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HRG > SEC Filings for HRG > Form 10-K on 27-Nov-2013All Recent SEC Filings

Show all filings for HARBINGER GROUP INC.



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Harbinger Group Inc. ("HGI," "we," "us," "our" and, collectively with its subsidiaries, the "Company") should be read in conjunction with Item 6, "Selected Financial Data," and our accompanying consolidated financial statements and related notes (the "Consolidated Financial Statements") referred to in Item 8 of this Annual Report on Form 10-K (the "Form 10-K"). Certain statements we make under this Item 7 constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. See "Forward-Looking Statements" at the beginning of Part I of this Form 10-K. You should consider our forward-looking statements in light of our Consolidated Financial Statements and other financial information appearing elsewhere in this Form 10-K and our other filings with the Securities and Exchange Commission (the "SEC"). All references to Fiscal 2013, 2012 and 2011 refer to fiscal periods ended September 30, 2013, 2012 and 2011, respectively. HGI Overview
We are a holding company and our principal operations are conducted through subsidiaries that offer life insurance and annuity products (Fidelity & Guaranty Life,"FGL", formerly Harbinger F&G LLC), financing and asset management (Five Island Asset Management, LLC, or "Five Island", and Salus Capital Partners, LLC or "Salus"), branded consumer products (Spectrum Brands Holdings, Inc. or "Spectrum Brands") such as batteries, small appliances, pet supplies, home and garden control products, personal care products and hardware and home improvement products. We also hold oil and natural gas properties through an equity investment in a joint venture (the "EXCO/HGI JV") with EXCO Resources, Inc. ("EXCO") through our wholly-owned subsidiary, HGI Energy Holdings, LLC ("HGI Energy").
Our outstanding common stock is 56.5% owned by Harbinger Capital Partners Master Fund I, Ltd. (the "Master Fund"), Global Opportunities Breakaway Ltd. and Harbinger Capital Partners Special Situations Fund, L.P. (together, the "HCP Stockholders"), not giving effect to the conversion rights of the Company's Series A Participating Convertible Preferred Stock or the Series A-2 Participating Convertible Preferred Stock (together, the "Preferred Stock"). We intend to acquire companies that we consider to be undervalued or fairly valued with attractive financial or strategic characteristics. We intend to take a long-term view and primarily seek opportunities that are able to generate high returns and significant cash flow to maximize long-term value for our stockholders. In addition to our intention to acquire controlling equity interests, we may also make investments in debt instruments and acquire minority equity interests in companies. We also own 97.9% of Zap.Com Corporation ("Zap.Com"), a public shell company that may seek assets or businesses to acquire or may sell assets and/or liquidate. While we search for additional acquisition opportunities, we manage a portion of our available cash and acquire interests in possible acquisition targets through our wholly-owned subsidiary, HGI Funding, LLC.
We believe that our access to the public equity markets may give us a competitive advantage over privately-held entities with whom we compete to acquire certain target businesses on favorable terms. We may pay acquisition consideration in the form of cash, our debt or equity securities, or a combination thereof. In addition, as a part of our acquisition strategy we may consider raising additional capital through the issuance of equity or debt securities.
We currently operate in four segments: (i) Consumer Products, which consists of Spectrum Brands; (ii) Insurance, which includes FGL and Front Street Re, Ltd. ("FSR"); (iii) Energy, which includes the EXCO/HGI JV; and (iv) Financial Services, which includes Salus and Five Island. Consumer Products Segment
Through Spectrum Brands, we are a diversified global branded consumer products company with positions in seven major product categories: consumer batteries; small appliances; pet supplies; home and garden control products; electric shaving and grooming; electric personal care products and hardware and home improvement.
Spectrum Brands' operating performance is influenced by a number of factors including: general economic conditions; foreign exchange fluctuations; trends in consumer markets; consumer confidence and preferences; overall product line mix, including pricing and gross margin, which vary by product line and geographic market; pricing of certain raw materials and commodities; energy and fuel prices; and general competitive positioning, especially as impacted by competitors' advertising and promotional activities and pricing strategies. Insurance Segment
Through FGL, we are a provider of annuity and life insurance products to the middle and upper-middle income markets in the United States. Based in Baltimore, Maryland, FGL operates in the United States through its subsidiaries Fidelity & Guaranty Life Insurance Company ("FGL Insurance") and Fidelity & Guaranty Life Insurance Company of New York ("FGL NY Insurance"). FGL's principal products are deferred annuities (including fixed indexed annuity ("FIA") contracts), immediate

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annuities, and life insurance products, which are sold through a network of approximately 200 independent marketing organizations ("IMOs"), representing approximately 20,000 independent agents.
FGL's profitability depends in large part upon the amount of assets under management, the ability to manage operating expenses, the costs of acquiring new business (principally commissions to agents and bonuses credited to policyholders) and the investment spreads earned on contractholder fund balances. Managing net investment spreads involves the ability to manage investment portfolios to maximize returns and minimize risks such as interest rate changes and defaults or impairment of investments and the ability to manage interest rates credited to policyholders and costs of the options and futures purchased to fund the annual index credits on the FIAs. Energy Segment
On February 14, 2013, EXCO and HGI formed the EXCO/HGI JV to own and operate conventional oil and natural gas properties. EXCO contributed to the EXCO/HGI JV its conventional assets in and above the Canyon Sand formation in the Permian Basin in West Texas as well as in the Holly, Waskom, Danville and Vernon fields in East Texas and North Louisiana.
The EXCO/HGI JV acquired the conventional oil and natural gas assets from EXCO for approximately $725.0 million of total consideration, representing HGI's effective equity interest of $372.5 million, $127.5 million in properties contributed by EXCO, in each case before giving effect to the closing adjustments related to the July 1, 2012 effective date, and approximately $225.0 million of indebtedness borrowed by the EXCO/HGI JV from a revolving credit agreement entered into by the EXCO/HGI JV ("EXCO/HGI JV Credit Agreement"). In exchange for the contribution of its assets, EXCO received cash consideration of $574.8 million, a 24.5% limited partner interest in the EXCO/HGI JV and a 50.0% interest in the general partner of the EXCO/HGI JV. HGI and its subsidiaries contributed $349.8 million cash, after customary closing adjustments, and received a 73.5% limited partner interest in the EXCO/HGI JV and a 50.0% interest in the general partner. After giving effect to the 2.0% general partner interest in the EXCO/HGI JV, EXCO and HGI own an economic interest in the Partnership of 25.5% and 74.5% respectively.
EXCO/HGI JV's primary business objective is to over time generate stable cash flows and grow its asset base through acquisitions from a variety of sources, including third parties, EXCO Parent and HGI. It is expected that the acquisition focus will be on assets and/or companies that own mature properties with long-lived, predictable production profiles, modest capital requirements and substantial reserve exploitation potential. Consistent with this strategy, on February 14, 2013, the EXCO/HGI JV entered into an agreement to acquire oil and natural gas assets in the Danville, Waskom and Holly fields in East Texas and North Louisiana from an affiliate of BG Group plc ("BG Group") for $132.5 million, subject to customary closing adjustments. These properties represent an incremental working interest in properties that EXCO contributed to the EXCO/HGI JV. This transaction was funded using funds drawn from the EXCO/HGI JV Credit Agreement.
The EXCO/HGI JV intends to use oil and natural gas derivatives and financial risk management instruments to manage its exposure to commodity prices. Management of the EXCO/HGI JV believes that these oil and natural gas derivative contracts may allow the EXCO/HGI JV to mitigate the impact of price fluctuations and achieve a more predictable cash flow from the EXCO/HGI JV's operations. Financial Services Segment
Our Financial Services segment includes the activities of our asset-based lender, Salus, and our newly formed asset manager, Five Island.
Through Salus, we are a provider of secured loans to the middle market across a variety of industries. Salus finances loan commitments that typically range from $5.0 to $50.0 million with the ability to lead and agent larger transactions. The Salus platform may also serve as an asset manager to certain institutional investors such as community and regional banks, insurance companies, family offices, private equity funds and/or hedge funds who may lack the infrastructure and dedicated competency within senior secured lending. Salus' loans are funded through capital commitments from Salus equity, funds committed by FGL and FSR as participants and funds committed by Salus' CLO. As of September 30, 2013, Salus, along with its co-lenders FGL and FSR, have funded loans totaling $565.6 million aggregate principal amount outstanding on a consolidated basis. During Fiscal 2013 Salus closed on 33 transactions, representing approximately $779.5 million in total commitments to a variety of well recognized businesses. Salus provides secured asset-based loans to the middle market. Asset-based finance is a financing tool where the decision to lend is primarily based on the value of the borrowers' collateral. Collateral is viewed as the primary source of repayment, while the borrowers' creditworthiness is viewed a secondary source of repayment. As a result, asset-based finance emphasizes the monitoring of the collateral that secures the asset-based loan. Salus focuses its credit analysis on the value of accounts receivable and inventory (or other assets) and estimates how much liquidity it can provide against those assets. Salus establishes a loan structure and collateral monitoring process that is continuous and focused on the collateral, significantly reducing the risk of loss inherent in delayed intervention and/or asset recovery. As of September 30, 2013, none of these loans were delinquent.

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Salus looks to create partnerships with borrowers that may not qualify for traditional bank financing because of their size, historical performance, geography or complexity of their situation. Salus' loans are used across a range of industries for growth capital, general working capital or seasonal needs, acquisitions or opportunistic situations, trade finance, turnarounds, dividend recaps, refinancing and debtor-in-possession financing. Highlights for the Fiscal 2013
Significant Transactions and Activity
During Fiscal 2013, we made significant progress in our business strategy to reduce our cost of capital, increase our investor base, grow our existing business, and diversify the businesses in which we operate. The most significant of these steps include the following:
In December 2012, we issued $700.0 million aggregate principal amount 7.875% Senior Secured Notes due 2019 (the "7.875% Notes") and used part of the proceeds of the offering to accept for purchase $498.0 million aggregate principal amount of our 10.625% Senior Secured Notes due 2015 (the "10.625% Notes") pursuant to a tender offer (the "Tender Offer") for the 10.625% Notes. The remaining 10.625% Notes were redeemed by the trustee on January 23, 2013. The remainder of the proceeds of the issuance of the 7.875% Notes was used for working capital by the Company and its subsidiaries and for general corporate purposes, including the financing of future acquisitions and businesses. In July 2013, the initial offering of 7.7875% Notes were supplemented by a further issuance of $225.0 million aggregate principal amount of the 7.875% Notes (the "New Notes".) The New Notes were issued under the same indenture governing the 7.875% Notes by and between the Company and Wells Fargo Bank, National Association, a national banking association, as trustee. The New Notes were priced at 101.50% of par plus accrued interest from July 15, 2013.

In December 2012, we assisted the HCP Stockholders with the closing of a secondary offering of 20.0 million shares of common stock at a price to the public of $7.50 per share, increasing our public float and broadening our shareholder base. In addition, in January 2013, the underwriters exercised their option to purchase an additional 3.0 million shares of common stock from the HCP Stockholders. We did not receive any proceeds from the sale of shares in this offering.

In February 2013, we finalized a joint venture with EXCO to create the EXCO/HGI JV. The EXCO/HGI JV purchased and will operate certain of EXCO's producing U.S. conventional oil and natural gas assets in the Permian Basin, East Texas and North Louisiana.

In September 30, 2013, we repurchased 1,700.0 thousand shares of our common stock at a price of $7.25 per share from the HCP Stockholders under our $50.0 million share repurchase program.

Consumer Products segment
In December 2012, Spectrum Brands acquired the residential hardware and home improvement business (the "HHI Business") from Stanley Black & Decker, Inc. ("Stanley Black & Decker") (the "Hardware Acquisition"). The Hardware Acquisition is expected to enhance Spectrum Brand's top-line growth, margins and free cash flow profile, while providing added scale, greater product diversity and attractive cross-selling opportunities.

In December 2012, Spectrum Brands assumed from Spectrum Brands Escrow Corp. $520.0 million aggregate principal amount of 6.375% Senior Notes due 2020 (the "6.375% Notes") and $570.0 million aggregate principal amount of 6.625% Senior Notes due 2022 (the "6.625% Notes"), in connection with the Hardware Acquisition. Spectrum Brands used the net proceeds from the offering to fund a portion of the purchase price and related fees and expenses for the Hardware Acquisition. Spectrum Brands financed the remaining portion of the Hardware Acquisition with a new $800.0 million term loan facility, of which $100.0 million is in Canadian dollar equivalents (the "HHI Term Loan"). A portion of the HHI Term Loan proceeds were also used to refinance the former term loan facility, maturing June 17, 2016, which had an aggregate amount outstanding of $370.2 million prior to refinancing.

In April 2013, the Company completed the acquisition of certain assets of Tong Lung Metal Industry Co. Ltd., a Taiwan Corporation ("TLM Taiwan"), completing the Hardware Acquisition. TLM Taiwan is involved in the production of residential locksets.

In September 2013, Spectrum Brands, announced that it had closed on $1.15 billion of term loans (the "New Term Loans", and together with the HHI Term Loan, the "Term Loan") pursuant to the New Term Loan Commitment Agreement No. 1 among Spectrum Brands, the lenders party thereto, and Deutsche Bank AG New York Branch, as administrative agent (the "Term Administrative Agent"). The proceeds of the New Term Loans were used (i) to fund the consummation of Spectrum Brands cash tender offer and consent solicitation (the "Tender Offer and Consent Solicitation") to purchase any and all of its outstanding 9.5% Senior Secured Notes due 2018 (the "9.5% Notes"), (ii) to fund the satisfaction and discharge of the

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indenture governing the 9.5% Notes not tendered in the Tender Offer and Consent Solicitation and (iii) for working capital and general corporate purposes. Insurance segment
In December 2012, Fidelity & Guaranty Life Holdings, Inc.,"FGH" (formerly, Old Mutual U.S. Life Holdings, Inc.) entered into a coinsurance agreement (the "Reinsurance Agreement") with Front Street Re (Cayman) Ltd. ("Front Street Cayman"), also an indirect subsidiary of the Company. Pursuant to the Reinsurance Agreement, Front Street Cayman has reinsured approximately 10%, or approximately $1.5 billion of FGH's policy liabilities, on a funds-withheld basis.

In March 2013, FGH issued $300.0 million aggregate principal amount of their 6.375% senior notes, due April 1, 2021, at par value (the "FGL Notes".) FGH used a portion of the net proceeds from the issuance to pay a special dividend to HGI and expects to use the remainder for general corporate purposes, to support the growth of its subsidiary life insurance company.

In August 2013, FGL filed a registration statement on Form S-1 with the SEC relating to a proposed initial public offering of its common stock. All of the shares will be offered by the issuer, FGL. We are not a selling stockholder in the offering.

Energy segment
Immediately following closing of the EXCO/HGI JV, the EXCO/HGI JV entered into an agreement to purchase all of the shallow Cotton Valley assets from an affiliate of BG Group, for $130.7 million, after customary closing adjustments. The transaction closed on March 5, 2013 and was funded with borrowings from the EXCO/HGI JV Credit Agreement. In connection with the acquisition of the properties from BG Group, the EXCO/HGI JV received an increase to the borrowing base to $470.0 million under the EXCO/HGI JV Credit Agreement.

Financial Services segment
Salus originated $779.5 million of new asset-based loan commitments in the Fiscal 2013 and had $560.4 million of loans outstanding as of September 30, 2013.

In February 2013, Salus announced the closing of Salus CLO 2012-1, Ltd., a collateralized loan obligation ("CLO") vehicle providing for the issuance of up to $250.0 million in collateralized obligations, initially funded with $175.5 million of the asset-based loans that Salus had originated through that date. In September 2013 Salus announced the closing of an additional $300.0 million note issuance by the CLO, bringing the aggregate amount of notes issued by the CLO to $550.0 million. In connection with this transaction, Salus and its affiliates funded the upsize of the CLO with an additional $167.0 million contribution from its portfolio of asset-based loans.

In connection with the Reinsurance Agreement, Front Street Cayman, FGH and Five Island, also entered into an investment management agreement, pursuant to which Five Island manages a portion of the assets securing Front Street Cayman's reinsurance obligations under the Reinsurance Agreement, which assets are held by FGL in a segregated account. The assets in the segregated account are invested in accordance with FGL's existing guidelines.

Key financial highlights
Net loss attributable to common and participating preferred stockholders decreased to $94.2 million, or $0.67 per common share attributable to controlling interest ($0.67 diluted), compared to net income attributable to common and participating preferred stockholders of $29.9 million, or $0.15 per common share attributable to controlling interest ($0.15 diluted), in Fiscal 2012.

Our Fiscal 2013 results include the following items:

         $248.0 million of realized investment gains in our Insurance segment;
          offset by,

         a $101.6 million loss from the change in the fair value of the equity
          conversion feature of preferred stock which was the result of an 23.0%
          increase in our stock price from $8.43 to $10.37 per share during
          Fiscal 2013;

         a $260.9 million increase in interest expense, that was primarily due
          to acquisition and other financing, along with refinancing to lower
          interest rate debt;

         tax expense of $187.3 million was primarily driven by; which was
          primarily driven by: (i) the profitability of FGL's life insurance
          business; (ii) pre-tax losses in the United States and some foreign
          jurisdictions for which the tax benefits are offset by valuation
          allowances; (iii) an increase in the fair value of the equity
          conversion feature of the Preferred Stock with no tax benefit; (iv) tax
          amortization of certain indefinite lived intangibles; and (v) tax
          expense on income in certain foreign jurisdictions for which the
          Company will not receive tax credits in the United

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States due to its tax loss position. Partially offsetting these factors was a partial release of U.S. valuation allowances as a result of a recent acquisition by Spectrum Brands. and,

         an impairment of oil and natural gas properties of $54.3 million from
          inception to the period ended September 30, 2013, primarily due to
          recent drilling results, modifications to our development plans, and a
          decline in natural gas futures prices.

   We ended the year with corporate cash and investments of approximately $301.2
    million (primarily held at HGI and HGI Funding, LLC).

   Our Consumer Product's operating profit for Fiscal 2013 increased $49.4
    million, or 16.4%, to $351.2 million from $301.8 million for Fiscal 2012. Our
    Consumer Products segment's adjusted earnings before interest, taxes,
    depreciation and amortization ("Adjusted EBITDA") increased by $8.7 million,
    or 1.3%, to $677.1 million versus Fiscal 2012 primarily due to higher sales,
    synergy benefits and cost reduction initiatives. Adjusted EBITDA margin
    represented 15.8% of sales as compared to 15.8% in Fiscal 2012. See Non-GAAP
    measures below for more details.

   Our Insurance segment's operating profit for the Fiscal 2013 increased $363.0
    million, to $522.9 million from an operating income of $159.9 million for the
    Fiscal 2012. Our Insurance segment's adjusted operating income ("Insurance
    AOI") increased by $163.5 million, or 282.4%, to $221.4 million versus the
    Fiscal 2012, primarily as a result of annual assumption changes made to the
    surrender rates, earned rates and future index credits used in the FIA
    embedded derivative reserve calculation, immediate annuity mortality gains
    caused by large case deaths, and the non-recurrence of an charge for an
    estimated unreported death claims liability, net of reinsurance, recorded in
    Fiscal 2012. See Non-GAAP measures below for more details.

   Our Energy segment's oil and natural gas revenues were $90.2 million for
    Fiscal 2013. Operating loss for Fiscal 2013 was $45.2 million, primarily as
    the result of the $54.3 million impairment of oil and natural gas properties.
    The Energy segment's adjusted earnings before interest, taxes, depreciation
    and amortization ("Adjusted EBITDA-Energy") for the Fiscal 2013 was $39.6
    million. For Fiscal 2013, the Energy segment's production was 283.0 MBbl of
    oil, 300.0 MBbl of natural gas liquids and 14,570.0 Mmcf of natural gas.

   Our Financial Services segment contributed approximately $28.9 million to our
    consolidated revenues for Fiscal 2013 from the operations of Salus and Five
    Island together, gross of revenue from affiliated entities. The Financial
    Services segment had net income for the Fiscal 2013 of $6.2 million.

   Through the year ended September 30, 2013, we received dividends of
    approximately $127.1 million from our respective subsidiaries, including
    $93.0 million, $22.8 million, $7.5 million and $3.8 million from FGL,
    Spectrum Brands, the EXCO/HGI JV and Salus, respectively. The FGL dividend of
    $93.0 million includes the special dividend of $73.0 million paid out of the
    proceeds from the $300.0 million aggregate principal amount of the FGL Notes.

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Results of Operations
Fiscal Year Ended September 30, 2013 Compared to Fiscal Year Ended September 30, 2012, and Fiscal Year Ended September 30, 2012 Compared to Fiscal Year September 30, 2011
Presented below is a table that summarizes our results of operations and compares the amount of the change between the fiscal periods (in millions):

                                                    Fiscal                        Increase / (Decrease)
                                                                              2013 compared    2012 compared
                                       2013          2012          2011          to 2012          to 2011
Consumer Products                   $ 4,085.6     $ 3,252.4     $ 3,186.9     $      833.2     $      65.5
Insurance                             1,348.4       1,221.8         290.8            126.6           931.0
Energy                                   90.2             -             -             90.2               -
Financial Services                       28.9           8.6             -             20.3             8.6
Intersegment elimination                 (9.7 )        (2.1 )           -             (7.6 )          (2.1 )
Consolidated revenues               $ 5,543.4     $ 4,480.7     $ 3,477.7     $    1,062.7     $   1,003.0

Operating income (loss):
Consumer Products                   $   351.2     $   301.8     $   227.9     $       49.4     $      73.9
Insurance                               522.9         159.9         (41.5 )          363.0           201.4
Energy                                  (45.2 )           -             -            (45.2 )             -
Financial Services                       10.4           2.5             -              7.9             2.5
Intersegment elimination                (10.9 )        (2.1 )           -             (8.8 )          (2.1 )
Total segments                          828.4         462.1         186.4            366.3           275.7
Corporate and Other                     (91.0 )       (52.6 )       (22.7 )          (38.4 )         (29.9 )
Consolidated operating income           737.4         409.5         163.7            327.9           245.8
Interest expense                       (511.9 )      (251.0 )      (249.3 )         (260.9 )          (1.7 )
(Loss) gain from the change in the
fair value of the equity conversion
feature of preferred stock             (101.6 )      (156.6 )        27.9             55.0          (184.5 )
Bargain purchase gain from business
acquisition                                 -             -         158.3                -          (158.3 )
Gain on contingent purchase price
reduction                                   -          41.0             -            (41.0 )          41.0
Other expense, net                       (5.6 )       (17.5 )       (42.7 )           11.9            25.2
Consolidated (loss) income from
. . .
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