Spectrum Brands Holdings, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended March 31, 2019; filed May 8, 2019. Results are presented for Spectrum Brands Holdings, Inc. (SBH) and its wholly owned subsidiary SB/RH Holdings, LLC. The company is a global branded consumer products business operating in Hardware & Home Improvement (HHI), Home and Personal Care (HPC), Pet Supplies (PET), and Home and Garden (H&G).
Business Context and Major Transactions
- Completed the sale of Global Batteries & Lights (GBL) to Energizer on January 2, 2019 for $1,956.2 million of cash proceeds.
- Completed the sale of Global Auto Care (GAC) to Energizer on January 28, 2019 for $938.7 million of cash and $242.1 million of Energizer stock.
- GBL and GAC results and disposal gains or losses are reported as discontinued operations. HPC was reclassified from held for sale to continuing operations after management decided in November 2018 to retain the business.
- The company adopted ASC Topic 606 on October 1, 2018 using the modified retrospective method, reducing opening accumulated earnings by $0.7 million net of tax. Management reported no material ongoing impact on revenue or net income.
Financial Performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $906.7 million | $882.6 million | $1,787.0 million | $1,804.9 million |
| Gross profit | $305.5 million | $306.0 million | $611.3 million | $624.6 million |
| Gross margin | 33.7% | 34.7% | 34.2% | 34.6% |
| Operating income | $41.6 million | $31.3 million | $67.0 million | $82.9 million |
| Interest expense | $94.2 million | $67.7 million | $151.2 million | $143.0 million |
| Net income from continuing operations | $(54.0) million | $(34.7) million | $(83.0) million | $62.8 million |
| Income from discontinued operations | $783.6 million | $11.3 million | $700.4 million | $492.7 million |
| Net income attributable to controlling interest | $728.6 million | $(28.9) million | $616.2 million | $478.5 million |
| Diluted EPS | $14.07 | $(0.89) | $11.72 | $14.65 |
- Second-quarter sales increased 2.7%, while organic sales increased 4.9%, offset partly by unfavorable foreign exchange. Six-month sales declined 1.0%, although organic sales increased 0.8%.
- Operating income improved in the quarter despite lower gross margin, primarily because restructuring and transaction-related charges declined. Six-month operating income decreased because of higher depreciation and amortization associated with returning HPC to held-for-use classification.
- Continuing operations remained loss-making, with quarterly and six-month losses attributable to controlling interest of $55.0 million and $84.2 million, respectively.
- Reported net income was dominated by the GBL divestiture gain. GBL generated a $996.3 million pretax gain on sale; GAC recorded a $110.8 million pretax write-down of assets held for sale.
Segment Performance
| Segment | Q2 2019 sales | Q2 sales change | Q2 adjusted EBITDA | Six-month adjusted EBITDA |
|---|---|---|---|---|
| HHI | $331.1 million | +4.0% | $52.7 million | $108.2 million |
| HPC | $221.7 million | -4.1% | $4.5 million | $39.5 million |
| PET | $214.9 million | +1.8% | $32.8 million | $61.9 million |
| H&G | $139.0 million | +14.1% | $29.6 million | $32.7 million |
Consolidated adjusted EBITDA was $115.6 million in the quarter versus $115.9 million in the prior-year quarter, and $230.8 million for the six months versus $248.6 million. HHI and H&G improved, while HPC weakened materially and PET adjusted EBITDA declined despite modest sales growth.
Cash Flow, Debt and Liquidity
- SBH cash used in operating activities was $533.7 million for the six months, including $279.7 million from continuing operations and $254.0 million from discontinued operations. Continuing-operations cash use increased from $257.3 million in the prior-year period.
- Investing activities provided $2,822.1 million, primarily from $2,854.4 million of net proceeds from the GBL and GAC divestitures. Capital expenditures were $27.1 million versus $38.1 million.
- Financing activities used $2,661.6 million, including $2,479.9 million of debt repayments, $268.5 million of treasury-stock purchases, and $44.6 million of shareholder dividends.
- Cash, cash equivalents and restricted cash decreased to $185.1 million at March 31, 2019 from $561.4 million at September 30, 2018; cash and cash equivalents were $176.2 million.
- SBH reported total debt of $2,392.2 million before discounts and issuance costs, with long-term debt net of current maturities of $2,342.0 million. SB/RH reported long-term debt of $2,267.2 million net of current maturities.
- The company repaid its CAD term loan, USD term loan, HRG 7.75% senior notes, and $285.0 million of its 6.625% notes. Revolver availability was $652.4 million, net of letters of credit and other allocations.
- Management stated that the company was in compliance with its debt covenants and expects cash balances and operating cash flows to satisfy operating requirements for at least the next 12 months.
Material Changes, Outlook and Risks
- HPC’s return to continuing operations added approximately $29.0 million of incremental depreciation and amortization during the six months, affecting comparability.
- Restructuring charges were $21.5 million for the six months, with approximately $11.1 million of future costs expected. Project Ignite and other productivity initiatives remain in progress.
- The company recognized $36.6 million of interest expense related to debt extinguishment costs, premiums and write-offs during the six months, contributing to the continuing-operations loss.
- The GBL sale remains subject to a contingent purchase-price adjustment related to Energizer’s planned Varta divestiture. The company estimated a $200.0 million settlement and reported a $229.1 million estimated net settlement payable related to the GBL agreement.
- The company maintains transition-services and supply arrangements with Energizer. At March 31, 2019, it reported a $33.7 million net receivable from Energizer for transition services and related settlements.
- Key operating risks include commodity costs, foreign exchange and interest-rate exposure, retailer concentration, competitive pricing and promotions, seasonality and weather, product liability and recalls, litigation, cybersecurity, regulatory changes, integration and restructuring execution, and substantial indebtedness.
- SBH and SB/RH disclosed that disclosure controls and procedures were not effective because of a previously reported material weakness in internal control over financial reporting. Remediation efforts addressed risk assessment, GAAP changes, unusual transactions, divestitures and discontinued-operations accounting.
- Shareholder securities lawsuits were filed in federal and state courts in 2019. The company believes the claims are without merit, but acknowledges that litigation could result in costs, management distraction and adverse effects.
Investor Verification Checklist
- Verify the final purchase-price adjustments, indemnification settlements and contingent Varta-related payment associated with the GBL divestiture.
- Assess whether HPC sales, margins and adjusted EBITDA recover after the decision to retain the business and the associated incremental depreciation and amortization.
- Reconcile adjusted EBITDA to GAAP results and evaluate the recurring nature of restructuring, transaction, foreign-exchange and other exclusions.
- Monitor operating cash flow, seasonal working-capital requirements, revolver usage, debt maturities and covenant compliance.
- Review the effectiveness and remediation status of internal controls, including controls over unusual transactions and discontinued operations.
- Evaluate the financial exposure from shareholder litigation, product liability, environmental remediation, warranties and other contingencies.
- Confirm the effect of the $242.1 million Energizer equity consideration, including valuation changes, contractual transfer restrictions and any future repurchase rights.