Business Context and Reporting Period
This Form 10-Q is for HRG Group, Inc., not a standalone Spectrum Brands filing, for the three months ended December 31, 2016, filed February 7, 2017. HRG is a holding company with a 58.3% controlling interest in Spectrum Brands, insurance and reinsurance operations through Front Street and FGL, and smaller corporate, lending and other activities. FGL was classified as held for sale and its results were reported as discontinued operations.
Key Financial Metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Total revenues | $1,189.6 million | $1,209.4 million | Down $19.8 million |
| Operating income | $117.7 million | $99.8 million | Up $17.9 million |
| Income from continuing operations | $2.0 million | $9.5 million | Down $7.5 million |
| Net income | $260.8 million | $7.0 million | Up $253.8 million |
| Net income attributable to controlling interest | $212.2 million | $(33.9) million | Improved $246.1 million |
| EPS attributable to controlling interest | $1.06 | $(0.17) | Improved $1.23 |
| Operating cash flow from continuing operations | $7.9 million | $(221.3) million | Improved $229.2 million |
| Capital expenditures | $28.0 million | $17.4 million | Up $10.6 million |
Net income was substantially affected by $258.8 million of after-tax income from discontinued operations, primarily FGL. This included a $144.5 million partial reversal of a prior held-for-sale write-down. Continuing operations remained marginally profitable at the consolidated level, while the controlling interest reported a $25.5 million loss from continuing operations.
- Consumer Products revenue was $1,211.8 million, down 0.6%; operating income increased 6.0% to $151.0 million.
- Consumer Products gross margin increased to 37.1% from 36.2%, while Adjusted EBITDA increased 3.4% to $214.2 million. Adjusted EBITDA margin was 17.7%, versus 17.0%.
- Consumer Products sales benefited from batteries, hardware and home improvement, small appliances, and home and garden products, but were pressured by foreign exchange, global pet supplies, personal care and global auto care.
- Insurance segment revenue was a negative $28.7 million versus negative $10.0 million, and the segment recorded a $15.4 million operating loss, primarily from lower fair values of funds-withheld investments as rates and credit spreads increased.
- Cash and cash equivalents were $348.8 million at December 31, 2016, down from $497.3 million at September 30, 2016. Corporate cash and investments were approximately $148.2 million.
- Total debt was $5,459.0 million, compared with $5,430.9 million at September 30, 2016. Fair value of total debt was approximately $5,701.0 million.
- Total assets were $35,662.7 million and total equity was $1,669.4 million at quarter-end. Assets and liabilities held for sale totaled $26,801.6 million and $25,200.5 million, respectively.
Material Changes Versus the Prior Comparable Period
- Consolidated operating income improved due primarily to stronger Consumer Products profitability, lower Corporate and Other impairments and loan-loss provisions, and lower interest expense.
- Consumer Products sales declined modestly because a $18.8 million foreign-exchange headwind more than offset $11.8 million of organic sales growth.
- Interest expense declined to $91.7 million from $95.2 million following Spectrum Brands refinancing and repricing activity. Spectrum Brands also redeemed $129.7 million of 6.375% notes and paid a $4.6 million make-whole premium.
- Continuing operating cash flow changed from a $221.3 million use to a $7.9 million source, primarily due to working-capital improvements at Consumer Products.
- Financing activities used $137.8 million, including $135.9 million of Spectrum Brands debt repayment, $97.6 million of Spectrum Brands stock purchases and $34.9 million of share-based award tax withholding payments.
- Comprehensive loss attributable to the controlling interest improved to $31.7 million from $166.8 million, although unrealized investment losses and foreign-currency translation losses remained significant.
Guidance, Outlook, Risks and Unusual Items
- Management expected HRG cash, cash equivalents, investments and subsidiary dividends to cover anticipated interest and general administrative requirements for at least the next twelve months. It expected approximately $62.4 million of subsidiary dividends during fiscal 2017, subject to regulatory, contractual and board-level restrictions.
- Spectrum Brands expected fiscal 2017 capital expenditures of approximately $110 million to $120 million and identified $300.6 million of available Revolver capacity at December 31, 2016, net of specified letters of credit and allocations.
- On January 13, 2017, HRG entered into a secured loan allowing borrowings of up to $150.0 million at adjusted LIBOR plus 2.35%, maturing July 13, 2018. HRG had drawn $50.0 million by January 31, 2017.
- The proposed $26.80-per-share Anbang acquisition of FGL remained subject to regulatory approvals and other closing conditions. The outside termination date had been extended to February 8, 2017, with discussions regarding a further extension. If terminated under specified circumstances, FGL could owe a $51.5 million termination fee.
- HRG’s board was evaluating strategic alternatives, including a merger, sale or other business combination, but no definitive schedule or transaction was assured. CEO Omar Asali was expected to leave during fiscal 2017.
- Key risks include substantial indebtedness, dependence on subsidiary distributions, interest-rate and credit-spread volatility, foreign-exchange and commodity exposure, insurance regulatory capital requirements, FGL transaction uncertainty, customer concentration and litigation or regulatory contingencies.
- Raven Re’s statutory capital and surplus depended materially on permitted statutory accounting practices. Without those practices, the filing states that risk-based capital would fall below minimum regulatory requirements.
- Legal and environmental accruals totaled approximately $7.0 million, including $2.6 million related to businesses held for sale. Management did not expect currently identified matters to have a material effect, although unfavorable FGL litigation or regulatory outcomes could materially affect a particular period.
Most Important Facts for Investors to Verify
- Confirm whether the FGL merger closed, was extended or terminated after the February 8, 2017 deadline, and determine the resulting cash proceeds, ownership changes and termination-fee consequences.
- Separate recurring operating performance from the $258.8 million discontinued-operations gain and the $144.5 million held-for-sale valuation reversal.
- Reconcile HRG’s consolidated debt, Spectrum Brands’ debt and available revolver capacity, including the post-quarter $50.0 million HRG loan draw.
- Assess whether Consumer Products organic growth and margin improvement offset foreign-exchange pressure and weakness in pet supplies, personal care and auto care.
- Review the sensitivity of insurance assets, reserves, liquidity and regulatory capital to higher interest rates, wider credit spreads, investment losses and policyholder surrenders.
- Verify the sustainability and regulatory availability of expected subsidiary dividends, particularly after any FGL sale.