Spectrum Brands Holdings Inc (SPB) 2015 Q2 法說會逐字稿

Good morning. My name is Chris and I will be your conference operator today. At this time, I would like to welcome everyone to the HRG Group, Inc., third-quarter earnings call. (Operator Instructions). Thank you.

James Hart, Senior Vice President of Communications, you may begin your conference.

Thank you, Chris, and good morning, everyone. Welcome to our quarterly conference call. With me today are Omar Asali, President and CEO of HRG Group, and Tom Williams, CFO.

During today's call, a presentation will accompany our remarks. This presentation may be accessed through the webcast that is available from the investor relations section of our website at HRGGroup.com. As a reminder, this call cannot be taped or otherwise duplicated without the Company's prior consent.

Before we begin, I would like to remind everyone that this call may contain statements that are forward looking as that term is defined by the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, discussions regarding industry outlook, opinion, expectations regarding the performance of the Company's business, its liquidity and capital resources, and other nonhistorical statements in the discussion and analysis. These forward-looking statements are subject to certain risks, uncertainties, and assumptions, including risks related to the general economic and business conditions, and are based on management's beliefs, as well as assumptions made by and information currently available to management. When you listen to this call, the words believe, anticipate, estimate, expect, intend, and similar expressions are intended to identify forward-looking statements.

All forward-looking statements made today reflect the Company's current expectations only, and although management believes that its expectations reflected in these forward-looking statements are reasonable, the Company undertakes no obligation to revise or update any statements to reflect events or circumstances that occur after this call. Important risks, uncertainties, and assumptions and other factors that could cause actual results to differ materially from those in these forward-looking statements are identified and discussed in reports filed by HRG with the Securities and Exchange Commission.

During the call, management will provide certain information that will constitute non-GAAP financial measures under the SEC rules, such as adjusted EBITDA and adjusted operating income. Certain information required to be disclosed about these non-GAAP measures, including reconciliations with the most comparable GAAP measures, is available in the earnings press release that we have issued this morning.

With that, we will begin by turning the call over to Omar.

Thank you, James. Good morning, everybody, and thank you for dialing into our call.

This past quarter was a very busy quarter, frankly a very productive quarter for HRG, and I think it's going to position us very well going forward.

Let me start at your slide five in terms of giving you a quick overview of the key themes for the quarter. Consolidated results were within our expectations. Spectrum Brands continues to perform very well and is performing according to our plan. The core business in FGL continues to also perform very well.

Obviously this past quarter and, frankly, the quarter prior to that, we've had some certain headwinds, commodity prices in the energy space, FX challenges at the consumer product area, as well as the general low rate environment in insurance have provided us with some headwinds, but we believe we and our management teams below continue to mitigate those and are very well positioned despite some of those challenges and, frankly, are very optimistic about the second half of the year.

We have executed on a number of leadership changes in our businesses, both in Spectrum Brands and FGL. Those leadership changes have been very seamless and they have been part of our succession plan. As Andreas Rouve in SPB and Chris Littlefield in FGL are running those businesses now and going forward, we continue to feel very good about our management teams there.

In the last few weeks, we've done some management changes at Salus, our ABL lender, and feel very good about the co-presidents that we've put in place to lead the business going forward and achieve our goals there.

Some of the important initiatives that many of you have read about and you've seen come out of us from this past quarter and the last few weeks were exploring strategic alternatives for FGL. We believe the M&A environment in the insurance space is very robust and we think that that process, which will commence soon, hopefully will yield a very attractive result for us.

We also have been active in the consumer area. We announced the Armored AutoGroup transaction at SPB and are very excited about that transaction. We continue to take steps to simplify our cost in the energy space and simplify our broader asset management team.

In addition to that, this past quarter we spent quite a bit of time simplifying, frankly, the structure at HRG itself. So we have managed to reduce some of the headcount we have in the business, as well as become a more focused company in terms of where we allocate capital in the different entities and OpCos that we would have in HRG.

Moving on to slide six, taking just a closer look at some of the specific segments, SPB had a record performance and we continue to think that we will deliver that in 2015. Despite the challenges in the first half, we are very optimistic about the second half of the year. Obviously, part of the challenges in the first half of the year were the port challenges and we think those are largely behind us. And again, we continue to mitigate some of the risks in FX.

Internationally, our sales have grown at roughly 5% in this past quarter, excluding the currency impact, as well as the new acquisitions.

I mentioned the Armored AutoGroup deal, the $1.4 billion deal. We are very excited about that transaction. It helps SPB enter a new vertical, diversifies our revenue, and is accretive from an EBITDA and cash flow standpoint.

In insurance, FGL, as I said, is exploring strategic alternatives. We are very bullish on the M&A environment in that space. We continue to focus in FGL on delivering our strategy in terms of increasing our market share, increasing the annuity sales book, managing the investment portfolio well, and being one of the solution providers in the middle market for consumers who want to buy annuity products.

In energy, pricing has been a challenge, but, as I mentioned earlier, we continue to focus on our costs and, frankly, continue to focus on our production numbers in that space. And over the next couple of quarters, we are very focused on delevering Compass and our MLP.

And then I mentioned a little bit asset management, the simplifications that we've done. Just to give our shareholders a sense of the corporate G&A and how we are managing things more efficiently, our operating costs have been reduced at a 40% level in terms of our run rate. The headcount in HRG has been reduced from 30 employees down to 21. The annual run rate going forward will be approximately $8 million for our D&A, and that excludes one-time deal costs, as well as the performance bonuses.

And we've also shut down Five Island and outsourced that business to a third-party provider, further reducing our overhead and our costs.

So we really believe we have done quite a bit this past quarter to become a much more focused company, much more efficient, and running at a much lower run rate in terms of G&A.

Onto your slide seven, just to do a slightly deeper dive on some of the key segments. Spectrum Brands reaffirmed its outlook for a 6th straight year of record financial performance. The second quarter, as I said, despite headwinds, has been a pretty good quarter for us. Revenue was up 10% on a currency-neutral basis and adjusted EBITDA was up 16% on a currency-neutral basis. We continue to invest in our topline and believe the management is doing very well in growing the business organically.

The challenges have been in batteries, where we continue to see pricing pressure, as well as in the pet area. As you've known and as you've seen from the management team at SPB, we continue to run a very lean business with shared services and cost improvements, and the team continues to manage the cost part of the ledger very, very well.

In terms of just some commentary on some of the recent acquisitions we have done, Tell Manufacturing, which is the leading commercial lockset provider in HHI, that acquisition continues to be on target and performing as we expected. Same with the P&G European pet food business, as well as Salix business, which is the leading provider of rawhide chews. So Spectrum continues to execute on integrating some of these bolt-on acquisitions.

We are also increasing investing in some of the organic opportunities, given the breadth of the brands and the different verticals that we are in. And management continues to work on its what we call more, more, and more strategy, trying to expand into more countries and geographies serving more channels and then launching more categories with our existing retailers.

On slide eight, just a couple of comments on Armored AutoGroup. These are iconic brands that Spectrum is acquiring. We are very excited about this transaction. It has number one US market share in automotive aftermarket appearance category, the number one US market position for do-it-yourself air-conditioner re-charges, and the number three US market share in performance chemicals and fuel additives.

These are iconic brands. We think they're going to fit very well in our channels and in our business, and we think there's going to be very attractive opportunities for these brands under our umbrella.

The expected sales for these brands, we are expecting to generate $440 million and then EBITDA in excess of $140 million, as well as about $60 million in free cash flow. As you can tell from some of these numbers, this business has very attractive EBITDA margins and that was a big part of the appeal for us. It will expand the overall margins of our business, it will add scale, and we think put it on our footprint we will be able to grow it internationally, as well as in more channels.

The $1.4 billion acquisition here will be funded through newly issued SPB debt, as well as SPB equity. And the Board at HRG has authorized us to participate in the new common stock offering from SPB, so you'll be hearing more about that in the upcoming weeks.

I think the Armored AutoGroup deal is a very exciting deal for SPB, and frankly, it's more exciting than what we've done in HHI, which was itself a great deal that we did a couple of years ago. I think acquiring these iconic brands is a very different edition and is a very sort of attractive addition to our platform.

Moving onto your slide nine in terms of insurance, FGL had an okay quarter. It continued to perform in terms of growing the underlying business. Assets under management are at $17.6 billion. We've purchased new assets this quarter of about $860 million at a yield of 4.73. The overall yield in the book is roughly 4.72, and that's up 20 basis points from a year ago. And the overall portfolio has an NAIC rating of 1.5. So it is conservatively positioned with 96% of the book in investment-grade NAIC 1 and 2 securities.

Sales were very robust this past quarter, in particular in the fixed indexed annuity area, so our sales were about $600 million, up 89% from a year ago. We de-emphasized the MYGA program, given the low rate environment, and again, this shows the discipline of this management team in terms of growing our topline only when we believe we are achieving attractive rates of return.

Obviously this past quarter, as you've seen from FGL, the Company booked a $33 million after-tax impairment on its participation in Radio Shack alone. Tom later on will give you the details more on that impairment. Going forward, we are shifting away the exposure of FGL from ABL loans to other areas where the management team believes there are more attractive sort of risk/reward opportunities. And we continue, as I said, to manage the overall book very, very conservatively, which is an important piece of how we have run that business since we've owned it.

Moving on to slide 10, which is Compass, so obviously here you know the story in terms of oil prices, as well as gas prices coming under pressure quite a bit this past quarter. Despite the challenging in the commodity pricing environment, our team has done very well in terms of managing the operations, keeping production levels essentially on track. So this past quarter, we had production of 126,000 barrels of oil, 151,000 barrels of NGLs, and about 6.4 billion cubic feet of natural gas. So the team has done a very good job in terms of limiting the decline in these areas, in the production levels, as well as managing our costs very, very well.

Going forward, our focus is to reduce leverage in this area, which Tom will discuss in a bit more detail, as well as we are exploring different transactions and different paths to both protect and build the equity value in Compass, given what has happened with the commodity price.

On slide 11, in asset management, results were obviously down in this quarter, predominantly driven by the Radio Shack exposure. Salus was the manager of that exposure. It was $150 million of secured term loan to Radio Shack. As I said earlier, Tom will walk you through the details.

We have taken some key steps at Salus. We have changed the management team. We have put a new emphasis on, obviously, the recovery of the loans. We continue to work on the Radio Shack situation itself. I can't get into the details of that as it is still very fluid, but suffice it to say we are very focused on recovery there, and there are certain matters with respect to that loan that are being litigated and we will continue to pursue our rights and that litigation strategy very, very aggressively.

In addition to sort of just what happened with Salus, we continue to build CorAmerica and EIC. They're focused on building third-party asset management capability. It's still in its early stage, but the teams both in EIC and CorAmerica continue to perform well and according to plan.

Lastly from me, just on slide 12, I know things have been very busy with a lot of changes in HRG, so we thought it's worthwhile just to map something that's simple to show you the path forward, frankly, in 2015 and later on. Near term, we are very focused on the Armored AutoGroup deal, closing that deal, and participating in the Spectrum Brands equity offering.

In the intermediate term, obviously we are very focused on the FGL process and trying to maximize value there. An important thing to highlight there is we think we will be able to execute on a very tax-efficient transaction, given our NOLs, and then longer term, if an FGL transaction is consummated, we are allocators of capital. We will be looking for the best ways to allocate that capital. And that could include things like delevering our balance sheet, investing in new verticals, and obviously continuing to simplify the business and make sure we have a more focused company where we are just focused on a few platforms below.

The guiding principles in here, they stay the same. It's the same principles from us. We will continue to be efficient in how we allocate our capital. We are very focused on what we call diffusing our Company and improving the credit metrics in the intermediate term, and then obviously if we are looking at transactions, we have a value lens and we'll continue to maintain that discipline and continue to try to build our net asset value.

So, a very busy quarter. With that, let me turn it over to Tom to walk you through the financial highlights.

Thanks, Omar, and I'll begin my remarks today by reviewing HRG Group's topline performance for the quarter.

So on page 14, you'll see that we reported $1.37 billion of consolidated revenues in the second quarter. This reflects a 2.3% increase from the second quarter of last year, or strong 6.3% growth rate on a currency-neutral basis if we adjust for approximately $55 million of impact from ongoing unfavorable foreign exchange.

So taking a closer look at the key drivers to revenue this quarter, consumer products continues to deliver a very strong performance with growth in all product categories except batteries, where growth was affected by promotion activity from a key competitor. But this didn't lessen the quality of Spectrum's results, as currency-consistent revenue grew nearly 10%.

Next, as expected, energy revenues declined this quarter due to significant drop-off in oil and natural gas prices relative to this time last year. And we understand that commodity prices can be unpredictable and that the present trend has been unfavorable. So we have focused our efforts on managing the operations at Compass as efficiently as possible and weathering through the current environment.

In asset management, revenue declined approximately $5 million. This was due primarily to the loss of interest income at Salus related to a loan that was originated to Radio Shack. As discussed previously, Radio Shack filed for bankruptcy earlier in the second quarter. Accordingly, our results reflect an impairment on this investment in both asset management and insurance, which I will describe more fully in a moment.

Turning to insurance, FGL continues to see strong demand for its core products, as core fixed annuity sales grew nearly 90% from the second quarter of last year to $600 million. However, the reported revenues decline reflect impairments taken at FGL and FSR for investments in Radio Shack. Excluding net investment gains and losses for both periods, segment revenue increased more than 12% this quarter. And with more than $17.6 billion of assets under management, this one investment is not material and has had negligible effects on the solid long-term trajectory and performance of FGL.

However, since this impairment is impacting our results in a few places, I wanted to take a moment to describe the accounting in more detail. So on page 15, you will see in 2013 Salus originated a $250 million secured term loan to Radio Shack, which resulted in a net exposure to HRG subsidiaries of $150 million after accounting for the portion of the loan that was syndicated to a third party. Our insurance segment participated in a portion of this loan and in amounts that were immaterial to their overall portfolio.

In February, Radio Shack filed for bankruptcy protection and that proceeding is well underway. Although that process is not complete and the resolution of certain litigation matters may change in amounts that eventually affect the recovery, our results this quarter reflect an impairment of $105 million, or 70% of the original loan. $65 million of that is taken in the asset management segment and treated as bad debt expense. The remaining $40 million is reflected in insurance as a reduction to that segment's topline.

The ultimate recovery may be higher or lower, and we will work to get it higher, and it was appropriate this quarter to book our best estimate of an expected loss, which you see in our results this quarter.

Moving on to our energy segment, as we discussed with you last quarter, the recent trend in commodity pricing increased the likelihood of additional impairments to our oil and gas properties. Pursuant to SEC reporting requirements, we performed a ceiling test this quarter under the full cost method of accounting. As a reminder, this test uses simple average spot prices for the LPM periods to value proven reserves and is usually not indicative of current market values or forward strip prices.

With the ongoing declines in energy pricing, the carrying value for Compass exceeded what was permissible under the ceiling test and we recorded a $147 million non-cash impairment to our oil and gas properties in the energy segment.

Moving onto page 16, now turning to profitability, we reported consolidated operating loss of $174 million. If we were to take away the impact of the two non-cash impairments that I just described, our operating income would be $78 million this quarter, compared to operating income of $97 million for the second quarter of 2014. This modest decline relates primarily to the reduced profitability at energy and $22 million of impact from unfavorable FX at Spectrum.

Looking at the preferred measures of profitability for each of our segments, you'll see adjusted EBITDA and consumer products increased on a reported basis and grew a very healthy 16% on a currency-neutral basis. And adjusted EBITDA in energy declined $10 million, due primarily to the impact of the lower commodity prices, as well as the occurrence of certain costs as Compass transitioned to a standalone company outside of the legacy [geevay] joint venture.

Our insurance adjusted operating income decreased, primarily due to a $35 million nonrecurring tax benefit in the prior year as FGL repositions its portfolio, and the underlying trends remain very healthy. And finally, we recorded an operating loss at asset management due primarily to the reduced revenues at Salus.

Turning to page 17 and now taking a closer look at our capital structure, at the midpoint of our fiscal year we have received $37 million in dividends from our subsidiaries, nearly $20 million from Spectrum, $6 million from FGL, $10 million from Compass, and $1 million from our asset management businesses. We expect we will receive approximately $77 million in consolidated dividends this year, with Spectrum and FGL accounting for the majority of our dividend flow. We also continue to expect Compass will use its available free cash flow from operations to reduce its debt, rather than provide HRG with additional dividends over the short term.

We ended the quarter with corporate cash and investments of approximately $253 million at HRG and HDI funding and believe our liquidity is strong. We also remain very comfortable with our ability to access the capital markets as needed to execute our strategic vision. In April, shortly after the close of our quarter, we successfully raised $100 million through a tack-on of our existing 7-7/8% senior secured notes. The offering was more than three times oversubscribed and priced at 104.5, which we believe also attests to the attractiveness as an issuer in this market.

As you heard Omar describe earlier, our Board has authorized us to participate in an equity offering from Spectrum in connection with their Armored AutoGroup purchase. Thereafter, if a transaction at FGL is consummated, we would also intend to use portions of any proceeds raised to delever at HRG and also reinvest in attractive new businesses, improving our key metrics, such as dividends to interest coverage ratios, which we are targeting to be no less than 1 times. So we'll keep you informed of our progress as these initiatives unfold.

Next, on page 18, I will conclude today with a review of our sum of the parts, which provides a measurement of shareholder value that we've created. The largest contributor to value is our holdings in our publicly-traded Spectrum and FGL companies and are based on 20-day view after the period ended March 31. And other equity positions, including additional shares of SPB, are reflected in HDI funding at market prices. All other assets and liabilities are measured at book value.

So taken together, our estimated value at the end of the quarter was $14.36. This is a 3% decline from where we were at this time last year, reflecting a 12.5% growth in the blended value of our growth in consumer products and insurance segments, offset by reductions in energy and asset management, which are valued lower due to the recent impairments.

We remain committed to achieving our annual benchmarks for value creation and will be working diligently over the second half of the year to continue our track record of strong performance. We expect the acquisition of Spectrum -- in Spectrum, the disposition of our interest in FGL, and the subsequent use of proceeds to delever and reinvest are the right next steps to move us in this direction.

With that, we'll open up the call right now for your questions. Operator, can you please provide those instructions?

(Operator Instructions). It appears that we have no questions at this time. I'll turn the call back over to our presenters.

Thanks, Chris. Thank you, everybody, for joining us today. That concludes our call.

This concludes today's conference call. You may now disconnect.