Filing Scope and Reporting Period
Important scope note: The supplied filing is the fiscal 2011 Form 10-K of Harbinger Group Inc. (HGI), not a standalone Spectrum Brands Holdings, Inc. filing. Spectrum Brands is HGI’s majority-owned consumer-products subsidiary and its results are consolidated. The reporting period ended September 30, 2011; “2011 Q4” refers to the fourth quarter within this fiscal year, but the filing primarily reports full-year results.
HGI is a diversified holding company with two operating segments: consumer products through Spectrum Brands and insurance through Fidelity & Guaranty Life Holdings, Inc. (FGL). HGI owned approximately 53.1% of Spectrum Brands at September 30, 2011. The financial statements reflect common-control accounting for the Spectrum Brands acquisition and include FGL only from its April 6, 2011 acquisition date.
Key Financial Metrics
| Metric | Fiscal 2011 | Fiscal 2010 |
|---|---|---|
| Total revenue | $3,477.8 million | $2,567.0 million |
| Consumer-products net sales | $3,186.9 million | $2,567.0 million |
| Insurance revenue | $290.9 million | Not applicable |
| Operating income | $163.7 million | $160.5 million |
| Income from continuing operations | $0.1 million | $(195.5) million |
| Net income attributable to common and participating preferred stockholders | $15.0 million | $(151.9) million |
| Basic EPS | $0.07 | $(1.15) |
| Cash flow from operating activities | $153.1 million | $51.2 million |
| Capital expenditures | $38.2 million | $40.4 million |
| Cash and cash equivalents | $1,137.4 million | $256.8 million |
| Total debt | $2,143.8 million | $1,743.8 million |
| Total assets | $23,579.6 million | $4,016.2 million |
HGI’s consolidated operating margin was approximately 4.7% in fiscal 2011, compared with approximately 6.3% in fiscal 2010. Consumer-products gross margin was 35.4%, down from 35.9%.
- Spectrum Brands net sales increased 24% to $3,186.9 million, principally because fiscal 2011 included a full year of Russell Hobbs operations versus only part of the prior year.
- Spectrum Brands operating income was $227.9 million, compared with $168.8 million. Consumer-products segment profit was $379.6 million before corporate expenses and specified charges.
- Spectrum Brands generated $227.4 million of operating cash flow and ended the year with $142.4 million of cash. Its borrowing availability under the ABL facility was approximately $176.6 million.
- FGL reported $290.9 million of revenue and a reported operating loss of $18.0 million for the period after acquisition. Adjusted pretax operating income, a non-GAAP measure, was $48.0 million.
- FGL’s investment spread was 1.32% annualized, based on a 4.78% average investment yield and 3.46% interest-crediting and option costs.
- FGL held approximately $15.8 billion of investments, with 75.3% in corporate securities. Its fixed-income portfolio was concentrated in BBB-rated securities, representing 44.7% of the portfolio.
Material Changes Versus the Prior Comparable Period
- HGI acquired a controlling interest in Spectrum Brands on January 7, 2011 by issuing approximately 119.9 million HGI common shares in exchange for approximately 27.8 million Spectrum Brands shares.
- HGI acquired FGL for $350 million on April 6, 2011. The acquisition generated a $151.1 million bargain-purchase gain and added approximately $19.3 billion of assets and $18.7 billion of liabilities to the consolidated balance sheet.
- HGI issued $500 million of 10.625% senior secured notes due 2015 and $400 million of preferred stock. Preferred stock carries an 8% cash dividend, 4% annual accretion subject to reduction under specified conditions, and conversion rights that could represent approximately 61.0 million common shares.
- Spectrum Brands refinanced its term loan at a lower interest rate and repaid $225 million of term debt during fiscal 2011. Its term-loan balance declined to approximately $525.2 million from $750.0 million.
- Consumer-products sales growth was led by small appliances, which increased $547 million because of the full-year inclusion of Russell Hobbs. Consumer batteries declined $4 million, primarily due to competitive pressure in Latin America.
- HGI’s reported operating income increased only modestly despite higher revenue because of acquisition and integration expenses, corporate costs, commodity inflation, and a $32.5 million non-cash impairment of trade-name intangibles.
- Net cash provided by operating activities increased by $101.9 million. Investing cash flow benefited from $695 million of net cash acquired in the FGL transaction, while financing cash flow reflected the HGI notes and preferred-stock issuances and Spectrum Brands’ debt repayments.
Guidance, Outlook, Risks and Unusual Items
- Management expected HGI’s cash, cash equivalents and investments to fund corporate requirements for at least the next twelve months, but HGI depends materially on distributions from subsidiaries. Spectrum Brands was not expected to pay dividends in fiscal 2012 absent refinancing of its $245 million 12% notes.
- Spectrum Brands targeted fiscal 2012 operating cash flow less capital expenditures at a level similar to fiscal 2011 and expected approximately $45 million of fiscal 2012 capital expenditures.
- Subsequent to year-end, Spectrum Brands issued an additional $200 million of 9.5% notes, acquired certain Homax brands for $43.8 million, and agreed to acquire FURminator for $140 million, subject to customary conditions.
- FGL’s reserve facility was replaced on October 17, 2011 through a reinsurance transaction with Wilton Re. FGL transferred approximately $595.4 million of cash and invested assets, and the $95 million surplus note was retired. FGL remains directly liable to policyholders if a reinsurer fails to perform.
- The proposed Front Street reinsurance transaction, involving up to $3 billion of FGL obligations and up to $1 billion of managed trust assets, was subject to Maryland regulatory approval. Failure to obtain approval could reduce the FGL purchase price by up to $50 million; the filing states management did not believe a reduction was probable at September 30, 2011.
- Material risks include substantial leverage, restrictive debt covenants, dependence on subsidiary distributions, concentration of Spectrum Brands sales with Wal-Mart at approximately 24% of consumer-products net sales, commodity and foreign-exchange volatility, retailer concentration, integration risk, and FGL’s sensitivity to interest rates, credit markets, equity markets, policy surrenders, reinsurance counterparties and insurance regulation.
- FGL’s financial-strength ratings were below prior levels, including A.M. Best at B++ with a stable outlook, Moody’s at Ba1 with a stable outlook, and Fitch at BBB with a stable outlook. Management noted that ratings pressure had reduced new-policy sales and could increase surrenders.
- HGI disclosed a derivative action alleging that the Spectrum Brands acquisition was financially unfair and seeking damages and rescission. Management considered the allegations without merit. HGI also disclosed Wells Notices and regulatory investigations involving Harbinger Capital affiliates and key personnel; outcomes could not be predicted.
- The filing includes substantial non-comparability caused by Spectrum Brands’ 2009 Chapter 11 emergence and fresh-start accounting, HGI’s common-control acquisition accounting, and the partial-year consolidation of FGL.
Most Important Facts for Investors to Verify
- Confirm whether the intended security is HGI/HRG or Spectrum Brands/SPB; the supplied filing is HGI’s 10-K.
- Reconcile HGI parent-company liquidity with cash held at regulated or debt-constrained subsidiaries and verify the practical availability of subsidiary distributions.
- Review HGI’s $500 million 10.625% notes, minimum-liquidity and collateral covenants, and the pledged Spectrum Brands and subsidiary equity.
- Assess Spectrum Brands’ debt maturities, refinancing needs, ABL availability, and the effect of the additional $200 million notes and subsequent acquisitions.
- Evaluate FGL’s statutory capital, RBC ratios, rating outlook, dividend capacity, reserve facilities, and concentration of reinsurance recoverables with Wilton Re.
- Analyze the sustainability of Spectrum Brands’ sales growth and margins after the Russell Hobbs acquisition, including commodity costs, retailer concentration and integration savings.
- Separate recurring operating performance from the $151.1 million bargain-purchase gain, acquisition costs, derivative volatility, impairment charges, tax valuation allowances and other unusual items.
- Review the disclosed litigation, Wells Notices, regulatory examinations, contingent purchase-price provisions, and potential dilution from approximately 61.0 million preferred-share conversion shares.