Fortune Brands Home & Security, Inc. (now identified in the request as Fortune Brands Innovations) — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The filing was made under the name Fortune Brands Home & Security, Inc. Amounts below are in millions of dollars, except per-share data and percentages. Interim results are unaudited.
Business context and financial performance
The company makes branded cabinetry, plumbing products, entry doors and security products for home repair, remodeling and new construction. Its segments are Cabinets, Plumbing, Doors and Security. Comparisons are affected by Norcraft, acquired in May 2015, and a plumbing acquisition completed in May 2016.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $1,297.8 | $1,165.1 | $2,404.3 | $2,115.9 |
| Operating income | $187.7 | $128.2 | $283.2 | $195.5 |
| Net income from continuing operations | $125.1 | $78.0 | $186.1 | $118.9 |
| Diluted EPS from continuing operations | $0.80 | $0.48 | $1.18 | $0.73 |
| Operating margin | 14.5% | 11.0% | 11.8% | 9.2% |
Q2 sales increased 11.4% and operating income increased 46.4% year over year. For the first half, sales rose 13.6% and operating income 44.9%. Sales growth reflected Norcraft, higher volume amid improving U.S. home-product markets, pricing and favorable mix; foreign exchange and higher rebates partly offset gains. Productivity also supported earnings. Security was the only segment with lower operating income in both comparisons.
Six-month gross margin, calculated from reported sales and cost of products sold, was approximately 35.5%, versus 34.4% in 2015. The effective tax rate was 27.9% for the first half versus 35.0%; early adoption of stock-compensation accounting contributed a $14.2 million tax benefit and $0.09 to first-half basic and diluted EPS. Q2 included a $9 million tax benefit, adding $0.06 to basic and diluted EPS.
Cash flow, debt and liquidity
- First-half operating cash flow was $165.0, versus $55.4 in 2015. Capital expenditures were $74.7; cash used in investing was $155.6, including $81.2 for acquisitions.
- Cash and equivalents were $278.7 at June 30, 2016, including $215.2 held outside the U.S. Current assets were $1,542.6 and current liabilities $717.9.
- Long-term debt was $1,600.4, compared with $1,168.7 at December 31, 2015; notes payable to banks were $3.2. The company reported covenant compliance.
- In June, the company rolled its revolving facility and term loan into a $1.25 billion revolving credit facility maturing in June 2021. Borrowings under the facility were $710.0 at quarter-end. Senior notes had a carrying value of $890.4, with $400 million due 2020 at 3% and $500 million due 2025 at 4%.
- First-half financing included $362.7 of share repurchases and $49.0 of dividends. The company said approximately $285 million remained under its repurchase authorization at June 30.
Material changes and unusual items
- Norcraft contributed approximately $150 million of first-half sales and about $15 million of operating income, net of severance costs. The 2015 comparison included $14.9 million of Norcraft transaction costs that did not recur in 2016.
- The May 2016 plumbing acquisition cost $88.4 million in cash; its Q2 sales and operating income were not material to the company.
- Waterloo, sold in September 2015, is presented as discontinued operations. The filing reports no discontinued-operation income in 2016, compared with $0.8 million for the first half of 2015.
- The company early adopted ASU 2016-09, changing income-statement and cash-flow presentation of certain stock-compensation tax effects. It also disclosed an immaterial prior-period misclassification of first-quarter 2016 debt issuance and repayment cash flows; total financing cash flow was unaffected.
- A favorable court decision made realization of a retiree health-plan amendment benefit probable. The resulting remeasurement reduced accrued retiree benefit liabilities by $10.7 million; related prior-service credits are to be amortized over the 11 months after June 30.
- A new China manufacturing joint venture generated an $8.2 million fair-value liability for contractual payments and a 2024 preferred-share redemption.
Outlook, commentary and risks
Management described the U.S. home-products market as recovering and said it expects continued profitable organic growth as housing and consumer demand improve. It cited potential operating leverage and strategic investment, but provided no specific quantitative earnings or revenue guidance in the supplied filing text. Management noted that operating cash flow is seasonal and is typically strongest in the third and fourth quarters; it expected approximately $1 million of pension contributions in 2016.
Risks identified include reliance on North American repair, remodeling and construction activity; economic conditions; acquisition integration; competition and innovation; key customers and suppliers; raw-material and transportation costs; foreign exchange; pension costs and funding; regulatory and tax matters; and international operations. Litigation and environmental remediation matters were disclosed; management did not expect them to have a material adverse effect, while noting uncertainty in outcomes and remediation estimates. The company also warned that repatriating certain foreign cash could trigger tax expense. It reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much reported growth and margin improvement reflects Norcraft and other acquisitions versus organic volume, pricing, mix and productivity.
- Whether the $14.2 million stock-compensation tax benefit is nonrecurring, and its effect on comparable EPS and the effective tax rate.
- Debt and interest-rate exposure after the increase in revolver borrowings, including liquidity and covenant headroom.
- The pace and price of share repurchases, remaining authorization, and cash availability given foreign-held balances and acquisition needs.
- Whether Security-segment weakness, restructuring costs, sales rebates, foreign exchange and raw-material pressures persist.