Business Context and Reporting Period
This Form 10-Q is filed by HRG Group, Inc., not Spectrum Brands Holdings, Inc., for the quarter and six months ended March 31, 2018. HRG’s principal operating investment was its 62.0% controlling interest in Spectrum Brands, a diversified branded consumer products company operating in pet supplies, home and garden control, hardware and home improvement, and global auto care.
The filing reflects significant 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. The financial statements have been presented accordingly for all periods.
Financial Results and Key Metrics
| Metric | Three months ended March 31 | Six months ended March 31 | ||
|---|---|---|---|---|
| 2018 | 2017 | 2018 | 2017 | |
| Total revenue | $766.1 million | $757.4 million | $1,412.6 million | $1,359.7 million |
| Operating income | $28.9 million | $95.3 million | $55.5 million | $136.6 million |
| Net income from continuing operations | $(37.3) million | $(7.8) million | $40.8 million | $(49.8) million |
| Net income attributable to HRG shareholders | $(37.1) million | $(82.1) million | $470.3 million | $130.1 million |
| Basic EPS | $(0.18) | $(0.41) | $2.34 | $0.65 |
Revenue increased 1.1% in the quarter and 3.9% for the six-month period. Operating income declined 69.7% and 59.4%, respectively. Consolidated interest expense declined to $67.6 million for the quarter and $143.1 million for six months, primarily following the redemption of HRG’s 7.875% senior secured notes.
Continuing operations generated a loss of $37.3 million in the quarter but income of $40.8 million for six months. The six-month result benefited substantially from discontinued operations, including a $445.9 million reclassification of accumulated other comprehensive income related to FGL after its sale. Discontinued operations contributed $0.7 million in the quarter and $501.5 million for six months.
Consumer Products revenue was $766.1 million for the quarter and $1,412.6 million for six months. Consumer Products operating income declined to $43.1 million from $104.8 million in the prior-year quarter and to $77.1 million from $166.3 million for six months. Adjusted EBITDA declined to $115.6 million from $160.2 million in the quarter and to $221.3 million from $265.4 million for six months. Adjusted EBITDA margin was 15.1% versus 21.2% in the quarter and 15.7% versus 19.5% for six months.
Consumer Products gross margin fell to 35.4% from 41.1% in the quarter and to 36.4% from 40.6% for six months. Management attributed the decline to raw-material inflation, unfavorable product mix and weather, restructuring inefficiencies, and higher production costs related to the pet safety recall.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $758.8 million at March 31, 2018, including approximately $616.8 million of corporate cash and $135.2 million held by Spectrum Brands.
- Cash used in operating activities was $185.8 million for the six months, including $234.6 million from continuing operations, compared with total operating cash flow of $109.2 million in the prior-year period.
- Continuing investing activities provided $1,486.9 million, principally from $1,520.2 million of proceeds from the FGL merger and Front Street sale, partially offset by $34.2 million of capital expenditures.
- Continuing financing activities used $711.9 million, including repayment of HRG’s $864.4 million senior secured notes, repayment of $92.0 million of HGI Energy notes, and $258.0 million of Spectrum Brands stock purchases, partly offset by $573.2 million of new debt issuance.
- Total debt was $5.3 billion net of discounts and issuance costs at March 31, 2018, compared with $5.7 billion at September 30, 2017. Noncurrent debt was $5.25 billion.
- Spectrum Brands had $210.0 million of borrowing availability under its $800.0 million revolving facility, net of letters of credit and foreign subsidiary allocations.
- HRG expected cash, available borrowings and subsidiary dividends to cover corporate requirements for at least the next twelve months. Management expected approximately $60.7 million of subsidiary dividends during fiscal 2018, subject to restrictions and approvals.
- Spectrum Brands expected fiscal 2018 capital expenditures of approximately $110 million to $120 million.
Material Changes Versus the Prior Comparable Period
- Consumer Products sales increased, led by hardware and home improvement and acquisitions of PetMatrix and GloFish, but organic sales declined 3.7% in the quarter and 1.2% for six months after excluding acquisitions and foreign currency.
- Quarterly product-line sales changes were: hardware and home improvement up 1.5%, global pet supplies up 10.1%, global auto care down 0.6%, and home and garden control down 10.5%.
- Consumer Products operating income decreased primarily because of lower gross margins, restructuring charges, higher input costs, operating inefficiencies, recall-related costs, and merger transaction expenses.
- Restructuring charges increased to $23.2 million for the quarter and $43.6 million for six months, versus $8.0 million and $10.2 million, respectively, in the prior-year periods.
- Cash operating performance weakened, with continuing operating cash use increasing to $234.6 million from $151.7 million.
- The balance sheet changed materially because the insurance businesses were sold and the GBA segment was classified as held for sale. Current assets of businesses held for sale declined to $2.0 billion from $28.9 billion at September 30, 2017.
- The effective tax rate was unusually volatile, at 3.1% for the quarter and 147.2% for six months, reflecting the Tax Cuts and Jobs Act, provisional deferred-tax remeasurement, deemed repatriation tax, and valuation allowances.
Guidance, Outlook, Risks and Unusual Items
- Spectrum Brands agreed to sell its Global Batteries and Lighting business to Energizer for $2.0 billion in cash, subject to customary adjustments. U.S. antitrust waiting periods had expired, but other closing conditions and international approvals remained. Management continued to expect closing before December 31, 2018.
- Spectrum Brands was actively marketing its Home and Personal Care business and expected a transaction before December 31, 2018; no transaction value was provided.
- HRG and Spectrum Brands entered into a merger agreement under which HRG would acquire the remaining Spectrum Brands interests in exchange for HRG equity. The transaction remained subject to shareholder, regulatory, tax, registration and other closing conditions.
- The pet safety recall generated costs of $3.8 million in the quarter and $11.1 million for six months. Management stated that the estimates were provisional and could change as customer claims were substantiated.
- Remaining estimated restructuring costs were approximately $19.2 million at March 31, 2018. The principal initiatives involved hardware and home improvement distribution consolidation, global auto care rationalization and pet rightsizing.
- Tax accounting remained provisional. Spectrum Brands recorded a $206.7 million deferred-tax remeasurement benefit and $78.0 million of deemed repatriation tax expense for six months. The final amounts could differ materially.
- Key risks include substantial leverage, variable interest rates, commodity and foreign-exchange volatility, customer concentration, seasonal demand and weather, execution of divestitures and the merger, restructuring and integration risks, product liability and recall exposure, tax-law changes, and dependence on subsidiary dividends.
- Management reported no material adverse effect expected from pending litigation, environmental matters or product liability claims based on currently available information and recorded accruals.
Important Facts for Investors to Verify
- Confirm that the intended issuer is HRG Group, Inc.; this filing is not a standalone Spectrum Brands Holdings, Inc. Form 10-Q.
- Reconcile reported earnings with discontinued operations and the $445.9 million FGL accumulated-other-comprehensive-income reclassification.
- Track closing conditions, proceeds, debt repayment and separation costs for the Energizer transaction and the proposed HRG-Spectrum Brands merger.
- Assess whether Spectrum Brands can restore gross margins and operating cash flow while absorbing restructuring, recall, transaction and integration costs.
- Review debt maturities, covenant compliance, revolver availability, variable-rate exposure and the ability to upstream dividends to HRG.
- Monitor final Tax Cuts and Jobs Act accounting, utilization of tax attributes, and potential changes in valuation allowances.
- Evaluate customer concentration: three customers represented 40.3% of quarterly and 37.9% of six-month Spectrum Brands sales.