterly loss of $45.5 million from a loss of $3.9 million, despite higher operating income. The primary factors were a $39.6 million loss from remeasuring the preferred stock conversion feature and $66.0 million of income tax expense.
- The quarterly effective tax rate was 425.8%; the six-month rate was 88.1%. The unusual rates reflected valuation allowances on tax benefits, deferred tax effects related to indefinite-lived intangibles and taxes in jurisdictions where benefits were not creditable. A $49.3 million release of Spectrum Brands valuation allowances partly offset six-month tax expense.
- Operating cash flow changed from $106.3 million provided to $87.4 million used. Investing cash flow changed from $793.2 million provided to $1.992 billion used, primarily due to acquisitions. Financing cash flow increased to $2.086 billion provided, primarily from new debt issuance.
- Goodwill increased from $694.2 million to $1.434 billion and total intangibles increased from $1.989 billion to $2.468 billion, principally from acquisitions. HHI goodwill and acquired intangible values remained provisional.
Guidance, outlook, risks and unusual items
- Management stated that HGI’s available cash, investments and expected subsidiary distributions should fund operating and capital requirements for at least the next twelve months, but future acquisitions may require additional debt or equity financing.
- Spectrum Brands expected $49 million to $59 million of capital expenditures for the remaining six months of fiscal 2013 and $75 million to $100 million of foreign cash generation and repatriation.
- The EXCO/HGI Partnership forecast a 2013 consolidated capital budget of $28.4 million, of which HGI’s proportionate share was $21.1 million. Management expected low natural gas prices to persist and noted potential pressure on borrowing capacity and leverage covenants.
- The EXCO/HGI Partnership was in compliance with its covenants at March 31, 2013: current ratio of 3.4-to-1 versus a 1.0 minimum, and funded debt to EBITDAX of 3.9-to-1 versus a 4.5 maximum.
- HGI recognized a $41.0 million receivable related to a potential FGL purchase-price reduction, but recovery depends on litigation and regulatory outcomes. The filing states that HGI is pursuing recovery of up to $50.0 million.
- The SEC had granted a temporary exemption from the oil and gas ceiling test for recently acquired conventional properties. Without the exemption, the calculated ceiling test limitation exceeded carrying costs by approximately $234 million. A future impairment remains possible if commodity prices decline or the valuation support is no longer adequate.
- Spectrum Brands recorded $43.9 million of acquisition and integration charges during the first six months, primarily related to HHI and the EXCO/HGI Partnership. It expected approximately $15 million of HHI integration costs and approximately $90 million of transaction-related fees and other costs overall.
- Material risks include substantial leverage, debt covenant compliance, dependence on subsidiary distributions, integration of HHI, customer concentration, commodity and interest-rate volatility, insurance investment and policyholder risks, reinsurance and counterparty risk, regulatory limitations on insurance dividends, and oil and gas reserve, production and environmental risks.
- The Principal Stockholders pledged a majority of HGI common shares as collateral for portfolio financing. A foreclosure or other disposition could trigger change-of-control provisions, debt acceleration, counterparty termination rights and limitations on tax attributes.
- On April 8, 2013, after quarter-end, Spectrum Brands completed the $100.0 million acquisition of TLM Taiwan, the final step of the Hardware Acquisition. The preliminary purchase-price allocation was not yet available.
Most important facts for investors to verify
- Confirm that the relevant issuer is HGI rather than Spectrum Brands Holdings, Inc.; this filing consolidates Spectrum Brands but is not Spectrum Brands’ standalone 10-Q.
- Assess whether HHI integration delivers the anticipated revenue, margin and cash-flow benefits after provisional inventory, goodwill and intangible valuations are finalized.
- Reconcile reported earnings with volatile Insurance investment gains, derivative fair-value changes, preferred-stock remeasurement losses and unusually high tax expense.
- Review consolidated and subsidiary debt maturities, interest costs, covenant headroom and the availability of upstream dividends to HGI.
- Evaluate the sustainability of FGL dividends and the impact of insurance regulatory capital, rating requirements and reinsurance arrangements.
- Monitor oil and gas prices, reserve estimates, ceiling-test exposure, borrowing-base redeterminations and EXCO/HGI Partnership leverage.
- Track the $41.0 million contingent purchase-price receivable, related litigation and the probability of recovering the full potential $50.0 million reduction.
- Review acquisition-related contingencies, legal reserves, customer concentration and the $140.9 million of unfunded Salus lending commitments.