Spectrum Brands Holdings, Inc. quarterly report, Q2 FY2012

Filing Scope and Business Context

The supplied Form 10-Q is filed by Harbinger Group Inc. (HGI), not Spectrum Brands Holdings, Inc. It covers the three and six months ended April 1, 2012, compared with April 3, 2011, and was filed May 10, 2012. HGI consolidates a 57.4% interest in Spectrum Brands and owns Fidelity & Guaranty Life Holdings (FGL), an insurance business. Salus Capital Partners began operations in January 2012.

Financial Performance and Position

Metric	Three Months Ended April 1, 2012	Six Months Ended April 1, 2012
Total revenues	$1.106 billion	$2.272 billion
Operating income	$95.9 million	$207.7 million
Income before taxes	$16.7 million	$101.8 million
Net income	$(0.2) million	$45.3 million
Net income attributable to common and participating preferred stockholders	$(3.9) million	$19.9 million
Basic diluted EPS attributable to common stock	$(0.02)	$0.10

Consumer Products net sales were $746.3 million for the quarter and $1.595 billion for the six months. Consumer Products operating income was $55.3 million and $139.0 million, respectively.
Insurance and Financial Services revenues were $359.4 million for the quarter and $676.6 million for the six months. Insurance segment operating income was $56.3 million and $92.9 million, respectively.
Consumer Products gross margin declined to approximately 35% for the quarter and 34% for the six months, from 37% and 36%, respectively, in the comparable periods.
For the insurance business, net investment spread was 1.16% for the quarter and 1.29% for the six months. Pretax adjusted operating income, a non-GAAP measure, was $14 million and $38 million, respectively.
Six-month operating cash flow was $106.4 million, compared with cash used of $133.5 million in the prior-year period. Investing activities provided $793.1 million, principally reflecting investment sales and maturities.
Cash and cash equivalents totaled $2.320 billion at April 1, 2012, including $303.4 million in Consumer Products and $2.016 billion in Insurance and Financial Services. HGI reported approximately $470 million of cash, cash equivalents and short-term investments excluding amounts held by FGL and Spectrum Brands.
Total assets were $24.535 billion and total liabilities were $22.832 billion at April 1, 2012.
Consumer Products and Other debt was $2.379 billion, including HGI's $500 million of 10.625% senior secured notes, Spectrum Brands' $950 million of 9.5% senior secured notes, $523 million term loan, $300 million of 6.75% senior notes and $50 million drawn under the ABL facility.

Material Changes Versus the Prior Comparable Period

Total revenues increased $411.8 million for the quarter and $716.8 million for the six months, primarily because FGL was not included in the 2011 reported periods. On a comparable basis, FGL pro forma revenue was $1.035 billion for the 2011 quarter and $2.241 billion for the 2011 six months.
Consumer Products sales increased 8% for the quarter and 3% for the six months. Growth was led by home and garden products, pet supplies, batteries and small appliances. The Black Flag and FURminator acquisitions contributed to growth.
Consumer Products gross profit margin declined because of higher commodity prices, Asian supply-chain costs, product mix and restructuring costs related to a Colombian battery facility closure.
Consolidated operating income increased from $22.4 million to $95.9 million for the quarter and from $87.1 million to $207.7 million for the six months. The improvement reflected the FGL contribution, lower acquisition-related expenses and Spectrum Brands cost synergies.
The company completed a Spectrum Brands refinancing: $300 million of 6.75% notes due 2020 were issued, while approximately $245 million of 12% toggle notes were repaid or discharged. The transaction generated $27.5 million of interest expense charges.
FGL's investment portfolio declined from $15.751 billion to $14.985 billion, while cash and reinsurance recoverables increased. Gross unrealized investment losses improved to $64.5 million from $234.8 million.
Net income attributable to common and participating preferred stockholders improved from an $82.0 million loss to $19.9 million of income for the six months, but the quarter remained slightly loss-making after preferred dividends and accretion.

Outlook, Risks, Contingencies and Unusual Items

Management expected remaining fiscal 2012 operating costs to increase because of acquisition activity, corporate oversight and hiring, partly offset by Spectrum Brands synergies and cost-reduction savings.
HGI expected cash, investments and distributions from FGL to fund holding-company needs for at least the next twelve months. FGL dividend capacity remains subject to regulatory approval, statutory capital requirements and rating-agency expectations.
Spectrum Brands expected to fund the remainder of fiscal 2012 through cash, operating cash flow and ABL borrowings, with approximately $26 million of capital expenditures anticipated. Borrowing availability under the ABL facility was approximately $125 million after reserves and letters of credit.
The Maryland Insurance Administration rejected the proposed Front Street reinsurance transaction. Management recorded a $41 million receivable, reflecting an estimated reduction of the FGL acquisition purchase price from a potential $50 million reduction. Collection remains subject to litigation, regulatory action and timing risks.
FGL had a significant concentration of reinsurance recoverables with Wilton Re; the net recoverable was approximately $1.250 billion. Future settlement adjustments remained possible.
Market-related earnings were unusually significant. FGL recorded $267.5 million of net investment gains for the six months, including $133.8 million of derivative gains, while changes in FIA embedded derivatives can produce substantial earnings volatility.
Key risks include substantial leverage, restrictive debt covenants, commodity and foreign-exchange volatility, dependence on major retailers, insurance regulation, interest-rate and equity-market movements, investment impairments, reinsurance counterparty risk and limitations on subsidiary distributions.
HGI's principal stockholders pledged a majority of the company's common shares as collateral. A foreclosure or other disposition could trigger change-of-control provisions, debt acceleration, counterparty termination rights and tax-attribute limitations.
Legal, environmental and regulatory reserves totaled approximately $14.2 million. Spectrum Brands had approximately $8.1 million reserved for environmental remediation. The filing states that material adverse outcomes were not expected based on information then available.

Investor Verification Checklist

Confirm the intended issuer: the supplied filing is HGI's Form 10-Q, not Spectrum Brands Holdings' standalone Form 10-Q.
Reconcile Spectrum Brands' standalone revenue, EBITDA, cash flow, debt and covenant compliance using Spectrum Brands' own filing.
Assess the sustainability of FGL's investment gains and the 1.16% quarterly net investment spread, excluding market-sensitive derivative effects.
Review HGI's ability to receive dividends from FGL and other subsidiaries given insurance regulation and subsidiary debt restrictions.
Verify the $41 million contingent purchase-price receivable and the status of related litigation or regulatory proceedings.
Analyze Spectrum Brands' refinancing, approximately $1.8 billion of debt, ABL availability and required interest payments.
Stress-test exposure to interest rates, equity markets, credit spreads, foreign exchange, commodities and reinsurance counterparties.
Consider dilution and seniority from HGI's redeemable preferred stock, which was convertible into approximately 62.2 million common shares as of April 1, 2012.