Spectrum Brands Holdings, Inc. — Q3 FY2019 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended June 30, 2019, compared with the corresponding 2018 periods. Spectrum is a diversified branded consumer products company with four continuing segments: Hardware & Home Improvement (HHI), Home and Personal Care (HPC), Global Pet Care (PET), and Home and Garden (H&G). SB/RH Holdings, LLC is reported concurrently as a wholly owned subsidiary and debt issuer.
The comparison is significantly affected by the January 2019 divestitures of Global Batteries & Lights (GBL) and Global Auto Care (GAC) to Energizer, the decision to retain HPC as a continuing operation, the 2018 Spectrum merger, and related debt refinancing.
Financial results and key metrics
| Metric | Q3 FY2019 | Q3 FY2018 | 9M FY2019 | 9M FY2018 |
|---|---|---|---|---|
| Net sales | $1,022.2 million | $1,029.4 million | $2,809.2 million | $2,834.3 million |
| Gross profit | $361.0 million | $362.7 million | $972.4 million | $987.4 million |
| Gross margin | 35.3% | 35.2% | 34.6% | 34.8% |
| Operating income | $92.8 million | $106.8 million | $159.9 million | $189.6 million |
| Operating margin | 9.1% | 10.4% | 5.7% | 6.7% |
| Net income attributable to controlling interest | $(25.9) million | $405.6 million | $590.3 million | $884.0 million |
| Continuing operations attributable to controlling interest | $(24.7) million | $382.9 million | $(108.8) million | $390.3 million |
| Diluted EPS | $(0.53) | $12.37 | $11.50 | $27.04 |
| Adjusted EBITDA | $172.9 million | $177.7 million | $403.7 million | $426.3 million |
| Adjusted EBITDA margin | 16.9% | 17.3% | 14.4% | 15.0% |
Q3 sales declined 0.7%, while organic sales increased 0.8% excluding currency. Nine-month sales declined 0.9%, while organic sales increased 0.8%. Q3 continuing-operations net loss attributable to controlling interest was $24.7 million, compared with income of $382.9 million in the prior-year quarter, which benefited from unusually favorable tax items.
Cash flow from continuing operating activities was $(186.1) million for the nine months, compared with $(175.2) million in the prior-year period. Total operating cash flow, including discontinued operations, was $(436.5) million. Capital expenditures were $40.3 million. Ending cash and cash equivalents were $161.4 million, compared with $552.5 million at September 30, 2018.
At June 30, 2019, SBH reported total debt of $2,321.4 million before discounts and issuance costs, with net current and long-term debt carrying values totaling approximately $2,289.0 million. Revolver borrowing availability was $724.4 million, net of letters of credit and other allocations. The company stated that it was in compliance with applicable debt covenants.
Material changes versus the prior comparable period
- GBL was sold on January 2, 2019 for $1,956.2 million of cash proceeds and generated a reported pre-tax gain on sale of $990.6 million, subject to purchase-price adjustments and indemnification matters.
- GAC was sold on January 28, 2019 for $938.7 million of cash and $242.1 million of Energizer stock. The transaction resulted in a $110.0 million write-down of assets held for sale.
- Discontinued operations contributed $699.1 million after tax in the first nine months, including divestiture gains, compared with $526.5 million in the prior-year period. Q3 discontinued operations produced a $1.2 million loss.
- HPC was reclassified from held for sale to held for use. The company recorded $29.0 million of incremental depreciation and amortization in the nine months because those charges had previously been suspended.
- Debt was materially reduced using divestiture proceeds. The company repaid the CAD and USD term loans, the former HRG 7.75% notes, and $285.0 million of 6.625% notes. Interest expense declined 46.4% in Q3 and 10.3% in the nine-month period.
- Operating expenses increased 4.8% in Q3 and 1.8% year to date, driven by higher selling and administrative costs, HPC depreciation and amortization, share-based compensation, distribution costs, and restructuring activity.
- The company repurchased 4.6 million shares under its $1 billion authorization for approximately $250.0 million, and repurchased an additional $18.5 million of shares in private employee-related transactions.
Segment performance
| Segment | Q3 sales change | Q3 adjusted EBITDA | 9M sales change | 9M adjusted EBITDA |
|---|---|---|---|---|
| HHI | (4.8%) | $67.7 million; 19.1% margin | (2.6%) | $175.9 million; 17.8% margin |
| HPC | (4.3%) | $18.2 million; 7.5% margin | (5.5%) | $57.7 million; 7.4% margin |
| PET | 13.9% | $39.0 million; 17.6% margin | 5.4% | $100.9 million; 15.7% margin |
| H&G | (2.6%) | $53.3 million; 26.3% margin | 3.5% | $85.9 million; 21.8% margin |
PET was the strongest sales contributor, benefiting from pricing, e-commerce, distribution gains, recovery from the prior-year safety recall, and acquired PetMatrix brands. HPC remained the weakest segment, with lower sales, unfavorable mix, higher input costs, and the effect of reinstated depreciation and amortization. HHI and H&G faced lower volumes, material costs, tariffs, and unfavorable mix.
Outlook, risks, contingencies, and unusual items
- The filing does not provide a clear quantitative revenue, earnings, or cash-flow guidance range. Management stated that existing cash balances and expected operating cash flow should satisfy operating requirements for at least the next 12 months, subject to business and market conditions.
- Project Ignite/global productivity improvement costs totaled $38.1 million through June 30, 2019, with $44.9 million of additional costs forecast through fiscal 2022. Restructuring charges were $20.7 million in Q3 and $42.2 million year to date.
- The company recognized a $33.2 million Q3 and $38.2 million year-to-date unrealized loss on its Energizer investment, plus foreign-currency losses on multicurrency divestiture-related loans of $7.7 million and $29.5 million, respectively.
- The GBL agreement requires Spectrum to contribute up to $200.0 million related to Energizer’s divestiture of the Varta consumer batteries business. Spectrum recorded a $200.0 million reserve and reported additional estimated settlement liabilities associated with the GBL agreement.
- Tax results were affected by June 2019 Treasury and IRS regulations concerning GILTI, foreign dividends, and Subpart F income. The company recorded $95.1 million of tax expense from additional use of net operating losses, a $48.0 million tax benefit from recalculating the mandatory repatriation liability, and a $63.9 million valuation allowance against foreign tax credits.
- The company disclosed securities-related lawsuits and a Securities Act lawsuit arising from the Spectrum merger. Management believes the matters are without merit and does not currently expect a material adverse effect, but potential costs and damages are unspecified.
- Tariffs, particularly on products sourced from China, may require price increases or reduce gross margins. Other principal risks include retailer concentration, commodity and foreign-exchange volatility, debt restrictions, cybersecurity and privacy obligations, product liability, litigation, and reliance on Energizer transition-service arrangements.
- Management reported that disclosure controls and procedures were not effective at June 30, 2019 because of a previously disclosed material weakness in internal control over financial reporting. Remediation efforts addressed risk assessment, GAAP changes, unusual transactions, and divestiture accounting.
Investor verification checklist
- Reconcile continuing-operations earnings and cash flow after removing GBL and GAC divestiture effects and other discontinued operations.
- Assess the sustainability of adjusted EBITDA, including the substantial add-backs for restructuring, share compensation, divestiture costs, Energizer investment losses, and foreign-currency losses.
- Verify debt covenant headroom, revolver availability, maturity schedules, variable-rate exposure, and the effect of debt repayments on future interest expense.
- Review the $200.0 million Varta-related obligation, other GBL and GAC purchase-price adjustments, indemnities, and Energizer transition-service commitments.
- Evaluate HPC’s operating recovery excluding the $29.0 million reinstated depreciation and amortization charge, and monitor continuing weakness in HHI, HPC, and H&G margins.
- Monitor remediation of the material internal-control weakness and the status and potential cost of the disclosed securities litigation.
- Confirm the valuation, lock-up restrictions, dividend rights, and market sensitivity of the Energizer share investment.