Spectrum Brands Holdings, Inc. annual report, FY2012

Filing scope and reporting period

The supplied document is a Form 10-K filed by Harbinger Group Inc. (HGI), not a standalone filing by Spectrum Brands Holdings, Inc. It covers the fiscal year ended September 30, 2012, with unaudited quarterly data for the quarter ended September 30, 2012. Spectrum Brands Holdings is consolidated as HGI’s majority-owned consumer-products subsidiary.

HGI is a diversified holding company with principal interests in Spectrum Brands, Fidelity & Guaranty Life (FGL), Salus Capital Partners and Front Street. HGI owned approximately 57.4% of Spectrum Brands at September 30, 2012.

Key financial metrics

Metric	Fiscal 2012	Fiscal 2011	Change
Consolidated revenue	$4,480.7 million	$3,477.8 million	+29%
Operating income	$409.5 million	$163.7 million	+$245.8 million
Income from continuing operations	$110.7 million	$7.4 million	+$103.3 million
Net income	$110.7 million	$7.4 million	+$103.3 million
Net income attributable to common and participating preferred stockholders	$29.9 million	$22.2 million	+$7.7 million
Basic earnings per common share	$0.15	$0.11	+$0.04
Cash flow from operating activities	$618.7 million	$153.1 million	+$465.6 million
Capital expenditures	$53.5 million	$38.2 million	+$15.3 million
Cash and cash equivalents	$1,470.7 million	$1,137.4 million	+$333.3 million
Total debt	$2,167.0 million	$2,143.8 million	+$23.2 million

The consolidated figures include a full year of FGL in Fiscal 2012 versus approximately six months in Fiscal 2011, limiting direct comparability.

Spectrum Brands operating results

Net sales were $3,252.4 million, up 2% from $3,186.9 million; excluding a $73 million unfavorable foreign-exchange impact, sales increased approximately 4%.
Operating income increased to $301.7 million from $227.9 million.
Adjusted EBITDA increased 6% to $485 million, representing approximately 15% of sales.
Gross profit declined to $1,115.7 million from $1,128.9 million, and gross margin fell to 34.3% from 35.4%, primarily due to foreign exchange, higher commodity and sourced-goods costs, and product mix.
Sales were diversified across consumer batteries, small appliances, pet supplies, home and garden controls, electric shaving and grooming, and electric personal care. Wal-Mart represented approximately 23% of Spectrum Brands’ sales.

Insurance and financial services

Insurance and financial-services revenue was $1,228.3 million, compared with $290.9 million in Fiscal 2011.
FGL’s net investment income was $722.7 million and net investment gains were $410.0 million, compared with a $166.9 million net investment loss in Fiscal 2011.
FGL’s net investment spread increased to 1.28% from 1.24%; average investment yield declined to 4.40% from 4.51%.
FGL’s investment portfolio was approximately $16.6 billion at year-end, primarily consisting of fixed-income securities. Net unrealized gains on available-for-sale investments were approximately $1.1 billion on a US GAAP basis.
Salus originated approximately $260 million of asset-based loan commitments, with $181 million outstanding at year-end; management reported no delinquent loans.

Material changes versus the prior comparable period

Fiscal 2012 benefited from the first full year of FGL ownership, materially increasing consolidated revenue, operating income and operating cash flow.
Spectrum Brands improved operating income and adjusted EBITDA through cost synergies and cost-reduction initiatives, despite lower gross margin.
HGI’s preferred-stock conversion-feature liability increased by $156.6 million, principally because HGI’s stock price rose from $5.07 to $8.43 during Fiscal 2012. This was a non-cash earnings charge.
HGI recorded a $41 million gain related to a contingent purchase-price reduction receivable arising after the Maryland Insurance Administration rejected a proposed Front Street reinsurance transaction.
HGI’s consolidated valuation allowance for deferred tax assets decreased by approximately $142 million, producing an $85.3 million income-tax benefit despite pretax income of $25.4 million.
Spectrum Brands refinanced or amended portions of its capital structure, including issuing $300 million of 6.75% notes, increasing its 9.5% notes to $950 million, repaying its 12% notes and amending its term loan and ABL facility.
FGL’s gross unrealized investment losses decreased to approximately $30.5 million from $234.8 million, while its investment portfolio increased to approximately $16.7 billion from $15.8 billion.

Liquidity, debt and outlook

HGI reported approximately $433 million of corporate cash, cash equivalents and short-term investments at September 30, 2012. Management stated that available liquidity was adequate for at least the next twelve months under then-current operations.
HGI had $500 million of 10.625% senior secured notes due November 2015 and was in compliance with applicable covenants at year-end.
Spectrum Brands had $370.2 million outstanding under its term loan, $950 million of 9.5% notes, $300 million of 6.75% notes and no borrowings under its ABL facility. ABL availability was approximately $198.2 million.
After year-end, Spectrum Brands issued $520 million of 6.375% notes due 2020 and $570 million of 6.625% notes due 2022. It also obtained commitments for approximately $1.84 billion of financing to fund the Hardware Acquisition and refinance existing debt.
Spectrum Brands expected to fund Fiscal 2013 requirements through cash on hand, operating cash flow and available ABL borrowings. HGI expected future FGL and Spectrum Brands distributions to fund a substantial portion of corporate obligations.

Guidance, outlook, risks and unusual items

The filing does not provide formal consolidated earnings or revenue guidance. Management expects continued acquisition activity and higher corporate costs associated with oversight, integration and additional personnel.
Spectrum Brands agreed to acquire Stanley Black & Decker’s residential hardware and home-improvement business for $1.4 billion. Closing was subject to regulatory, financing and other conditions; termination fees could reach $78 million in specified circumstances.
HGI agreed to form an EXCO Resources joint venture to acquire producing conventional oil and gas assets for approximately $725 million. HGI expected to contribute $372.5 million in cash and receive an approximately 74.5% economic interest. Closing was subject to diligence, approvals, consents and financing; HGI could owe a $60 million termination fee under specified circumstances.
Key risks include substantial leverage, restrictive debt covenants, dependence on subsidiary distributions, retailer concentration, commodity prices, foreign exchange, consumer demand, supply-chain and third-party manufacturing exposure, insurance investment and interest-rate risk, reinsurance counterparty risk, regulatory capital requirements and acquisition-integration risk.
FGL remains directly liable to policyholders even when risks are ceded to reinsurers. Net reinsurance recoverables from Wilton Re were approximately $1.3 billion, creating material counterparty exposure.
FGL recorded an $11 million benefit expense, net of reinsurance, for potential unreported death claims identified through use of the Social Security Administration’s Death Master File. Additional costs related to regulatory developments could not be estimated clearly.
HGI was a nominal defendant in derivative litigation alleging that the Spectrum Brands acquisition was financially unfair. The filing states that management believes the claims are without merit, but the ultimate outcome is uncertain.

Most important facts for an investor to verify

Confirm that the intended issuer is HGI rather than Spectrum Brands Holdings, and use Spectrum Brands’ separate SEC filing for issuer-level analysis.
Separate recurring operating performance from FGL’s full-year consolidation, investment gains, the $41 million purchase-price gain, the $142 million tax valuation-allowance release and the $156.6 million preferred conversion-feature charge.
Reconcile Spectrum Brands’ post-year-end Hardware Acquisition financing, expected leverage and covenant capacity.
Assess whether subsidiary cash can be distributed to HGI given Spectrum Brands’ debt restrictions and FGL’s insurance-regulatory capital and dividend limitations.
Review FGL’s interest-rate sensitivity, investment portfolio quality, FIA embedded-derivative exposure and dependence on Wilton Re and other reinsurers.
Evaluate the conditions, financing, valuation, environmental diligence and termination-fee exposure associated with the EXCO/HGI joint venture.
Verify the treatment and recoverability of deferred tax assets, including substantial NOL carryforwards subject to Section 382 limitations.