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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K/A

(Amendment No. 2)

 

þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2012

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 1-4219

 

 

Harbinger Group Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   74-1339132

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

450 Park Avenue, 30th Floor

New York, NY

  10022
(Address of principal executive offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code (212) 906-8555

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.01 par value   New York Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:

None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    or    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    or    No  þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    or    No  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    or    No  ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

¨

   

Accelerated filer

 

¨

Non-accelerated filer

 

þ

 

(Do not check if a smaller reporting company)

 

Smaller reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    or    No  þ

The aggregate market value of the common stock held by non-affiliates of the registrant, computed by reference to the closing price as of the last business day of the registrant’s most recently completed second fiscal quarter, April 1, 2012, was approximately $49.8 million. For the sole purpose of making this calculation, the term “non-affiliate” has been interpreted to exclude directors and executive officers and other affiliates of the registrant and persons affiliated with Harbinger Capital Partners LLC.

As of March 22, 2013, the registrant had outstanding 143,176,546 shares of common stock, $0.01 par value.

Documents Incorporated By Reference: None.

 

 

 


EXPLANATORY NOTE

Harbinger Group Inc. (the “Company”) is filing this Amendment No. 2 on Form 10-K/A (this “Amendment”) to the Annual Report on Form 10-K of the Company for the year ended September 30, 2012 (“Original 10-K”) solely for the purpose of including a conformed signature on the report of KPMG LLP (“KPMG”), the Company’s independent registered accounting firm, for the Harbinger F&G, LLC and Subsidiaries Consolidated Financial Statements provided under rule 3-16 under Regulation S-X (“HF&G Financial Statements”), which was inadvertently excluded from the Original 10-K.

Accordingly, pursuant to the applicable rules of the SEC, (i) the Original 10-K’s “Item 8. Financial Statements and Supplementary Data” is being filed in its entirety solely to add the conformed signature to the report of KPMG to the HF&G Financial Statements and (ii) the certifications of the Company’s principal executive officers and principal financial and accounting officer are being filed as of the date of this Amendment. The only change in these certifications is their date.

Except as described above, this Amendment does not modify or update disclosure in, or exhibits to the Original 10-K. Furthermore, this Amendment does not change any previously reported financial results, nor does it reflect events occurring after the date of the Original 10-K. Information not affected by this Amendment remains unchanged and reflects the disclosures made at the time the Original 10-K was filed.


PART II

 

Item 8. Financial Statements and Supplementary Data

 

HARBINGER GROUP INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheets as of September 30, 2012 and 2011

     F-3   

Consolidated Statements of Operations for the Years Ended September 30, 2012, 2011 and 2010

     F-4   

Consolidated Statements of Permanent Equity and Comprehensive Income (Loss) for the Years Ended September 30, 2012, 2011 and 2010

     F-5   

Consolidated Statements of Cash Flows for the Years Ended September 30, 2012, 2011 and 2010

     F-6   

Notes to Consolidated Financial Statements

     F-7   

(1) Basis of Presentation and Nature of Operations

     F-7   

(2) Significant Accounting Policies and Practices

     F-8   

(3) Significant Risks and Uncertainties

     F-20   

(4) Receivables

     F-22   

(5) Investments

     F-22   

(6) Derivative Financial Instruments

     F-30   

(7) Fair Value of Financial Instruments

     F-36   

(8) Inventories

     F-43   

(9) Properties

     F-43   

(10) Goodwill and Intangibles

     F-44   

(11) Accrued and Other Liabilities

     F-47   

(12) Debt

     F-47   

(13) Temporary Equity

     F-52   

(14) Permanent Equity

     F-54   

(15) Employee Benefit Plans

     F-55   

(16) Stock Compensation

     F-59   

(17) Income Taxes

     F-62   

(18) Earnings Per Share

     F-69   

(19) Commitments and Contingencies

     F-71   

(20) Reinsurance

     F-73   

(21) Insurance Subsidiary — Financial Information

     F-75   

(22) Acquisitions

     F-76   

(23) Restructuring and Related Charges

     F-83   

(24) Reorganization Items

     F-84   

(25) Discontinued Operations

     F-85   

(26) Related Party Transactions

     F-85   

(27) Segment and Geographic Data

     F-89   

(28) Quarterly Results (Unaudited)

     F-91   

(29) Subsequent Events

     F-92   

Schedule I — Summary of Investments — Other than Investments in Related Parties

     F-94   

Schedule II — Condensed Financial Information of Registrant

     F-95   

Schedule III — Supplementary Insurance Information

     F-98   

Schedule IV — Reinsurance

     F-99   

 

F-1


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Harbinger Group Inc.:

We have audited the accompanying consolidated balance sheets of Harbinger Group Inc. and subsidiaries as of September 30, 2012 and 2011, and the related consolidated statements of operations, permanent equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended September 30, 2012. In connection with our audits of the consolidated financial statements we also audited financial statement schedules I to IV. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Harbinger Group Inc. and subsidiaries as of September 30, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2012 in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

New York, New York

November 27, 2012

 

F-2


HARBINGER GROUP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

    September 30,  
    2012     2011  
ASSETS   

Consumer Products and Other:

   

Cash and cash equivalents

  $ 408,889      $ 321,352   

Short-term investments (Note 5)

    181,828        350,638   

Receivables, net (Note 4)

    414,417        394,283   

Inventories, net (Note 8)

    452,633        434,630   

Prepaid expenses and other current assets (Note 17)

    86,272        143,654   
 

 

 

   

 

 

 

Total current assets

    1,544,039        1,644,557   

Properties, net (Note 9)

    214,319        206,799   

Goodwill (Note 10)

    694,245        610,338   

Intangibles, net (Note 10)

    1,714,929        1,683,909   

Deferred charges and other assets (Note 12)

    82,141        97,324   
 

 

 

   

 

 

 
    4,249,673        4,242,927   
 

 

 

   

 

 

 

Insurance and Financial Services:

   

Investments (Notes 5 and 6):

   

Fixed maturities, available-for-sale, at fair value

    16,088,913        15,367,474   

Equity securities, available-for-sale, at fair value

    248,087        287,043   

Derivative investments

    200,667        52,335   

Asset-backed loans and other invested assets

    198,868        44,279   
 

 

 

   

 

 

 

Total investments

    16,736,535        15,751,131   

Cash and cash equivalents

    1,061,822        816,007   

Accrued investment income

    191,577        212,848   

Reinsurance recoverable (Note 20)

    2,363,083        1,612,036   

Intangibles, net (Note 10)

    273,543        457,167   

Deferred tax assets (Note 17)

    279,636        207,729   

Other assets

    44,622        291,043   
 

 

 

   

 

 

 
    20,950,818        19,347,961   
 

 

 

   

 

 

 

Total assets

  $ 25,200,491      $ 23,590,888   
 

 

 

   

 

 

 
LIABILITIES AND EQUITY   

Consumer Products and Other:

   

Current portion of long-term debt (Note 12)

  $ 16,414      $ 16,090   

Accounts payable

    325,943        328,635   

Accrued and other current liabilities (Note 11)

    336,908        317,629   
 

 

 

   

 

 

 

Total current liabilities

    679,265        662,354   

Long-term debt (Note 12)

    2,150,625        2,032,690   

Equity conversion feature of preferred stock (Notes 6 and 13)

    231,950        75,350   

Employee benefit obligations (Note 15)

    95,113        89,857   

Deferred tax liabilities (Note 17)

    382,390        338,679   

Other liabilities

    31,897        44,957   
 

 

 

   

 

 

 
    3,571,240        3,243,887   
 

 

 

   

 

 

 

Insurance and Financial Services:

   

Contractholder funds (Note 2)

    15,290,475        14,549,970   

Future policy benefits (Note 2)

    3,614,788        3,598,208   

Liability for policy and contract claims

    91,082        56,650   

Note payable (Note 12)

    —          95,000   

Other liabilities (Note 11)

    714,708        381,597   
 

 

 

   

 

 

 
    19,711,053        18,681,425   
 

 

 

   

 

 

 

Total liabilities

    23,282,293        21,925,312   
 

 

 

   

 

 

 

Commitments and contingencies (Note 19)

   

Temporary equity (Note 13):

   

Redeemable preferred stock, $0.01 par; 10,000 preferred shares authorized; 400 shares outstanding with aggregate liquidation preference of $626,008 and $607,583 at September 30, 2012 and 2011, respectively

    319,225        292,437   
 

 

 

   

 

 

 

Harbinger Group Inc. stockholders’ equity (Note 14):

   

Common stock, $0.01 par; 500,000 shares authorized; 140,184 shares and 139,346 shares issued and outstanding at September 30, 2012 and 2011, respectively

    1,402        1,393   

Additional paid-in capital

    861,191        872,683   

Accumulated deficit

    (98,168     (128,083

Accumulated other comprehensive income

    413,172        149,448   
 

 

 

   

 

 

 

Total Harbinger Group Inc. stockholders’ equity

    1,177,597        895,441   

Noncontrolling interest

    421,376        477,698   
 

 

 

   

 

 

 

Total permanent equity

    1,598,973        1,373,139   
 

 

 

   

 

 

 

Total liabilities and equity

  $ 25,200,491      $ 23,590,888   
 

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

F-3


HARBINGER GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

     Year Ended September 30,  
     2012     2011     2010  

Revenues:

      

Consumer Products and Other:

      

Net sales

   $ 3,252,435      $ 3,186,916      $ 2,567,011   
  

 

 

   

 

 

   

 

 

 

Insurance and Financial Services:

      

Premiums

     55,297        39,002        —     

Net investment income (Note 5)

     722,733        369,840        —     

Net investment gains (losses) (Note 5)

     410,000        (166,891     —     

Insurance and investment product fees and other

     40,251        48,915        —     
  

 

 

   

 

 

   

 

 

 
     1,228,281        290,866        —     
  

 

 

   

 

 

   

 

 

 

Total revenues

     4,480,716        3,477,782        2,567,011   
  

 

 

   

 

 

   

 

 

 

Operating costs and expenses:

      

Consumer Products and Other:

      

Cost of goods sold (Note 23)

     2,136,757        2,058,049        1,645,601   

Selling, general and administrative expenses (Notes 2, 15, 16, 19, 22 and 23)

     870,755        947,140        760,956   
  

 

 

   

 

 

   

 

 

 
     3,007,512        3,005,189        2,406,557   
  

 

 

   

 

 

   

 

 

 

Insurance and Financial Services:

      

Benefits and other changes in policy reserves

     777,372        247,632        —     

Acquisition and operating expenses, net of deferrals

     125,685        72,390        —     

Amortization of intangibles (Note 10)

     160,656        (11,115     —     
  

 

 

   

 

 

   

 

 

 
     1,063,713        308,907        —     
  

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     4,071,225        3,314,096        2,406,557   
  

 

 

   

 

 

   

 

 

 

Operating income

     409,491        163,686        160,454   

Interest expense (Note 12)

     (251,032     (249,260     (277,015

(Increase) decrease in fair value of equity conversion feature of preferred stock (Note 6)

     (156,600     27,910        —     

Bargain purchase gain from business acquisition (Note 22)

     —          158,341        —     

Gain on contingent purchase price reduction (Note 22)

     41,000        —          —     

Other expense, net (Notes 2, 5, 6 and 27)

     (17,473     (42,743     (12,105
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before reorganization items and income taxes

     25,386        57,934        (128,666

Reorganization items expense (Note 24)

     —          —          (3,646
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     25,386        57,934        (132,312

Income tax (benefit) expense (Note 17)

     (85,282     50,555        63,195   
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     110,668        7,379        (195,507

Loss from discontinued operations, net of tax (Note 25)

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     110,668        7,379        (198,242

Less: Net income (loss) attributable to noncontrolling interest

     21,112        (34,680     (46,373
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to controlling interest

     89,556        42,059        (151,869

Less: Preferred stock dividends and accretion

     59,641        19,833        —     
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common and participating preferred stockholders

   $ 29,915      $ 22,226      $ (151,869
  

 

 

   

 

 

   

 

 

 

Basic income (loss) per common share attributable to controlling interest (Note 18):

      

Continuing operations

   $ 0.15      $ 0.11      $ (1.13

Discontinued operations

     —          —          (0.02
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.15      $ 0.11      $ (1.15
  

 

 

   

 

 

   

 

 

 

Diluted income (loss) per common share attributable to controlling interest (Note 18):

      

Continuing operations

   $ 0.15      $ 0.09      $ (1.13

Discontinued operations

     —          —          (0.02
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.15      $ 0.09      $ (1.15
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

F-4


HARBINGER GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF PERMANENT EQUITY AND COMPREHENSIVE INCOME (LOSS)

(In thousands)

 

    Common Stock     Additional
Paid-in
Capital
    Accumulated
Deficit
    Accumulated Other
Comprehensive
Income(Loss)
(Note 14)
    Treasury
Stock
    Total
Stockholder’s
Equity
    Noncontrolling
Interest
    Total Permanent
Equity
 
    Shares     Amount                

Balances at September 30, 2009

    129,600      $ 1,296      $ 723,800      $ (70,785   $ 6,568      $ —        $ 660,879      $ —        $ 660,879   

Net loss

    —          —          —          (151,869     —          —          (151,869     (46,373     (198,242

Actuarial adjustments to pension plans (Note 15)

    —          —          —          —          (13,561     —          (13,561     (8,084     (21,645

Translation adjustment

    —          —          —          —          395        —          395        12,682        13,077   

Other unrealized losses

    —          —          —          —          (5,330     —          (5,330     (1,276     (6,606
             

 

 

   

 

 

   

 

 

 

Comprehensive loss

                (170,365     (43,051     (213,416
             

 

 

   

 

 

   

 

 

 

Issuance of common stock in merger (Note 22)

    88,271        883        574,320        —          —          —          575,203        —          575,203   

Issuance of restricted stock

    4,056        41        (41     —          —          —          —          —          —     

Unvested restricted stock units, not issued or outstanding

    (1,171     (12     12        —          —          —          —          —          —     

Treasury stock purchases

    —          —          —          —          —          (2,207     (2,207     —          (2,207

Stock compensation (Note 16)

    —          —          14,032        —          —          —          14,032        2,678        16,710   

Capital contributions from a principal stockholder

    —          —          491        —          —          —          491        —          491   

Retrospective adjustments for common control transaction as of June 16, 2010 (Note 1)

    (81,559     (816     (456,847     72,345        6,733        2,207        (376,378     516,545        140,167   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2010

    139,197      $ 1,392      $ 855,767      $ (150,309   $ (5,195   $ —        $ 701,655      $ 476,172      $ 1,177,827   

Net income

    —          —          —          42,059        —          —          42,059        (34,680     7,379   

Unrealized investment gains, net

    —          —          —          —          159,302        —          159,302        —          159,302   

Non-credit related other-than-temporary impaiments

    —          —          —          —          191        —          191        —          191   

Other unrealized gains

    —          —          —          —          2,300        —          2,300        2,128        4,428   

Actuarial adjustments to pension plans (Note 15)

    —          —          —          —          (1,662     —          (1,662     (373     (2,035

Translation adjustment

    —          —          —          —          (5,171     —          (5,171     (5,436     (10,607
             

 

 

   

 

 

   

 

 

 

Comprehensive income

                197,019        (38,361     158,658   
             

 

 

   

 

 

   

 

 

 

Issuance of subsidiary stock, net

    —          —          (377     —          (317     —          (694     27,136        26,442   

Exercise of stock options

    149        1        416        —          —          —          417        —          417   

Stock compensation (Note 16)

    —          —          16,573        —          —          —          16,573        13,932        30,505   

Subsidiary restricted stock units surrendered

    —          —          (1,412     —          —          —          (1,412     (1,181     (2,593

Capital contributions from a principal stockholder

    —          —          1,716        —          —          —          1,716        —          1,716   

Preferred stock dividends and accretion

    —          —          —          (19,833     —          —          (19,833     —          (19,833
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

    139,346      $ 1,393      $ 872,683      $ (128,083   $ 149,448      $ —        $ 895,441      $ 477,698      $ 1,373,139   

Net income

    —          —          —          89,556        —          —          89,556        21,112        110,668   

Unrealized investment gains, net

    —          —          —          —          275,602        —          275,602        —          275,602   

Non-credit related other-than-temporary impaiments

    —          —          —          —          (613     —          (613     —          (613

Other unrealized gains

    —          —          —          —          809        —          809        736        1,545   

Actuarial adjustments to pension plans (Note 15)

    —          —          —          —          (6,601     —          (6,601     (5,074     (11,675

Translation adjustment

    —          —          —          —          (4,420     —          (4,420     (4,182     (8,602
             

 

 

   

 

 

   

 

 

 

Comprehensive income

                354,333        12,592        366,925   
             

 

 

   

 

 

   

 

 

 

Purchases of subsidiary stock

    —          —          (25,975     —          (1,053     —          (27,028     (58,019     (85,047

Stock compensation (Note 16)

    838        9        16,631        —          —          —          16,640        14,574        31,214   

Subsidiary restricted stock units surrendered

    —          —          (2,148     —          —          —          (2,148     (1,849     (3,997

Preferred stock dividends and accretion

    —          —          —          (59,641     —          —          (59,641     —          (59,641

Dividend paid by subsidiary

    —          —          —          —          —          —          —          (23,620     (23,620
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

    140,184      $ 1,402      $ 861,191      $ (98,168   $ 413,172      $ —        $ 1,177,597      $ 421,376      $ 1,598,973   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

F-5


HARBINGER GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended September 30,  
     2012     2011     2010  

Cash flows from operating activities:

      

Net income (loss)

   $ 110,668      $ 7,379      $ (198,242

Loss from discontinued operations

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     110,668        7,379        (195,507

Adjustments to reconcile income (loss) from continuing operations to net cash provided by continuing operating activities:

      

Bargain purchase gain from business acquisition

     —          (158,341     —     

Gain on contingent purchase price adjustment

     (41,000     —          —     

Depreciation of properties

     43,984        48,841        54,841   

Amortization of intangibles

     224,322        46,580        45,920   

Stock-based compensation

     31,214        30,505        16,710   

Intangible asset impairment

     —          32,450        —     

Amortization of debt issuance costs

     12,778        14,968        9,030   

Amortization of debt discount

     1,293        5,386        18,302   

Write off of debt issuance costs on retired debt

     2,946        15,420        6,551   

Write off of unamortized (premium) discount on retired debt

     (466     8,950        59,162   

Deferred income taxes

     (153,470     (16,119     52,612   

Cost of trading securities acquired for sale

     (643,763     (770,453     —     

Proceeds from trading securities sold

     766,120        756,986        —     

Interest credited/index credits to contractholder account balances

     586,814        140,004        —     

Collateral returned (posted)

     49,339        (148,420     —     

Amortization of fixed maturity discounts and premiums

     86,943        59,937        —     

Net recognized (gains) losses on investments and derivatives

     (231,930     181,177        —     

Charges assessed to contractholders for mortality and administration

     (14,932     (28,358     —     

Deferred policy acquisition costs

     (194,900     (41,152     —     

Cash transferred to reinsurers

     (176,770     (52,585     —     

Administrative related reorganization items

     —          —          3,646   

Payments for administrative related reorganization items

     —          —          (47,173

Non-cash increase to cost of goods sold due to fresh-start reporting inventory valuation

     —          —          34,865   

Non-cash interest expense

     —          —          24,555   

Non-cash restructuring and related charges

     5,195        15,143        16,359   

Changes in operating assets and liabilities:

      

Receivables

     22,892        12,969        12,702   

Inventories

     (11,642     96,406        (66,127

Prepaid expenses and other current assets

     11,338        (14,770     1,435   

Accrued investment income

     15,224        1,674        —     

Reinsurance recoverable

     (89,078     (39,446     —     

Accounts payable and accrued and other current liabilities

     (26,587     (23,875     88,594   

Future policy benefits

     16,580        (6,337     —     

Liability for policy and contract claims

     34,432        (3,750     —     

Other operating

     181,155        (18,064     (74,019
  

 

 

   

 

 

   

 

 

 

Net cash provided by continuing operating activities

     618,699        153,105        62,458   

Net cash used in discontinued operating activities

     —          —          (11,221
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     618,699        153,105        51,237   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Proceeds from investments sold, matured or repaid

     6,206,696        1,699,919        30,094   

Cost of investments acquired

     (5,972,715     (1,808,999     (3,989

Acquisitions, net of cash acquired

     (185,067     684,417        (2,577

Asset-backed loans originated

     (181,414     —          —     

Capital expenditures

     (53,518     (38,250     (40,374

Cash acquired in common control transaction

     —          —          65,780   

Proceeds from sales of assets

     500        7,240        388   

Other investing activities, net

     (118     (12,365     —     
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (185,636     531,962        49,322   
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Proceeds from issuances of senior notes

     517,000        498,459        —     

Proceeds from preferred stock issuances, net of issuance costs

     —          385,973        —     

Proceeds from new senior credit facilities, net of discount

     —          —          1,474,755   

Repayment of senior subordinated toggle notes, including tender and call premiums

     (270,431     —          —     

Payment of extinguished senior credit facilities, including prepayment penalties

     —          (230,416     (1,278,760

Proceeds from other debt financing, net

     392        5,788        13,688   

Repayments of other debt

     (254,173     —          (53,456

Debt issuance costs

     (11,231     (28,823     (55,024

Revolving credit facility activity

     —          —          (33,225

Contractholder account deposits

     2,040,512        494,956        —     

Contractholder account withdrawals

     (1,979,558     (959,961     —     

(Purchases) issuances of subsidiary stock, net

     (85,047     26,442        (2,207

Dividends paid on preferred stock

     (31,670     —          —     

Dividend paid by subsidiary to noncontrolling interest

     (23,620     —          —     

Other financing activities, net

     (953     2,134        491   
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (98,779     194,552        66,262   
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (932     909        258   

Effect of exchange rate changes on cash and cash equivalents due to Venezuela hyperinflation

     —          —          (8,048
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     333,352        880,528        159,031   

Cash and cash equivalents at beginning of year

     1,137,359        256,831        97,800   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 1,470,711      $ 1,137,359      $ 256,831   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents — Consumer Products and Other

   $ 408,889      $ 321,352      $ 256,831   

Cash and cash equivalents — Insurance and Financial Services

     1,061,822        816,007        —     
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents at end of year

   $ 1,470,711      $ 1,137,359      $ 256,831   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

      

Cash paid for interest

   $ 238,605      $ 190,171      $ 136,429   

Cash paid for income taxes, net

     47,232        37,171        36,951   

See accompanying notes to consolidated financial statements.

 

F-6


HARBINGER GROUP INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share figures)

(1) Basis of Presentation and Nature of Operations

Harbinger Group Inc., a Delaware corporation (“HGI” and, collectively with its subsidiaries, the “Company”), is a diversified holding company, the outstanding common stock of which is 92.6% owned, collectively, 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 “Principal Stockholders”), not giving effect to the conversion rights of the Series A Participating Convertible Preferred Stock (the “Series A Preferred Stock”) or the Series A-2 Participating Convertible Preferred Stock (the “Series A-2 Preferred Stock”, together the “Preferred Stock”). Such common stock ownership by the Principal Stockholders represents a voting interest of 69% in relation to the existing voting rights of all HGI’s common and preferred stockholders. HGI’s shares of common stock trade on the New York Stock Exchange (“NYSE”) under the symbol “HRG.”

HGI is focused on obtaining controlling equity stakes in companies that operate across a diversified set of industries and growing acquired businesses. In addition to acquiring controlling interests, HGI may make investments in debt instruments, acquire minority equity interests in companies and expand its operating businesses. The Company also owns 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.

On January 7, 2011, HGI completed the acquisition (the “Spectrum Brands Acquisition”) of a controlling financial interest in Spectrum Brands Holdings, Inc., a Delaware corporation (“Spectrum Brands”), under the terms of a contribution and exchange agreement (the “Exchange Agreement”) with the Principal Stockholders. The Principal Stockholders contributed approximately 54.5% of the then outstanding Spectrum Brands common stock to the Company and, in exchange for such contribution, the Company issued to the Principal Stockholders 119,910 shares of its common stock. Subsequently, HGI has directly and indirectly through a wholly-owned subsidiary, acquired additional Spectrum Brands stock. The Company’s beneficial ownership of the outstanding common stock of Spectrum Brands was 57.4% and 53.1% at September 30, 2012 and 2011, respectively.

Spectrum Brands is a global and diversified consumer products company and a leading supplier of batteries, small household appliances, specialty pet supplies, home and garden control products, shaving and grooming products, personal care products and portable lighting. Spectrum Brands offers a broad portfolio of brands including Rayovac®, Remington®, VARTA®, George Foreman®, Black & Decker®, Toastmaster®, Farberware®, Tetra®, Marineland®, Nature’s Miracle®, Dingo®, 8-in-1®, FURminator®, Littermaid®, Spectracide®, Cutter®, Repel®, Hot Shot® and Black Flag®. Spectrum Brands trades on the NYSE under the symbol “SPB.”

Spectrum Brands was formed in connection with the combination (the “SB/RH Merger”) of Spectrum Brands, Inc. (“SBI”), a global branded consumer products company, and Russell Hobbs, Inc. (“Russell Hobbs”), a global branded small appliance company. The SB/RH Merger was consummated on June 16, 2010. As a result of the SB/RH Merger, both SBI and Russell Hobbs are wholly-owned subsidiaries of Spectrum Brands and Russell Hobbs is a wholly-owned subsidiary of SBI. Prior to the SB/RH Merger, the Principal Stockholders owned approximately 40% and 100% of the outstanding common stock of SBI and Russell Hobbs, respectively. Spectrum Brands issued an approximately 65% controlling financial interest to the Principal Stockholders and an approximately 35% noncontrolling financial interest to other stockholders (other than the Principal Stockholders) in the SB/RH Merger.

Immediately prior to the Spectrum Brands Acquisition, the Principal Stockholders held controlling financial interests in both HGI and Spectrum Brands. As a result, the Spectrum Brands Acquisition was considered a transaction between entities under common control under Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations,” and was accounted for similar to the pooling of interest method. In accordance with the guidance in ASC Topic 805, the assets and liabilities transferred between entities under common control

 

F-7


are recorded by the receiving entity based on their carrying amounts (or at the historical cost basis of the parent, if these amounts differ). Although HGI was the issuer of shares in the Spectrum Brands Acquisition, during the historical periods presented Spectrum Brands was an operating business and HGI was not. Therefore, Spectrum Brands has been reflected as the predecessor and receiving entity in the Company’s financial statements to provide a more meaningful presentation of the transaction to the Company’s stockholders. Accordingly, the Company’s financial statements were retrospectively adjusted to reflect as the Company’s historical financial statements, those of SBI prior to June 16, 2010 and the combination of Spectrum Brands, HGI and HGI’s other subsidiaries thereafter. HGI’s assets and liabilities were recorded at the Principal Stockholders’ basis as of June 16, 2010, the date that common control was first established. As SBI was the accounting acquirer in the SB/RH Merger, the financial statements of SBI are included as the Company’s predecessor entity for periods preceding the June 16, 2010 date of the SB/RH Merger. In connection with the Spectrum Brands Acquisition, the Company changed its fiscal year end from December 31 to September 30 to conform to the fiscal year end of Spectrum Brands.

As discussed further in Note 22, on April 6, 2011 (the “FGL Acquisition Date”), the Company acquired Fidelity & Guaranty Life Holdings, Inc. (formerly, Old Mutual U.S. Life Holdings, Inc.), a Delaware corporation (“FGL”), from OM Group (UK) Limited (“OMGUK”). Such acquisition (the “FGL Acquisition”) has been accounted for using the acquisition method of accounting. Accordingly, the results of FGL’s operations have been included in the Company’s consolidated financial statements commencing April 6, 2011.

FGL’s primary business is the sale of individual life insurance products and annuities through independent agents, managing general agents, and specialty brokerage firms and in selected institutional markets. FGL’s principal products are deferred annuities (including fixed indexed annuity (“FIA”) contracts), immediate annuities and life insurance products. FGL markets products through its wholly-owned insurance subsidiaries, Fidelity & Guaranty Life Insurance Company (“FGL Insurance”) and Fidelity & Guaranty Life Insurance Company of New York (“FGL NY Insurance”), which together are licensed in all fifty states and the District of Columbia.

In connection with the acquisition of FGL, the Company acquired all of the equity of Front Street Re, Ltd. (“Front Street”) which was formed in March 2010 to act as a long-term reinsurer and to provide reinsurance to specialty insurance sectors of fixed, deferred and pay out annuities.

Additionally, the Company formed Salus Capital Partners, LLC (“Salus”), a subsidiary engaged in providing secured asset-based loans to entities across a variety of industries. Commencing December 1, 2011, the financial position and results of operations of Salus are reflected in the “Insurance and Financial Services” sections of the consolidated balance sheet and statement of operations, respectively.

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

(2) Significant Accounting Policies and Practices

Consolidation and Fiscal Year End

The accompanying consolidated financial statements include the accounts of HGI and all other entities in which HGI has a controlling financial interest; including Spectrum Brands (and SBI as its accounting predecessor prior to the SB/RH Merger), FGL, HGI Funding LLC (“HGI Funding”), Salus, Zap.Com and certain wholly-owned non-operating subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. At September 30, 2012, the non-controlling interest component of total equity represents the 42.6% share of Spectrum Brands and the 2.1% share of Zap.Com not owned by HGI. The Company’s fiscal year ends September 30 and its interim fiscal quarters end every thirteenth Sunday, except for its first fiscal quarter which may end on the fourteenth Sunday following September 30. References herein to Fiscal 2012, 2011 and 2010 refer to the fiscal years ended September 30, 2012, 2011 and 2010, respectively.

 

F-8


Segment Reporting

The Company follows the accounting guidance which establishes standards for reporting information about operating segments in annual financial statements and related disclosures about products and services, geographic areas and major customers. The Company’s reportable business segments are organized in a manner that reflects how HGI’s management views those business activities subsequent to the Spectrum Brands Acquisition and the FGL Acquisition. Accordingly, for purposes of the consolidated financial statement information of HGI presented herein, the Company operated in two major business segments, consumer products and, commencing April 6, 2011, insurance. In addition, commencing December 1, 2011, the Company includes the results of Salus in “Other financial services” in the segment data set forth in Note 27.

Revenue Recognition

Net Sales

The Company recognizes revenue from product sales generally upon delivery to the customer or the shipping point in situations where the customer picks up the product or where delivery terms so stipulate. This represents the point at which title and all risks and rewards of ownership of the product are passed, provided that: there are no uncertainties regarding customer acceptance; there is persuasive evidence that an arrangement exists; the price to the buyer is fixed or determinable; and collectability is deemed reasonably assured. The Company is generally not obligated to allow for, and it’s general policy is not to accept, product returns for battery sales. The Company does accept returns in specific instances related to its shaving, grooming, personal care, home and garden, small appliances and pet products. The provision for customer returns is based on historical sales and returns and other relevant information. The Company estimates and accrues the cost of returns, which are treated as a reduction of “Net sales.”

The Company enters into various promotional arrangements, primarily with retail customers, including arrangements entitling such retailers to cash rebates from the Company based on the level of their purchases, which require the Company to estimate and accrue the estimated costs of the promotional programs. These costs are treated as a reduction of “Net sales.”

The Company also enters into promotional arrangements that target the ultimate consumer. The costs associated with such arrangements are treated as either a reduction of “Net sales” or an increase of “Cost of goods sold,” based on the type of promotional program. The income statement presentation of the Company’s promotional arrangements complies with ASC Topic 605, “Revenue Recognition.” For all types of promotional arrangements and programs, the Company monitors its commitments and uses various measures, including past experience, to determine amounts to be recorded for the estimate of the earned, but unpaid, promotional costs. The terms of the Company’s customer-related promotional arrangements and programs are tailored to each customer and are documented through written contracts, correspondence or other communications with the individual customers.

The Company also enters into various arrangements, primarily with retail customers, which require the Company to make upfront cash, or “slotting” payments, in order to secure the right to distribute through such customers. The Company capitalizes slotting payments; provided the payments are supported by a time or volume based arrangement with the retailer, and amortizes the associated payment over the appropriate time or volume based term of the arrangement. The amortization of slotting payments is treated as a reduction of “Net sales” and a corresponding asset is reported in “Deferred charges and other assets” in the accompanying Consolidated Balance Sheets.

Insurance Premiums

FGL’s insurance premiums for traditional life insurance products are recognized as revenue when due from the contractholder. FGL’s traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of term life insurance and certain annuities with life contingencies.

 

F-9


Premium collections for fixed indexed and fixed rate annuities, indexed universal life (“IUL”) policies and immediate annuities without life contingency are reported as deposit liabilities (i.e., contractholder funds) instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liability for contractholder funds and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender and other charges deducted from contractholder funds, and net recognized gains (losses) on investments.

Net Investment Income

Dividends and interest income of FGL and Salus, recorded in “Net investment income,” are recognized when earned. Amortization of premiums and accretion of discounts on investments in fixed maturity securities are reflected in “Net investment income” over the contractual terms of the investments in a manner that produces a constant effective yield.

For mortgage-backed securities, included in the fixed maturity available-for-sale securities portfolios, FGL recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from originally anticipated prepayments, the effective yield is recalculated prospectively to reflect actual payments to date plus anticipated future payments. Any adjustments resulting from changes in effective yield are reflected in “Net investment income.”

Net Investment Gains (Losses)

Net investment gains (losses) include realized gains and losses of FGL from the sale of investments, write-downs for other-than-temporary impairments of available-for-sale investments, and gains and losses on derivative investments. For the insurance segment, realized gains and losses on the sale of investments are determined using the specific identification method.

Product Fees

Product fee revenue from indexed universal life insurance products and deferred annuities is comprised of policy and contract fees charged for the cost of insurance policy administration and is assessed on a monthly basis and recognized as revenue when assessed and earned. Product fee revenue also includes surrender charges which are recognized and collected when the policy is surrendered.

Cash Equivalents

The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. As of September 30, 2012 and 2011, cash and cash equivalents included such cash equivalents of $19,994 and $29,009, respectively, for Consumer Products and Other, and $2,250 and $2,768, respectively, for Insurance and Financial Services.

Investments

Consumer Products and Other

HGI’s short-term investments consist of (1) marketable equity and debt securities classified as trading and carried at fair value with unrealized gains and losses recognized in earnings, including certain securities for which the Company has elected the fair value option under ASC Topic 825, Financial Instruments, which would otherwise have been classified as available-for-sale, and (2) U.S. Treasury securities and a certificate of deposit classified as held to maturity and carried at amortized cost, which approximates fair value.

Insurance and Financial Services

FGL’s investments in debt and equity securities have been designated as available-for-sale and are carried at fair value with unrealized gains and losses included in “Accumulated other comprehensive income (loss)” (“AOCI”), net of associated intangibles “shadow adjustments” (discussed in Note 10) and deferred income taxes. Also

 

F-10


included under “Investments” are asset-based loans originated by Salus that it intends to hold in its portfolio and which are stated at the principal amount outstanding, adjusted for unamortized deferred fees and costs as well as discounts and premiums, which are amortized to interest income (included in “Net Investment income”) over the expected life of the loan on a straight-line basis.

Available-for-sale Securities—Other-Than-Temporary Impairments

FGL regularly reviews its available-for-sale securities for declines in fair value that FGL determines to be other-than-temporary. For an equity security, if FGL does not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, FGL concludes that an other-than-temporary impairment has occurred and the cost of the equity security is written down to the current fair value, with a corresponding charge to “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations. When assessing FGL’s ability and intent to hold an equity security to recovery, FGL considers, among other things, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, a fundamental analysis of the liquidity, business prospects and the overall financial condition of the issuer.

For FGL’s fixed maturity available-for-sale securities, FGL generally considers the following in determining whether FGL’s unrealized losses are other than temporarily impaired:

 

   

The estimated range and period until recovery;

 

   

Current delinquencies and nonperforming assets of underlying collateral;

 

   

Expected future default rates;

 

   

Collateral value by vintage, geographic region, industry concentration or property type;

 

   

Subordination levels or other credit enhancements as of the balance sheet date as compared to origination; and

 

   

Contractual and regulatory cash obligations.

FGL recognizes other-than-temporary impairments on debt securities in an unrealized loss position when one of the following circumstances exists:

 

   

FGL does not expect full recovery of its amortized cost based on the estimate of cash flows expected to be collected;

 

   

FGL intends to sell a security; or

 

   

It is more likely than not that FGL will be required to sell a security prior to recovery.

If FGL intends to sell a debt security or it is more likely than not FGL will be required to sell the security before recovery of its amortized cost basis and the fair value of the security is below amortized cost, FGL will conclude that an other-than-temporary impairment has occurred and the amortized cost is written down to current fair value, with a corresponding charge to “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations. If FGL does not intend to sell a debt security or it is more likely than not FGL will not be required to sell a debt security before recovery of its amortized cost basis and the present value of the cash flows expected to be collected is less than the amortized cost of the security (referred to as the credit loss), an other-than-temporary impairment has occurred and the amortized cost is written down to the estimated recovery value with a corresponding charge to “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations, as this amount is deemed the credit loss portion of the other-than-temporary impairment. The remainder of the decline to fair value is recorded in AOCI as unrealized other-than-temporary impairment on available-for-sale securities, as this amount is considered a non-credit (i.e., recoverable) impairment.

 

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When assessing FGL’s intent to sell a debt security or if it is more likely than not FGL will be required to sell a debt security before recovery of its cost basis, FGL evaluates facts and circumstances such as, but not limited to, decisions to reposition FGL’s security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing and tax planning strategies. In order to determine the amount of the credit loss for a security, FGL calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows FGL expects to recover. The discount rate is the effective interest rate implicit in the underlying security. The effective interest rate is the original purchased yield or the yield at the date the debt security was previously impaired.

When evaluating mortgage-backed securities and asset-backed securities, FGL considers a number of pool-specific factors as well as market level factors when determining whether or not the impairment on the security is temporary or other-than-temporary. The most important factor is the performance of the underlying collateral in the security and the trends of that performance. FGL uses this information about the collateral to forecast the timing and rate of mortgage loan defaults, including making projections for loans that are already delinquent and for those loans that are currently performing but may become delinquent in the future. Other factors used in this analysis include type of underlying collateral (e.g., prime, Alternative A-paper (“Alt-A”), or subprime), geographic distribution of underlying loans and timing of liquidations by state. Once default rates and timing assumptions are determined, FGL then makes assumptions regarding the severity of a default if it were to occur. Factors that impact the severity assumption include expectations for future home price appreciation or depreciation, loan size, first lien versus second lien, existence of loan level private mortgage insurance, type of occupancy and geographic distribution of loans. Once default and severity assumptions are determined for the security in question, cash flows for the underlying collateral are projected including expected defaults and prepayments. These cash flows on the collateral are then translated to cash flows on FGL’s tranche based on the cash flow waterfall of the entire capital security structure. If this analysis indicates the entire principal on a particular security will not be returned, the security is reviewed for other-than-temporary impairments by comparing the present value of expected cash flows to amortized cost. To the extent that the security has already been impaired or was purchased at a discount, such that the amortized cost of the security is less than or equal to the present value of cash flows expected to be collected, no impairment is required. FGL also considers the ability of monoline insurers to meet their contractual guarantees on wrapped mortgage-backed securities. Otherwise, if the amortized cost of the security is greater than the present value of the cash flows expected to be collected, then an impairment is recognized.

Asset-backed Loans—Allowance for Credit Losses

Asset-backed loans originated by Salus that are intended to be held in its portfolio are stated at the principal amount outstanding, adjusted for an allowance for credit losses. The delinquency status is based upon the contractual terms of the loans. At September 30, 2012, Salus has no delinquent loans. Salus generally has a cash dominion provision in its loans whereby all cash generated by its borrowers is swept into a concentration account to pay down each loan on a daily or weekly basis. In instances where Salus believes that it may not be able to collect the entirety of a loan’s principal, interest payments are applied to principal.

The allowance for credit losses represents Salus’ estimate of probable losses inherent in its lending activities and is initially established upon origination of a loan. The allowance for credit losses does not include amounts related to accrued interest receivable, as accrued interest receivable is reversed when a loan is placed on nonaccrual status. Salus regularly evaluates the adequacy of the allowance for credit losses on a combined loan basis. Salus will charge loans off against its allowance for credit losses when it becomes evident that Salus will not fully collect the balance of the loan. The provision for credit losses related to the loan portfolio is charged to “Acquisition and operating expenses, net of deferrals” in the Consolidated Statements of Operations.

Included in the allowance for credit losses are reserves that are maintained to cover uncertainties that affect Salus’ estimate of probable losses, including domestic and global economic uncertainty and large single name defaults. This collective allowance for credit losses is calculated using loss rates delineated by risk rating and

 

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loan type. Factors considered when assessing loss rates include the value of the underlying collateral, if applicable, the industry of the obligor, and the obligor’s liquidity and other financial indicators along with certain qualitative factors. If necessary, a specific allowance is also established for loans if they are deemed to be individually impaired. A loan is considered impaired when, based on current information and events, it is probable that Salus will be unable to collect all amounts due, including principal and/or interest, according to the contractual terms of the agreement. Once a loan has been identified as potentially impaired, management measures impairment based on the present value of payments expected to be received, discounted at the loans’ original effective contractual interest rates, or discounted at the portfolio average contractual annual percentage rate. Impaired loans may also be measured based on observable market prices, or for loans that are solely dependent on the collateral for repayment, the estimated fair value of the collateral less estimated costs to sell. If the recorded investment in impaired loans exceeds this amount, a specific allowance is established as a component of the allowance for loan losses.

Derivative Financial Instruments

Consumer Products and Other

Derivative financial instruments are used by the Company’s consumer products segment principally in the management of its interest rate, foreign currency exchange rate and raw material price exposures. When hedge accounting is elected at inception, the Company formally designates the financial instrument as a hedge of a specific underlying exposure if such criteria are met, and documents both the risk management objectives and strategies for undertaking the hedge. The Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in the forecasted cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the forecasted cash flows of the underlying exposures being hedged. Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in earnings. For derivatives that are not designated as cash flow hedges, or do not qualify for hedge accounting treatment, the change in the fair value is also immediately recognized in earnings.

The Company has outstanding Preferred Stock that contain a conversion feature (see Note 13). If the Company were to issue certain equity securities at a price lower than the conversion price of the respective Preferred Stock, the conversion price would be adjusted downward to reflect the dilutive effect of the newly issued securities (a “down round” provision). Therefore, in accordance with the guidance in ASC Topic 815, “Derivatives and Hedging,” the conversion feature is considered to be an embedded derivative that must be separately accounted for as a liability at fair value with any changes in fair value reported in current earnings. The embedded derivative has been bifurcated from the host contracts as of the respective issuance dates, marked to fair value and included in “Equity conversion feature of preferred stock” in the “Consumer Products and Other” sections of the accompanying Consolidated Balance Sheets with the change in fair value shown separately in the Consolidated Statements of Operations. The Company valued the conversion feature using the Monte Carlo simulation approach, as discussed further in Note 6.

Insurance and Financial Services

The Company’s insurance segment hedges certain portions of its exposure to product related equity market risk by entering into derivative transactions. All of such derivative instruments are recognized as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. The change in fair value is recognized within “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations.

FGL purchases and issues financial instruments and products that may contain embedded derivative instruments. If it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and a separate instrument with the same terms

 

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would qualify as a derivative instrument, the embedded derivative is bifurcated from the host contract for measurement purposes. The embedded derivative is carried at fair value with changes in fair value reported in the accompanying Consolidated Statements of Operations.

Displays and Fixtures

Temporary displays are generally disposable cardboard displays shipped to customers to facilitate display of the Company’s products. Temporary displays are generally disposed of after a single use by the customer.

Permanent fixtures are more permanent in nature, are generally made from wire or other longer-lived materials, and are shipped to customers for use in displaying the Company’s products. These permanent fixtures are restocked with the Company’s product multiple times over the fixture’s useful life.

The costs of both temporary and permanent displays are capitalized as a prepaid asset until shipped to the customer and are included in “Prepaid expenses and other current assets” in the accompanying Consolidated Balance Sheets. The costs of temporary displays are expensed in the period in which they are shipped to customers and the costs of permanent fixtures are amortized over an estimated useful life of one to two years from the date they are shipped to customers and are reflected in “Deferred charges and other assets” in the accompanying Consolidated Balance Sheets.

Inventories

The Company’s inventories are valued at the lower of cost or net realizable value. Cost of inventories is determined using the first-in, first-out (FIFO) method.

Properties

Properties are recorded at cost or at fair value if acquired in a purchase business combination. Depreciation on plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Building and improvements depreciable lives are 20-40 years and machinery, equipment and other depreciable lives are 2-15 years. Properties held under capitalized leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset and is included in depreciation expense.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Goodwill and Intangibles

Consumer Products

Intangible assets are recorded at cost or at fair value if acquired in a purchase business combination. In connection with fresh-start reporting following SBI’s emergence from Chapter 11 of the U.S. Bankruptcy Code, intangible assets were recorded at their estimated fair value on August 30, 2009. Customer lists, proprietary technology and certain trade name intangibles are amortized, using the straight-line method, over their estimated useful lives of approximately 1 to 20 years. Excess of cost over fair value of net assets acquired (goodwill) and indefinite-lived intangible assets (certain trade name intangibles) are not amortized. Goodwill is tested for impairment at least annually, at the reporting unit level. If impairment is indicated, a write-down to fair value (normally measured by discounting estimated future cash flows) is recorded. Indefinite-lived trade name

 

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intangibles are tested for impairment at least annually by comparing the fair value, determined using a relief from royalty methodology, with the carrying value. Any excess of carrying value over fair value is recognized as an impairment loss in income from operations. ASC Topic 350, “Intangibles-Goodwill and Other,” (“ASC 350”) requires that goodwill and indefinite-lived intangible assets be tested for impairment annually, or more often if an event or circumstance indicates that an impairment loss may have been incurred. During Fiscal 2012, 2011 and 2010, Spectrum Brands’ goodwill and trade name intangibles were tested for impairment as of the August financial period end, the annual testing date for Spectrum Brands, as well as in certain interim periods where an event or circumstance occurred that indicated an impairment loss may have been incurred (see Note 10).

Intangibles with Indefinite Lives

In accordance with ASC Topic 360, “Property, Plant and Equipment” (“ASC 360”) and ASC 350, in addition to its annual impairment testing Spectrum Brands conducts goodwill and trade name intangible asset impairment testing if an event or circumstance (“triggering event”) occurs that indicates an impairment loss may have been incurred. Spectrum Brands’ management uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel, and acts by governments and courts may signal that an asset has become impaired.

Intangibles with Definite or Estimable Useful Lives

Spectrum Brands assesses the recoverability of intangible assets with definite or estimable useful lives whenever an event or circumstance occurs that indicates an impairment loss may have been incurred. Spectrum Brands assesses the recoverability of these intangible assets by determining whether their carrying value can be recovered through projected undiscounted future cash flows. If projected undiscounted future cash flows indicate that the carrying value of the assets will not be recovered, an adjustment would be made to reduce the carrying value to an amount equal to estimated fair value determined based on projected future cash flows discounted at Spectrum Brands’ incremental borrowing rate. The cash flow projections used in estimating fair value are based on historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions.

Impairment reviews are conducted at the judgment of management when it believes that a change in circumstances in the business or external factors warrants a review. Circumstances such as the discontinuation of a product or product line, a sudden or consistent decline in the sales forecast for a product, changes in technology or in the way an asset is being used, a history of operating or cash flow losses, or an adverse change in legal factors or in the business climate, among others, may trigger an impairment review.

Insurance

Intangible assets of the Company’s insurance segment include value of business acquired (“VOBA”) and deferred acquisition costs (“DAC”).

VOBA represents the estimated fair value of the right to receive future net cash flows from in-force contracts in a life insurance company acquisition at the acquisition date. DAC represents costs that are related directly to new or renewal insurance contracts, which may be deferred to the extent recoverable. These costs include incremental direct costs of contract acquisition, primarily commissions, as well as certain costs related directly to underwriting, policy issuance and processing. Up front bonus credits to policyholder account values, which are considered to be deferred sales inducements (“DSI”), are accounted for similarly to DAC.

 

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The methodology for determining the amortization of VOBA and DAC varies by product type. For all insurance contracts, amortization is based on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and expected trends. US GAAP requires that assumptions for these types of products not be modified unless recoverability testing deems them to be inadequate. VOBA and DAC amortization are reported within “Amortization of intangibles” in the accompanying Consolidated Statements of Operations.

VOBA and DAC for IUL and investment-type products are generally amortized over the lives of the policies in relation to the incidence of estimated gross profits (“EGPs”) from investment income, surrender charges and other product fees, policy benefits, maintenance expenses, mortality net of reinsurance ceded and expense margins, and recognized gains (losses) on investments.

Changes in assumptions can have a significant impact on VOBA and DAC balances and amortization rates. Due to the relative size and sensitivity to minor changes in underlying assumptions of VOBA and DAC balances, FGL performs quarterly and annual analyses of VOBA and DAC for the annuity and indexed universal life businesses. The VOBA and DAC balances are also periodically evaluated for recoverability to ensure that the unamortized portion does not exceed the expected recoverable amounts. At each evaluation date, actual historical gross profits are reflected, and estimated future gross profits and related assumptions are evaluated for continued reasonableness. Any adjustment in estimated future gross profits requires that the amortization rate be revised (“unlocking”) retroactively to the date of the policy or contract issuance. The cumulative unlocking adjustment is recognized as a component of current period amortization.

The carrying amounts of VOBA and DAC are adjusted for the effects of realized and unrealized gains and losses on debt securities classified as available-for-sale and certain derivatives and embedded derivatives. Amortization expense of VOBA and DAC reflects an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, FGL performs a retrospective unlocking of VOBA and DAC amortization as actual margins vary from expected margins. This unlocking is reflected in the accompanying Consolidated Statements of Operations.

For investment-type products, the VOBA and DAC assets are adjusted for the impact of unrealized gains (losses) on investments as if these gains (losses) had been realized, with corresponding credits or charges included in AOCI.

Reinsurance

FGL’s insurance subsidiaries enter into reinsurance agreements with other companies in the normal course of business. The assets, liabilities, premiums and benefits of certain reinsurance contracts are presented on a net basis in the accompanying Consolidated Balance Sheets and Consolidated Statements of Operations, respectively, when there is a right of offset explicit in the reinsurance agreements. All other reinsurance agreements are reported on a gross basis in the Company’s Consolidated Balance Sheets as an asset for amounts recoverable from reinsurers or as a component of other liabilities for amounts, such as premiums, owed to the reinsurers, with the exception of amounts for which the right of offset also exists. Premiums and benefits are reported net of insurance ceded.

Debt Issuance Costs

Debt issuance costs, which are capitalized within “Deferred charges and other assets,” and original issue discount, net of any premiums, on debt are amortized to interest expense using the effective interest method over the lives of the related debt agreements.

Accounts Payable

Included in accounts payable are book overdrafts, net of deposits on hand, on disbursement accounts that are replenished when checks are presented for payment.

 

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Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has the ability and intent to recover in a tax-free manner assets (or liabilities) with book/tax basis differences for which no deferred taxes have been provided, in accordance with ASC Topic 740, “Income Taxes.” Accordingly, the Company did not provide deferred income taxes on the bargain purchase gain of $158,341 on the FGL Acquisition or the gain on contingent purchase price reduction of $41,000 in Fiscal 2011 and 2012, respectively.

The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Accrued interest expense and penalties related to uncertain tax positions are recorded in “Income tax (benefit) expense” in the accompanying Consolidated Statements of Operations.

Contractholder Funds and Future Policy Benefits

The liabilities for contractholder funds and future policy benefits for investment contracts and IUL policies consist of contract account balances that accrue to the benefit of the contractholders, excluding surrender charges. Investment contracts include FIAs, deferred annuities and immediate annuities without life contingencies. The liabilities for future insurance contract benefits and claim reserves for traditional life policies and pay-out annuity policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Assumptions for contracts in-force as of the FGL Acquisition Date were updated as of that date.

Liabilities for the secondary guarantees on IUL-type products or Investment-type contracts are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of VOBA and DAC. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of VOBA and DAC.

FIA contracts are equal to the total of the policyholder account values before surrender charges, and additional reserves established on certain features offered that link interest credited to an equity index. These features create an embedded derivative that is not clearly and closely related to the host insurance contract. The embedded derivative is carried at fair value with changes in fair value reported in the accompanying Consolidated Statements of Operations.

Federal Home Loan Bank of Atlanta Agreements

Contractholder funds include funds related to funding agreements that have been issued to the Federal Home Loan Bank of Atlanta (“FHLB”) as a funding medium for single premium funding agreements issued by FGL to the FHLB.

Funding agreements were issued to the FHLB in 2003, 2004, 2005 and 2011. The funding agreements (i.e., immediate annuity contracts without life contingencies) provide a guaranteed stream of payments. Single premiums were received at the initiation of the funding agreements and were in the form of advances from the

 

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FHLB. Payments under the funding agreements extend through 2022. The reserves for the funding agreements totaled $364,140 and $169,580 at September 30, 2012 and 2011, respectively, and are included in “Contractholder funds” in the accompanying Consolidated Balance Sheets.

In accordance with the agreements, the investments supporting the funding agreement liabilities are pledged as collateral to secure the FHLB funding agreement liabilities. The collateral investments had a fair value of $390,563 and $191,331 at September 30, 2012 and 2011, respectively.

Foreign Currency Translation

Local currencies are considered the functional currencies for most of the Company’s operations outside the United States. Assets and liabilities of the Company’s foreign subsidiaries are translated at the rate of exchange existing at year-end, with revenues, expenses, and cash flows translated at the average of the monthly exchange rates. Adjustments resulting from translation of the financial statements are recorded as a component of AOCI. Also included in AOCI are the effects of exchange rate changes on intercompany balances of a long-term nature.

As of September 30, 2012 and 2011, accumulated (losses) gains related to foreign currency translation adjustments of $(129) and $4,448 (net of taxes and non-controlling interest), respectively, were reflected in the accompanying Consolidated Balance Sheets in AOCI.

Foreign currency transaction gains and losses related to assets and liabilities that are denominated in a currency other than the functional currency are reported in the Consolidated Statements of Operations in the period they occur. Exchange losses on foreign currency transactions aggregating $1,654, $3,370 and $13,336 for Fiscal 2012, 2011 and 2010, respectively, are included in “Other expense, net” in the accompanying Consolidated Statements of Operations.

Shipping and Handling Costs

Shipping and handling costs, which are included in “Selling, general and administrative expenses” in the accompanying Consolidated Statements of Operations, include costs incurred with third-party carriers to transport products to customers and salaries and overhead costs related to activities to prepare the Company’s products for shipment at the Company’s distribution facilities. The Company incurred shipping and handling costs of $198,152, $201,480 and $161,148 during Fiscal 2012, 2011 and 2010, respectively.

Advertising Costs

Advertising costs, which are included in “Selling, general and administrative expenses” in the accompanying Consolidated Statements of Operations, include agency fees and other costs to create advertisements, as well as costs paid to third parties to print or broadcast the Company’s advertisements. The Company incurred advertising costs of $20,706, $30,673 and $37,520 during Fiscal 2012, 2011 and 2010, respectively.

Research and Development Costs

Research and development costs are charged to “Selling, general and administrative expenses” in the period they are incurred. The Company incurred research and development costs of $33,087, $32,901 and $31,013 during Fiscal 2012, 2011 and 2010, respectively.

Environmental Expenditures

Environmental expenditures that relate to current ongoing operations or to conditions caused by past operations are expensed or capitalized as appropriate. The Company determines its liability for environmental matters on a site-by-site basis and records a liability at the time when it is probable that a liability has been incurred and such

 

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liability can be reasonably estimated. The estimated liability is not reduced for possible recoveries from insurance carriers. Estimated environmental remediation expenditures are included in the determination of the net realizable value recorded for assets held for sale.

Comprehensive Income (Loss)

Comprehensive income (loss) includes foreign currency translation gains and losses on assets and liabilities of foreign subsidiaries, effects of exchange rate changes on intercompany balances of a long-term nature and transactions designated as a hedge of a net investment in a foreign subsidiary, deferred gains and losses on derivative financial instruments designated as cash flow hedges, actuarial adjustments to pension plans, and unrealized gains (losses) and non-credit related other-than-temporary impairments on investment securities of the insurance segment classified as available-for-sale. Except for gains and losses resulting from exchange rate changes on intercompany balances of a long-term nature, the Company did not provide income taxes on currency translation adjustments prior to Fiscal 2012, as earnings from international subsidiaries were considered to be permanently reinvested. As of the beginning of Fiscal 2012, earnings from international subsidiaries are no longer considered to be permanently reinvested by the Company. Net unrealized gains and losses on investment securities classified as available-for-sale by FGL are reduced by deferred income taxes and adjustments to intangible assets, including VOBA and DAC, that would have resulted had such gains and losses been realized (see Note 14).

Restructuring and Related Charges

Restructuring charges are recognized and measured according to the provisions of ASC Topic 420, “Exit or Disposal Cost Obligations,” (“ASC 420”). Under ASC 420, restructuring charges include, but are not limited to, termination and related costs consisting primarily of one-time termination benefits such as severance costs and retention bonuses, and contract termination costs consisting primarily of lease termination costs. Related charges, as defined by the Company, include, but are not limited to, other costs directly associated with exit and integration activities, including impairment of properties and other assets, departmental costs of full-time incremental integration employees, and any other items related to the exit or integration activities. Costs for such activities are estimated by management after evaluating detailed analyses of the cost to be incurred. Restructuring and related charges are reflected in “Cost of goods sold” and “Selling, general and administrative expenses” as applicable (see Note 23).

Benefits and Other Changes in Policy Reserves

Benefit expenses for deferred annuity, FIA and IUL policies include benefit claims incurred during the period in excess of contract account balances. Other changes in policy reserves also include the change in reserves for life insurance products with secondary guarantee benefits. For traditional life, policy benefit claims are charged to expense in the period that the claims are incurred.

Reclassifications and Retrospective Adjustments

Certain prior year amounts have been reclassified or combined to conform to the current year presentation. These reclassifications and combinations had no effect on previously reported results of operations or accumulated deficit. As discussed further in Note 22, in Fiscal 2012 the Company finalized the provisional acquisition accounting balances for the FGL Acquisition, resulting in retrospective adjustments which increased the bargain purchase gain and net income by $7,264 in Fiscal 2011.

Recent Accounting Pronouncements Not Yet Adopted

Presentation of Comprehensive Income

In June 2011, the Financial Accounting Standards Board (“FASB”) issued amended disclosure requirements to report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This

 

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guidance will be effective for the Company beginning in the fiscal year ending September 30, 2013. The Company does not expect the guidance to impact its consolidated financial statements, as such guidance only requires a change in the format of presentation.

Impairment Testing

In September 2011, the FASB issued new accounting guidance intended to simplify how an entity tests goodwill for impairment. The guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting guidance is effective for the Company for the annual and any interim goodwill impairment tests performed beginning in the fiscal year ending September 30, 2013. The Company does not expect the adoption of this guidance to have a significant impact on its consolidated financial statements.

Additionally, in July 2012, the FASB issued new accounting guidance intended to simplify how an entity tests indefinite-lived intangible assets for impairment. The guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An entity will no longer be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting guidance is effective for the Company for the annual and any interim indefinite-lived intangible asset impairment tests performed for the fiscal year ending September 30, 2013. The Company does not expect the adoption of this guidance to have a significant impact on its consolidated financial statements.

Offsetting Assets and Liabilities

In December 2011, the FASB issued amended disclosure requirements for offsetting financial assets and financial liabilities to allow investors to better compare financial statements prepared under US GAAP with financial statements prepared under International Financial Reporting Standards. The new standards are effective for the Company beginning in the first quarter of its fiscal year ending September 30, 2014. The Company is currently evaluating the impact of this new accounting guidance on the disclosures included in its consolidated financial statements.

(3) Significant Risks and Uncertainties

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the inherent uncertainty involved in making estimates, actual results in future periods could differ from those estimates.

The Company’s significant estimates which are susceptible to change in the near term relate to (1) recognition of deferred tax assets and related valuation allowances (see Notes 17 and 22), (2) fair value of certain invested assets and derivatives including embedded derivatives (see Notes 5, 6 and 7), (3) other-than-temporary impairments of available-for-sale investments (see Note 5), (4) fair value of equity conversion feature of preferred stock (see Note 7), (5) estimates of reserves for loss contingencies, including litigation, regulatory and environmental reserves (see Note 19), (6) valuation and impairment recognition for long-lived assets including properties, goodwill and intangibles (see Note 10) and (7) VOBA and DAC amortization (see Notes 2 and 10).

 

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Concentrations of Credit Risk and Major Customers

Trade receivables subject the Company’s consumer products segment to credit risk. Trade accounts receivable are carried at net realizable value. The Company extends credit to its customers based upon an evaluation of the customer’s financial condition and credit history, but generally does not require collateral. The Company monitors its customers’ credit and financial condition based on changing economic conditions and makes adjustments to credit policies as required. Provisions for losses on uncollectible trade receivables are determined based on ongoing evaluations of the Company’s receivables, principally on the basis of historical collection experience and evaluations of the risks of nonpayment for a given customer.

The Company’s consumer products segment has a broad range of customers including many large retail outlet chains, one of which accounts for a significant percentage of its sales volume. This major customer represented approximately 23%, 24% and 22% of the Company’s “Net sales” during Fiscal 2012, 2011 and 2010, respectively. This major customer also represented approximately 13% and 16% of the Company’s trade accounts receivable, net as of September 30, 2012 and 2011, respectively (see Note 4).

Approximately 46%, 44% and 44% of the Company’s “Net sales” during Fiscal 2012, 2011 and 2010, respectively, occurred outside of the United States. These sales and related receivables are subject to varying degrees of credit, currency, and political and economic risk. The Company monitors these risks and makes appropriate provisions for collectibility based on an assessment of the risks present.

Concentrations of Financial Instruments

As of September 30, 2012, the Company’s most significant investment in one industry was FGL’s investment securities in the banking industry with a fair value of $2,000,355, or 12%, of the invested assets portfolio. FGL’s holdings in this industry includes investments in 118 different issuers with the top ten investments accounting for 36% of the total holdings in this industry. As of September 30, 2012, FGL’s exposure to sub-prime and Alternative-A residential mortgage-backed securities was $233,318 and $121,629, or approximately 1% of FGL’s invested assets. As of September 30, 2012 and 2011, the Company had investments in 8 and 19 issuers that exceeded 10% of stockholders’ equity with a fair value of $1,081,955 and $2,126,380, or 6% and 13% of the invested assets portfolio, respectively. Additionally, the Company’s largest concentration in any single issuer as of September 30, 2012 and 2011 had a fair value of $152,876 and $159,265, or approximately 1% of the invested assets portfolio.

Concentrations of Financial and Capital Markets Risk

Financial markets in the United States and elsewhere have experienced extreme volatility and disruption for more than three years, due largely to the stresses affecting the global banking system. Like other life insurers, FGL has been adversely affected by these conditions. FGL is exposed to financial and capital markets risk, including changes in interest rates and credit spreads which have had an adverse effect on FGL’s results of operations, financial condition and liquidity prior to the FGL Acquisition. As discussed further in the following paragraph regarding risk factors, FGL expects to continue to face challenges and uncertainties that could adversely affect FGL’s results of operations and financial condition.

FGL’s exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will decrease the net unrealized gain position of FGL’s investment portfolio and, if long-term interest rates rise dramatically within a six to twelve month time period, certain of FGL’s products may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring FGL to liquidate assets in an unrealized loss position. This risk is mitigated to some extent by the high level of surrender charge protection provided by FGL’s products.

 

F-21


Concentration of Reinsurance Risk

FGL has a significant concentration of reinsurance with Wilton Reassurance Company (“Wilton Re”) (see Note 20) that could have a material impact on FGL’s financial position in the event that Wilton Re fails to perform its obligations under the various reinsurance treaties. As of September 30, 2012, the net amount recoverable from Wilton Re was $1,317,114. FGL monitors both the financial condition of individual reinsurers and risk concentration arising from similar geographic regions, activities and economic characteristics of reinsurers to reduce the risk of default by such reinsurers.

(4) Receivables

Receivables, net consist of the following:

 

     September 30,  
     2012      2011  

Trade accounts receivable

   $ 357,171       $ 370,733   

Contingent purchase price reduction receivable (Note 22)

     41,000         —     

Other receivables

     38,116         37,678   
  

 

 

    

 

 

 
     436,287         408,411   

Less: Allowance for doubtful trade accounts receivable

     21,870         14,128   
  

 

 

    

 

 

 
   $ 414,417       $ 394,283   
  

 

 

    

 

 

 

The following is an analysis of the allowance for doubtful trade accounts receivable:

 

Period

   Balance at
Beginning of Period
     Charged to
Costs and Expenses
     Deductions      Other
Adjustments
     Balance at
End of Period
 

Fiscal 2012

   $ 14,128       $ 7,742       $ —         $ —         $ 21,870   

Fiscal 2011

     4,351         9,777         —           —           14,128   

Fiscal 2010

     1,011         3,340         —           —           4,351   

(5) Investments

Consumer Products and Other

The Company’s short-term investments are summarized as follows:

 

     September 30,  
     2012      2011  

Trading:

     

Marketable equity securities

   $ 146,842       $ 262,085   

Marketable debt securities

     —           12,665   
  

 

 

    

 

 

 
     146,842         274,750   
  

 

 

    

 

 

 

Held to maturity:

     

U.S. Treasury securities

     34,735         75,638   

Certificate of deposit

     251         250   
  

 

 

    

 

 

 
     34,986         75,888   
  

 

 

    

 

 

 

Total short-term investments

   $ 181,828       $ 350,638   
  

 

 

    

 

 

 

There were $45,004 and $44,030 of net unrealized losses recognized in “Short-term investments” that relate to trading securities held at September 30, 2012 and 2011, respectively.

 

F-22


Insurance and Financial Services

Investments of FGL and Salus at September 30, 2012 and 2011 are summarized as follows:

 

     September 30, 2012  
     Amortized
Cost
     Gross Unrealized
Gains
     Gross Unrealized
Losses
    Fair Value and
Carrying Value
 

Available-for-sale securities

          

Asset-backed securities

   $ 1,010,938       $ 18,553       $ (1,609   $ 1,027,882   

Commercial mortgage-backed securities

     520,043         36,178         (2,407     553,814   

Corporates

     10,211,804         807,175         (9,968     11,009,011   

Equities

     237,499         11,860         (1,272     248,087   

Hybrids

     519,009         18,836         (9,550     528,295   

Municipals

     1,083,231         141,854         (1,090     1,223,995   

Agency residential mortgage-backed securities

     149,455         5,769         (334     154,890   

Non-agency residential mortgage-backed securities

     629,122         35,799         (4,262     660,659   

U.S. Government

     917,452         12,915         —          930,367   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

     15,278,553         1,088,939         (30,492     16,337,000   

Derivative investments

     142,123         66,973         (8,429     200,667   

Asset-backed loans and other invested assets

     198,868         —           —          198,868   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments

   $ 15,619,544       $ 1,155,912       $ (38,921   $ 16,736,535   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     September 30, 2011  
     Amortized
Cost
     Gross Unrealized
Gains
     Gross Unrealized
Losses
    Fair Value and
Carrying Value
 

Available-for-sale securities

          

Asset-backed securities

   $ 501,469       $ 1,785       $ (2,770   $ 500,484   

Commercial mortgage-backed securities

     580,313         3,427         (18,163     565,577   

Corporates

     11,479,862         506,264         (130,352     11,855,774   

Equities

     292,112         3,964         (9,033     287,043   

Hybrids

     699,915         10,429         (51,055     659,289   

Municipals

     824,562         111,929         (7     936,484   

Agency residential mortgage-backed securities

     217,354         4,966         (295     222,025   

Non-agency residential mortgage-backed securities

     465,666         1,971         (23,120     444,517   

U.S. Government

     175,054         8,270         —          183,324   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

     15,236,307         653,005         (234,795     15,654,517   

Derivative investments

     171,612         405         (119,682     52,335   

Other invested assets

     44,279         —           —          44,279   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments

   $ 15,452,198       $ 653,410       $ (354,477   $ 15,751,131   
  

 

 

    

 

 

    

 

 

   

 

 

 

Included in AOCI were cumulative unrealized gains of $851 and $524 and unrealized losses of $1,880 and $24 related to the non-credit portion of other-than-temporary impairments on non-agency residential-mortgage-backed securities at September 30, 2012 and 2011, respectively.

Securities held on deposit with various state regulatory authorities had a fair value of $20,692 and $17,867 at September 30, 2012 and 2011, respectively.

 

F-23


The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities, as applicable, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.

 

     September 30, 2012  
     Amortized Cost      Fair Value  

Corporate, Non-structured Hybrids, Municipal and U.S. Government securities:

     

Due in one year or less

   $ 700,491       $ 703,931   

Due after one year through five years

     3,230,602         3,324,453   

Due after five years through ten years

     3,692,333         3,995,811   

Due after ten years

     4,972,233         5,532,389   
  

 

 

    

 

 

 

Subtotal

     12,595,659         13,556,584   

Other securities which provide for periodic payments:

     

Asset-backed securities

     1,010,938         1,027,882   

Commercial-mortgage-backed securities

     520,043         553,814   

Structured hybrids

     135,837         135,084   

Agency residential mortgage-backed securities

     149,455         154,890   

Non-agency residential mortgage-backed securities

     629,122         660,659   
  

 

 

    

 

 

 

Total fixed maturity available-for-sale securities

   $ 15,041,054       $ 16,088,913   
  

 

 

    

 

 

 

As part of FGL’s ongoing securities monitoring process, FGL evaluates whether securities in an unrealized loss position could potentially be other-than-temporarily impaired. Excluding the non-credit portion of other-than-temporary impairments on non-agency residential-mortgage backed securities above, FGL has concluded that the fair values of the securities presented in the table below were not other-than-temporarily impaired as of September 30, 2012. This conclusion is derived from the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms along with the expectation that they will continue to do so. Also contributing to this conclusion is FGL’s determination that it is more likely than not that FGL will not be required to sell these securities prior to recovery, an assessment of the issuers’ financial condition, and other objective evidence. As it specifically relates to asset-backed securities and commercial mortgage-backed securities, the present value of cash flows expected to be collected is at least the amount of the amortized cost basis of the security and FGL’s management has the intent to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value.

 

F-24


The fair value and gross unrealized losses of available-for-sale securities, aggregated by investment category, were as follows:

 

    September 30, 2012  
    Less than 12 months     12 months or longer     Total  
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized

Losses
 

Available-for-sale securities

           

Asset-backed securities

  $ 169,794      $ (1,042   $ 7,533      $ (567   $ 177,327      $ (1,609

Commercial-mortgage-backed securities

    813        (853     10,716        (1,554     11,529        (2,407

Corporates

    411,310        (8,124     45,482        (1,844     456,792        (9,968

Equities

    —          —          44,513        (1,272     44,513        (1,272

Hybrids

    13,407        (339     107,707        (9,211     121,114        (9,550

Municipals

    71,160        (1,090     —          —          71,160        (1,090

Agency residential mortgage-backed securities

    1,754        (199     6,110        (135     7,864        (334

Non-agency residential mortgage-backed securities

    12,853        (289     101,777        (3,973     114,630        (4,262
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

  $ 681,091      $ (11,936   $ 323,838      $ (18,556   $ 1,004,929      $ (30,492
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total number of available-for-sale securities in an unrealized loss position

   

 

100

  

   

 

56

  

      156   
   

 

 

     

 

 

     

 

 

 

 

    September 30, 2011  
    Less than 12 months     12 months or longer     Total  
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized

Losses
 

Available-for-sale securities

           

Asset-backed securities

  $ 275,135      $ (2,770   $ —        $ —        $ 275,135      $ (2,770

Commercial-mortgage-backed securities

    338,865        (18,163     —          —          338,865        (18,163

Corporates

    3,081,556        (130,352     —          —          3,081,556        (130,352

Equities

    99,772        (9,033     —          —          99,772        (9,033

Hybrids

    450,376        (51,055     —          —          450,376        (51,055

Municipals

    1,137        (7     —          —          1,137        (7

Agency residential mortgage-backed securities

    25,820        (295     —          —          25,820        (295

Non-agency residential mortgage-backed securities

    375,349        (23,120     —          —          375,349        (23,120
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

  $ 4,648,010      $ (234,795   $ —        $ —        $ 4,648,010      $ (234,795
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total number of available-for-sale securities in an unrealized loss position

      505              505   
   

 

 

         

 

 

 

As the amortized cost of all investments was adjusted to fair value as of the FGL Acquisition Date, no individual securities had been in a continuous unrealized loss position greater than twelve months as of September 30, 2011.

 

F-25


At September 30, 2012 and 2011, securities in an unrealized loss position were primarily concentrated in investment grade corporate debt instruments, residential mortgage-backed securities and hybrids. Total unrealized losses were $30,492 and $234,795 at September 30, 2012 and 2011, respectively. Exposure to finance-related holdings represents the largest component of the unrealized loss position in the portfolio, as spreads for holdings in this industry sector remain above historical levels. Similar risk aversion effects have impacted prices of commercial mortgage-backed securities and non-agency residential mortgage-backed securities. FGL has added to its non-agency residential mortgage-backed holdings during the year by purchasing securities with an “A” credit rating or above at discounts. As of September 30, 2012, these securities were in an unrealized gain position. FGL has not added to its commercial mortgage-backed security exposure. The improvement in unrealized loss positions in corporate debt instruments from September 30, 2011 to September 30, 2012 was primarily a result of improving conditions for corporate issues.

The combination of ongoing liquidity efforts by global central banks to stem contagion from a Eurozone slowdown, and accommodative monetary policy (especially in the U.S.) that is keeping base interest rates low, helped drive strong performance in risk assets in the September 2012 quarter. The prices of securities exposed to the residential real estate market in the U.S. also increased, which management believes is a result of the decline in risk aversion and data indicating that the housing market in the U.S. has begun to improve.

At September 30, 2012 and 2011, securities with a fair value of $1,192 and $31,320, respectively, were depressed greater than 20% of amortized cost, which represented less than 1% of the carrying values of all investments. The improvement in unrealized loss positions from September 30, 2011 is primarily due to two factors: (i) securities at depressed prices were sold over the past fiscal year, reducing the size of holdings in an unrealized loss position and (ii) improving risk sentiment has lifted the market prices of investment grade bonds. Based upon FGL’s current evaluation of these securities in accordance with its impairment policy and its intent to retain these investments for a period of time sufficient to allow for recovery in value, FGL has determined that these securities are not other-than-temporarily impaired.

The following table provides a reconciliation of the beginning and ending balances of the credit loss portion of other-than-temporary impairments on fixed maturity securities held by FGL at September 30, 2012 and 2011, for which a portion of the other-than-temporary impairment was recognized in AOCI:

 

     Year Ended September 30,  
             2012                      2011          

Beginning balance

   $ 667       $ —     

Increases attributable to credit losses on securities:

     

Other-than-temporary impairment was previously recognized

     112         —     

Other-than-temporary impairment was not previously recognized

     1,902         667   
  

 

 

    

 

 

 

Ending balance

   $ 2,681       $ 667   
  

 

 

    

 

 

 

 

F-26


For the year ended September 30, 2012, FGL recognized impairment losses in operations totaling $22,807, including credit impairments of $5,712 and change-of-intent impairments of $17,095, as well as non-credit losses in other comprehensive income totaling $1,529, for investments which experienced other-than-temporary impairments and had an amortized cost of $162,349 and a fair value of $138,013 at the time of impairment. For the year ended September 30, 2011, FGL recognized impairment losses in operations totaling $17,966, including credit impairments of $5,059 and change-of-intent impairments of $12,907, as well as non-credit gains totaling $500 in other comprehensive income, for investments which experienced other-than-temporary impairments and had an amortized cost of $103,312 and a fair value of $85,846 at the time of impairment. Details underlying write-downs taken as a result of other-than-temporary impairments that were recognized in operations and included in net realized gains on securities were as follows:

 

     Year Ended September 30,  
         2012              2011      

Other-than-temporary impairments recognized in net income:

     

Commercial mortgage-backed securities

   $ —         $ 20   

Corporates

     4,116         1,462   

Equities

     —           11,007   

Hybrids

     9,688         —     

Non-agency residential mortgage-backed securities

     7,531         5,059   

Other invested assets

     1,472         418   
  

 

 

    

 

 

 

Total other-than-temporary impairments

   $ 22,807       $ 17,966   
  

 

 

    

 

 

 

Asset-backed Loans

Salus’ portfolio of asset-backed loans receivable, included in “Asset-backed loans and other invested assets” in the Consolidated Balance Sheet as of September 30, 2012, consisted of the following:

 

     September 30, 2012  

Asset-backed loans, by major industry:

  

Wholesale

   $ 77,217   

Apparel

     70,073   

Jewelry

     27,829   

Other

     6,295   
  

 

 

 

Total asset-backed loans

     181,414   

Allowance for credit losses

     1,360   
  

 

 

 

Total asset-backed loans, net

   $ 180,054   
  

 

 

 

As further discussed in Note 2, Salus establishes its allowance for credit losses through a provision for credit losses based on its evaluation of the credit quality of its loan portfolio. The following table presents the activity in its allowance for credit losses for the year ended September 30, 2012:

 

     Year Ended
September 30, 2012
 

Allowance for credit losses:

  

Balance at beginning of year

   $ —     

Provision for credit losses

     1,360   

Charge-offs

     —     

Recoveries

     —     
  

 

 

 

Balance at end of year

   $ 1,360   
  

 

 

 

 

F-27


Salus monitors credit quality as indicated by various factors and utilizes such information in its evaluation of the adequacy of the allowance for credit losses. As of September 30, 2012, Salus had no outstanding loans that either were non-performing, in a non-accrual status, or had been subject to a troubled-debt restructuring. As of September 30, 2012, Salus had no outstanding loans that had been individually considered impaired, as all loans were in current payment status.

Salus’ internal loan ratings provide information about the credit quality of its asset-based lending borrowers, and its risk of potential loss. The following tables present information about the credit quality of Salus’ asset-based loan portfolio, based on National Association of Insurance Commissioners (“NAIC”) risk rating, as of September 30, 2012:

Asset-backed loans, by credit quality rating:

 

NAIC Designation

  

Credit Equivalent Rating

   September 30, 2012      Percent of Total  

1

   AAA/AA/A    $ 75,737         42

2

   BBB      94,901         52

3

   B      10,773         6

Not rated

        3         —     
     

 

 

    

 

 

 
   Total asset-backed loans    $ 181,414         100
     

 

 

    

 

 

 

Net Investment Income

The major sources of “Net investment income” in the accompanying Consolidated Statements of Operations were as follows:

 

     Year Ended September 30,  
     2012     2011  

Fixed maturity available-for-sale securities

   $ 707,132      $ 364,771   

Equity available-for-sale securities

     13,966        10,190   

Invested cash and short-term investments

     4,921        129   

Policy loans

     707        1,511   

Other investments

     7,736        326   
  

 

 

   

 

 

 

Gross investment income

     734,462        376,927   

External investment expense

     (11,729     (7,087
  

 

 

   

 

 

 

Net investment income

   $ 722,733      $ 369,840   
  

 

 

   

 

 

 

 

F-28


Net Investment Gains (Losses)

Details underlying “Net investment gains (losses)” reported in the accompanying Consolidated Statements of Operations were as follows:

 

     Year Ended September 30,  
     2012     2011  

Net realized gains on fixed maturity available-for-sale securities

   $ 264,408      $ 16,912   

Realized gains (losses) on equity securities

     924        (10,977
  

 

 

   

 

 

 

Net realized gains on securities

     265,332        5,935   
  

 

 

   

 

 

 

Realized losses on certain derivative instruments

     (10,280     (44,776

Unrealized gains (losses) on certain derivative instruments

     156,332        (125,976
  

 

 

   

 

 

 

Change in fair value of derivatives

     146,052        (170,752
  

 

 

   

 

 

 

Realized losses on other invested assets

     (1,384     (2,074
  

 

 

   

 

 

 

Net investment gains (losses)

   $ 410,000      $ (166,891
  

 

 

   

 

 

 

Additional detail regarding the net investment losses is as follows:

 

     Year Ended September 30,  
     2012     2011  

Total other-than-temporary impairments

   $ (24,336   $ (17,466

Less non-credit portion of other-than-temporary impairments included in other comprehensive income

     (1,529     500   
  

 

 

   

 

 

 

Net other-than-temporary impairments

     (22,807     (17,966

Gains (losses) on derivative instruments

     146,052        (170,752

Other realized investment gains

     286,755        21,827   
  

 

 

   

 

 

 

Net investment gains (losses)

   $ 410,000      $ (166,891
  

 

 

   

 

 

 

For the years ended September 30, 2012 and 2011, proceeds from the sale of fixed maturity available-for-sale securities, including assets transferred to Wilton Re as discussed in Note 15 totaled $4,602,958 and $1,803,964, gross gains on such sales totaled $295,923 and $41,989 and gross losses totaled $13,842 and $17,109, respectively.

Underlying write-downs taken to fixed maturity available-for-sale securities as a result of other-than-temporary impairments that were recognized in earnings and included in net realized gains on securities above were $22,807 and $17,966 for the year ended September 30, 2012 and 2011, respectively. The portion of other-than-temporary impairments recognized in AOCI is disclosed in Note 14.

 

F-29


Cash flows from consolidated investing activities by security classification were as follows:

 

    Year Ended September 30,  
    2012     2011      2010  

Proceeds from investments sold, matured or repaid:

      

Available-for-sale

  $ 5,833,423      $ 1,482,195       $ —     

Held-to-maturity

    109,636        101,755         30,094   

Trading (acquired for holding)

    106,074        29,532         —     

Derivatives and other

    157,563        86,437         —     
 

 

 

   

 

 

    

 

 

 
  $ 6,206,696      $ 1,699,919       $ 30,094   
 

 

 

   

 

 

    

 

 

 

Cost of investments acquired:

      

Available-for-sale

  $ 5,640,090      $ 1,285,951       $ —     

Held-to-maturity

    68,733        123,428         3,989   

Trading

    122,289        332,715         —     

Derivatives and other

    141,603        66,905         —     
 

 

 

   

 

 

    

 

 

 
  $ 5,972,715      $ 1,808,999       $ 3,989   
 

 

 

   

 

 

    

 

 

 

(6) Derivative Financial Instruments

Consumer Products and Other

The fair value of outstanding derivative contracts recorded in the “Consumer Products and Other” sections of the accompanying Consolidated Balance Sheets were as follows:

 

          September 30,  

Asset Derivatives

  

Classification

   2012      2011  

Derivatives designated as hedging instruments:

        

Commodity contracts

   Receivables    $ 985       $ 274   

Commodity contracts

   Deferred charges and other assets      1,017         —     

Foreign exchange contracts

   Receivables      1,194         3,189   
     

 

 

    

 

 

 

Total asset derivatives designated as hedging instruments

        3,196         3,463   

Derivatives not designated as hedging instruments:

        

Foreign exchange contracts

   Receivables      41         —     
     

 

 

    

 

 

 

Total asset derivatives

      $ 3,237       $ 3,463   
     

 

 

    

 

 

 

 

        September 30,  

Liability Derivatives

 

Classification

  2012     2011  

Derivatives designated as hedging instruments:

     

Interest rate contracts

  Accounts payable   $ —        $ 1,246   

Interest rate contracts

  Accrued and other current liabilities     —          708   

Commodity contracts

  Accounts payable     9        1,228   

Commodity contracts

  Other liabilities     —          4   

Foreign exchange contracts

  Accounts payable     3,063        2,698   
   

 

 

   

 

 

 

Total liability derivatives designated as hedging instruments

      3,072        5,884   

Derivatives not designated as hedging instruments:

     

Foreign exchange contracts

  Accounts payable     3,967        10,945   

Foreign exchange contracts

  Other liabilities     2,926        12,036   

Equity conversion feature of preferred stock

  Equity conversion feature of preferred stock     231,950        75,350   
   

 

 

   

 

 

 

Total liability derivatives

    $ 241,915      $ 104,215   
   

 

 

   

 

 

 

 

F-30


Changes in AOCI from Derivative Instruments

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative, representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness, are recognized in current earnings.

The following table summarizes the pretax impact of derivative instruments designated as cash flow hedges in the accompanying Consolidated Statements of Operations, and within AOCI, for the years ended September 30, 2012, 2011 and 2010:

 

Derivatives in Cash
Flow Hedging
Relationships

   Amount of Gain
(Loss) Recognized
in AOCI on
Derivatives (Effective
Portion)
    Amount of Gain
(Loss) Reclassified
from AOCI
into Income (Effective
Portion)
    Amount of Gain
(Loss) Recognized
in Income on
Derivatives

(Ineffective Portion and
Amount

Excluded from
Effectiveness Testing)
   

Location of

Gain (Loss)
Recognized in
Income on
Derivatives

Year Ended
September 30,

   2012     2011     2010     2012     2011     2010     2012      2011     2010      

Commodity contracts

   $ 1,606      $ (1,750   $ 3,646      $ (1,148   $ 2,617      $ 719      $ 94       $ (47   $ (1  

Cost of goods sold

Interest expense

Net sales

Cost of goods sold

Interest rate contracts

     15        (88     (13,955     (864     (3,319     (4,439     —           (205 ) (a)      (6,112 ) (b)   

Foreign exchange contracts

     61        (487     (752     (474     (131     (812     —           —          —       

Foreign exchange contracts

     (3,506     (3,667     (4,560     (611     (12,384     2,481        —           —          —       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

Total

   $ (1,824   $ (5,992   $ (15,621   $ (3,097   $ (13,217   $ (2,051   $ 94       $ (252   $ (6,113  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

(a)

Reclassified from AOCI associated with the prepayment of portions of Spectrum Brands’ senior credit facility (see Note 12).

(b)

Includes $(4,305) reclassified from AOCI associated with the refinancing of Spectrum Brands’ senior credit facility (see Note 12).

Fair Value Contracts and Other

For derivative instruments that are used to economically hedge the fair value of Spectrum Brands’ third party and intercompany foreign currency payments, commodity purchases and interest rate payments, and the equity conversion feature of the Company’s Preferred Stock, the gain (loss) associated with the derivative contract is recognized in earnings in the period of change. During the years ended September 30, 2012, 2011 and 2010, the Company recognized the following gains (losses) on those derivatives:

 

     Amount of Gain (Loss) Recognized in
Income on Derivatives
     
     Year Ended September 30,      

Derivatives Not Designated as Hedging
Instruments

   2012     2011     2010    

Location of Gain ( Loss) Recognized in Income
on Derivatives

Commodity contracts

   $ —        $ —        $ 153      Cost of goods sold

Foreign exchange contracts

     5,916        (5,052     (42,039   Other expense, net

Equity conversion feature of preferred stock

     (156,600     27,910        —       

(Increase) decrease in fair value of equity conversion feature of preferred stock

  

 

 

   

 

 

   

 

 

   

Total

   $ (150,684   $ 22,858      $ (41,886  
  

 

 

   

 

 

   

 

 

   

 

F-31


Additional Disclosures

Cash Flow Hedges

Spectrum Brands has used interest rate swaps to manage its interest rate risk. The swaps are designated as cash flow hedges with the changes in fair value recorded in AOCI and as a derivative hedge asset or liability, as applicable. The swaps settle periodically in arrears with the related amounts for the current settlement period payable to, or receivable from, the counter-parties included in accrued liabilities or receivables, respectively, and recognized in earnings as an adjustment to interest expense from the underlying debt to which the swap is designated. At September 30, 2012, Spectrum Brands did not have any interest rate swaps outstanding. At September 30, 2011, Spectrum Brands had a portfolio of U.S. dollar-denominated interest rate swaps outstanding which effectively fixed the interest on floating rate debt (exclusive of lender spreads) as follows: 2.25% for a notional principal amount of $200,000 through December 2011 and 2.29% for a notional principal amount of $300,000 through January 2012. During Fiscal 2010, in connection with the refinancing of its senior credit facilities, Spectrum Brands terminated a portfolio of Euro-denominated interest rate swaps at a cash loss of $(3,499) which was recognized as an adjustment to interest expense. At September 30, 2012, there were no unrecognized gains or losses related to interest rate swaps recorded in AOCI. The derivative net (loss) on the U.S. dollar swap contracts recorded in AOCI at September 30, 2011 was $(467), net of tax benefit of $0 and noncontrolling interest of $412.

In connection with the SB/RH Merger and the refinancing of Spectrum Brands’ existing senior credit facilities associated with the closing of the SB/RH Merger, Spectrum Brands assessed the prospective effectiveness of its interest rate cash flow hedges during Fiscal 2010. As a result, during Fiscal 2010, Spectrum Brands ceased hedge accounting and recorded a loss of $(1,451) as an adjustment to interest expense for the change in fair value of its U.S. dollar swaps from the date of de-designation until the U.S. dollar swaps were re-designated. Spectrum Brands also evaluated whether the amounts recorded in AOCI associated with the forecasted U.S. dollar swap transactions were probable of not occurring and determined that occurrence of the transactions was still reasonably possible. Upon the refinancing of then existing senior credit facility associated with the closing of the SB/RH Merger, Spectrum Brands re-designated the U.S. dollar swaps as cash flow hedges of certain scheduled interest rate payments on its new $750,000 U.S. dollar term loan expiring June 17, 2016.

Spectrum Brands periodically enters into forward foreign exchange contracts to hedge the risk from forecasted foreign currency denominated third party and intercompany sales or payments. These obligations generally require Spectrum Brands to exchange foreign currencies for U.S. Dollars, Euros, Pounds Sterling, Australian Dollars, Brazilian Reals, Canadian Dollars or Japanese Yen. These foreign exchange contracts are cash flow hedges of fluctuating foreign exchange related to sales of product or raw material purchases. Until the sale or purchase is recognized, the fair value of the related hedge is recorded in AOCI and as a derivative hedge asset or liability, as applicable. At the time the sale or purchase is recognized, the fair value of the related hedge is reclassified as an adjustment to “Net sales” or purchase price variance in “Cost of goods sold.”

At September 30, 2012, Spectrum Brands had a series of foreign exchange derivative contracts outstanding through September 2013 with a contract value of $202,453. At September 30, 2011, it had a series of foreign exchange derivative contracts outstanding through September 30, 2012 with a contract value of $223,417. The derivative net (loss) on these contracts recorded in AOCI at September 30, 2012 was $(809), net of tax benefit of $565 and noncontrolling interest of $600. The derivative net gain on these contracts recorded in AOCI at September 30, 2011 was $126, net of tax expense of $148 and noncontrolling interest of $112. At September 30, 2012, the portion of derivative net losses estimated to be reclassified from AOCI into earnings over the next twelve months is $(809), net of tax and noncontrolling interest.

Spectrum Brands is exposed to risk from fluctuating prices for raw materials, specifically zinc used in its manufacturing processes. Spectrum Brands hedges a portion of the risk associated with these materials through the use of commodity swaps. The hedge contracts are designated as cash flow hedges with the fair value changes recorded in AOCI and as a hedge asset or liability, as applicable. The unrecognized changes in fair value of the hedge contracts are reclassified from AOCI into earnings when the hedged purchase of raw materials also affects

 

F-32


earnings. The swaps effectively fix the floating price on a specified quantity of raw materials through a specified date. At September 30, 2012, Spectrum Brands had a series of such swap contracts outstanding through September 2014 for 15 tons of raw materials with a contract value of $29,207. At September 30, 2011, it had a series of such swap contracts outstanding through December 2012 for 9 tons with a contract value of $18,858. The derivative net gain on these contracts recorded in AOCI at September 30, 2012 was $934, net of tax expense of $320 and noncontrolling interest of $693. The derivative net (loss) on these contracts recorded in AOCI at September 30, 2011 was $(364), net of tax benefit of $121 and noncontrolling interest of $322. At September 30, 2012, the portion of derivative net gains estimated to be reclassified from AOCI into earnings over the next twelve months is $457, net of tax and noncontrolling interest.

Fair Value Contracts

Spectrum Brands periodically enters into forward and swap foreign exchange contracts to economically hedge the risk from third party and intercompany payments resulting from existing obligations. These obligations generally require Spectrum Brands to exchange foreign currencies for U.S. Dollars, Euros or Australian Dollars. These foreign exchange contracts are economic fair value hedges of a related liability or asset recorded in the accompanying Consolidated Balance Sheets. The gain or loss on the derivative hedge contracts is recorded in earnings as an offset to the change in value of the related liability or asset at each period end. At September 30, 2012 and 2011, Spectrum Brands had $172,581 and $265,974, respectively, of notional value for such foreign exchange derivative contracts outstanding.

Credit Risk

Spectrum Brands is exposed to the risk of default by the counterparties with which Spectrum Brands transacts and generally does not require collateral or other security to support financial instruments subject to credit risk. Spectrum Brands monitors counterparty credit risk on an individual basis by periodically assessing each such counterparty’s credit rating exposure. The maximum loss due to credit risk equals the fair value of the gross asset derivatives which are primarily concentrated with two foreign financial institution counterparties. Spectrum Brands considers these exposures when measuring its credit reserve on its derivative assets, which was $46 and $18 at September 30, 2012 and 2011, respectively.

Spectrum Brands’ standard contracts do not contain credit risk related contingent features whereby Spectrum Brands would be required to post additional cash collateral as a result of a credit event. However, Spectrum Brands is typically required to post collateral in the normal course of business to offset its liability positions. At September 30, 2012 and 2011, Spectrum Brands had posted cash collateral of $50 and $418, respectively, related to such liability positions. At September 30, 2012, Spectrum Brands had no standby letters of credit, compared to posted letters of credit of $2,000 at September 30, 2011, related to such liability positions. The cash collateral is included in “Receivables, net” within the accompanying Consolidated Balance Sheets.

 

F-33


Insurance and Financial Services

The carrying amounts (which equal fair value) of derivative instruments of FGL, including derivative instruments embedded in FIA contracts, is as follows:

 

     Year Ended September 30,  
     2012      2011  

Assets:

     

Derivative investments:

     

Call options

   $ 200,667       $ 52,335   
  

 

 

    

 

 

 

Liabilities:

     

Contractholder funds:

     

FIA embedded derivative

   $ 1,550,805       $ 1,396,340   

Other liabilities:

     

Futures contracts

     928         3,828   

Available-for-sale embedded derivative

     —           400   
  

 

 

    

 

 

 
   $ 1,551,733       $ 1,400,568   
  

 

 

    

 

 

 

The change in fair value of derivative instruments included in the accompanying Consolidated Statements of Operations is as follows:

 

     Year Ended September 30,  
     2012        2011  

Revenues:

       

Net investment gains (losses):

       

Call options

   $ 100,030         $ (142,665

Futures contracts

     46,022           (28,087
  

 

 

      

 

 

 
     146,052           (170,752

Net investment income:

       

Available-for-sale embedded derivatives

     400           19   
  

 

 

      

 

 

 
   $ 146,452         $ (170,733
  

 

 

      

 

 

 

Benefits and other changes in policy reserves:

       

FIA embedded derivatives

   $ 154,465         $ (69,968
  

 

 

      

 

 

 

Additional Disclosures

FIA Contracts

FGL has FIA contracts that permit the holder to elect an interest rate return or an equity index linked component, where interest credited to the contracts is linked to the performance of various equity indices, primarily the Standard and Poor’s (“S&P”) 500 Index. This feature represents an embedded derivative under US GAAP. The FIA embedded derivative is valued at fair value and included in the liability for contractholder funds in the accompanying Consolidated Balance Sheets with changes in fair value included as a component of benefits and other changes in policy reserves in the Consolidated Statements of Operations.

FGL purchases derivatives consisting of a combination of call options and futures contracts on the applicable market indices to fund the index credits due to FIA contractholders. The call options are one, two and three year options purchased to match the funding requirements of the underlying policies. On the respective anniversary dates of the index policies, the index used to compute the interest credit is reset and FGL purchases new one, two

 

F-34


or three year call options to fund the next index credit. FGL manages the cost of these purchases through the terms of its FIA contracts, which permit FGL to change caps or participation rates, subject to guaranteed minimums on each contract’s anniversary date. The change in the fair value of the call options and futures contracts is generally designed to offset the portion of the change in the fair value of the FIA embedded derivative related to index performance. The call options and futures contracts are marked to fair value with the change in fair value included as a component of “Net investment gains (losses).” The change in fair value of the call options and futures contracts includes the gains and losses recognized at the expiration of the instrument term or upon early termination and the changes in fair value of open positions.

Other market exposures are hedged periodically depending on market conditions and FGL’s risk tolerance. FGL’s FIA hedging strategy economically hedges the equity returns and exposes FGL to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. FGL uses a variety of techniques, including direct estimation of market sensitivities and value-at-risk, to monitor this risk daily. FGL intends to continue to adjust the hedging strategy as market conditions and FGL’s risk tolerance change.

Credit Risk

FGL is exposed to credit loss in the event of nonperformance by its counterparties on the call options and reflects assumptions regarding this nonperformance risk in the fair value of the call options. The nonperformance risk is the net counterparty exposure based on the fair value of the open contracts less collateral held. FGL maintains a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.

Information regarding FGL’s exposure to credit loss on the call options it holds is presented in the following table:

 

          September 30, 2012      September 30, 2011  

Counterparty

   Credit Rating
(Moody’s/S&P)
   Notional
Amount
     Fair Value      Notional
Amount
     Fair
Value
 

Bank of America

   Baa2/A-    $ 1,884,047       $ 64,101       $ 1,692,142       $ 14,637   

Deutsche Bank

   A2/A+      1,816,532         61,704         1,463,596         11,402   

Morgan Stanley

   Baa1/A-      1,634,686         51,630         1,629,247         15,373   

Royal Bank of Scotland

   Baa1/A-      353,875         19,595         —           —     

Barclay’s Bank

   A2/A+      131,255         3,081         385,189         4,105   

Credit Suisse

   A2/A      10,000         556         327,095         2,785   

Nomura

   Baa2/A      —           —           107,000         4,033   
     

 

 

    

 

 

    

 

 

    

 

 

 
      $ 5,830,395       $ 200,667       $ 5,604,269       $ 52,335   
     

 

 

    

 

 

    

 

 

    

 

 

 

Collateral Agreements

FGL is required to maintain minimum ratings as a matter of routine practice under its ISDA agreements. Under some ISDA agreements, FGL has agreed to maintain certain financial strength ratings. A downgrade below these levels provides the counterparty under the agreement the right to terminate the open derivative contracts between the parties, at which time any amounts payable by FGL or the counterparty would be dependent on the market value of the underlying derivative contracts. FGL’s current rating allows multiple counterparties the right to terminate ISDA agreements. No ISDA agreements have been terminated, although the counterparties have reserved the right to terminate the ISDA agreements at any time. In certain transactions, FGL and the counterparty have entered into a collateral support agreement requiring either party to post collateral when the net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. As of September 30, 2012 and 2011, no collateral was posted by FGL’s counterparties as they did not meet the net

 

F-35


exposure thresholds. Accordingly, the maximum amount of loss due to credit risk that FGL would incur if parties to the call options failed completely to perform according to the terms of the contracts was $200,667 and $52,335 at September 30, 2012 and 2011, respectively.

FGL held 2,835 and 2,458 futures contracts at September 30, 2012 and 2011, respectively. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). FGL provides cash collateral to the counterparties for the initial and variation margin on the futures contracts which is included in “Cash and cash equivalents” in the “Insurance and Financial Services” sections of the Consolidated Balance Sheets. The amount of collateral held by the counterparties for such contracts was $9,820 at both September 30, 2012 and 2011.

(7) Fair Value of Financial Instruments

The Company’s measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which may include the Company’s own credit risk. The Company’s estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:

 

Level 1 —

 

Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.

Level 2 —

 

Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves.

Level 3 —

 

Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lower level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.

When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.

 

F-36


The carrying amounts and estimated fair values of the Company’s consolidated financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, with the exception of investment contracts, are summarized according to the hierarchy previously described as follows:

 

    September 30, 2012  
    Level 1     Level 2     Level 3     Fair Value     Carrying
Amount
 

Assets

         

Consumer Products and Other

         

Cash and cash equivalents

  $ 408,889      $ —        $ —        $ 408,889      $ 408,889   

Contingent purchase price reduction receivable

    —          —          41,000        41,000        41,000   

Short-term investments (including related interest receivable of $5)

         

Equity securities — trading

    146,842        —          —          146,842        146,842   

Fixed maturity securities — held-to-maturity

    —          35,000        —          35,000        34,991   

Derivatives:

         

Foreign exchange forward agreements

    —          1,235        —          1,235        1,235   

Commodity swap and option agreements

    —          2,002        —          2,002        2,002   

Insurance and Financial Services

         

Cash and cash equivalents

    1,059,572        2,250        —          1,061,822        1,061,822   

Fixed maturity securities, available-for-sale:

         

Asset-backed securities

    —          1,012,027        15,855        1,027,882        1,027,882   

Commercial mortgage-backed securities

    —          548,791        5,023        553,814        553,814   

Corporates

    —          10,873,715        135,296        11,009,011        11,009,011   

Hybrids

    —          519,422        8,873        528,295        528,295   

Municipals

    —          1,223,995        —          1,223,995        1,223,995   

Agency residential mortgage-backed securities

    —          154,890        —          154,890        154,890   

Non-agency residential mortgage-backed securities

    —          660,659        —          660,659        660,659   

U.S. Government

    930,367        —          —          930,367        930,367   

Equity securities — available-for-sale

    —          248,087        —          248,087        248,087   

Derivative financial instruments

    —          200,667        —          200,667        200,667   

Asset-backed loans and other invested assets

    —          —          198,868        198,868        198,868   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets

  $ 2,545,670      $ 15,482,740      $ 404,915      $ 18,433,325      $ 18,433,316   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

         

Consumer Products and Other

         

Total debt

  $ 524,000      $ 1,804,831      $ —        $ 2,328,831      $ 2,167,039   

Derivatives:

         

Foreign exchange forward agreements

    —          9,956        —          9,956        9,956   

Commodity swap and option agreements

    —          9        —          9        9   

Equity conversion feature of preferred stock

    —          —          231,950        231,950        231,950   

Redeemable preferred stock, excluding equity conversion feature

    —          —          368,880        368,880        319,225   

Insurance and Financial Services

         

Derivatives:

         

FIA embedded derivatives, included in contractholder funds

    —          —          1,550,805        1,550,805        1,550,805   

Futures contracts

    —          928        —          928        928   

Investment contracts, included in contractholder funds

    —          —          12,271,882        12,271,882        13,739,670   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial liabilities

  $ 524,000      $ 1,815,724      $ 14,423,517      $ 16,763,241      $ 18,019,582   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

F-37


    September 30, 2011  
    Level 1     Level 2     Level 3     Fair Value     Carrying
Amount
 

Assets

         

Consumer Products and Other

         

Cash and cash equivalents

  $ 321,352      $ —        $ —        $ 321,352      $ 321,352   

Short-term investments (including related interest receivable of $9)

         

Equity securities — trading

    238,062        24,023        —          262,085        262,085   

Fixed maturity securities — held to maturity

    —          75,899        —          75,899        75,897   

Fixed maturity securities — trading

    —          12,665        —          12,665        12,665   

Derivatives:

         

Foreign exchange forward agreements

    —          3,189        —          3,189        3,189   

Commodity swap and option agreements

    —          274        —          274        274   

Insurance and Financial Services

         

Cash and cash equivalents

    813,239        2,768        —          816,007        816,007   

Fixed maturity securities, available-for-sale:

         

Asset-backed securities

    —          125,966        374,518        500,484        500,484   

Commercial mortgage-backed securities

    —          565,577        —          565,577        565,577   

Corporates

    —          11,696,090        159,684        11,855,774        11,855,774   

Hybrids

    —          654,084        5,205        659,289        659,289   

Municipals

    —          936,484        —          936,484        936,484   

Agency residential mortgage-backed securities

    —          218,713        3,312        222,025        222,025   

Non-agency residential mortgage-backed securities

    —          440,758        3,759        444,517        444,517   

U.S. Government

    183,324        —          —          183,324        183,324   

Equity securities — available-for-sale

    —          287,043        —          287,043        287,043   

Derivative financial instruments

    —          52,335        —          52,335        52,335   

Other invested assets

    —          —          44,279        44,279        44,279   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets

  $ 1,555,977      $ 15,095,868      $ 590,757      $ 17,242,602      $ 17,242,600   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

         

Consumer Products and Other

         

Total debt

  $ 500,000      $ 1,635,528      $ —        $ 2,135,528      $ 2,048,780   

Derivatives:

         

Foreign exchange forward agreements

    —          25,679        —          25,679        25,679   

Interest rate swap agreements

    —          1,954        —          1,954        1,954   

Commodity swap and option agreements

    —          1,232        —          1,232        1,232   

Equity conversion feature of preferred stock

    —          —          75,350        75,350        75,350   

Redeemable preferred stock, excluding equity conversion feature

    —          —          337,060        337,060        292,437   

Insurance and Financial Services

         

Derivatives:

         

FIA embedded derivatives, included in contractholder funds

    —          —          1,396,340        1,396,340        1,396,340   

Futures contracts

    —          3,828        —          3,828        3,828   

Available-for-sale embedded derivative

    —          —          400        400        400   

Investment contracts, included in contractholder funds

    —          —          11,992,013        11,992,013        13,153,630   

Note payable

    —          95,000        —          95,000        95,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial liabilities

  $ 500,000      $ 1,763,221      $ 13,801,163      $ 16,064,384      $ 17,094,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

F-38


The carrying amounts of trade receivables, accounts payable, accrued investment income and portions of other insurance liabilities approximate fair value due to their short duration and, accordingly, they are not presented in the tables above.

The fair values of cash equivalents, short-term investments and debt set forth above are generally based on quoted or observed market prices.

FGL measures the fair value of its securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and FGL will then consistently apply the valuation methodology to measure the security’s fair value. FGL’s fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include a third-party pricing service, independent broker quotations or pricing matrices. FGL uses observable and unobservable inputs in its valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored and further market data will be acquired when certain thresholds are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. Management believes the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices. The fair value of the asset-backed loans originated by Salus approximate their carrying value, as those loans carry a variable rate, are revolving in nature, and can be settled at the demand of either party.

FGL did not adjust prices received from third parties as of September 30, 2012 and 2011. However, FGL does analyze the third party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy.

The fair value of derivative assets and liabilities is based upon valuation pricing models, which represents what FGL would expect to receive or pay at the balance sheet date if it cancelled the options, entered into offsetting positions, or exercised the options. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). Fair values for these instruments are determined externally by an independent actuarial firm using market observable inputs, including interest rates, yield curve volatilities, and other factors. Credit risk related to the counterparty is considered when estimating the fair values of these derivatives. The fair values of the embedded derivatives in FGL’s FIA products are derived using market indices, pricing assumptions and historical data.

Investment contracts include deferred annuities, FIAs, IUL and immediate annuities. The fair values of deferred annuity, FIAs, and IUL contracts are based on their cash surrender value (i.e. the cost FGL would incur to extinguish the liability) as these contracts are generally issued without an annuitization date. The fair value of immediate annuities contracts is derived by calculating a new fair value interest rate using the updated yield curve and treasury spreads as of the respective reporting date. At September 30, 2012 and 2011, this resulted in lower fair value reserves relative to the carrying value. FGL is not required to and has not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosure of fair value. The fair value of FGL’s note payable at September 30, 2011 approximated its carrying value as it was settled at such carrying value in October 2011.

Goodwill, intangible assets and other long-lived assets are also tested annually or if an event occurs that indicates an impairment loss may have been incurred (see Note 10) using fair value measurements with unobservable inputs (Level 3).

See Note 15 with respect to fair value measurements of the Company’s pension plan assets.

 

F-39


Quantitative information regarding significant unobservable inputs used for recurring Level 3 fair value measurements of financial instruments carried at fair value as of September 30, 2012 is as follows:

 

    Fair Value at
September 30,

2012
   

Valuation technique

 

Unobservable input(s)

 

Range (Weighted average)

Assets

       

Contingent purchase price reduction receivable

  $ 41,000      Discounted cash flow  

Probability of collection Expected term

Discount rate

Credit insurance risk premium

 

88% - 96% (92%)

9 months

0.72%

11.7%

Asset-backed securities

    15,855      Broker-quoted   Offered quotes   100% - 109.73% (103.09%)

Corporates

    103,319      Broker-quoted   Offered quotes   0% - 140.61% (68.47%)

Corporates

    31,977      Market pricing   Quoted prices   87.50% - 158.11% (97.89%)

Hybrids

    8,873      Broker-quoted   Offered quotes   0% - 103% (25.35%)

Commercial mortgage-backed securities

    5,023      Broker-quoted   Offered quotes   100.69%
 

 

 

       

Total

  $ 206,047         
 

 

 

       

Liabilities

       

FIA embedded derivatives, included in contractholder funds

  $ 1,550,805      Discounted cash flow  

Market value of option

SWAP rates

Mortality multiplier Surrender rates

Non-performance spread

 

0% - 31.05% (3.55%)

0.76% - 1.7% (1.22%)

70% - 70% (70%)

2% - 50% (7%)

0.25% - 0.25% (0.25%)

Equity conversion feature of preferred stock

    231,950      Monte Carlo simulation / Option model  

Annualized volatility of equity

Discount yield

Non-cash accretion rate

Calibration adjustment

 

41%

11.5% - 12.7% (11.9%)

0%

10% - 13% (10.9%)

 

 

 

       

Total

  $ 1,782,755         
 

 

 

       

The significant unobservable inputs used in the fair value measurement of the contingent purchase price reduction receivable are the probability of collection depending on the outcomes of litigation and regulatory action, the expected term until payment, discount rate and the credit insurance risk premium. Generally, an increase in the assumptions for the expected term, discount rate or credit insurance risk premium would decrease the fair value of the contingent purchase price receivable. An increase in the probability of collection would increase the fair value of the contingent purchase price reduction receivable.

The significant unobservable inputs used in the fair value measurement of FIA embedded derivatives included in contractholder funds are market value of option, interest swap rates, mortality multiplier, surrender rates, and non-performance spread. The mortality multiplier is based on the 1983 annuity table and assumes the contractholder population is 50% female and 50% male. Significant increases (decreases) in the market value of option in isolation would result in a higher (lower) fair value measurement. Significant increases (decreases) in interest swap rates, mortality multiplier, surrender rates, or non-performance spread in isolation would result in a lower (higher) fair value measurement. Generally, a change in any one unobservable input would not result in a change in any other unobservable input.

The significant unobservable inputs used in the fair value measurement of the equity conversion feature of the Company’s Preferred Stock are annualized volatility of the market value of the Company’s listed shares of common stock, the discount yield as of the valuation date, a calibration factor to the issued date fair value of the Preferred Stock and the forecasted non-cash accretion rate. Significant increases (decreases) in any of the inputs in isolation would result in a significantly higher (lower) fair value measurement. Generally, an increase in the assumptions used for the volatility and discount yield would increase the fair value of the equity conversion feature of Preferred Stock, and maintaining a higher forecasted non-cash accretion rate, would also increase the fair value of the equity conversion feature of Preferred Stock. A decrease in the calibration factor would result in an increase in the fair value of the equity conversion feature of Preferred Stock.

 

F-40


The following tables summarize changes to the Company’s financial instruments carried at fair value and classified within Level 3 of the fair value hierarchy for the years ended September 30, 2012 and 2011 (none in Fiscal 2010). This summary excludes any impact of amortization of VOBA and DAC. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.

 

     Year Ended September 30, 2012  
     Balance at
Beginning
of Period
    Total Gains (Losses)     Net
Purchases,
Sales &
Settlements
    Net
Transfer In
(Out) of
Level 3 (a)
    Balance at
End of

Period
 
       Included in
Earnings
    Included
in AOCI
       

Assets

            

Contingent purchase price reduction receivable

   $ —        $ 41,000      $ —        $ —        $ —        $ 41,000   

Fixed maturity securities, available-for-sale:

            

Asset-backed securities

     374,518        —          7,355        371,896        (737,914     15,855   

Commercial mortgage-backed securities

     —          —          24        4,999        —          5,023   

Corporates

     159,684        28        (3,662     (39,686     18,932        135,296   

Hybrids

     5,205        —          (44     —          3,712        8,873   

Municipals

     —          (2     72        10,177        (10,247     —     

Agency residential mortgage-backed securities

     3,312        —          18        —          (3,330     —     

Non-agency residential mortgage-backed securities

     3,759        (126     4        (777     (2,860     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 546,478      $ 40,900      $ 3,767      $ 346,609      $ (731,707   $ 206,047   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

            

FIA embedded derivatives, included in contractholder funds

   $ (1,396,340   $ (154,465   $ —        $ —        $ —        $ (1,550,805

Available-for-sale embedded derivatives

     (400     400        —          —          —          —     

Equity conversion feature of preferred stock

     (75,350     (156,600     —          —          —          (231,950
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities at Level 3 fair value

   $ (1,472,090   $ (310,665   $ —        $ —        $ —        $ (1,782,755
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

The net transfers in and out of Level 3 during the year ended September 30, 2012 were exclusively to or from Level 2.

 

F-41


     Year Ended to September 30, 2011  
     Balance at
FGL Acquisition
Date
    Total Gains (Losses)     Net
Purchases,
Sales &
Settlements
    Net
Transfer In
(Out) of
Level 3 (a)
    Balance at
End of

Period
 
       Included in
Earnings
     Included
in AOCI
       

Assets

             

Fixed maturity securities, available-for-sale:

             

Asset-backed securities

   $ 399,967      $ —         $ 863      $ (11,709   $ (14,603   $ 374,518   

Corporates

     197,573        1,993         5,408        (45,229     (61     159,684   

Hybrids

     8,305        —           (61     —          (3,039     5,205   

Agency residential mortgage-backed securities

     3,271        —           41        —          —          3,312   

Non-agency residential mortgage-backed securities

     18,519        2,364         379        (17,503     —          3,759   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 627,635      $ 4,357       $ 6,630      $ (74,441   $ (17,703   $ 546,478   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

             

FIA embedded derivatives, included in contractholder funds

   $ (1,466,308   $ 69,968       $ —        $ —        $ —        $ (1,396,340

Available-for-sale embedded derivatives

     (419     19         —          —          —          (400

Equity conversion feature of preferred stock

     —          27,910         —          (103,260     —          (75,350
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities at Level 3 fair value

   $ (1,466,727   $ 97,897       $ —        $ (103,260   $ —        $ (1,472,090
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

The net transfers in and out of Level 3 during the year ended September 30, 2011 were exclusively to or from Level 2.

FGL reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. There were no transfers between Level 1 and Level 2 for the years ended September 30, 2012 and 2011.

Primary market issuance and secondary market activity for certain asset-backed securities, corporates, municipals and residential mortgage-backed securities during Fiscal 2012, as well as asset-backed securities, corporates and hybrid securities during Fiscal 2011 increased the market observable inputs used to establish fair values for similar securities. These factors, along with more consistent pricing from third-party sources, resulted in FGL concluding that there is sufficient trading activity in similar instruments to support classifying these securities as Level 2 as of September 30, 2012 and 2011, respectively. Additionally, during the year a new third party began pricing FGL’s collateral loan obligations (“CLOs”) holdings included in asset-backed securities. This new pricing vendor uses market observable inputs such as actual trade prices, yields, and other market assumptions as well as observable deal, tranche and collateral information in the pricing of CLOs and therefore supported a level 2 classification of these securities as of September 30, 2012. Accordingly, FGL’s assessment resulted in a net transfer out of Level 3 of $794,012 related to asset-backed securities, corporates, hybrids, municipals, and residential mortgage-backed securities during the year ended September 30, 2012 and $17,703 related to asset-backed securities, corporates and hybrids during the year ended September 30, 2011. There were also net transfers in to Level 3 of $3,712 related to hybrid securities during the year ended September 30, 2012.

 

F-42


The following tables present the gross components of purchases, sales, and settlements, net, of Level 3 financial instruments for the years ended September 30, 2012 and 2011. There were no issuances during these periods.

 

     Year Ended September 30, 2012  
     Purchases      Sales     Settlements     Net Purchases, Sales
& Settlements
 

Assets

         

Fixed maturity, securities available-for-sale:

         

Asset-backed securities

   $ 410,707       $ —        $ (38,811   $ 371,896   

Commercial mortgage-backed securities

     4,999         —          —          4,999   

Corporates

     1,326         (26,788     (14,224     (39,686

Municipals

     10,197         —          (20     10,177   

Non-agency residential mortgage-backed securities

     —           (475     (302     (777
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 427,229       $ (27,263   $ (53,357   $ 346,609   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

     Year Ended September 30, 2011  
     Purchases      Sales     Settlements     Net Purchases, Sales
& Settlements
 

Assets

         

Fixed maturity, securities available-for-sale:

         

Asset-backed securities

   $ 2,007       $ —        $ (13,716   $ (11,709

Corporates

     10,365         (48,898     (6,696     (45,229

Non-agency residential mortgage-backed securities

     —           (15,729     (1,774     (17,503
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 12,372       $ (64,627   $ (22,186   $ (74,441
  

 

 

    

 

 

   

 

 

   

 

 

 

Liabilities

         

Equity conversion option of preferred stock

   $ —         $ (103,260   $ —        $ (103,260
  

 

 

    

 

 

   

 

 

   

 

 

 

(8) Inventories

Inventories, net consist of the following:

 

     September 30,  
     2012      2011  

Raw materials

   $ 58,515       $ 59,928   

Work-in-process

     23,434         25,465   

Finished goods

     370,684         349,237   
  

 

 

    

 

 

 
     $452,633         $434,630   
  

 

 

    

 

 

 

(9) Properties

Properties, net consist of the following:

 

     September 30,  
     2012      2011  

Land, buildings and improvements

   $ 88,580       $ 101,303   

Machinery, equipment and other

     247,626         202,844   

Construction in progress

     18,366         10,134   
  

 

 

    

 

 

 

Total properties, at cost

     354,572         314,281   

Less accumulated depreciation

     140,253         107,482   
  

 

 

    

 

 

 
   $ 214,319       $ 206,799   
  

 

 

    

 

 

 

 

F-43


(10) Goodwill and Intangibles

Consumer Products and Other

A summary of the changes in the carrying amounts of goodwill and intangible assets of the consumer products segment is as follows:

 

           Intangible Assets  
     Goodwill     Indefinite
Lived
    Amortizable     Total  

Balance at September 30, 2010

   $ 600,055      $ 857,478      $ 911,882      $ 1,769,360   

Acquisitions (Note 22)

     10,284        2,780        4,193        6,973   

Intangible asset impairment

     —          (32,450     —          (32,450

Amortization during period

     —          —          (57,695     (57,695

Effect of translation

     (1     (1,013     (1,266     (2,279
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 610,338      $ 826,795      $ 857,114      $ 1,683,909   

Acquisitions (Note 22)

     85,875        22,000        82,118        104,118   

Amortization during period

     —          —          (63,666     (63,666

Reclassifications

     —          (3,450     3,450        —     

Effect of translation

     (1,968     (4,277     (5,155     (9,432
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 694,245      $ 841,068      $ 873,861      $ 1,714,929   
  

 

 

   

 

 

   

 

 

   

 

 

 

Intangible assets subject to amortization include customer relationships, certain trade names and proprietary technology which are summarized as follows:

 

    September 30, 2012     September 30, 2011       
    Cost     Accumulated
Amortization
    Net     Cost     Accumulated
Amortization
    Net      Amortizable
Life

Customer relationships

  $ 796,235      $ 113,012      $ 683,223      $ 738,937      $ 73,373      $ 665,564       15-20 years

Trade names

    150,829        28,347        122,482        149,700        16,320        133,380       1-12 years

Technology assets

    90,924        22,768        68,156        71,805        13,635        58,170       4-17 years
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    
  $ 1,037,988      $ 164,127      $ 873,861      $ 960,442      $ 103,328      $ 857,114      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

Amortization expense related to intangible assets subject to amortization is as follows:

 

     Year Ended September 30,  
     2012      2011      2010  

Customer relationships

   $ 40,186       $ 38,320       $ 35,865   

Trade names

     14,347         12,558         3,750   

Technology assets

     9,133         6,817         6,305   
  

 

 

    

 

 

    

 

 

 
   $ 63,666       $ 57,695       $ 45,920   
  

 

 

    

 

 

    

 

 

 

Spectrum Brands estimates annual amortization expense for the next five fiscal years will approximate $63,600 per year.

Impairment Charges

In accordance with ASC 350, Spectrum Brands conducts impairment testing on its goodwill. To determine fair value during Fiscal 2012, 2011 and 2010, Spectrum Brands used the discounted estimated future cash flows methodology and third party valuations. Assumptions critical to Spectrum Brands’ fair value estimates under the discounted estimated future cash flows methodology are: (i) the present value factors used in determining the fair

 

F-44


value of the reporting units and trade names; (ii) projected average revenue growth rates used in estimating future cash flows for the reporting unit; and (iii) projected long-term growth rates used in the derivation of terminal year values. These and other assumptions are impacted by economic conditions and expectations of management and will change in the future based on period specific facts and circumstances. Spectrum Brands also tested the aggregate estimated fair value of its reporting units for reasonableness by comparison to the total market capitalization of Spectrum Brands, which includes both its equity and debt securities. In addition, in accordance with ASC 350, as part of Spectrum Brands’ annual impairment testing, Spectrum Brands tested its indefinite-lived trade name intangible assets for impairment by comparing the carrying amount of such trade names to their respective fair values. Fair value was determined using a relief from royalty methodology. Assumptions critical to Spectrum Brands’ fair value estimates under the relief from royalty methodology were: (i) royalty rates; (ii) projected average revenue growth rates; and (iii) applicable discount rates.

A triggering event occurred in Fiscal 2011 which required Spectrum Brands to test its indefinite-lived intangible assets for impairment between annual impairment dates. The realignment of Spectrum Brands’ operating structure constituted a triggering event for impairment testing. Spectrum Brands compared the fair values of its reporting units to their carrying amounts both before and after the realignment and determined the fair values were in excess of the carrying amounts and, accordingly, no further testing of goodwill was required. In connection with the triggering event impairment testing, Spectrum Brands also tested the recoverability of its identified indefinite-lived intangibles and concluded that the fair values of those assets exceeded their carrying values.

In connection with Spectrum Brands’ annual goodwill impairment testing performed during Fiscal 2012, 2011 and 2010, the first step of such testing indicated that the fair value of Spectrum Brands’ reporting segments were in excess of their carrying amounts and, accordingly, no further testing of goodwill was required.

In connection with its annual impairment testing of indefinite-lived intangible assets during Fiscal 2012 and 2010, Spectrum Brands concluded that the fair values of its intangible assets exceeded their carrying values. Additionally, during Fiscal 2012 Spectrum Brands reclassified $3,450 of certain indefinite lived trade names to definite lived trade names. Those trade names are being amortized over the remaining useful lives, which have been estimated to be 1-3 years. During Fiscal 2011, Spectrum Brands concluded that the fair values of certain trade name intangible assets were less than the carrying amounts of those assets. As a result, during Fiscal 2011 the Company recorded non-cash pretax intangible asset impairment charges of $32,450 within “Selling, general and administrative expenses” which was equal to the excess of the carrying amounts of the intangible assets over the fair values of such assets.

The Fiscal 2011 impairments of trade name intangible assets were primarily attributed to lower current and forecasted profits, reflecting more conservative growth rates versus those originally assumed by Spectrum Brands at the time of acquisition or upon adoption of fresh start reporting.

 

F-45


Insurance and Financial Services

Information regarding VOBA and DAC (including DSI) is as follows:

 

     VOBA     DAC     Total  

Balance at September 30, 2010

   $ —        $ —        $ —     

Acquisition of FGL on April 6, 2011

     577,163        —          577,163   

Deferrals

     —          41,152        41,152   

Less: Components of amortization —

      

Periodic amortization

     294        (996     (702

Interest

     14,040        —          14,040   

Unlocking

     (2,320     97        (2,223

Add: Adjustment for unrealized investment (gains), net

     (170,117     (2,146     (172,263
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 419,060      $ 38,107      $ 457,167   

Deferrals

     —          194,900        194,900   

Less: Components of amortization —

      

Periodic amortization

     (171,833     (20,239     (192,072

Interest

     28,883        1,942        30,825   

Unlocking

     (2,487     3,078        591   

Add: Adjustment for unrealized investment (gains), net

     (169,303     (48,565     (217,868
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 104,320      $ 169,223      $ 273,543   
  

 

 

   

 

 

   

 

 

 

Amortization of VOBA and DAC is based on the amount of gross margins or profits recognized, including investment gains and losses. The adjustment for unrealized net investment gains represents the amount of VOBA and DAC that would have been amortized if such unrealized gains and losses had been recognized. This is referred to as the “shadow adjustments” as the additional amortization is reflected in other comprehensive income rather than the statements of operations. As of September 30, 2012 and 2011, the VOBA balance included cumulative adjustments for net unrealized investment gains of $(339,420) and $(170,117), respectively, and the DAC balances included cumulative adjustments for net unrealized investment gains of $(50,711) and $(2,146), respectively.

The above DAC balances include $9,068 and $5,048 of DSI, net of shadow adjustments, as of September 30, 2012 and 2011, respectively.

The weighted average amortization period for VOBA and DAC are approximately 5.5 and 6.3 years, respectively. Estimated amortization expense for VOBA and DAC in future fiscal years is as follows:

 

     Estimated Amortization Expense  

Fiscal Year

         VOBA                  DAC        

2013

   $ 49,851       $ 18,293   

2014

     57,552         23,090   

2015

     51,503         23,376   

2016

     47,148         22,315   

2017

     39,965         21,042   

Thereafter

     197,721         111,818   

 

F-46


(11) Accrued and Other Liabilities

Accrued and other current liabilities consist of the following:

 

     September 30,  
     2012      2011  

Wages and benefits

   $ 110,931       $ 72,945   

Accrued interest

     50,395         50,389   

Income taxes payable

     30,272         31,606   

Accrued dividends on Preferred Stock

     8,305         7,123   

Restructuring and related charges

     6,572         16,187   

Other

     130,433         139,379   
  

 

 

    

 

 

 
   $ 336,908       $ 317,629   
  

 

 

    

 

 

 

Insurance and Financial Services — Other liabilities consist of the following:

 

     September 30,  
     2012      2011  

Amounts payable for investment purchases

   $ 206,681       $ 13,353   

Retained asset account

     203,685         191,452   

Income taxes payable

     66,284         —     

Funds withheld from reinsurers

     54,691         52,953   

Amounts payable to reinsurers

     31,959         13,884   

Remittances and items not allocated

     29,469         34,646   

Accrued expenses

     25,135         20,612   

Derivatives — futures contracts

     928         3,828   

Other

     95,876         50,869   
  

 

 

    

 

 

 
   $ 714,708       $ 381,597   
  

 

 

    

 

 

 

(12) Debt

The Company’s consolidated debt consists of the following:

 

     September 30, 2012     September 30, 2011  
     Amount      Rate     Amount     Rate  

HGI:

         

10.625% Senior Secured Notes, due November 15, 2015

   $ 500,000         10.625   $ 500,000        10.625

Spectrum Brands:

         

Term loan, due June 17, 2016

     370,175         5.1     525,237        5.1

9.5% Senior Secured Notes, due June 15, 2018

     950,000         9.5     750,000        9.5

6.75% Senior Notes, due March 15, 2020

     300,000         6.75     —          —     

12% Senior Subordinated Toggle Notes due 2019

     —           —          245,031        12.0

ABL Revolving Loan Facility, expiring May 3, 2016

     —           4.3     —          2.5

Other notes and obligations

     18,059         10.9     19,333        10.5

Capitalized lease obligations

     26,683         6.2     24,911        6.2
  

 

 

      

 

 

   
     2,164,917           2,064,512     

Original issuance premiums (discounts) on debt, net

     2,122           (15,732  

Less current maturities

     16,414           16,090     
  

 

 

      

 

 

   

Long-term debt — Consumer Products and Other

   $ 2,150,625         $ 2,032,690     
  

 

 

      

 

 

   

FGL:

         

Note payable — Insurance and Financial Services

   $ —           $ 95,000     
  

 

 

      

 

 

   

 

F-47


Aggregate scheduled maturities of debt as of September 30, 2012 are as follows:

 

Fiscal Year

   Scheduled
Maturities
 

2013

   $ 16,414   

2014

     13,164   

2015

     8,063   

2016

     861,222   

2017

     1,500   

Thereafter

     1,264,554   
  

 

 

 
   $ 2,164,917   
  

 

 

 

Aggregate capitalized lease obligations included in the amounts above are payable in installments of $3,097 in 2013, $3,153 in 2014, $2,513 in 2015, $1,866 in 2016, $1,500 in 2017 and $14,554 thereafter.

HGI

On November 15, 2010 and June 28, 2011, HGI issued $350,000 and $150,000, respectively, or $500,000 aggregate principal amount of 10.625% Senior Secured Notes due November 15, 2015 (the “10.625% Notes”). The 10.625% Notes were sold only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and to certain persons in offshore transactions in reliance on Regulation S, but were subsequently registered under the Securities Act. The 10.625% Notes were issued at an aggregate price equal to 99.311% of the principal amount thereof, with a net original issue discount (“OID”) of $3,445. Interest on the 10.625% Notes is payable semi-annually, commencing on May 15, 2011 and ending November 15, 2015. The 10.625% Notes are collateralized with a first priority lien on substantially all of the assets directly held by HGI, including stock in its subsidiaries (with the exception of Zap.Com, but including Spectrum Brands, Harbinger F&G, LLC (“HFG”), the wholly-owned parent of FGL, HGI Funding, and the securities of other subsidiaries formed since that date) and HGI’s directly held cash and investment securities.

HGI has the option to redeem the 10.625% Notes prior to May 15, 2013 at a redemption price equal to 100% of the principal amount plus a make-whole premium and accrued and unpaid interest to the date of redemption. At any time on or after May 15, 2013, HGI may redeem some or all of the 10.625% Notes at certain fixed redemption prices expressed as percentages of the principal amount, plus accrued and unpaid interest. At any time prior to November 15, 2013, HGI may redeem up to 35% of the original aggregate principal amount of the 10.625% Notes with net cash proceeds received by HGI from certain equity offerings at a price equal to 110.625% of the principal amount of the 10.625% Notes redeemed, plus accrued and unpaid interest, if any, to the date of redemption, provided that redemption occurs within 90 days of the closing date of such equity offering, and at least 65% of the aggregate principal amount of the 10.625% Notes remains outstanding immediately thereafter.

The indenture governing the 10.625% Notes contains customary covenants limiting, among other things, and subject to certain qualifications and exceptions, the ability of HGI, and, in certain cases, HGI’s subsidiaries, to incur additional indebtedness; create liens; engage in sale-leaseback transactions; pay dividends or make distributions in respect of capital stock; make certain restricted payments; sell assets; engage in certain transactions with affiliates; or consolidate or merge with, or sell substantially all of its assets to, another person. HGI is also required to maintain compliance with certain financial tests, including minimum liquidity and collateral coverage ratios that are based on the fair market value of the assets held directly by HGI, including its equity interests in Spectrum Brands and its other subsidiaries such as HFG and HGI Funding. At September 30, 2012, the Company was in compliance with all covenants under the 10.625% Notes.

HGI incurred $16,200 of costs in connection with its issuance of the 10.625% Notes. These costs are classified as “Deferred charges and other assets” in the accompanying Consolidated Balance Sheets and, along with the OID, are being amortized to interest expense utilizing the effective interest method over the term of the 10.625% Notes.

 

F-48


Spectrum Brands

In connection with the SB/RH Merger, on June 16, 2010, Spectrum Brands (i) entered into a new senior secured term loan pursuant to a new senior credit agreement consisting of a $750,000 U.S. dollar term subsequently refinanced in February 2011 (the “Term Loan”), (ii) issued $750,000 in aggregate principal amount of 9.5% Senior Secured Notes due June 15, 2018 (the “9.5% Notes”) and (iii) entered into a $300,000 U.S. Dollar asset based revolving loan facility (the “ABL Facility”). The proceeds from such financings were used to repay Spectrum Brands’ then-existing senior term credit facility (the “Prior Term Facility”) and Spectrum Brands’ then-existing asset based revolving loan facility, to pay fees and expenses in connection with the refinancing and for general corporate purposes.

The 9.5% Notes were issued by SBI. SB/RH Holdings, LLC, a wholly-owned subsidiary of Spectrum Brands, and the wholly-owned domestic subsidiaries of SBI are the guarantors under the 9.5% Notes. Spectrum Brands is not an issuer or guarantor of the 9.5% Notes. Spectrum Brands is also not a borrower or guarantor under the Term Loan or the ABL Facility. SBI is the borrower under the Term Loan and its wholly-owned domestic subsidiaries along with SB/RH Holdings, LLC are the guarantors under that facility. SBI and its wholly-owned domestic subsidiaries are the borrowers under the ABL Facility and SB/RH Holdings, LLC is a guarantor of that facility.

Term Loan

In February 2011, Spectrum Brands completed the refinancing of its term loan facility, which was initially established in connection with the SB/RH Merger and had an aggregate amount outstanding of $680,000 upon refinancing with an amended and restated credit agreement.

In connection with the refinancing, the Term Loan was issued at par with a maturity date of June 17, 2016. Subject to certain mandatory prepayment events, the Term Loan is subject to repayment according to a scheduled amortization, with the final payment of all amounts outstanding, plus accrued and unpaid interest, due at maturity. Among other things, the Term Loan provides for interest at a rate per annum equal to, at Spectrum Brands’ option, the LIBO rate (adjusted for statutory reserves) subject to a 1% floor plus a margin equal to 4%, or an alternate base rate plus a margin equal to 3%.

In December 2011 and June 2012, Spectrum Brands amended its Term Loan. As a result, the aggregate incremental amount by which Spectrum Brands, subject to compliance with financial covenants and certain other conditions, may increase the amount of the commitment under the Term Loan has been increased from $100,000 to $250,000. Certain covenants in respect to indebtedness, liens and interest coverage were also amended to provide for dollar limits more favorable to Spectrum Brands and, subject to compliance with financial covenants and certain other conditions, to allow for the incurrence of incremental unsecured indebtedness.

The Term Loan contains financial covenants with respect to debt, including, but not limited to, a maximum leverage ratio and a minimum interest coverage ratio, which covenants, pursuant to their terms, become more restrictive over time. In addition, the Term Loan contains customary restrictive covenants, including, but not limited to, restrictions on Spectrum Brands’ ability to incur additional indebtedness, create liens, make investments or specified payments, give guarantees, pay dividends, make capital expenditures and merge or acquire or sell assets. Pursuant to a guarantee and collateral agreement, SBI and its domestic subsidiaries have guaranteed their respective obligations under the Term Loan and related loan documents and have pledged substantially all of their respective assets to secure such obligations. The Term Loan also provides for customary events of default, including payment defaults and cross-defaults on other material indebtedness.

9.5% Notes

In November 2011, Spectrum Brands issued $200,000 aggregate principal amount of 9.5% Notes at a price of 108.5% of the par value; these notes are in addition to the $750,000 aggregate principal amount of 9.5% Notes that were already outstanding and had been issued at a 1.37% discount.

 

F-49


Spectrum Brands may redeem all or a part of the 9.5% Notes, upon not less than 30 or more than 60 days notice, at specified redemption prices. Further, the indenture governing the 9.5% Notes (the “2018 Indenture”) requires Spectrum Brands to make an offer, in cash, to repurchase all or a portion of the applicable outstanding notes for a specified redemption price, including a redemption premium, upon the occurrence of a change of control of Spectrum Brands, as defined in such indenture.

The 2018 Indenture contains customary covenants that limit, among other things, the incurrence of additional indebtedness, payment of dividends on or redemption or repurchase of equity interests, the making of certain investments, expansion into unrelated businesses, creation of liens on assets, merger or consolidation with another company, transfer or sale of all or substantially all assets, and transactions with affiliates.

In addition, the 2018 Indenture provides for customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to make payments on or acceleration of certain other indebtedness, and certain events of bankruptcy and insolvency. Events of default under the 2018 Indenture arising from certain events of bankruptcy or insolvency will automatically cause the acceleration of the amounts due under the 9.5% Notes. If any other event of default under the 2018 Indenture occurs and is continuing, the trustee for the 2018 Indenture or the registered holders of at least 25% in the then aggregate outstanding principal amount of the 9.5% Notes may declare the acceleration of the amounts due under those notes.

6.75% Notes

In March 2012, Spectrum Brands issued $300,000 aggregate principal amount of its 6.75% Senior Notes due 2020 (the “6.75% Notes”) at a price of 100% of the par value. The 6.75% Notes are unsecured and guaranteed by SBI’s parent company, SB/RH Holdings, LLC, as well as by existing and future domestic restricted subsidiaries of SBI.

Spectrum Brands may redeem all or part of the 6.75% Notes, upon not less than 30 or more than 60 days notice, at specified redemption prices. Further, the indenture governing the 6.75% Notes (the “2020 Indenture”) requires Spectrum Brands to make an offer, in cash, to repurchase all or a portion of the applicable outstanding notes for a specified redemption price, including a redemption premium, upon the occurrence of a change of control of Spectrum Brands, as defined in such indenture.

In addition, the 2020 Indenture contains customary covenants that limit, among other things, the incurrence of additional indebtedness, payment of dividends on or redemption or repurchase of equity interests, the making of certain investments, expansion into unrelated businesses, creation of liens on assets, merger or consolidation with another company, transfer or sale of all or substantially all assets, and transactions with affiliates.

In addition, the 2020 Indenture provides for customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to make payments when due or on acceleration of certain other indebtedness, and certain events of bankruptcy and insolvency. Events of default under the 2020 Indenture arising from certain events of bankruptcy or insolvency will automatically cause the acceleration of the amounts due under the 6.75% Notes. If any other event of default under the 2020 Indenture occurs and is continuing, the trustee for the 2020 Indenture or the registered holders of at least 25% in the then aggregate outstanding principal amount of the 6.75% Notes may declare the acceleration of the amounts due under those notes.

12% Notes

In March 2012, Spectrum Brands launched a cash tender offer (the “Tender Offer”) and consent solicitation (the “Consent Solicitation”) with respect to any and all of its outstanding 12% Senior Subordinated Toggle Notes due 2019 (the “12% Notes”). Pursuant to the Consent Solicitation, Spectrum Brands received consents to the adoption of certain amendments to the indenture governing the 12% Notes to, among other things, eliminate

 

F-50


substantially all of the restrictive covenants, certain events of default and other related provisions. The terms of the Tender Offer provided that holders of the 12% Notes who tendered their 12% Notes prior to the expiration of a consent solicitation period, which ended March 14, 2012, would receive tender offer consideration and a consent payment. Holders tendering their 12% Notes subsequent to expiration of the consent solicitation period, but prior to the March 28, 2012 expiration of the Tender Offer period, would receive only tender offer consideration. As of the expiration of the consent solicitation period, holders of the 12% Notes had tendered approximately $231,421 of the 12% Notes. Following the expiration of the Tender Offer period, an additional $88 of the 12% Notes were tendered. Following expiration of the Tender Offer period, Spectrum Brands paid the trustee principal, interest and a call premium sufficient to redeem the remaining approximately $13,522 of the 12% Notes not tendered on the first redemption date, August 28, 2012. The trustee under the indenture governing the 12% Notes accepted those funds in trust for the benefit of the holders of the 12% Notes and has acknowledged the satisfaction and discharge of the 12% Notes and the indenture governing the 12% Notes.

ABL Facility

In May 2012, Spectrum Brands amended its ABL Facility. As a result, the maturity date was extended from April 21, 2016 to May 3, 2016.

The amended facility carries an interest rate at the option of Spectrum Brands, which is subject to change based on availability under the facility, of either: (a) the base rate plus (currently) 0.75% per annum or (b) the reserve-adjusted LIBOR rate plus (currently) 1.75% per annum. No principal amortizations are required with respect to the ABL Facility. Pursuant to the credit and security agreement, the obligations under the ABL Facility are secured by certain current assets of Spectrum Brands, including, but not limited to, deposit accounts, trade receivables and inventory.

The ABL Facility is governed by a credit agreement (the “ABL Credit Agreement”) with Bank of America as administrative agent. The ABL Facility consists of revolving loans (the “Revolving Loans”), with a portion available for letters of credit and a portion available as swing line loans, in each case subject to the terms and limits described therein.

The Revolving Loans may be drawn, repaid and reborrowed without premium or penalty. The proceeds of borrowings under the ABL Facility are to be used for costs, expenses and fees in connection with the ABL, working capital requirements of Spectrum Brands and its subsidiaries, restructuring costs, and for other general corporate purposes.

The ABL Credit Agreement contains various representations and warranties and covenants, including, without limitation, enhanced collateral reporting, and a maximum fixed charge coverage ratio. The ABL Credit Agreement also provides for customary events of default, including payment defaults and cross-defaults on other material indebtedness.

As a result of borrowings and payments under the ABL Facility, at September 30, 2012 Spectrum Brands had aggregate borrowing availability of approximately $198,209, net of lender reserves of $7,942 and outstanding letters of credit of $25,302.

Debt Related Costs

In connection with the 6.75% Note offering, the 9.5% Note offerings, the voluntary prepayments and amendments to the Term Loan and ABL Facility and, in Fiscal 2010, the debt refinancings in connection with the SB/RH Merger, Spectrum Brands recorded fees of $11,231, $12,616 and $55,024 during Fiscal 2012, 2011 and 2010, respectively. These fees are classified as “Deferred charges and other assets” in the accompanying Consolidated Balance Sheets and are being amortized to interest expense utilizing the effective

 

F-51


interest method over the respective terms of the debt. In addition, Spectrum Brands recorded the following charges to “Interest expense” relating to the extinguishment, prepayment and amendment of its debt instruments, as described above:

 

     Year Ended September 30,  
     2012      2011      2010  

Cash fees and expenses

   $ 26,413       $ 5,654       $ 17,009   

Non-cash charges for write-off and accelerated amortization of unamortized debt issuance costs and discount/premium

     5,303         31,891         65,713   
  

 

 

    

 

 

    

 

 

 

Total charges to interest expense

     31,716         37,545         82,722   
  

 

 

    

 

 

    

 

 

 

FGL

On April 7, 2011, Raven Reinsurance Company (“Raven Re”), a newly-formed wholly-owned subsidiary of FGL, issued a $95,000 surplus note to OMGUK, as discussed further in Note 20. The surplus note was issued at par and carried a 6% fixed interest rate. The note had a maturity date which was the later of (i) December 31, 2012 or (ii) the date on which all amounts due and payable to the lender have been paid in full. The note was settled at face value (without the payment of interest) in October 2011 in connection with the closing of the Raven springing amendment and the replacement of the reserve facility discussed in Note 20.

(13) Temporary Equity

On May 13, 2011 and August 5, 2011, the Company issued 280 shares of Series A Preferred Stock and 120 shares of Series A-2 Preferred Stock, respectively, in private placements pursuant to securities purchase agreements, for aggregate gross proceeds of $400,000. The Preferred Stock (i) is redeemable for cash (or, if a holder does not elect cash, automatically converted into common stock) on May 13, 2018, (ii) is convertible into the Company’s common stock at an initial conversion price of $6.50 per share for the Series A and $7.00 per share for the Series A-2, both subject to anti-dilution adjustments, (iii) has a liquidation preference of the greater of 150% of the purchase price or the value that would be received if it were converted into common stock, (iv) accrues a cumulative quarterly cash dividend at an annualized rate of 8% and (v) has a quarterly non-cash principal accretion at an annualized rate of 4% that will be reduced to 2% or 0% if the Company achieves specified rates of growth measured by increases in its net asset value. Effective April 1, 2012, and October 1, 2012, such accretion rate was reduced from, respectively, 4% to 2% for the remainder of Fiscal 2012, and then from 2% to 0% for the period subsequent to Fiscal 2012, as a result of achieving a specified level of growth in the Company’s net asset value as calculated in accordance with the terms of the certificates of designation governing the Preferred Stock. The Preferred Stock is entitled to vote, subject to certain regulatory limitations, and to receive cash dividends and in-kind distributions on an as-converted basis with the common stock.

If the Company were to issue certain equity securities at a price lower than the conversion price of the respective series of Preferred Stock, the conversion price would be adjusted downward to reflect the dilutive effect of the newly issued equity securities (a “down round” provision). Therefore, as discussed further in Note 2, the conversion feature required bifurcation and must be separately accounted for at fair value with any changes in fair value reported in current earnings.

As of the respective issuance dates, the Company determined the fair values of the bifurcated conversion feature were approximately $85,700 for the Series A Preferred Stock and approximately $17,560 for the Series A-2 Preferred Stock. The residual $296,740 aggregate value of the host contracts, less $14,027 of issuance costs, has been classified as temporary equity, as the securities are redeemable at the option of the holder and upon the occurrence of an event that is not solely within the control of the issuer. The resulting $117,287 difference between the issuance price and initial carrying value of $282,713 is being accreted to “Preferred stock dividends and accretion” in the accompanying Consolidated Statements of Operations using the effective interest method over the Preferred Stock’s contractual/expected life of approximately seven years through May 13, 2018.

 

F-52


The carrying value of Preferred Stock reflects the following components:

 

     Series A
(280 shares)
    Series A-2
(120 shares)
    Total  

Initial issuance price in Fiscal 2011

   $ 280,000      $ 120,000      $ 400,000   

Principal accretion:

      

Fiscal 2011

     4,308        747        5,055   

Fiscal 2012

     8,622        3,662        12,284   
  

 

 

   

 

 

   

 

 

 

Redemption value as of September 30, 2012

     292,930        124,409        417,339   

Bifurcation of embedded conversion feature at issuance

     (85,700     (17,560     (103,260

Issuance costs

     (11,058     (2,969     (14,027

Accretion:

      

Fiscal 2011

     4,210        459        4,669   

Fiscal 2012

     11,705        2,799        14,504   
  

 

 

   

 

 

   

 

 

 

Carrying value of Preferred Stock as of September 30, 2012

   $ 212,087      $ 107,138      $ 319,225   
  

 

 

   

 

 

   

 

 

 

 

F-53


(14) Permanent Equity

Accumulated Other Comprehensive Income

Amounts recorded in AOCI in the accompanying Consolidated Statements of Permanent Equity and Comprehensive Income (Loss) consist of the following components:

 

    Unrealized
Investment
Gains, net
    Non-credit
Related
Other-than-
temporary
Impairments
    Other
Unrealized
Gains (Losses)
— Cash Flow
Hedges
    Actuarial
Adjustments
to Pension
Plans
    Cumulative
Translation
Adjustments
    Total  

Balances at September 30, 2009

  $ —        $ —        $ 851      $ (190   $ 5,907      $ 6,568   

Gross change before reclassification adjustment

    —          —          (15,621     (29,141     11,511        (33,251

Net reclassification adjustment for losses (gains) included in earnings

    —          —          6,356        1,355        —          7,711   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

    —          —          (9,265     (27,786     11,511        (25,540

Deferred tax effect

    —          —          2,775        8,904        1,085        12,764   

Deferred tax valuation allowance

    —          —          (116     (2,763     481        (2,398

Noncontrolling interest

    —          —          1,276        8,084        (12,682     (3,322
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

    —          —          (5,330     (13,561     395        (18,496

Noncontrolling interest recapitalization adjustment

    —          —          1,342        1,347        4,044        6,733   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2010

  $ —        $ —        $ (3,137   $ (12,404   $ 10,346      $ (5,195

Gross change before reclassification adjustment

    420,929        500        (5,992     (7,609     (12,857     394,971   

Net reclassification adjustment for losses (gains) included in earnings

    (3,861     —          13,422        8        —          9,569   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

    417,068        500        7,430        (7,601     (12,857     404,540   

Intangible assets adjustment

    (172,057     (206     —          —          —          (172,263

Deferred tax effect

    (85,709     (103     (2,671     2,037        2,742        (83,704

Deferred tax valuation allowance

    —          —          (331     3,529        (492     2,706   

Noncontrolling interest

    —          —          (2,128     373        5,436        3,681   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

    159,302        191        2,300        (1,662     (5,171     154,960   

Change in noncontrolling interest

    —          —          132        278        (727     (317
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

  $ 159,302      $ 191      $ (705   $ (13,788   $ 4,448      $ 149,448   

Gross change before reclassification adjustment

    906,473        (1,529     (1,824     (15,452     (8,602     879,066   

Net reclassification adjustment for losses (gains) included in earnings

    (263,948     —          3,097        927        —          (259,924
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

    642,525        (1,529     1,273        (14,525     (8,602     619,142   

Intangible assets adjustment

    (218,454     586        —          —          —          (217,868

Deferred tax effect

    (148,469     330        (636     3,632        —          (145,143

Deferred tax valuation allowance

    —          —          908        (782     —          126   

Noncontrolling interest

    —          —          (736     5,074        4,182        8,520   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

    275,602        (613     809        (6,601     (4,420     264,777   

Change in noncontrolling interest

    —          —          21        (917     (157     (1,053
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

  $ 434,904      $ (422   $ 125      $ (21,306   $ (129   $ 413,172   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative components at September 30, 2012:

  

         

Gross amounts (after reclassification adjustments)

  $ 1,059,593      $ (1,029   $ 305      $ (39,937   $ (3,722   $ 1,015,210   

Intangible assets adjustments

    (390,511     380        —          —          —          (390,131

Tax effects

    (234,178     227        (87     4,392        3,497        (226,149

Noncontrolling interest

    —          —          (93     14,239        96        14,242   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 434,904      $ (422   $ 125      $ (21,306   $ (129   $ 413,172   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative components at September 30, 2011:

  

         

Gross amounts (after reclassification adjustments)

  $ 417,068      $ 500      $ (968   $ (25,412   $ 4,880      $ 396,068   

Intangible assets adjustments

    (172,057     (206     —          —          —          (172,263

Tax effects

    (85,709     (103     (359     1,542        3,497        (81,132

Noncontrolling interest

    —          —          622        10,082        (3,929     6,775   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 159,302      $ 191      $ (705   $ (13,788   $ 4,448      $ 149,448   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

F-54


Restricted Net Assets of Subsidiaries

HGI’s equity in restricted net assets of consolidated subsidiaries was approximately $1,709,008 as of September 30, 2012, representing 145% of HGI’s consolidated stockholders’ equity as of September 30, 2012 and consisted of net assets of FGL and Spectrum Brands, less noncontrolling interest, which were restricted as to transfer to HGI in the form of cash dividends, loans or advances under regulatory or debt covenant restrictions.

(15) Employee Benefit Plans

Defined Benefit Plans

HGI

HGI has a noncontributory defined benefit pension plan (the “HGI Pension Plan”) covering certain former U.S. employees. During 2006, the HGI Pension Plan was frozen which caused all existing participants to become fully vested in their benefits.

Additionally, HGI has an unfunded supplemental pension plan (the “Supplemental Plan”) which provides supplemental retirement payments to certain former senior executives of HGI. The amounts of such payments equal the difference between the amounts received under the HGI Pension Plan and the amounts that would otherwise be received if HGI Pension Plan payments were not reduced as the result of the limitations upon compensation and benefits imposed by Federal law. Effective December 1994, the Supplemental Plan was frozen.

Spectrum Brands

Spectrum Brands has various defined benefit pension plans (the “Spectrum Brands Pension Plans”) covering some of its employees in the United States and certain employees in other countries, primarily the United Kingdom and Germany. The Spectrum Brands Pension Plans generally provide benefits of stated amounts for each year of service. Spectrum Brands funds its U.S. pension plans in accordance with the requirements of the defined benefit pension plans and, where applicable, in amounts sufficient to satisfy the minimum funding requirements of applicable laws. Additionally, in compliance with Spectrum Brands’ funding policy, annual contributions to non-U.S. defined benefit plans are equal to the actuarial recommendations or statutory requirements in the respective countries.

Spectrum Brands also sponsors or participates in a number of other non-U.S. pension arrangements, including various retirement and termination benefit plans, some of which are covered by local law or coordinated with government-sponsored plans, which are not significant in the aggregate and therefore are not included in the information presented below. Spectrum Brands also has various nonqualified deferred compensation agreements with certain of its employees. Under certain of these agreements, Spectrum Brands has agreed to pay certain amounts annually for the first 15 years subsequent to retirement or to a designated beneficiary upon death. It is management’s intent that life insurance contracts owned by Spectrum Brands will fund these agreements. Under the remaining agreements, Spectrum Brands has agreed to pay such deferred amounts in up to 15 annual installments beginning on a date specified by the employee, subsequent to retirement or disability, or to a designated beneficiary upon death.

Spectrum Brands also provides postretirement life insurance and medical benefits to certain retirees under two separate contributory plans.

Consolidated

The recognition and disclosure provisions of ASC Topic 715: “Compensation-Retirement Benefits” (“ASC 715”) requires recognition of the overfunded or underfunded status of defined benefit pension and postretirement plans as an asset or liability in the consolidated balance sheet, and to recognize changes in that funded status in AOCI.

 

F-55


In accordance with the measurement date provisions of ASC 715, the Company measures all of its defined benefit pension and postretirement plan assets and obligations as of September 30, which is the Company’s fiscal year end.

The following tables provide additional information on the Company’s pension and other postretirement benefit plans which principally relate to Spectrum Brands:

 

     Pension and Deferred
Compensation Benefits
    Other Benefits  
     2012     2011     2012     2011  

Change in benefit obligation

        

Benefit obligation, beginning of year

   $ 228,662      $ 234,807      $ 542      $ 527   

Service cost

     2,048        2,543        12        11   

Interest cost

     11,436        11,239        27        27   

Actuarial (gain) loss

     31,251        (9,022     (14     (21

Participant contributions

     182        189        —          —     

Benefits paid

     (10,890     (10,189     (1     (2

Foreign currency exchange rate changes

     (1,969     (905     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Benefit obligation, end of year

   $ 260,720      $ 228,662      $ 566      $ 542   
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in plan assets

        

Fair value of plan assets, beginning of year

   $ 143,668      $ 140,072      $ —        $ —     

Actual return on plan assets

     22,290        (501     —          —     

Employer contributions

     13,612        14,912        1        2   

Employee contributions

     182        189        —          —     

Benefits paid

     (10,890     (10,189     (1     (2

Plan expenses paid

     —          (226     —          —     

Foreign currency exchange rate changes

     (241     (589     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Fair value of plan assets, end of year

   $ 168,621      $ 143,668      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Benefit Cost / Funded Status

   $ (92,099   $ (84,994   $ (566   $ (542
  

 

 

   

 

 

   

 

 

   

 

 

 

Range of assumptions:

        

Discount rate

     4.0%-13.5     4.0%-13.6     4.0     5.0

Expected return on plan assets

     4.0%-7.8     3.0%-7.8     N/A        N/A   

Rate of compensation increase

     2.3%-5.5     0.0%-5.5     N/A        N/A   

The net underfunded status as of September 30, 2012 and 2011 of $92,099 and $84,994, respectively, is recognized in the accompanying Consolidated Balance Sheets within “Employee benefit obligations.” Included in AOCI as of September 30, 2012 and 2011 are unrecognized net (losses) of $(21,306), net of tax benefit of $4,392 and noncontrolling interest of $14,239, and $(13,788), net of tax benefit of $1,542 and noncontrolling interest of $10,082, respectively, which have not yet been recognized as components of net periodic pension cost. The net loss in AOCI expected to be recognized during the year ending September 30, 2013 (“Fiscal 2013”) is $1,204.

At September 30, 2012, the Company’s total pension and deferred compensation benefit obligation of $260,720 consisted of $95,494 associated with U.S. plans and $165,226 associated with international plans. The fair value of the Company’s pension and deferred compensation benefit assets of $168,621 consisted of $66,415 associated with U.S. plans and $102,206 associated with international plans. The weighted average discount rate used for the Company’s domestic plans was approximately 4.4% and approximately 5.3% for its international plans. The weighted average expected return on plan assets used for the Company’s domestic plans was approximately 7.6% and approximately 5.4% for its international plans.

At September 30, 2011, the Company’s total pension and deferred compensation benefit obligation of $228,662 consisted of $86,801 associated with U.S. plans and $141,861 associated with international plans. The fair value

 

F-56


of the Company’s pension and deferred compensation benefit assets of $143,668 consisted of $56,609 associated with U.S. plans and $87,059 associated with international plans. The weighted average discount rate used for the Company’s domestic plans was approximately 5.0% and approximately 4.9% for its international plans. The weighted average expected return on plan assets used for the Company’s domestic plans was approximately 7.6% and approximately 5.4% for its international plans.

 

     Pension and Deferred Compensation Benefits     Other Benefits  
     Year Ended September 30,     Year Ended September 30,  
         2012             2011             2010           2012         2011         2010    

Components of net periodic benefit cost:

            

Service cost

   $ 2,403      $ 2,689      $ 2,479      $ 12      $ 11      $ 9   

Interest cost

     11,436        11,239        8,515        27        27        26   

Expected return on assets

     (9,112     (8,835     (6,063     —          —          —     

Amortization of prior service cost

     72        —          535        —          —          —     

Amortization of transition obligation

     —          —          207        —          —          —     

Recognized net actuarial (gain) loss

     855        8        613        (54     (52     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 5,654      $ 5,101      $ 6,286      $ (15   $ (14   $ (23
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The discount rate is used to calculate the projected benefit obligation. The discount rate used is based on the rate of return on government bonds as well as current market conditions of the respective countries where such plans are established.

Below is a summary allocation of all pension plan assets as of the measurement date.

 

     Weighted Average Allocation  
     Target     Actual  
     2012     2012     2011  

Asset Category

      

Equity securities

     0-60     50     47

Fixed income securities

     0-40     21     21

Other

     0-100     29     32
  

 

 

   

 

 

   

 

 

 
     100     100     100
  

 

 

   

 

 

   

 

 

 

The weighted average expected long-term rate of return on total assets is 6.3%.

The Company has established formal investment policies for the assets associated with these plans. Policy objectives include maximizing long-term return at acceptable risk levels, diversifying among asset classes, if appropriate, and among investment managers, as well as establishing relevant risk parameters within each asset class. Specific asset class targets are based on the results of periodic asset liability studies. The investment policies permit variances from the targets within certain parameters. The weighted average expected long-term rate of return is based on a Fiscal 2012 review of such rates. The plan assets currently do not include holdings of common stock of HGI or its subsidiaries.

The Company’s fixed income securities portfolio is invested primarily in commingled funds and managed for overall return expectations rather than matching duration against plan liabilities; therefore, debt maturities are not significant to the plan performance.

The Company’s other portfolio consists of all pension assets, primarily insurance contracts, in the United Kingdom, Germany and the Netherlands.

 

F-57


The Company’s expected future pension benefit payments for Fiscal 2013 through its fiscal year 2022 are as follows:

 

Fiscal Year

      

2013

   $ 11,196   

2014

     10,301   

2015

     10,604   

2016

     10,939   

2017

     11,202   

2018 to 2022

     62,711   

The following table sets forth the fair value of the Company’s pension plan assets:

 

          September 30,  
     Fair Value Hierarchy  (a)    2012      2011  

U.S. defined benefit plan assets:

        

Mutual funds — equity

   Level 1    $ 20,520       $ 16,516   

Common collective trusts — equity

   Level 2      25,781         21,024   

Common collective trusts — fixed income

   Level 2      19,507         18,402   

Other

   Level 2      607         667   
     

 

 

    

 

 

 

Total U.S. defined benefit plan assets

        66,415         56,609   
     

 

 

    

 

 

 

International defined benefit plan assets:

        

Common collective trusts — equity

   Level 2      38,507         29,532   

Common collective trusts — fixed income

   Level 2      15,661         11,467   

Insurance contracts — general fund

   Level 2      40,651         37,987   

Other

   Level 2      7,387         8,073   
     

 

 

    

 

 

 

Total International defined benefit plan assets

        102,206         87,059   
     

 

 

    

 

 

 

Total defined benefit plan assets

      $ 168,621       $ 143,668   
     

 

 

    

 

 

 

 

(a)

The fair value measurements of the Company’s defined benefit plan assets are based on unadjusted quoted prices for identical assets and liabilities in active markets (Level 1) for mutual funds and observable market price inputs (Level 2) for common collective trusts and other investments. Each collective trust’s valuation is based on its calculation of net asset value per share reflecting the fair value of its underlying investments. Since each of these collective trusts allows redemptions at net asset value per share at the measurement date, its valuation is categorized as a Level 2 fair value measurement. The fair values of insurance contracts and other investments are also based on observable market price inputs (Level 2).

Defined Contribution Plans

Spectrum Brands sponsors a defined contribution pension plan for its domestic salaried employees, which allows participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. Spectrum Brands also sponsors defined contribution pension plans for employees of certain foreign subsidiaries. FGL sponsors a defined contribution plan in which eligible participants may defer a fixed amount or a percentage of their eligible compensation, subject to limitations, and FGL makes a discretionary matching contribution of up to 5% of eligible compensation. FGL has also established a nonqualified defined contribution plan for independent agents. FGL makes contributions to the plan based on both FGL’s and the agent’s performance. Contributions are discretionary and evaluated annually. HGI also sponsors a defined contribution plan for its corporate employees in which eligible participants may defer a fixed amount or a percentage of their eligible compensation, subject to limitations. HGI makes a discretionary matching contribution of up to 4% of eligible compensation. Aggregate contributions charged to operations for the defined contribution plans, including discretionary amounts, for Fiscal 2012, 2011 and 2010 were $2,795, $5,346 and $3,471, respectively.

 

F-58


(16) Stock Compensation

The Company recognized consolidated stock compensation expense as follows:

 

     Year Ended September 30,  
     2012      2011      2010  

Stock compensation expense

   $ 31,214       $ 30,505       $ 16,710   

Related tax benefit

     10,265         10,636         5,837   

Noncontrolling interest

     8,177         9,057         4,932   
  

 

 

    

 

 

    

 

 

 

Net

   $ 12,772       $ 10,812       $ 5,941   
  

 

 

    

 

 

    

 

 

 

The amounts before taxes and non-controlling interest are principally included in “Selling, general and administrative expenses” in the accompanying Consolidated Statements of Operations.

A summary of stock options outstanding as of September 30, 2011 and 2012, and related activity during Fiscal 2012, under HGI and FGL’s respective incentive plans are as follows:

 

     HGI      FGL  

Stock Option Awards

   Options     Weighted
Average
Exercise
Price
     Weighted
Average
Grant Date
Fair Value
     Options     Weighted
Average
Exercise
Price
     Weighted
Average
Grant Date
Fair Value
 

Stock options outstanding at September 30, 2011

     143      $ 6.77       $ 2.54         —        $ —         $ —     

Granted

     2,275        4.95         1.76         207        38.20         3.90   

Exercised

     (8     3.33         1.29         —          —           —     

Forfeited or expired

     (125     7.01         2.64         (6     38.14         3.90   
  

 

 

         

 

 

      

Stock options outstanding at September 30, 2012

     2,285        4.96         1.77         201        38.20         3.90   
  

 

 

         

 

 

      

Vested and exercisable at September 30, 2012

     7        6.50         2.35         —          —           —     
  

 

 

         

 

 

      

Outstanding and expected to vest at September 30, 2012

     2,285        4.96         1.77         161        38.20         3.90   
  

 

 

         

 

 

      

A summary of restricted stock and restricted stock units outstanding as of September 30, 2011 and 2012, and related activity during Fiscal 2012, under HGI and Spectrum Brands’ respective incentive plans are as follows:

 

     HGI      Spectrum Brands  

Restricted Stock Awards

   Shares     Weighted
Average
Grant Date
Fair Value
     Shares     Weighted
Average
Grant Date
Fair Value
 

Restricted stock outstanding at September 30, 2011

     —        $ —           123      $ 24.20   

Granted

     838        4.93         —          —     

Vested

     (9     4.61         (110     23.75   

Forfeited

     —          —           —          —     
  

 

 

      

 

 

   

Restricted stock outstanding at September 30, 2012

     829        4.93         13        28.00   
  

 

 

      

 

 

   

Outstanding and expected to vest at September 30, 2012

     829        4.93         13        28.00   
  

 

 

      

 

 

   

 

F-59


     HGI      Spectrum Brands  

Restricted Stock Units

   Units     Weighted
Average
Grant Date
Fair Value
     Units     Weighted
Average
Grant Date
Fair Value
 

Restricted stock units outstanding at September 30, 2011

     —        $ —           1,645      $ 28.97   

Granted

     22        4.61         863        28.28   

Vested

     (5     4.61         (520     29.83   

Forfeited

     —          —           (57     28.49   
  

 

 

      

 

 

   

Restricted stock units outstanding at September 30, 2012

     17        4.61         1,931        28.45   
  

 

 

      

 

 

   

Vested and exercisable at September 30, 2012

     5        4.61        
  

 

 

        

Outstanding and expected to vest at September 30, 2012

     17        4.61         1,931        28.45   
  

 

 

      

 

 

   

HGI

On December 5, 1996, HGI’s stockholders approved a long-term incentive plan (the “1996 HGI Plan”) that permitted the grant of options to purchase up to 8,000 shares of common stock to key employees of the Company. These awards were granted at prices equivalent to the market value of the common stock on the date of grant. These options vest ratably over three years beginning on the first anniversary and expire on the tenth anniversary of the grant. At September 30, 2012, stock options covering a total of 1,797 shares had been exercised and 10 options to purchase common stock are outstanding, with a weighted average exercise price of $6.50.

On September 15, 2011, the Company’s stockholders approved the 2011 Omnibus Award Plan (the “2011 HGI Plan”). The 2011 HGI Plan provides for the issuance of stock options or stock appreciation rights (“SARs”) for up to 17,000 shares of common stock. The 2011 HGI Plan prohibits granting stock options with exercise prices and SARs with grant prices lower than the fair market value of the common stock on the date of grant, except in connection with the issuance or assumption of awards in connection with certain mergers, consolidations, acquisitions of property or stock or reorganizations. Following the adoption of the 2011 HGI Plan, no new awards will be granted under the 1996 HGI Plan and any shares of common stock available for issuance under the 1996 HGI Plan that are not subject to outstanding awards are no longer available for issuance. As of September 30, 2012, 13,865 shares are available for issuance under the 2011 HGI Plan.

During Fiscal 2012, HGI granted approximately 2,275 stock option awards, 838 restricted stock awards and 22 restricted stock units. All of these grants are time based, and vest over periods of 7 months to 4 years. The total fair value of the stock grants on their respective grant dates was approximately $8,245.

During Fiscal 2010, prior to the June 16, 2010 inclusion of HGI’s results herein, stock options for 10,000 and 125,000 shares were granted by HGI with grant date fair values of $2.35 and $2.63 per share, respectively, having a total fair value of $352 on their respective grant dates.

Under HGI’s executive bonus plan, executives will be paid in cash, stock options and restricted stock shares. Based on Fiscal 2012 performance measures, the Company expects to grant approximately 3,200 restricted shares and 1,500 stock options in the first quarter of fiscal 2013 with a portion vesting immediately and the remaining shares vesting between 12 and 36 months from the grant date. The Company expects to recognize approximately $25,000 of deferred bonus compensation expense with respect to cash and stock-based awards as it vests over the next three fiscal years, subject to clawback provisions if the subsequent increase in net asset value for bonus compensation purposes does not exceed specified threshold returns.

As of September 30, 2012, there was approximately $6,435 of total unrecognized compensation cost related to unvested share-based compensation arrangements, which is expected to be recognized over a weighted average period of 2.7 years.

 

F-60


The weighted-average remaining contractual term of outstanding stock option awards was 9.4 years.

The following assumptions were used in Fiscal 2012 and 2010 in the determination of the grant date fair values of HGI’s stock options using the Black-Scholes option pricing model:

 

     2012    2010

Risk-free interest rate

   0.97% - 1.19%    2.60%

Assumed dividend yield

   —      —  

Expected option term

   6 years    6 years

Volatility

   33.0% - 35.5%    32.0%

The fair values of restricted stock and restricted stock units are determined based on the market price of HGI’s shares on the grant date.

Spectrum Brands

In September 2009, SBI’s board of directors adopted the 2009 Spectrum Brands Inc. Incentive Plan (the “2009 Plan”). In conjunction with the SB/RH Merger, the 2009 Plan was assumed by Spectrum Brands. Prior to October 21, 2010, up to 3,333 shares of common stock, net of forfeitures and cancellations, could have been issued under the 2009 Plan.

In conjunction with the SB/RH Merger, Spectrum Brands adopted the Spectrum Brands Holdings, Inc. 2007 Omnibus Equity Award Plan (formerly known as the Russell Hobbs Inc. 2007 Omnibus Equity Award Plan, as amended on June 24, 2008) (the “2007 RH Plan”). Prior to October 21, 2010, up to 600 shares of common stock, net of forfeitures and cancellations, could have been issued under the RH Plan.

On October 21, 2010, Spectrum Brands’ board of directors adopted the Spectrum Brands Holdings, Inc. 2011 Omnibus Equity Award Plan (the “2011 Plan”), which was approved by Spectrum Brands’ stockholders on March 1, 2011. Up to 4,626 shares of common stock of Spectrum Brands, net of cancellations, may be issued under the 2011 Plan.

Spectrum Brands granted approximately 863 restricted stock units during Fiscal 2012. Of these grants, 160 restricted stock units are time-based and vest over a period ranging from one year to two years. The remaining 703 restricted stock units are both performance and time based and vest over a one year performance-based period followed by a one year time-based period. The total market value of the restricted shares on the date of the grant was approximately $24,408.

Spectrum Brands granted approximately 1,674 restricted stock units during Fiscal 2011. Of these grants, 93 restricted stock units are time-based and vest over a period ranging from one year to three years. The remaining 1,581 restricted stock units are both performance and time based and vest as follows: (i) 699 stock units vest over a one year performance-based period followed by a one year time-based period and (ii) 882 stock units vest over a two year performance-based period followed by a one year time-based period. The total market value of the restricted stock units on the date of the grant was approximately $48,530.

Spectrum Brands granted approximately 939 shares of restricted stock during Fiscal 2010. Of these grants, 271 restricted stock units were granted in conjunction with the SB/RH Merger and are time-based and vest over a one year period. The remaining 668 shares are restricted stock grants that are time based and vest as follows: (i) 18 shares vest over a one year period; (ii) 611 shares vest over a two year period; and (iii) 39 shares vest over a three year period. The total market value of the restricted shares on the date of the grant was approximately $23,299.

The fair values of restricted stock and restricted stock units are determined based on the market price of Spectrum Brands’ shares on the grant date.

 

F-61


FGL

On November 2, 2011, FGL’s compensation committee (on behalf of its board of directors) approved a long-term stock-based incentive plan that permits the grant of options to purchase shares of FGL common stock to key employees of FGL. On November 2, 2011, FGL’s compensation committee also approved a dividend equivalent plan that permits holders of these options the right to receive a payment in cash in an amount equal to the ordinary dividends declared and paid or debt service payments to HGI by FGL in each calendar year, divided by the total number of FGL common shares outstanding, starting in the year in which the dividend equivalent is granted through the year immediately prior to the year in which the dividend equivalent vests with respect to a participant’s option shares. As of September 30, 2012, FGL determined that it was probable that the dividend equivalent will vest and recorded a provision of $504 for the ratable recognition of such projected liability over the option vesting period.

During Fiscal 2012, FGL granted 207 stock option awards under the terms of the plan. These stock options vest over a period of 3 years and expire on the seventh anniversary of the grant. The total fair value of the grants on their grant dates was approximately $807.

The total compensation cost related to non-vested awards not yet recognized as of September 30, 2012 totaled $464 and will be recognized over a weighted–average period of 2.1 years.

The following assumptions were used in the determination of the grant date fair values using the Black-Scholes option pricing model:

 

     2012

Risk-free interest rate

   0.8%

Assumed dividend yield

   10.0%

Expected option term

   4.5 years

Volatility

   35.0%

(17) Income Taxes

Income tax (benefit) expense was calculated based upon the following components of income (loss) from continuing operations before income tax:

 

     September 30,  
     2012     2011     2010  

Pretax income (loss):

      

United States

   $ (146,542   $ (74,815   $ (238,179

Outside the United States

     171,928        132,749        105,867   
  

 

 

   

 

 

   

 

 

 

Total pretax income (loss)

   $ 25,386      $ 57,934      $ (132,312
  

 

 

   

 

 

   

 

 

 

 

F-62


The components of income tax (benefit) expense were as follows:

 

     September 30,  
     2012     2011     2010  

Current:

      

Federal

   $ 74,388      $ (875   $ —     

Foreign

     38,113        32,649        44,481   

State

     (370     2,336        2,913   
  

 

 

   

 

 

   

 

 

 

Total current

     112,131        34,110        47,394   
  

 

 

   

 

 

   

 

 

 

Deferred:

      

Federal

     (199,162     (20,622     22,119   

Foreign

     5,190        28,054        (6,514

State

     (3,441     9,013        196   
  

 

 

   

 

 

   

 

 

 

Total deferred

     (197,413     16,445        15,801   
  

 

 

   

 

 

   

 

 

 

Income tax (benefit) expense

   $ (85,282   $ 50,555      $ 63,195   
  

 

 

   

 

 

   

 

 

 

The differences between income taxes expected at the U.S. Federal statutory income tax rate of 35% and reported income tax (benefit) expense are summarized as follows:

 

     September 30,  
     2012     2011     2010  

Expected income tax (benefit) expense at Federal statutory rate

   $ 8,885      $ 20,277      $ (46,309

Valuation allowance for deferred tax assets

     (142,126     72,335        92,673   

Preferred stock equity conversion feature

     54,810        (9,486     —     

Residual tax on foreign earnings

     29,844        18,943        6,609   

Foreign rate differential

     (14,115     (12,650     (9,601

Bargain purchase gain

     —          (55,419     —     

Gain on contingent purchase price reduction

     (14,350     —          —     

Permanent items

     9,544        10,657        4,829   

Exempt foreign income

     (5,760     (380     (9

Unrecognized tax benefits

     (4,386     (2,793     3,234   

State and local income taxes

     (8,539     1,235        (4,975

Dividends received deduction

     (965     —          —     

Inflationary adjustments

     (803     (1,472     3,409   

Capitalized transaction costs

     343        2,800        —     

Deferred tax correction of immaterial prior period error

     —          4,873        5,900   

Reorganization items

     —          —          8,678   

Other

     2,336        1,635        (1,243
  

 

 

   

 

 

   

 

 

 

Reported income tax (benefit) expense

   $ (85,282   $ 50,555      $ 63,195   
  

 

 

   

 

 

   

 

 

 

Effective tax rate

     (335.9 )%      87.3     (47.8 )% 
  

 

 

   

 

 

   

 

 

 

For the year ended September 30, 2012, the Company’s effective tax rate of (335.9)%, representing a tax benefit despite pretax income, was positively impacted by the net release of valuation allowance attributed to the Company’s determination that certain of its deferred tax assets are more likely than not realizable, income in foreign jurisdictions in which the Company operates that is subject to lower tax rates than the U.S. Federal statutory income tax rate and a contingent purchase price reduction. The Company’s effective tax rate was negatively impacted by an expense for the increase in fair value of the equity conversion feature of Preferred Stock, for which no tax benefit is available, and deferred tax provision related to the change in book versus tax basis of indefinite lived intangibles, which are amortized for tax purposes, but not for book purposes. In addition, for Fiscal 2012 and forward, the Company has asserted that it is no longer permanently reinvesting the income from its foreign operations, thereby subjecting non-U.S. unremitted earnings to the U.S. Federal statutory income tax rate of 35%.

 

F-63


For the year ended September 30, 2011, the Company’s effective tax rate of 87.3% was negatively impacted by the net establishment of valuation allowances against losses in the United States and some foreign jurisdictions. In addition, no tax benefits were recognized on the Company’s indefinite lived intangibles, which are amortized for tax purposes, but not for book purposes. The Company’s effective tax rate was positively impacted by the recognition of a bargain purchase gain from the FGL Acquisition, for which no income tax provision was required. In addition, permanently reinvested income in the foreign jurisdictions in which the Company operates is subject to lower tax rates than the U.S. Federal statutory income tax rate.

For the year ended September 30, 2010, the Company’s effective tax rate of (47.8)%, representing a tax provision despite a pretax loss, was negatively impacted by (i) a deferred income tax provision related to the change in book versus tax basis of indefinite lived intangibles, which are amortized for tax purposes but not for book purposes, (ii) pretax losses in the United States and some foreign jurisdictions for which no tax benefit can be recognized due to full valuation allowances the Company provided on its net operating loss carryforward tax benefits and other deferred tax assets and (iii) pretax income in certain non-U.S. jurisdictions that was subject to tax.

 

F-64


The following table summarizes the components of deferred income tax assets and liabilities:

 

     September 30,  
     2012     2011  

Current deferred tax assets:

    

Employee benefits

   $ 29,491      $ 14,188   

Restructuring

     8,054        10,682   

Inventories and receivables

     22,495        21,521   

Marketing and promotional accruals

     8,270        8,911   

Capitalized transaction costs

     129        292   

Unrealized losses on mark-to-market securities

     10,213        9,574   

Other

     15,090        14,971   

Valuation allowance

     (48,968     (37,523
  

 

 

   

 

 

 

Total current deferred tax assets

     44,774        42,616   
  

 

 

   

 

 

 

Current deferred tax liabilities:

    

Inventories and receivables

     (2,618     (5,015

Unrealized gains

     (1,153     (2,382

Other

     (7,936     (5,705
  

 

 

   

 

 

 

Total current deferred tax liabilities

     (11,707     (13,102
  

 

 

   

 

 

 

Net current deferred tax assets, included in “Prepaid expenses and other current assets”

   $ 33,067      $ 29,514   
  

 

 

   

 

 

 

Noncurrent deferred tax assets:

    

Employee benefits

   $ 37,488      $ 32,369   

Restructuring and purchase accounting

     371        2,269   

Net operating loss, credit and capital loss carry forwards

     914,480        1,026,610   

Prepaid royalty

     7,006        7,346   

Properties

     3,255        5,240   

Capitalized transaction costs

     —          4,648   

Unrealized losses on mark-to-market securities

     12,734        18,574   

Long-term debt

     3,976        22,602   

Intangibles

     4,282        4,749   

Deferred acquisition costs

     9,906        74,175   

Insurance reserves and claim related adjustments

     620,285        408,214   

Other

     30,850        28,556   

Valuation allowance

     (611,139     (764,710
  

 

 

   

 

 

 

Total noncurrent deferred tax assets

     1,033,494        870,642   
  

 

 

   

 

 

 

Noncurrent deferred tax liabilities:

    

Properties

     (15,337     (16,593

Unrealized gains

     (15,803     (11,619

Intangibles

     (596,199     (571,454

Value of business acquired

     (36,512     (148,876

Tax on unremitted foreign earnings

     (29,231     —     

Investments

     (438,655     (246,632

Other

     (4,511     (6,418
  

 

 

   

 

 

 

Total noncurrent deferred tax liabilities

     (1,136,248     (1,001,592
  

 

 

   

 

 

 

Net noncurrent deferred tax liabilities, included in “Deferred tax assets” (Insurance and Financial Services) and “Deferred tax liabilities” (Consumer Products and Other)

   $ (102,754   $ (130,950
  

 

 

   

 

 

 

Net current and noncurrent deferred tax liabilities

   $ (69,687   $ (101,436
  

 

 

   

 

 

 

 

F-65


In accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment, are not more-likely-than-not realizable. These judgments are based on projections of future income, including tax-planning strategies, by individual tax jurisdiction. Changes in industry and economic conditions and the competitive environment may impact the accuracy of these projections. In accordance with ASC Topic 740, during each reporting period, the Company assesses the likelihood that its deferred tax assets will be realized and determines if adjustments to its valuation allowances are appropriate. As a result of this assessment, for the years ended September 30, 2012, 2011 and 2010, the Company had a net charge (release) of valuation allowance to earnings totaling $(142,126), $72,335 and $92,673, respectively, as more fully described below.

HGI

As a result of HGI’s cumulative losses over the past three years, management concluded at September 30, 2012, that a valuation allowance was required for its entire net deferred tax asset balance. HGI’s valuation allowance at September 30, 2012, totaled $97,799. This resulted from the Company’s conclusion that tax benefits on its pretax losses are not more-likely-than-not realizable. HGI has approximately $121,867 of U.S. Federal net operating loss (“NOL”) carryforwards which, if unused, will expire in years 2029 through 2032. HGI has approximately $20,891 of U.S. capital loss carryforwards which, if unused, will expire in 2017. The Company also concluded that a valuation allowance was required for HGI’s entire net deferred tax asset balance at September 30, 2011, in the amount of $53,034.

Spectrum Brands

At September 30, 2012, Spectrum Brands has U.S. Federal and state and local NOL carryforwards of $1,304,763 and $1,340,761, respectively. If unused, they will expire through 2032. Spectrum Brands has foreign loss carryforwards totaling $119,100 which will expire beginning in 2016. Certain of the foreign net operating losses have indefinite carryforward periods. Spectrum Brands is subject to an annual limitation on use of its NOL carryforwards that arose prior to its emergence from bankruptcy. Spectrum Brands has had multiple changes of ownership, as defined under the Internal Revenue Code (the “IRC”), Section 382, that subject the utilization of Spectrum Brands’ U.S. Federal and state and local NOL carryforwards and other tax attributes to certain limitations. Due to these limitations, Spectrum Brands estimates that $301,202 of its U.S. Federal NOL carryforwards and $385,159 of its state and local NOL carryforwards will expire unused even if it generates sufficient income to otherwise use all its NOLs. In addition, separate return year limitations apply to Spectrum Brands’ utilization of U.S. Federal and state and local NOL carryforwards acquired from Russell Hobbs. Spectrum Brands projects that $110,794 of its total foreign loss carryforwards will expire unused. Accordingly, the Company has provided a full valuation allowance against the deferred tax assets recorded for these losses.

As of September 30, 2012 and 2011, Spectrum Brands’ valuation allowances totaled approximately $384,800 and $373,893, respectively. These valuation allowances were recorded on: (i) U.S. net deferred tax assets totaling $349,316 and $338,539, respectively; and (ii) foreign net deferred tax assets totaling $35,484 and $35,354, respectively. The increase in Spectrum Brands’ valuation allowance during the year ended September 30, 2012 totaled $10,907, of which $10,777 relates to U.S. net deferred tax assets, and $130 relates to foreign net deferred tax assets. In addition, as a result of an acquisition, Spectrum Brands was able to release $14,511 of its U.S. valuation allowance during Fiscal 2012. The release was attributable to $14,511 of net deferred tax liabilities recorded on the acquiree’s opening balance sheet that offset other U.S. net deferred tax assets. During the year ended September 30, 2011, Spectrum Brands concluded that its deferred tax assets recorded for Brazil NOL carryforwards are not more-likely-than not realizable. As a result, the Company recorded $25,877 of valuation allowance, increasing foreign deferred tax expense in Fiscal 2011.

Effective October 1, 2012, Spectrum Brands began recording residual U.S. and foreign taxes on current foreign earnings in accordance with its change in position under ASC 740. To the extent necessary, the Company intends to utilize earnings of foreign subsidiaries generated after September 30, 2011, to support management’s plans to voluntarily accelerate its pay down of U.S. debt, fund distributions to shareholders, fund U.S. acquisitions and

 

F-66


satisfy ongoing U.S. operational cash flow requirements. As a result, earnings of the Company’s non-U.S. subsidiaries after September 30, 2011 are not considered to be permanently reinvested, except in jurisdictions where repatriation is either precluded or restricted by law. Accordingly, the Company is providing residual U.S. and foreign deferred taxes to these earnings to the extent they cannot be repatriated in a tax-free manner. As a result for the year ending September 30, 2012, Spectrum Brands recorded residual U.S. and foreign income and withholding taxes on approximately $97,638 of foreign earnings, causing an increase to income tax expense, net of a corresponding adjustment to Spectrum Brands’ domestic valuation allowance, of $3,278 (including $2,465 of expected tax on $76,475 of earnings not yet taxed in the U.S.). During Fiscal 2011, Spectrum Brands recorded residual U.S. and foreign taxes on approximately $39,391 of distributions of foreign earnings resulting in an increase of tax expense, net of a corresponding adjustment to Spectrum Brands’ domestic valuation allowance, of approximately $771. During Fiscal 2010, Spectrum Brands recorded residual U.S. and foreign taxes on approximately $26,600 of actual and deemed distributions of foreign earnings resulting in an increase in tax expense, net of a corresponding adjustment to Spectrum Brands domestic valuation allowance, of approximately $0. The Fiscal 2011 and Fiscal 2010 distributions were primarily non-cash deemed distributions under U.S. tax law.

Remaining undistributed earnings of Spectrum Brands’ foreign operations, which total approximately $415,713 at September 30, 2012, are intended to remain permanently invested. Accordingly, no residual income taxes have been provided on these earnings at September 30, 2012. If at some future date these earnings cease to be permanently invested, Spectrum Brands may be subject to U.S. income taxes and foreign withholding and other taxes on such amounts, which cannot be reasonably estimated at this time.

FGL

At September 30, 2012, FGL’s deferred tax assets were primarily the result of U.S. NOL, capital loss and tax credit carryforwards and insurance reserves. Its net deferred tax asset position at September 30, 2012 and 2011, before consideration of its recorded valuation allowance, totaled $457,144 and $583,035, respectively. A valuation allowance of $177,508 and $375,306 was recorded against its gross deferred tax asset balance at September 30, 2012 and 2011, respectively. FGL’s net deferred tax asset position at September 30, 2012 and 2011, after taking into account the valuation allowance, is $279,636 and $207,729, respectively. For the years ended September 30, 2012 and 2011, FGL recorded a net valuation allowance release of $197,798 (comprised of a full year valuation release of $204,736 related to the life insurance companies, partially offset by an increase to valuation allowance of $6,938 related to the non-life companies) and $30,064, respectively, based on management’s reassessment of the amount of its deferred tax assets that are more-likely-than-not realizable.

At September 30, 2012, FGL’s valuation allowance of $177,508 consisted of a partial valuation allowance of $145,854 on capital loss carryforwards and a full valuation allowance of $31,654 on non-life insurance net deferred taxes. At September 30, 2011, FGL’s valuation allowance of $375,306 consisted of a partial valuation allowance of $138,257 on capital loss carryforwards, a full valuation allowance of $24,716 on non-life insurance net deferred taxes and a partial valuation allowance of $212,333 on other net deferred taxes, including NOLs.

As a consequence of FGL’s acquisition, certain tax attributes (carry-forwards) became limited at the FGL Acquisition Date. In addition, FGL experienced cumulative losses during the three year period preceding its acquisition. These are among the factors the Company considered in establishing a valuation allowance against FGL’s deferred tax asset position at the FGL Acquisition Date.

At each reporting date, FGL management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets. As of September 30, 2012, management considered the following positive and negative evidence concerning the future realization of FGL’s deferred tax assets:

 

F-67


Positive Evidence:

 

   

FGL has three years of cumulative US GAAP pre-tax income;

 

   

FGL’s internal projections of taxable income estimated in future periods reflect a continuation of this trend;

 

   

FGL has projected that the reversal of taxable temporary timing differences will unwind in the twenty-year projection period;

 

   

FGL has refined tax planning strategies to utilize capital loss carryforwards by selling assets with acquisition date built-in gains;

 

   

FGL has a history of utilizing all significant tax attributes before they expire; and

 

   

FGL’s inventory of limited attributes has been significantly reduced as a result of a tax planning transaction that required amending certain tax returns.

Negative Evidence:

 

   

Tax rules limit the ability to use carryforwards in future years;

 

   

There is a brief carryback/carryforward period for life insurance company capital losses (i.e. 3-year carryback/ 5-year carryforward period.)

Based on its assessment of the evidence above, management determined that sufficient positive evidence exists as of September 30, 2012 to conclude that it is “more likely than not” that additional deferred taxes of FGL are more-likely-than-not realizable, and therefore, reduced the valuation allowance accordingly.

At September 30, 2012 and 2011, FGL has NOL carryforwards of $86,978 and $428,005, respectively, which, if unused, will expire in years 2026 through 2032. FGL has capital loss carryforwards totaling $551,897 and $717,267 at September 30, 2012 and 2011, respectively, which if unused, will expire in years 2013 through 2017. In addition, at September 30, 2012 and 2011, FGL has low income housing tax credit carryforwards totaling $52,780 and $68,099, respectively, which, if unused, will expire in years 2017 through 2032 and alternative minimum tax credits of $7,602 and $6,304, respectively, that may be carried forward indefinitely. Certain tax attributes are subject to an annual limitation as a result of the acquisition of FGL by the Company, which constitutes a change of ownership, as defined under IRC Section 382.

Uncertain Tax Positions

The total amount of unrecognized tax benefits (“UTBs”) at September 30, 2012 and 2011 are $5,877 and $9,013, respectively. If recognized in the future, the entire amount of UTBs would impact the effective tax rate. The Company records interest and penalties related to uncertain tax positions in income tax expense. At September 30, 2012 and 2011, the Company’s accrued balances of interest and penalties on uncertain tax positions totaled $3,564 and $4,682, respectively. For Fiscal 2012, 2011 and 2010, interest and penalties (decreased) increased income tax expense by $(1,184), $(1,422) and $1,527, respectively. In connection with the SB/RH Merger, Spectrum Brands recorded reserves for additional UTBs of approximately $3,299 as part of purchase accounting.

At September 30, 2012, filed income tax returns for certain of the Company’s legal entities in various jurisdictions are undergoing income tax audits. The Company cannot predict the ultimate outcome of these examinations. However, it is reasonably possible that during the next 12 months some portion of previously unrecognized tax benefits could be recognized.

The Company believes its income tax reserves for UTB’s are adequate, consistent with the principles of ASC Topic 740. The Company regularly assesses the likelihood of additional tax assessments by jurisdiction and, if necessary, adjusts its tax reserves based on new information or developments.

 

F-68


The following table summarizes changes to the Company’s UTB reserves, excluding related interest and penalties:

 

Unrecognized tax benefits at September 30, 2009

   $ 7,765   

Russell Hobbs acquired unrecognized tax benefits

     3,251   

HGI unrecognized tax benefits as of June 16, 2010

     732   

Gross decrease — tax positions in prior period

     (904

Gross increase — tax positions in current period

     3,390   

Lapse of statutes of limitations

     (1,060
  

 

 

 

Unrecognized tax benefits at September 30, 2010

   $ 13,174   

Gross increase — tax positions in prior period

     1,658   

Gross decrease — tax positions in prior period

     (823

Gross increase — tax positions in current period

     596   

Settlements

     (1,850

Lapse of statutes of limitations

     (3,742
  

 

 

 

Unrecognized tax benefits at September 30, 2011

   $ 9,013   

Gross increase — tax positions in prior period

     773   

Gross decrease — tax positions in prior period

     (1,308

Gross increase — tax positions in current period

     776   

Settlements

     (1,737

Lapse of statutes of limitations

     (1,640
  

 

 

 

Unrecognized tax benefits at September 30, 2012

   $ 5,877   
  

 

 

 

HGI files U.S. Federal consolidated and state and local combined and separate income tax returns. HGI’s consolidated and combined returns do not include Spectrum Brands or FGL (life insurance group), each of which files their own consolidated Federal, and combined and separate state and local income tax returns. HGI’s U.S. Federal income tax returns for years prior to and including 2010 are no longer subject to audit by the taxing authorities. With limited exception, HGI’s state and local income tax returns are no longer subject to audit for years prior to 2008.

Spectrum Brands files U.S. Federal consolidated and state and local combined and separate income tax returns as well as foreign income tax returns in various jurisdictions. They are subject to ongoing examination by various taxing authorities. Spectrum Brand’s major taxing jurisdictions are the United States, United Kingdom and Germany.

U.S. Federal income tax returns of Spectrum Brands and Russell Hobbs are no longer subject to audit for fiscal years prior to and including 2008. However, Federal NOL carryforwards from their fiscal years ended September 30, 2008 and June 30, 2008, respectively, will continue to be subject to Internal Revenue Service examination until the statute of limitations expires for the years in which these NOL carryforwards are ultimately utilized.

U.S. Federal income tax returns of FGL for years prior to 2008 are no longer subject to examination by the taxing authorities. With limited exception, FGL is no longer subject to state and local income tax audits for years prior to 2008. However, Federal NOL carryforwards from tax years ended June 30, 2006 and December 31, 2006, respectively, continue to be subject to Internal Revenue Service examination until the statute of limitations expires for the years in which these NOL carryforwards are ultimately utilized.

(18) Earnings Per Share

The Company follows the provisions of ASC Topic 260, “Earnings Per Share,” which requires companies with complex capital structures, such as having two (or more) classes of securities that participate in declared dividends to calculate earnings (loss) per share (“EPS”) utilizing the two-class method. As the holders of the

 

F-69


Preferred Stock are entitled to receive dividends with common stock on an as-converted basis, the Preferred Stock has the right to participate in undistributed earnings and must therefore be considered under the two-class method.

The following table sets forth the computation of basic and diluted EPS:

 

     September 30,  
     2012     2011     2010  

Income (loss) attributable to common and participating preferred stockholders:

      

Income (loss) from continuing operations

   $ 29,915      $ 22,226      $ (149,134

Loss from discontinued operations

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 29,915      $ 22,226      $ (151,869
  

 

 

   

 

 

   

 

 

 

Participating shares at end of period:

      

Common stock outstanding

     139,357        139,346        139,197   

Preferred stock (as-converted basis)

     62,839        60,989        —     
  

 

 

   

 

 

   

 

 

 

Total

     202,196        200,335        139,197   
  

 

 

   

 

 

   

 

 

 

Percentage of income (loss) allocated to:

      

Common stock

     68.9     69.6     100

Preferred stock

     31.1     30.4     —     

Income (loss) attributable to common shares — basic:

      

Income (loss) from continuing operations

   $ 20,618      $ 15,460      $ (149,134

Loss from discontinued operations

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 20,618      $ 15,460      $ (151,869
  

 

 

   

 

 

   

 

 

 

Dilutive adjustments to income (loss) attributable to common stock from assumed conversion of preferred stock, net of tax:

      

Income allocated to preferred stock in basic calculation

   $ —        $ 6,766      $ —     

Reversal of preferred stock dividends and accretion

     —          19,833        —     

Reversal of income related to fair value of preferred stock conversion feature

     —          (27,910     —     
  

 

 

   

 

 

   

 

 

 

Net adjustment

   $ —        $ (1,311   $ —     
  

 

 

   

 

 

   

 

 

 

Income (loss) attributable to common shares — diluted:

      

Income (loss) from continuing operations

   $ 20,618      $ 14,149      $ (149,134

Loss from discontinued operations

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 20,618      $ 14,149      $ (151,869
  

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding — basic

     139,356        139,233        132,399   

Dilutive effect of preferred stock

     —          19,064        —     

Dilutive effect of stock options

     81        87        —     

Dilutive effect of restricted stock and restricted stock units

     381        —          —     
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding — diluted

     139,818        158,384        132,399   
  

 

 

   

 

 

   

 

 

 

Basic income (loss) per common share attributable to controlling interest:

      

Continuing operations

   $ 0.15      $ 0.11      $ (1.13

Discontinued operations

     —          —          (0.02
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.15      $ 0.11      $ (1.15
  

 

 

   

 

 

   

 

 

 

Diluted income (loss) per common share attributable to controlling interest:

      

Continuing operations

   $ 0.15      $ 0.09      $ (1.13

Discontinued operations

     —          —          (0.02
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.15      $ 0.09      $ (1.15
  

 

 

   

 

 

   

 

 

 

 

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The number of shares of common stock outstanding used in calculating the weighted average thereof reflects: (i) for the period prior to the June 16, 2010 (the date of the SB/RH Merger), the number of shares of SBI common stock outstanding multiplied by the 1:1 Spectrum Brands share exchange ratio used in the SB/RH Merger and the 4.32 HGI share exchange ratio used in the Spectrum Brands Acquisition, (ii) for the period from June 16, 2010 to the January 7, 2011 (the date of the Spectrum Brands Acquisition), the number of HGI shares of common stock outstanding plus the 119,910 HGI shares of common stock subsequently issued in connection with the Spectrum Brands Acquisition and (iii) for the periods subsequent to and including January 7, 2011, the actual number of shares of HGI common stock outstanding, excluding unvested restricted stock.

At September 30, 2012, there were 62,839 shares issuable upon the conversion of the Preferred Stock that were excluded from the calculation of “Diluted net income (loss) per common share attributable to controlling interest” because the as-converted effect of the Preferred Stock would have been anti-dilutive for the year ended September 30, 2012. The Preferred Stock had a weighted average conversion price of $6.64.

(19) Commitments and Contingencies

The Company has aggregate reserves for its legal, environmental and regulatory matters of approximately $27,816 at September 30, 2012. These reserves relate primarily to the matters described below. However, based on currently available information, including legal defenses available to the Company, and given the aforementioned reserves and related insurance coverage, the Company does not believe that the outcome of these legal, environmental and regulatory matters will have a material effect on its financial position, results of operations or cash flows.

Legal and Environmental Matters

HGI

HGI is a nominal defendant, and the members of its board of directors are named as defendants, in a derivative action filed in December 2010 by Alan R. Kahn in the Delaware Court of Chancery. The plaintiff alleges that the Spectrum Brands Acquisition was financially unfair to HGI and its public stockholders and seeks unspecified damages and the rescission of the transaction. The Company believes the allegations are without merit and intends to vigorously defend this matter.

HGI is also involved in other litigation and claims incidental to its current and prior businesses. These include worker compensation and environmental matters and pending cases in Mississippi and Louisiana state courts and in a Federal multi-district litigation alleging injury from exposure to asbestos on offshore drilling rigs and shipping vessels formerly owned or operated by its offshore drilling and bulk-shipping affiliates. Based on currently available information, including legal defenses available to it, and given its reserves and related insurance coverage, the Company does not believe that the outcome of these legal and environmental matters will have a material effect on its financial position, results of operations or cash flows.

Spectrum Brands

Spectrum Brands has provided approximately $5,432 for the estimated costs associated with environmental remediation activities at some of its current and former manufacturing sites. Spectrum Brands believes that any additional liability which may result from resolution of these matters in excess of the amounts provided for will not have a material adverse effect on the financial position, results of operations or cash flows of Spectrum Brands.

Spectrum Brands is a defendant in various other matters of litigation generally arising out of the ordinary course of business.

 

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FGL

FGL is involved in various pending or threatened legal proceedings, including purported class actions, arising in the ordinary course of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. In the opinion of FGL management and in light of existing insurance and other potential indemnification, reinsurance and established reserves, such litigation is not expected to have a material adverse effect on FGL’s financial position, although it is possible that the results of operations and cash flows could be materially affected by an unfavorable outcome in any one annual period.

Regulatory Matters

FGL

FGL is assessed amounts by the state guaranty funds to cover losses to policyholders of insolvent or rehabilitated insurance companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. At September 30, 2012, FGL has accrued $5,909 for guaranty fund assessments which is expected to be offset by estimated future premium tax deductions of $4,213.

FGL has received inquiries from a number of state regulatory authorities regarding its use of the U.S. Social Security Administration’s Death Master File (“Death Master File”) and compliance with state claims practices regulation and unclaimed property and escheatment laws. To date, FGL has received inquiries from authorities in Maryland, Minnesota and New York. The New York Insurance Department issued a letter and subsequent regulation requiring life insurers doing business in New York to use the Death Master File or similar databases to determine if benefits were payable under life insurance policies, annuities, and retained asset accounts. Legislation requiring insurance companies to use the Death Master File to identify potential claims has recently been enacted in FGL’s state of domicile (Maryland) and other states. As a result of these legislative and regulatory developments, in May 2012 FGL undertook an initiative to use the Death Master File and other publicly available databases to identify persons potentially entitled to benefits under life insurance policies, annuities and retained asset accounts. During Fiscal 2012, FGL incurred an $11,000 benefit expense, net of reinsurance, to increase reserves to cover potential benefits payable resulting from this ongoing effort. Based on its analysis to date and management’s estimate, FGL believes its remaining accrual will cover the reasonably estimated liability arising out of these developments. Additional costs that cannot be reasonably estimated as of the date of this filing are possible as a result of ongoing regulatory developments and other future requirements related to this matter.

Guarantees

Throughout its history, the Company has entered into indemnifications in the ordinary course of business with customers, suppliers, service providers, business partners and, in certain instances, when it sold businesses. Additionally, the Company has indemnified its directors and officers who are, or were, serving at the request of the Company in such capacities. Although the specific terms or number of such arrangements is not precisely known due to the extensive history of past operations, costs incurred to settle claims related to these indemnifications have not been material to the Company’s financial statements. The Company has no reason to believe that future costs to settle claims related to its former operations will have a material impact on its financial position, results of operations or cash flows.

The First Amended and Restated Stock Purchase Agreement, dated February 17, 2011 (the “F&G Stock Purchase Agreement”) between HFG and OMGUK includes a Guarantee and Pledge Agreement which creates certain obligations for FGL as a grantor and also grants a security interest to OMGUK of FGL’s equity interest in FGL Insurance in the event that HFG fails to perform in accordance with the terms of the F&G Stock Purchase Agreement. The Company is not aware of any events or transactions that resulted in non-compliance with the Guarantee and Pledge Agreement.

 

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Shareholder Contingencies

The Master Fund has pledged all of its shares of the Company’s common stock, together with securities of other issuers to secure a certain portfolio financing, which as of the date hereof, constitutes a majority of the outstanding shares of the Company’s common stock. The sale or other disposition of a sufficient number of such shares (including any foreclosure on or sale of the Company’s shares pledged as collateral) to non-affiliates could cause the Company and its subsidiaries to experience a change of control, which may accelerate certain of the Company’s and its subsidiaries’ debt instruments and other obligations (including the 10.625% Notes and Preferred Stock) and/or allow certain counterparties to terminate their agreements. Any such sale or disposition may also cause the Company and its subsidiaries to be unable to utilize certain of their net operating loss and other tax carryforwards for income tax purposes.

Lease Commitments

The Company’s minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease. Future minimum rental commitments under non-cancelable operating leases, principally pertaining to land, buildings and equipment, principally relating to Spectrum Brands, are as follows:

 

      Future Minimum
Rental Commitments
 

Fiscal Year

      

2013

   $ 34,093   

2014

     29,156   

2015

     23,746   

2016

     23,023   

2017

     18,286   

Thereafter

     48,711   
  

 

 

 

Total minimum lease payments

   $ 177,015   
  

 

 

 

All of the leases expire between October 2012 and January 2023. The Company’s total rent expense was $36,925, $41,825 and $30,273 during Fiscal 2012, 2011 and 2010, respectively.

Unfunded Asset Based Lending Commitments

Through Salus, the Company enters into commitments to extend credit to meet the financing needs of its asset-based lending customers upon satisfaction of certain conditions. At September 30, 2012, the notional amount of unfunded, legally binding lending commitments was approximately $63,586, of which $14,744 expires in one year or less, and the remainder expires between one and three years.

(20) Reinsurance

FGL reinsures portions of its policy risks with other insurance companies. The use of reinsurance does not discharge an insurer from liability on the insurance ceded. The insurer is required to pay in full the amount of its insurance liability regardless of whether it is entitled to or able to receive payment from the reinsurer. The portion of risks exceeding FGL’s retention limit is reinsured with other insurers. FGL seeks reinsurance coverage in order to limit its exposure to mortality losses and enhance capital management. FGL follows reinsurance accounting when there is adequate risk transfer. Otherwise, the deposit method of accounting is followed. FGL also assumes policy risks from other insurance companies.

 

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The effect of reinsurance on premiums earned, benefits incurred and reserve changes for the year ended September 30, 2012 and 2011 were as follows:

 

     Year Ended September 30,  
     2012     2011  
     Net Premiums
Earned
    Net Benefits
Incurred and
Reserve Changes
    Net Premiums
Earned
    Net Benefits
Incurred and
Reserve Changes
 

Direct

   $ 297,964      $ 1,033,336      $ 157,772      $ 392,073   

Assumed

     47,179        34,940        22,858        19,571   

Ceded

     (289,846     (290,904     (141,628     (164,012
  

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 55,297      $ 777,372      $ 39,002      $ 247,632   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts payable or recoverable for reinsurance on paid and unpaid claims are not subject to periodic or maximum limits. During the years ended September 30, 2012 and 2011, FGL did not write off any reinsurance balances nor did it commute any ceded reinsurance.

No policies issued by FGL have been reinsured with a foreign company, which is controlled, either directly or indirectly, by a party not primarily engaged in the business of insurance.

FGL has not entered into any reinsurance agreements in which the reinsurer may unilaterally cancel any reinsurance for reasons other than non-payment of premiums or other similar credit issues.

FGL has the following significant reinsurance agreements as of September 30, 2012:

Reserve Facility

Pursuant to the F&G Stock Purchase Agreement, on April 7, 2011, FGL Insurance recaptured all of the life insurance business ceded to Old Mutual Reassurance (Ireland) Ltd. (“OM Re”), an affiliate of OMGUK. OM Re transferred assets with a fair value of $653,684 to FGL Insurance in settlement of all of OM Re’s obligations under these reinsurance agreements. The fair value of the transferred assets, which was based on the economic reserves, was approved by the Maryland Insurance Administration. No gain or loss was recognized in connection with the recapture. The fair value of the assets acquired and liabilities assumed is reflected in the FGL purchase price allocation. See Note 22 for additional details.

On April 7, 2011, FGL Insurance ceded to Raven Re, on a coinsurance basis, a significant portion of the business recaptured from OM Re. Raven Re was capitalized by a $250 capital contribution from FGL Insurance and a surplus note (i.e., subordinated debt) issued to OMGUK in the principal amount of $95,000 (see Note 12 for the terms of such note). The proceeds from the surplus note issuance and the surplus note are reflected in the FGL purchase price allocation. Raven Re financed $535,000 of statutory reserves for this business with a letter of credit facility provided by Nomura and guaranteed by OMGUK and HFG.

On April 7, 2011, FGL Insurance entered into a reimbursement agreement with Nomura to establish a reserve facility and Nomura charged an upfront structuring fee (the “Structuring Fee”). The Structuring Fee was in the amount of $13,750 and is related to the retrocession of the life business recaptured from OM Re and related credit facility. The Structuring Fee was deferred and was fully amortized as of September 30, 2011 as a result of the termination of the reserve facility in connection with FGL Insurance accelerating the effective date of the amended and restated Raven Springing Amendment which is described in the Wilton Agreement discussion below.

Wilton Agreement

On January 26, 2011, HFG entered into a commitment agreement (the “Commitment Agreement”) with Wilton Re U.S. Holdings, Inc. (“Wilton”) committing Wilton Re, a wholly-owned subsidiary of Wilton and a Minnesota insurance company, to enter into one of two amendments to an existing reinsurance agreement with FGL

 

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Insurance. On April 8, 2011, FGL Insurance ceded significantly all of the remaining life insurance business that it had retained to Wilton Re under the first of the two amendments with Wilton. FGL Insurance transferred assets with a fair value of $535,826, net of ceding commission, to Wilton Re. The Company considered the effects of the first amendment in the opening balance sheet and purchase price allocation as of FGL Acquisition Date. Effective April 26, 2011, HFG elected the second of the two amendments under the Commitment Agreement (the “Raven Springing Amendment”), which committed FGL Insurance to cede to Wilton Re all of the business (the “Raven Block”) then reinsured with Raven Re on or before December 31, 2012, subject to regulatory approval. The Raven Springing Amendment was intended to mitigate the risk associated with HFG’s obligation under the F&G Stock Purchase Agreement, by replacing the Raven Re reserve facility by December 31, 2012. On September 9, 2011, FGL Insurance and Wilton Re executed an amended and restated Raven Springing Amendment whereby the recapture of the business ceded to Raven Re by FGL Insurance and the re-cession to Wilton Re closed on October 17, 2011 with an effective date of October 1, 2011. In connection with the closing, FGL Insurance transferred assets with a fair value of $580,683, including ceding commission, to Wilton Re.

In September 2012, Wilton Re and FGL Insurance reached a final agreement on the initial settlements associated with the reinsurance transactions FGL Insurance entered into subsequent to the FGL Acquisition. The final settlement amounts did not result in any material adjustments to the amounts reflected in the financial statements. FGL Insurance recognized a net pre-tax gain of $18,029 on these reinsurance transaction which has been deferred and is being amortized over the remaining life of the underlying reinsured contracts.

Commissioners Annuity Reserve Valuation Method Facility (“CARVM”)

Effective September 30, 2008, FGL Insurance entered into a yearly renewable term quota share reinsurance agreement with OM Re, an affiliated company of OMGUK, FGL’s former parent, whereby OM Re assumed a portion of the risk that policyholders exercise the “waiver of surrender charge” features on certain deferred annuity policies. This agreement did not meet risk transfer requirements to qualify as reinsurance under US GAAP. Under the terms of the agreement, FGL expensed net fees of $4,004 and $1,809 for the years ended September 30, 2012 and 2011, respectively. Although this agreement did not provide reinsurance for reserves on a US GAAP basis, it did provide for reinsurance of reserves on a statutory basis. The statutory reserves were secured by a letter of credit with Old Mutual plc of London, England (“OM”), OMGUK’s parent.

Effective October 1, 2012, FGL Insurance recaptured the CARVM reinsurance agreement from OM Re and simultaneously ceded the business to Raven Re. The recapture of the OM Re CARVM reinsurance agreement satisfies FGL’s obligation under the F&G Stock Purchase Agreement to replace the letter of credit provided by OM no later than December 31, 2015. In connection with the new CARVM reinsurance agreement, FGL and Raven Re entered into an agreement with Nomura Bank International plc (“Nomura”) to establish a $295,000 reserve financing facility in the form of a letter of credit issued by Nomura and Nomura charged an upfront structuring fee in the amount of $2,800. The structuring fee was paid by FGL Insurance and will be deferred and amortized over the expected life of the facility.

(21) Insurance Subsidiary — Financial Information

The Company’s insurance subsidiaries file financial statements with state insurance regulatory authorities and the NAIC that are prepared in accordance with Statutory Accounting Principles (“SAP”) prescribed or permitted by such authorities, which may vary materially from US GAAP. Prescribed SAP includes the Accounting Practices and Procedures Manual of the NAIC as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with US GAAP are that statutory financial statements do not reflect VOBA and DAC, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contractholder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the US GAAP basis financial statements for comparable items.

 

F-75


For example, in accordance with the US GAAP acquisition method of accounting, the amortized cost of FGL’s invested assets was adjusted to fair value as of the FGL Acquisition Date while it was not adjusted for statutory reporting. Thus, the net unrealized gains on a statutory basis were $1,245,445 (unaudited) and $697,825 (unaudited) as of September 30, 2012 and 2011, respectively, compared to net unrealized gains of $1,058,447 and $418,210, respectively, on a US GAAP basis, as reported in Note 5.

The Company’s insurance subsidiaries’ statutory financial statements are based on a December 31 year end. The total statutory capital and surplus of FGL Insurance was $861,588 (unaudited) and $801,945 (unaudited) as of September 30, 2012 and 2011, respectively, and $846,434 and $902,118 as of December 31, 2011 and 2010, respectively. The total adjusted statutory capital of FGL Insurance was $901,371 (unaudited) and $830,225 (unaudited) at September 30, 2012 and 2011, respectively. FGL Insurance had statutory net income of $88,437 (unaudited) and $22,094 (unaudited) for the nine months ended September 30, 2012 and 2011, respectively, and $110,264 and $245,849 for the years ended December 31, 2011 and 2010, respectively.

Life insurance companies are subject to certain Risk-Based Capital (“RBC”) requirements as specified by the NAIC. The RBC is used to evaluate the adequacy of capital and surplus maintained by an insurance company in relation to risks associated with: (i) asset risk, (ii) insurance risk, (iii) interest rate risk and (iv) business risk. FGL monitors the RBC of its insurance subsidiaries. As of September 30, 2012 and 2011, each of FGL’s insurance subsidiaries had exceeded the minimum RBC requirements.

The Company’s insurance subsidiaries are restricted by state laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders, depositors or investors. Any dividends in excess of limits are deemed “extraordinary” and require approval. Based on statutory results as of December 31, 2011, in accordance with applicable dividend restrictions, the Company’s subsidiaries could pay “ordinary” dividends of $84,643 to FGL in 2012 less any dividends paid during the 12 month period from the last dividend payment. On September 26, 2012, FGL Insurance paid a dividend to FGL in the amount of $20,000 with respect to its 2011 results. On September 29, 2011 and December 22, 2011, FGL Insurance paid dividends to FGL in the amount of $20,000 and $20,000, respectively, with regard to its 2010 results. Based on its 2011 calendar year statutory results, FGL Insurance is able to declare an ordinary dividend up to $24,643 through September 29, 2012 (taking into account the dividend payments of $20,000 on September 29, 2011, December 22, 2011 and September 26, 2012), and $44,643 after September 29, 2012 through December 22, 2012 (taking into account the dividend payments of $20,000 on December 22, 2011 and $20,000 on September 26, 2012). In addition, between December 23 and December 31, 2012, FGL Insurance may be able to declare an additional ordinary dividend of $20,000 with respect to its 2011 statutory results (for an aggregate ordinary dividend of $64,643), subject to management’s discretion.

(22) Acquisitions

FGL in Fiscal 2011

On April 6, 2011, the Company acquired all of the outstanding shares of capital stock of FGL and certain intercompany loan agreements between the seller, as lender, and FGL, as borrower, for cash consideration of $350,000, which amount could be reduced by up to $50,000 post closing (as discussed further below). The Company incurred approximately $22,700 of expenses related to the FGL Acquisition, including $5,000 of the $350,000 cash purchase price which has been re-characterized as an expense since the seller made a $5,000 expense reimbursement to the Master Fund upon closing of the FGL Acquisition. Such expenses are included in “Selling, general and administrative expenses” in the Consolidated Statement of Operations for the year ended September 30, 2011. The FGL Acquisition continued HGI’s strategy of obtaining controlling equity stakes in subsidiaries that operate across a diversified set of industries.

 

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Net Assets Acquired

The acquisition of FGL has been accounted for under the acquisition method of accounting which requires the total purchase price to be allocated to the assets acquired and liabilities assumed based on their estimated fair values. The fair values assigned to the assets acquired and liabilities assumed are based on valuations using management’s best estimates and assumptions and were preliminary pending the completion of the valuation analysis of selected assets and liabilities. During the measurement period (which is not to exceed one year from the acquisition date), the Company is required to retrospectively adjust the provisional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets or liabilities as of that date. Effective April 1, 2012, the Company finalized such provisional amounts which were previously disclosed as of September 30, 2011.

The following table summarizes the provisional and final amounts recognized at fair value for each major class of assets acquired and liabilities assumed as of the FGL Acquisition Date:

 

     Provisional
Amounts
     Fiscal 2012
Measurement
Period
Adjustments
    Final Amounts  

Investments, cash and accrued investment income, including cash acquired of $1,040,470

   $ 17,705,419       $ —        $ 17,705,419   

Reinsurance recoverable

     929,817         15,246        945,063   

Intangible assets (VOBA)

     577,163         —          577,163   

Deferred tax assets

     256,584         (3,912     252,672   

Other assets

     72,801         —          72,801   
  

 

 

    

 

 

   

 

 

 

Total assets acquired

     19,541,784         11,334        19,553,118   
  

 

 

    

 

 

   

 

 

 

Contractholder funds and future policy benefits

     18,415,022         —          18,415,022   

Liability for policy and contract claims

     60,400         —          60,400   

Note payable

     95,000         —          95,000   

Other liabilities

     475,285         4,070        479,355   
  

 

 

    

 

 

   

 

 

 

Total liabilities assumed

     19,045,707         4,070        19,049,777   
  

 

 

    

 

 

   

 

 

 

Net assets acquired

     496,077         7,264        503,341   

Cash consideration, net of $5,000 re-characterized as expense

     345,000         —          345,000   
  

 

 

    

 

 

   

 

 

 

Bargain purchase gain

   $ 151,077       $ 7,264      $ 158,341   
  

 

 

    

 

 

   

 

 

 

The application of acquisition accounting resulted in a bargain purchase gain of $158,341, which is reflected in the Consolidated Statement of Operations for the year ended September 30, 2011. The amount of the bargain purchase gain is equal to the amount by which the fair value of net assets acquired exceeded the consideration transferred. The Company believes that the resulting bargain purchase gain is reasonable based on the following circumstances: (a) the seller was highly motivated to sell FGL, as it had publicly announced its intention to do so approximately a year prior to the sale, (b) the fair value of FGL’s investments and statutory capital increased between the date that the purchase price was initially negotiated and the FGL Acquisition Date, (c) as a further inducement to consummate the sale, the seller waived, among other requirements, any potential upward adjustment of the purchase price for an improvement in FGL’s statutory capital between the date of the initially negotiated purchase price and the FGL Acquisition Date and (d) an independent appraisal of FGL’s business indicated that its fair value was in excess of the purchase price.

Reinsurance Transactions

As discussed in Note 20, pursuant to the F&G Stock Purchase Agreement on April 7, 2011, FGL recaptured all of the life business ceded to OM Re. OM Re transferred assets with a fair value of $653,684 to FGL in settlement of all of OM Re’s obligations under these reinsurance agreements. Such amounts are reflected in FGL’s purchase

 

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price allocation. Further, on April 7, 2011, FGL ceded on a coinsurance basis a significant portion of this business to Raven Re. Certain transactions related to Raven Re such as the surplus note issued to OMGUK in the principal amount of $95,000, which was used to partially capitalize Raven Re and the Structuring Fee of $13,750 are also reflected in FGL’s purchase price allocation. Pursuant to the terms of the Raven Springing Amendment, the amount payable to Wilton at the closing of such amendment was adjusted to reflect the economic performance for the Raven Block from January 1, 2011 until the effective time of the closing of the Raven Springing Amendment. The estimated economic performance for the period from January 1, 2011 to April 6, 2011 was considered in the FGL’s opening balance sheet and purchase price allocation. Of the ongoing settlement adjustments resolved with Wilton Re, as discussed in Note 20, it was determined that $11,176, less $3,912 of deferred income taxes, related to the pre-acquisition period, and were reflected as measurement period adjustments to the initial purchase price allocation. Such adjustments have been retrospectively reflected in the accompanying consolidated financial statements as of and for the year ended September 30, 2011.

Contingent Purchase Price Reduction

As contemplated by the terms of the F&G Stock Purchase Agreement, Front Street Re, Ltd. (“Front Street”), a Bermuda-based reinsurer and wholly-owned subsidiary of the Company, sought to enter into a reinsurance agreement (the “Reinsurance Agreement”) with the Company whereby Front Street would reinsure up to $3,000,000 of insurance obligations under annuity contracts of FGL, and Harbinger Capital Partners II LP (“HCP II”), an affiliate of the Principal Stockholders, would be appointed the investment manager of up to $1,000,000 of assets securing Front Street’s reinsurance obligations under the Reinsurance Agreement. These assets would be deposited in a reinsurance trust account for the benefit of FGL.

The Reinsurance Agreement required the approval of the Maryland Insurance Administration (the “MIA”). The F&G Stock Purchase Agreement provides that the seller may be required to pay up to $50,000 as a post-closing reduction in purchase price if, among other things, the Reinsurance Agreement is not approved by the MIA or is approved subject to certain restrictions or conditions. FGL received written notice, dated January 10, 2012, from the MIA, rejecting the Reinsurance Agreement, as proposed by the respective parties. HGI is pursuing all available options to recover the full purchase price reduction, including the commencement of litigation against the seller; however, the outcome of any such action is subject to risk and uncertainty and there can be no assurance that any or all of the $50,000 purchase price reduction will be obtained by HGI.

Prior to the receipt of the written rejection notice from the MIA, management believed, based on the facts and circumstances at that time, that the likelihood was remote that the purchase price would be required to be reduced. Therefore a fair value of zero had been assigned to the contingent purchase price reduction as of the FGL Acquisition Date and at each subsequent quarterly remeasurement date through January 1, 2012. Management now believes that it is near certain that the purchase price will be required to be reduced by the full $50,000 amount and has estimated a fair value of $41,000 for the contingent receivable as of September 30, 2012, reflecting appropriate discounts for potential litigation and regulatory action, length of time until expected payment is received and a credit insurance risk premium. Such $41,000 estimated fair value of the contingent receivable has been reflected in “Receivables, net” in the Consolidated Balance Sheet as of September 30, 2012 with a corresponding credit to “Gain on contingent purchase price reduction” in the Consolidated Statement of Operations for the year ended September 30, 2012. Changes in the estimated fair value of the contingent consideration resulting from events after the acquisition date are accounted for in earnings upon each remeasurement date, until such time as the contingency is resolved.

Intangible Assets

VOBA represents the estimated fair value of the right to receive future net cash flows from in-force contracts in a life insurance company acquisition at the acquisition date. VOBA is being amortized over the expected life of the contracts in proportion to either gross premiums or gross profits, depending on the type of contract. Total gross profits include both actual experience as it arises and estimates of gross profits for future periods. FGL will regularly evaluate and adjust the VOBA balance with a corresponding charge or credit to earnings for the effects of actual gross profits and changes in assumptions regarding estimated future gross profits. The amortization of

 

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VOBA is reported in “Amortization of intangibles” in the Consolidated Statements of Operations. The proportion of the VOBA balance attributable to each of the product groups associated with this acquisition as of the FGL Acquisition Date is as follows: 80.4% related to FIA’s, and 19.6% related to deferred annuities.

Refer to Note 10 for FGL’s historical and estimated future amortization of VOBA, net of interest.

Deferred Taxes

The future tax effects of temporary differences between financial reporting and tax bases of assets and liabilities are measured at the balance sheet date and are recorded as deferred income tax assets and liabilities. The acquisition of FGL is considered a non-taxable acquisition under tax accounting criteria, therefore, the tax basis of assets and liabilities reflect an historical (carryover) basis at the FGL Acquisition Date. However, since assets and liabilities reported under US GAAP are adjusted to fair value as of the FGL Acquisition Date, the deferred tax assets and liabilities are also adjusted to reflect the effects of those fair value adjustments. This resulted in shifting FGL into a significant net deferred tax asset position at the FGL Acquisition Date, principally due to the write-off of DAC and the establishment of a significantly lesser amount of VOBA which resulted in reducing the associated deferred tax liabilities and thereby shifting FGL’s net deferred tax position. This shift, coupled with the application of certain tax limitation provisions that apply in the context of a change in ownership transaction, most notably Section 382 of the IRC, relating to “Limitation in Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change,” as well as other applicable provisions under Sections 381-384 of the IRC, require FGL to reconsider the realization of FGL’s gross deferred tax asset position and the need to establish a valuation allowance against it. Management determined that a valuation allowance against a portion of the gross deferred tax asset (“DTA”) was required as of FGL Acquisition Date.

The components of the net deferred tax assets as of the FGL Acquisition Date (updated for measurement period adjustments) are as follows:

 

Deferred tax assets:

  

DAC

   $ 96,764   

Insurance reserves and claim related adjustments

     401,659   

Net operating losses

     128,437   

Capital losses (carryovers and deferred)

     267,468   

Tax credits

     75,253   

Other deferred tax assets

     24,066   
  

 

 

 

Total deferred tax assets

     993,647   

Valuation allowance

     (405,370
  

 

 

 

Deferred tax assets, net of valuation allowance

     588,277   
  

 

 

 

Deferred tax liabilities:

  

VOBA

     202,007   

Investments

     121,160   

Other deferred tax liabilities

     12,438   
  

 

 

 

Total deferred tax liabilities

     335,605   
  

 

 

 

Net deferred tax assets

   $ 252,672   
  

 

 

 

 

F-79


Fiscal 2011 Results of FGL since the FGL Acquisition Date

The following table presents selected financial information reflecting results for FGL that are included in the Consolidated Statement of Operations for the year ended September 30, 2011:

 

     For the period
April 6, 2011 to
September 30, 2011
 

Total revenues

   $ 290,886   

Income, net of taxes

   $ 23,703   

Russell Hobbs in Fiscal 2010

On June 16, 2010, SBI merged with Russell Hobbs. Russell Hobbs is a designer, marketer and distributor of a broad range of branded small household appliances. Russell Hobbs markets and distributes small kitchen and home appliances, pet and pest products and personal care products. Russell Hobbs has a broad portfolio of recognized brand names, including Black & Decker, George Foreman, Russell Hobbs, Toastmaster, LitterMaid, Farberware, Breadman and Juiceman. Russell Hobbs’ customers include mass merchandisers, specialty retailers and appliance distributors primarily in North America, South America, Europe and Australia. The results of Russell Hobbs operations since June 16, 2010 are included in the accompanying Consolidated Statements of Operations for Fiscal 2010 and 2011.

In accordance with ASC Topic 805, Spectrum Brands accounted for the SB/RH Merger by applying the acquisition method of accounting. Inasmuch as Russell Hobbs was a private company and its common stock was not publicly traded, the closing market price of the SBI common stock at June 16, 2010 was used to calculate the purchase price. The total purchase price of Russell Hobbs was approximately $597,579 determined as follows:

 

SBI closing price per share on June 16, 2010

   $ 28.15   

Purchase price — Russell Hobbs allocation — 20,704 shares (a)(b)

     575,203   

Cash payment to pay off Russell Hobbs’ North American credit facility

     22,376   
  

 

 

 

Total purchase price of Russell Hobbs

   $ 597,579   
  

 

 

 

 

(a)

Number of shares calculated based upon conversion formula, as defined in the merger agreement, using balances as of June 16, 2010.

(b)

The fair value of 271 shares of unvested restricted stock units as they relate to post combination services will be recorded as operating expense over the remaining service period and were assumed to have no fair value for the purchase price.

 

F-80


Supplemental Pro Forma Information — Unaudited

The following table reflects the Company’s unaudited pro forma results for Fiscal 2011 and 2010 had the results of Russell Hobbs and FGL been included for each of the full year periods, as if the respective acquisitions were completed on October 1, 2009.

 

     Year Ended September 30,  
     2011 (a)      2010  

Revenues:

     

Reported revenues

   $ 3,477,782       $ 2,567,011   

FGL adjustment (b)

     685,767         953,911   

Russell Hobbs adjustment

     —           543,952   
  

 

 

    

 

 

 

Pro forma revenues

   $ 4,163,549       $ 4,064,874   
  

 

 

    

 

 

 

Income (loss) from continuing operations:

     

Reported income (loss) from continuing operations

   $ 7,379       $ (195,507

FGL adjustment (b)

     84,912         (206,441

Russell Hobbs adjustment

     —           (5,504
  

 

 

    

 

 

 

Pro forma income (loss) from continuing operations

   $ 92,291       $ (407,452
  

 

 

    

 

 

 

Income (loss) per common share attributable to controlling interest:

     

Reported basic income (loss) per common share from continuing operations

   $ 0.11       $ (1.13

FGL adjustment

     0.42         (1.56

Russell Hobbs adjustment

     —           (0.04
  

 

 

    

 

 

 

Pro forma basic income (loss) per common share from continuing operations

   $ 0.53       $ (2.73
  

 

 

    

 

 

 

Pro forma diluted income (loss) per common share from continuing operations

   $ 0.51       $ (2.73
  

 

 

    

 

 

 

 

(a)

Reported revenues and net income for Fiscal 2011 include the actual reported results of FGL for the approximate six month period subsequent to April 6, 2011. Reported net income also includes the $158,341 non-recurring bargain purchase gain which was recorded as of the FGL Acquisition Date, and reflects the retrospective measurement period adjustments disclosed above.

(b)

The pro forma information primarily reflects the following pro forma adjustments applied to FGL’s historical results:

 

   

Reduction in net investment income to reflect amortization of the premium on fixed maturity securities — available-for-sale resulting from the fair value adjustment of these assets;

 

   

Reversal of amortization associated with the elimination of FGL’s historical DAC;

 

   

Amortization of VOBA associated with the establishment of VOBA arising from the acquisition;

 

   

Adjustments to reflect the impacts of the recapture of the life business from OM Re and the retrocession of the majority of the recaptured business and the reinsurance of certain life business previously not reinsured to an unaffiliated third party reinsurer, including the amortization of the related $13,750 Structuring Fee;

 

   

Adjustments to eliminate interest expense on notes payable to seller and add interest expense on the new $95,000 surplus note payable (which was subsequently settled in October 2011);

 

   

Adjustments to reflect the full-period effect of interest expense on the initial $350,000 of 10.625% Notes issued on November 15, 2010, the proceeds of which were used to fund the FGL Acquisition; and

 

   

Reversal of the change in the deferred tax valuation allowance included in the income tax provision.

 

F-81


Other Acquisitions

During the years ended September 30, 2012 and 2011, Spectrum Brands completed the following acquisitions which were not considered significant individually or collectively:

Black Flag

On October 31, 2011, Spectrum Brands completed the $43,750 cash acquisition of the Black Flag and TAT trade names (“Black Flag”) from The Homax Group, Inc., a portfolio company of Olympus Partners. The Black Flag and TAT product lines consist of liquids, aerosols, baits and traps that control ants, spiders, wasps, bedbugs, fleas, flies, roaches, yellow jackets and other insects. In accordance with ASC Topic 805, Business Combinations (“ASC 805”), Spectrum Brands accounted for the acquisition by applying the acquisition method of accounting.

The results of Black Flag’s operations since October 31, 2011 are included in the accompanying Consolidated Statements of Operations. The purchase price of $43,750 has been allocated to the acquired net assets, including $25,000 of identifiable intangible assets, $15,852 of goodwill, $2,509 of inventories, and $389 of properties and other assets, based upon a preliminary valuation. Spectrum Brands’ estimates and assumptions for this acquisition are subject to change as Spectrum Brands obtains additional information for its estimates during the measurement period. The primary areas of the acquisition accounting that are not yet finalized relate to certain legal matters and residual goodwill.

FURminator

On December 22, 2011, Spectrum Brands completed the $141,745 cash acquisition of FURminator, Inc. (“FURminator”) from HKW Capital Partners III, L.P. FURminator is a leading worldwide provider of branded and patented pet deshedding products. In accordance with ASC 805, Spectrum Brands accounted for the acquisition by applying the acquisition method of accounting.

The results of FURminator operations since December 22, 2011 are included in the accompanying Consolidated Statements of Operations. The purchase price of $141,745 has been allocated to the acquired net assets, including $79,000 of identifiable intangible assets, $68,531 of goodwill, $9,240 of current assets, $648 of properties and $15,674 of current and long-term liabilities, based upon a preliminary valuation. Spectrum Brands’ estimates and assumptions for this acquisition are subject to change as Spectrum Brands obtains additional information for its estimates during the measurement period. The primary areas of the acquisition accounting that are not yet finalized relate to certain legal matters, income and non-income based taxes and residual goodwill.

Seed Resources

During Fiscal 2011, Spectrum Brands completed several business acquisitions which were not significant individually or collectively. The largest of these was the $10,524 cash acquisition of Seed Resources, LLC (“Seed Resources”) on December 3, 2010. Seed Resources is a wild seed cake producer through its Birdola premium brand seed cakes. The acquisition was accounted for under the acquisition method of accounting. The results of Seed Resources’ operations since December 3, 2010 are included in the accompanying Consolidated Statements of Operations. The purchase price of $12,500 (representing cash paid of $10,524 and contingent consideration accrued of $1,976) included $1,100 of trade name intangible assets and $10,029 of goodwill.

Acquisition and Integration Related Charges

Acquisition and integration related charges reflected in “Selling, general and administrative expenses” include, but are not limited to transaction costs such as banking, legal, accounting and other professional fees directly related to an acquisition or potential acquisition, termination and related costs for transitional and certain other employees, integration related professional fees and other post business combination related expenses.

 

F-82


The following table summarizes acquisition and integration related charges incurred by the Company:

 

     Year Ended September 30,  
     2012      2011      2010  

SB/RH Merger

        

Integration costs

   $ 10,168       $ 23,084       $ 3,777   

Employee termination charges

     3,900         8,105         9,713   

Legal and professional fees

     1,495         4,883         24,962   
  

 

 

    

 

 

    

 

 

 
     15,563         36,072         38,452   

FGL

     —           22,677         331   

Spectrum Brands

     —           1,129         4,284   

FURminator

     7,938         —           —     

BlackFlag

     3,379         —           —     

Other

     7,956         3,721         2,034   
  

 

 

    

 

 

    

 

 

 

Total acquisition and integration related charges

   $ 34,836       $ 63,599       $ 45,101   
  

 

 

    

 

 

    

 

 

 

(23) Restructuring and Related Charges

The Company reports restructuring and related charges associated with manufacturing and related initiatives of Spectrum Brands in “Cost of goods sold.” Restructuring and related charges reflected in “Cost of goods sold” include, but are not limited to, termination, compensation and related costs associated with manufacturing employees, asset impairments relating to manufacturing initiatives, and other costs directly related to the restructuring or integration initiatives implemented.

The Company reports restructuring and related charges relating to administrative functions of Spectrum Brands in “Selling, general and administrative expenses,” such as initiatives impacting sales, marketing, distribution, or other non-manufacturing functions. Restructuring and related charges reflected in “Selling, general and administrative expenses” include, but are not limited to, termination and related costs, any asset impairments relating to the functional areas described above, and other costs directly related to the initiatives.

In 2009, Spectrum Brands implemented a series of initiatives to reduce operating costs as well as evaluate Spectrum Brands’ opportunities to improve its capital structure (the “Global Cost Reduction Initiatives”). These initiatives included headcount reductions and the exit of certain facilities in the U.S. These initiatives also included consultation, legal and accounting fees related to the evaluation of Spectrum Brands’ capital structure.

The following table summarizes restructuring and related charges incurred by the Global Cost Reduction Initiatives, as well as other initiatives which were not significant in the periods presented below, and where those charges are classified in the accompanying Consolidated Statements of Operations:

Restructuring and Related Charges

 

    Year Ended September 30,     Charges
Since
Inception
    Expected
Future
Charges
    Total
Projected
Costs
    Expected Completion
Date
 

Initiatives:

  2012     2011     2010          

Global Cost Reduction

  $ 18,690      $ 25,484      $ 18,443      $ 83,018      $ 5,597      $ 88,615        January 31, 2015   

Other

    901        3,160        5,675           
 

 

 

   

 

 

   

 

 

         
  $ 19,591      $ 28,644      $ 24,118           
 

 

 

   

 

 

   

 

 

         

Classification:

                                         

Cost of goods sold

  $ 9,835      $ 7,841      $ 7,150           

Selling, general and administrative

    9,756        20,803        16,968           
 

 

 

   

 

 

   

 

 

         
  $ 19,591      $ 28,644      $ 24,118           
 

 

 

   

 

 

   

 

 

         

 

F-83


The following table summarizes restructuring and related charges incurred by type of charge and where those charges are classified in the accompanying Consolidated Statements of Operations:

 

     Year Ended September 30,  
     2012      2011      2010  

Costs included in cost of goods sold:

        

Global Cost Reduction Initiatives:

        

Termination benefits

   $ 2,941       $ 1,679       $ 2,630   

Other associated costs

     6,894         5,889         2,273   

Other restructuring initiatives:

        

Termination benefits

     —           —           201   

Other associated costs

     —           273         2,046   
  

 

 

    

 

 

    

 

 

 

Total included in cost of goods sold

     9,835         7,841         7,150   
  

 

 

    

 

 

    

 

 

 

Costs included in selling, general and administrative expenses:

        

Global Cost Reduction Initiatives:

        

Termination benefits

     3,079         10,155         4,268   

Other associated costs

     5,776         7,761         9,272   

Other restructuring initiatives:

        

Termination benefits

     —           956         5,269   

Other associated costs

     901         1,931         (1,841
  

 

 

    

 

 

    

 

 

 

Total included in selling, general and administrative expenses

     9,756         20,803         16,968   
  

 

 

    

 

 

    

 

 

 

Total restructuring and related charges

   $ 19,591       $ 28,644       $ 24,118   
  

 

 

    

 

 

    

 

 

 

The following table summarizes the remaining accrual balance associated with the initiatives and the activity during Fiscal 2012:

Remaining Accrual Balance

 

Initiatives

  Accrual Balance at
September 30, 2011
    Provisions     Cash
Expenditures
    Non-Cash
Items
    Accrual Balance at
September 30, 2012
    Expensed as
Incurred (a)
 

Global Cost Reduction Initiatives:

           

Termination benefits

  $ 8,795      $ 2,095      $ (7,765   $ 127      $ 3,252      $ 3,926   

Other costs

    3,021        (169     (1,353     (404     1,095        12,838   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    11,816        1,926        (9,118     (277     4,347        16,764   

Other initiatives

    4,371        (63     (2,094     11        2,225        964   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 16,187      $ 1,863      $ (11,212   $ (266   $ 6,572      $ 17,728   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

Consists of amounts not impacting the accrual for restructuring and related charges.

(24) Reorganization Items

Reorganization items expense represents expenses and losses that SBI identified as directly relating to its voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code in 2009 and consists of the following:

 

     Year Ended
September 30, 2010
 

Legal and professional fees

   $ 3,536   

Provision for rejected leases

     110   
  

 

 

 

Administrative related reorganization items

   $ 3,646   
  

 

 

 

 

F-84


The Company did not recognize any reorganization items in Fiscal 2012 and 2011.

(25) Discontinued Operations

On November 11, 2008, SBI’s board of directors approved the shutdown of its line of growing products, which included the manufacturing and marketing of fertilizers, enriched soils, mulch and grass seed. The decision to shut down the growing products line was made only after SBI was unable to successfully sell this business, in whole or in part. The shutdown of its line of growing products was completed during the second quarter of Fiscal 2009.

The presentation herein of the results of continuing operations excludes its line of growing products for all periods presented. The following amounts have been segregated from continuing operations and are reflected as discontinued operations:

 

    Year Ended
September 30, 2010
 

Net sales

  $ —     
 

 

 

 

Loss from discontinued operations before income taxes

  $ (2,512

Income tax expense

    223   
 

 

 

 

Loss from discontinued operations, net of tax

  $ (2,735
 

 

 

 

The Company did not record any income (loss) from discontinued operations in Fiscal 2012 and 2011.

(26) Related Party Transactions

During Fiscal 2012, Harbinger Capital Partners LLC (“Harbinger Capital”), an affiliate of the Company and the Principal Stockholders, provided the Company with certain advisory and consulting services and office space for certain of the Company’s employees and officers. The Company reimbursed Harbinger Capital for its out-of-pocket expenses and the cost of advisory and consulting services and office space provided to the Company by Harbinger Capital. In addition, on January 9, 2012, the Company hired certain former personnel of Harbinger Capital effective as of October 1, 2011. The Company reimbursed Harbinger Capital for employment and other costs associated with the above employees to the extent their services related to the Company from October 1, 2011 to the January 9, 2012. The Company has recognized $2,030 and $1,500 of expenses under these arrangements with respect to the years ended September 30, 2012 and 2011, respectively. Such amounts have been approved by a special committee of the Company’s board of directors, comprised solely of independent directors under the NYSE rules, which was advised by independent counsel. The Company believes that the amount of expenses recognized is reasonable; however, it does not necessarily represent the costs that would have been incurred by the Company on a stand-alone basis. There were no similar expenses recognized in the year ended September 30, 2010.

Subsequent to September 30, 2012, the Company and Harbinger Capital entered into a reciprocal services agreement (the “Services Agreement”) with respect to the provision of services to each other going forward. Pursuant to the Services Agreement, the parties each agreed to provide or cause to be provided services to each other, including their respective affiliates and subsidiaries. The services may include providing office space and operational support and each party making available their respective employees to provide services as reasonably requested by the other party, subject to any limitations contained in applicable employment agreements and the terms of the Services Agreement. Each party will pay the other party a service fee for the services provided and such service fee is intended to be the actual cost of the service without profit but including, as applicable, one-time costs, out-of pocket costs, costs of consents, fully loaded hourly rates and any pass through or allocation of payments. The Services Agreement provides that the parties are subject to confidentiality obligations and that the parties will indemnify each other and their related parties against certain costs and liabilities arising out of the

 

F-85


performance of the Services Agreement. The Services Agreement will continue in effect until terminated by either party, following thirty (30) days advance written notice. A special committee of the Company’s board of directors, comprised of independent directors under the rules of the New York Stock Exchange, advised by independent counsel, determined that it is in the best interests of the Company and its stockholders (other than Harbinger Capital and its affiliates) for the Company to enter into the Services Agreement and recommended to the Company’s board directors that they approve entry into the Services Agreement. Following such determination, the Company’s board of directors approved the Services Agreement.

On March 7, 2011, the Company entered into an agreement (the “Transfer Agreement”) with the Master Fund whereby on March 9, 2011, (i) the Company acquired from the Master Fund a 100% membership interest in HFG, which was the buyer under the F&G Stock Purchase Agreement, between HFG and OMGUK, pursuant to which HFG agreed to acquire all of the outstanding shares of capital stock of FGL and certain intercompany loan agreements between OM Group, as lender, and FGL, as borrower, and (ii) the Master Fund transferred to HFG the sole issued and outstanding Ordinary Share of FS Holdco Ltd, a Cayman Islands exempted limited company (“FS Holdco”) (together, the “Insurance Transaction”). In consideration for the interests in HFG and FS Holdco, the Company agreed to reimburse the Master Fund for certain expenses incurred by the Master Fund in connection with the Insurance Transaction (up to a maximum of $13,300) and to submit certain expenses of the Master Fund for reimbursement by OM Group under the F&G Stock Purchase Agreement. The Transfer Agreement and the transactions contemplated thereby, including the F&G Stock Purchase Agreement, was approved by the Company’s Board of Directors upon a determination by a special committee (the “FGL Special Committee”) comprised solely of directors who were independent under the rules of the NYSE and represented by independent counsel and other advisors, that it was in the best interests of the Company and its stockholders (other than the Master Fund and its affiliates) to enter into the Transfer Agreement and proceed with the Insurance Transaction. On April 6, 2011, the Company completed the FGL Acquisition.

FS Holdco is a holding company, which is the indirect parent company of Front Street. Neither HFG nor FS Holdco has engaged in any significant business other than transactions contemplated in connection with the Insurance Transaction.

On May 19, 2011, the FGL Special Committee unanimously determined that it is (i) in the best interests of the Company and its stockholders (other than Harbinger Capital and its affiliates) for Front Street and FGL, to enter into the Reinsurance Agreement, pursuant to which Front Street would reinsure up to $3,000,000 of insurance obligations under annuity contracts of FGL and (ii) in the best interests of the Company for Front Street and HCP II to enter into an investment management agreement (the “Investment Management Agreement”), pursuant to which HCP II would be appointed as the investment manager of up to $1,000,000 of assets securing Front Street’s reinsurance obligations under the Reinsurance Agreement, which assets would be deposited in a reinsurance trust account for the benefit of FGL pursuant to a trust agreement (the “Trust Agreement”). On May 19, 2011, the Company’s board of directors approved the Reinsurance Agreement, the Investment Management Agreement, the Trust Agreement and the transactions contemplated thereby. The FGL Special Committee’s consideration of the Reinsurance Agreement, the Trust Agreement, and the Investment Management Agreement was contemplated by the terms of the Transfer Agreement. In considering the foregoing matters, the FGL Special Committee was advised by independent counsel and received an independent third-party fairness opinion. As discussed further in Note 22, the Reinsurance Agreement required approval of the MIA, which ultimately was not received.

HFG’s pre-closing and closing obligations under the F&G Stock Purchase Agreement, including payment of the purchase price, were guaranteed by the Master Fund. Pursuant to the Transfer Agreement, the Company entered into a Guaranty Indemnity Agreement (the “Guaranty Indemnity”) with the Master Fund, pursuant to which the Company agreed to indemnify the Master Fund for any losses incurred by it or its representatives in connection with the Master Fund’s guaranty of HFG’s pre-closing and closing obligations under the Purchase Agreement.

 

F-86


On July 14, 2011, the Master Fund and Spectrum Brands entered into an equity underwriting agreement with Credit Suisse Securities (USA) LLC, as representative of the underwriters listed therein, with respect to the offering of 1,000 shares of Spectrum Brands common stock by Spectrum Brands and 5,495 shares of Spectrum Brands common stock by the Master Fund, at a price per share to the public of $28.00. HGI did not sell any shares of Spectrum Brands common stock in the offering. In connection with the offering, HGI entered into a 180-day lock up agreement. In addition, the Master Fund entered into a standstill agreement with HGI, pursuant to which the Master Fund agreed that it would not, among other things (a) either individually or as part of a group, acquire, offer to acquire, or agree to acquire any securities (or beneficial ownership thereof) of Spectrum Brands; (b) other than with respect to certain existing holdings, form, join or in any way participate in a group with respect to any securities of Spectrum Brands; (c) effect, seek, offer, propose or cause or participate in (i) any merger, consolidation, share exchange or business combination involving Spectrum Brands or any material portion of Spectrum Brands’ business, (ii) any purchase or sale of all or any substantial part of the assets of Spectrum Brands or any material portion of the Spectrum Brands’ business; (iii) any recapitalization, reorganization or other extraordinary transaction with respect to Spectrum Brands or any material portion of the Spectrum Brands’ business, or (iv) any representation on the board of directors of Spectrum Brands.

On September 10, 2010, the Company entered into the Exchange Agreement with the Principal Stockholders, whereby the Principal Stockholders agreed to contribute a majority interest in Spectrum Brands to the Company in the Spectrum Brands Acquisition in exchange for 4.32 shares of the Company’s common stock for each share of Spectrum Brands common stock contributed to the Company. The exchange ratio of 4.32 to 1.00 was based on the respective volume weighted average trading prices of the Company’s common stock ($6.33) and Spectrum Brands common stock ($27.36) on the NYSE for the 30 trading days from and including July 2, 2010 to and including August 13, 2010, the day the Company received the Principal Stockholders’ proposal for the Spectrum Brands Acquisition.

On September 10, 2010, a special committee of the Company’s board of directors advised by independent counsel and other advisors (the “Spectrum Special Committee”), consisting solely of directors who were determined by the Company’s board of directors to be independent under the NYSE rules, unanimously determined that the Exchange Agreement and the Spectrum Brands Acquisition, were advisable to, and in the best interests of, the Company and its stockholders (other than Harbinger Capital), approved the Exchange Agreement and the transactions contemplated thereby, and recommended that the Company’s board of directors approve the Exchange Agreement and the Company’s stockholders approve the issuance of the Company’s common stock pursuant to the Exchange Agreement. On September 10, 2010, the Company’s board of directors (based in part on the unanimous approval and recommendation of the Spectrum Special Committee) unanimously determined that the Exchange Agreement and the Spectrum Brands Acquisition were advisable to, and in the best interests of, the Company and its stockholders (other than Harbinger Capital), approved the Exchange Agreement and the transactions contemplated thereby, and recommended that the Company’s stockholders approve the issuance of its common stock pursuant to the Exchange Agreement.

On September 10, 2010, the Principal Stockholders, who held a majority of the Company’s outstanding common stock on that date, approved the issuance of the Company’s common stock pursuant to the Exchange Agreement by written consent in lieu of a meeting pursuant to Section 228 of the General Corporation Law of the State of Delaware.

On January 7, 2011, the Company completed the Spectrum Brands Acquisition pursuant to the Exchange Agreement entered into on September 10, 2010 with the Principal Stockholders. In connection therewith, the Company issued an aggregate of 119,910 shares of its common stock in exchange for an aggregate of 27,757 shares of common stock of Spectrum Brands (the “Spectrum Brands Contributed Shares”), or approximately 54.5% of the then outstanding Spectrum Brands common stock.

Upon the consummation of the Spectrum Brands Acquisition, the Company became a party to a registration rights agreement, by and among the Principal Stockholders, Spectrum Brands and the other parties listed therein,

 

F-87


pursuant to which the Company obtained certain demand and “piggy back” registration rights with respect to the shares of Spectrum Brands’ common stock held by the Company.

Following the consummation of the Spectrum Brands Acquisition, the Company also became a party to a stockholders agreement, by and among the Principal Stockholders and Spectrum Brands (the “SB Stockholder Agreement”). Under the SB Stockholder Agreement, the parties thereto have agreed to certain governance arrangements, transfer restrictions and certain other limitations with respect to Going Private Transactions (as such term is defined in the SB Stockholder Agreement).

The issuance of shares of the Company’s common stock to the Principal Stockholders pursuant to the Exchange Agreement and the acquisition by the Company of the Spectrum Brands Contributed Shares were not registered under the Securities Act. These shares are restricted securities under the Securities Act. The Company may not be able to sell the Spectrum Brands Contributed Shares and the Principal Stockholders may not be able to sell their shares of the Company’s common stock acquired pursuant to the Exchange Agreement except pursuant to: (i) an effective registration statement under the Securities Act covering the resale of those shares, (ii) Rule 144 under the Securities Act, which requires a specified holding period and limits the manner and volume of sales, or (iii) any other applicable exemption under the Securities Act.

 

F-88


(27) Segment and Geographic Data

Segment information for the periods presented is as follows:

 

     Year Ended September 30,  
     2012     2011     2010  

Revenues:

      

Consumer products

   $ 3,252,435      $ 3,186,916      $ 2,567,011   

Insurance

     1,221,724        290,866        —     

Other financial services

     8,694        —          —     

Intersegment elimination

     (2,137     —          —     
  

 

 

   

 

 

   

 

 

 

Consolidated revenues

   $ 4,480,716      $ 3,477,782      $ 2,567,011   
  

 

 

   

 

 

   

 

 

 

Depreciation and amortization:

      

Consumer products

   $ 133,780      $ 135,149      $ 117,418   

Insurance

     163,665        (9,430     —     

Other financial services

     55        —          —     
  

 

 

   

 

 

   

 

 

 

Total segments

     297,500        125,719        117,418   

Corporate depreciation and amortization

     2,020        207        53   
  

 

 

   

 

 

   

 

 

 

Consolidated depreciation and amortization

   $ 299,520      $ 125,926      $ 117,471   
  

 

 

   

 

 

   

 

 

 

Operating income (loss):

      

Consumer products

   $ 301,746      $ 227,944      $ 168,778   

Insurance

     163,783        (18,041     —     

Other financial services

     2,645        —          —     

Intersegment elimination

     (2,137     —          —     
  

 

 

   

 

 

   

 

 

 

Total segments

     466,037        209,903        168,778   

Corporate expenses (a)

     (56,546     (46,217     (8,324
  

 

 

   

 

 

   

 

 

 

Consolidated operating income

     409,491        163,686        160,454   

Interest expense

     (251,032     (249,260     (277,015

(Increase) decrease in fair value of equity conversion feature of preferred stock

     (156,600     27,910        —     

Bargain purchase gain from business acquisition

     —          158,341        —     

Gain on contingent purchase price reduction

     41,000        —          —     

Other expense, net

     (17,473     (42,743     (12,105

Reorganization items expense

     —          —          (3,646
  

 

 

   

 

 

   

 

 

 

Consolidated income (loss) from continuing operations before income taxes

   $ 25,386      $ 57,934      $ (132,312
  

 

 

   

 

 

   

 

 

 

Capital expenditures:

      

Consumer products

   $ 46,809      $ 36,160      $ 40,316   

Insurance

     6,209        1,745        —     

Other financial services

     474        —          —     
  

 

 

   

 

 

   

 

 

 

Total segments

     53,492        37,905        40,316   

Corporate capital expenditures

     26        345        58   
  

 

 

   

 

 

   

 

 

 

Consolidated capital expenditures

   $ 53,518      $ 38,250      $ 40,374   
  

 

 

   

 

 

   

 

 

 

 

F-89


     September 30,  
     2012     2011  

Total assets:

    

Consumer products

   $ 3,751,649      $ 3,626,706   

Insurance

     20,905,830        19,347,961   

Other financial services

     195,057        —     

Intersegment elimination

     (182,069     —     
  

 

 

   

 

 

 

Total segments

     24,670,467        22,974,667   

Corporate assets

     530,024        616,221   
  

 

 

   

 

 

 

Consolidated total assets

   $ 25,200,491      $ 23,590,888   
  

 

 

   

 

 

 

 

     September 30,  
     2012      2011  

Total long-lived assets (b):

     

Consumer products

   $ 2,690,222       $ 2,578,418   

Insurance

     280,434         460,694   

Other financial services

     449         —     
  

 

 

    

 

 

 

Total segments

     2,971,105         3,039,112   

Corporate long-lived assets

     15,412         19,952   
  

 

 

    

 

 

 

Consolidated long-lived assets

   $ 2,986,517       $ 3,059,064   
  

 

 

    

 

 

 

 

(a)

Included in corporate expenses are $3,770, $26,996 and $6,649 related to business acquisitions and other projects and $3,282, $4,359 and $212 related to Front Street for Fiscal 2012, 2011 and 2010, respectively.

(b)

Total long-lived assets include all non-current assets of the Consumer Products and Other section of the Consolidated Balance Sheet and properties (included in “Other assets”) and intangibles of the Insurance and Financial Services section.

The Company’s geographic data disclosures are as follows:

Net sales to external customers:

 

     Year Ended September 30,  
     2012      2011      2010  

United States

   $ 1,772,138       $ 1,780,127       $ 1,444,779   

Outside the United States

     1,480,297         1,406,789         1,122,232   
  

 

 

    

 

 

    

 

 

 

Consolidated net sales to external customers

   $ 3,252,435       $ 3,186,916       $ 2,567,011   
  

 

 

    

 

 

    

 

 

 

Long-lived assets:

 

     September 30,  
     2012      2011  

United States

   $ 2,284,927       $ 2,324,515   

Outside the United States

     701,590         734,549   
  

 

 

    

 

 

 

Consolidated long-lived assets

   $ 2,986,517       $ 3,059,064   
  

 

 

    

 

 

 

 

F-90


Venezuela Hyperinflation

Spectrum Brands does business in Venezuela through a Venezuelan subsidiary. At January 4, 2010, the beginning of the second quarter of Fiscal 2010, Spectrum Brands determined that Venezuela met the definition of a highly inflationary economy under US GAAP. As a result, beginning January 4, 2010, the U.S. dollar is the functional currency for Spectrum Brands’ Venezuelan subsidiary. Accordingly, subsequent to January 4, 2010, currency remeasurement adjustments for this subsidiary’s financial statements and other transactional foreign exchange gains and losses are reflected in earnings. Through January 3, 2010, prior to being designated as highly inflationary, translation adjustments related to the Venezuelan subsidiary were reflected as a component of AOCI.

In addition, on January 8, 2010, the Venezuelan government announced its intention to devalue its currency, the Bolivar fuerte, relative to the U.S. dollar. As a result, Spectrum Brands remeasured the local balance sheet of its Venezuela entity during the second quarter of Fiscal 2010 to reflect the impact of the devaluation to the official exchange rate of 4.3 Bolivian fuerte per U.S. dollar. Based on actual exchange activity as of September 30, 2010, Spectrum Brands determined that the most likely method of exchanging its Bolivar fuertes for U.S. dollars would be to formally apply with the Venezuelan government to exchange through commercial banks at the Transaction System for Foreign Currency Denominated Securities (“SITME”) rate specified by the Central Bank of Venezuela. The SITME rate as of September 30, 2010 was quoted at 5.3 Bolivar fuerte per U.S. dollar. Therefore, Spectrum Brands changed the rate used to remeasure Bolivar fuerte denominated transactions as of September 30, 2010 from the official exchange rate to the 5.3 SITME rate in accordance with ASC Topic 830, “Foreign Currency Matters,” (“ASC 830”) as it was the expected rate that exchanges of Bolivar fuerte to U.S. dollars would be settled.

The designation of the Spectrum Brands’ Venezuela entity as a highly inflationary economy and the devaluation of the Bolivar fuerte resulted in a $1,486 reduction to the Company’s operating income during Fiscal 2010. The Company also reported a foreign exchange loss in “Other expense, net” of $10,102 during Fiscal 2010.

As of September 30, 2011, Spectrum Brands is no longer exchanging its Bolivar Fuertes for U.S. dollars through the SITME mechanism and the SITME is no longer the most likely method of exchanging its Bolivar fuertes for U.S. dollars. Therefore, Spectrum Brands changed the rate used to remeasure Bolivar fuerte denominated transactions as of September 30, 2011 from the 5.3 SITME rate to the 4.3 official exchange rate in accordance with ASC 830 as it is the expected rate that exchanges of Bolivar fuerte to U.S. dollars will be settled. Spectrum Brands reported a foreign exchange gain in “Other expense, net” of $1,293 during Fiscal 2011 related to the change to the official exchange rate.

(28) Quarterly Results (Unaudited)

 

     Quarter Ended  
     September 30,
2012
     July 1,
2012
    April 1,
2012
    January 1,
2012
 

Net sales

   $ 832,576       $ 824,803      $ 746,285      $ 848,771   

Total revenues

     1,196,853         1,012,160        1,105,654        1,166,049   

Gross profit

     279,925         291,696        260,031        284,026   

Operating income (loss)

     120,364         81,403        95,893        111,831   

Net income (loss) attributable to common and participating preferred stockholders

     159,091         (149,080     (3,855     23,759   

Net income (loss) per common share attributable to controlling interest:

         

Basic

     0.79         (1.07     (0.02     0.12   

Diluted

     0.78         (1.07     (0.02     0.06   

 

F-91


     Quarter Ended  
     September 30,
2011
    July 3,
2011
    April 3,
2011
    January 2,
2011
 

Net sales

   $ 827,330      $ 804,635      $ 693,885      $ 861,066   

Total revenues

     888,541        1,034,290        693,885        861,066   

Gross profit

     280,496        293,694        255,439        299,238   

Operating income (loss)

     (43,953     120,516        22,429        64,694   

Net income (loss) attributable to common and participating preferred stockholders

     (107,095     211,341 (a)      (61,950     (20,070

Net income (loss) per common share attributable to controlling interest:

        

Basic

     (0.77     1.16 (a)      (0.45     (0.14

Diluted

     (0.77     1.16 (a)      (0.45     (0.14

 

(a)

The previously reported amounts of $204,077, or $1.12 per common share, have been retrospectively adjusted for a $7,264 increase in the bargain purchase gain from the FGL Acquisition resulting from adjustments made to finalize the purchase price allocation during the second quarter of Fiscal 2012 (see Note 22).

(29) Subsequent Events

ASC Topic 855, “Subsequent Events” (“ASC 855”), establishes general standards of accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 requires the Company to evaluate events that occur after the balance sheet date through the date the Company’s financial statements are issued and to determine whether adjustments to or additional disclosures in the financial statements are necessary. The Company has evaluated subsequent events through the date these financial statements were issued. The following are the significant events which occurred subsequent to September 30, 2012 but before these financial statements were issued:

Spectrum Brands’ Pending Acquisition of Stanley Black & Decker’s Hardware and Home Improvement Business

On October 8, 2012, Spectrum Brands entered into an agreement (the “HHI Acquisition Agreement”) with Stanley Black & Decker, Inc. (“Stanley Black and Decker”) to acquire the hardware and home improvement business (the “HHI Business”) currently operated by Stanley Black & Decker and certain of its subsidiaries for $1,400,000, consisting of (i) the equity interests of certain subsidiaries of Stanley Black & Decker engaged in the business and (ii) certain assets of Stanley Black & Decker used or held for use in connection with the business. The acquisition, when completed, includes (i) the purchase of shares and assets of certain subsidiaries of Stanley Black & Decker involved in the HHI Business and (ii) the purchase of certain assets of Tong Lung Metal Industry Co. Ltd., a Taiwan Corporation, which is involved in the production of residential locksets.

The HHI Acquisition Agreement contains certain termination rights for each of Stanley Black & Decker and Spectrum Brands that, upon termination of the HHI Acquisition Agreement under specified circumstances, could require Spectrum Brands to pay Stanley Black & Decker a termination fee of up to $78,000.

Spectrum Brands will account for the acquisition in accordance with ASC 805 which requires, among other things, that the assets acquired and liabilities assumed in a business combination be measured at their fair values as of the closing date of the acquisition.

Debt Commitments

On November 16, 2012, Spectrum Brands issued at par $520,000 aggregate principal amount of 6.375% Senior Notes due 2020 (the “2020 Notes”) and $570,000 aggregate principal amount of 6.625% Senior Notes due 2022 (the “2022 Notes” and together with the 2020 Notes, the “Notes”). Spectrum Brands will assume and unconditionally

 

F-92


guarantee, together with certain of its subsidiaries, the obligations under the Notes and intends to use the proceeds of the Notes to fund a portion of the Hardware Acquisition purchase price and related fees and expenses.

Additionally, Spectrum Brands has obtained debt financing commitments for approximately $1,840,000, inclusive of the Notes, to fund the Hardware Acquisition and refinance a portion of Spectrum Brands’ indebtedness outstanding as of September 30, 2012.

Spectrum Brands’ Shaser Acquisition

On November 8, 2012, Spectrum Brands completed a $50,000 cash acquisition of an approximately 56% interest in Shaser Biosciences, Inc. (“Shaser”), together with terms relating to a potential buyout of the remaining minority interest in Shaser. Spectrum Brands will account for the acquisition in accordance with ASC 805. Spectrum Brands is in the process of completing the preliminary purchase accounting.

HGI Joint Venture with EXCO Resources

On November 5, 2012, the Company announced a joint venture with EXCO Resources Inc. (“EXCO”) to create a private oil and gas limited partnership (the “Partnership”) that will purchase and operate EXCO’s producing U.S. conventional oil and gas assets, for a total consideration of $725,000.

Under the terms of the agreement, the Partnership will acquire oil and gas assets from EXCO for approximately $725,000 of total consideration, subject to customary closing adjustments. The purchase by the Partnership will be funded with approximately $225,000 of bank debt, $372,500 million in cash contributed from HGI and $127,500 in oil and gas properties and related assets being contributed by EXCO. In exchange for its cash investment, HGI will receive a 75% limited partner interest in the Partnership and a 50% member interest in the general partner of the Partnership (the “General Partner”). The General Partner will own a 2% interest in the Partnership, thus giving HGI directly and indirectly a net 74.5% total equity interest in the Partnership. In exchange for its asset contribution, EXCO will receive approximately $597,500 million in cash proceeds as well as a 25% limited partner interest in the Partnership and a 50% member interest in the General Partner, for a net 25.5% total equity interest in the Partnership. EXCO will provide services to the partnership with the operation of the partnership’s assets. The Partnership has been structured with incentive distribution rights to the General Partner intended to give EXCO upside and incentives to maintain efficient operations and grow cash flows for the benefit of all partners of the Partnership. In addition, HGI and EXCO will each own a 50% member interest in the General Partner and each will appoint two members of the General Partner’s board of directors.

The transaction, which has been approved by the Boards of Directors of Harbinger Group Inc. and EXCO Resources, Inc., is subject to customary closing conditions, including title and environmental reviews, receipt of applicable approvals and consents and receipt of bank debt at the Partnership in accordance with the terms of the purchase agreement. The transaction is expected to close in early 2013.

 

F-93


SCHEDULE I

HARBINGER GROUP INC. AND SUBSIDIARIES

Summary of Investments — Other than Investments in Related Parties

September 30, 2012

(In thousands)

 

     Amortized Cost  (a)      Fair Value      Amount at which
shown in the balance
sheet
 

Fixed maturities:

        

Bonds:

        

United States Government and government agencies and authorities

   $ 1,435,556       $ 1,466,488       $ 1,466,488   

States, municipalities and political subdivisions

     1,083,774         1,224,554         1,224,554   

Foreign governments

     672         815         815   

Public utilities

     2,166,720         2,400,804         2,400,804   

Convertibles and bonds with warrants attached

     —           —           —     

All other corporate bonds

     10,354,332         10,996,252         10,996,252   

Redeemable preferred stock

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total fixed maturities

     15,041,054         16,088,913         16,088,913   
  

 

 

    

 

 

    

 

 

 

Equity securities:

        

Common stocks:

        

Public utilities

     —           —           —     

Banks, trust, and insurance companies

     67,452         68,692         68,692   

Industrial, miscellaneous and all other

     —           —           —     

Nonredeemable preferred stock

     170,047         179,395         179,395   
  

 

 

    

 

 

    

 

 

 

Total equity securities

     237,499         248,087         248,087   
  

 

 

    

 

 

    

 

 

 

Derivative investments

     142,123         200,667         200,667   

Asset-backed loans

     180,054         180,054         180,054   

Policy loans

     11,758         11,758         11,758   

Other long-term investments

     7,056         7,056         7,056   
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 15,619,544       $ 16,736,535       $ 16,736,535   
  

 

 

    

 

 

    

 

 

 

 

(a)

Represents (i) original cost reduced by repayments and other-than-temporary impairments and adjusted for amortization of premiums and accrual of discounts for fixed maturity securities, (ii) original cost reduced by other-than-temporary impairments for equity securities, (iii) original cost for derivative investments, and (iv) unpaid principal balance reduced by an allowance for credit losses for asset-backed loans.

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-94


SCHEDULE II

Condensed Financial Information of the Registrant

HARBINGER GROUP INC. (Registrant Only)

BALANCE SHEETS

(In thousands)

 

     September 30,
2012
    September 30,
2011
 
ASSETS   

Cash and cash equivalents

   $ 235,783      $ 134,790   

Short-term investments

     33,986        74,889   

Prepaid expenses and other current assets

     6,433        1,678   
  

 

 

   

 

 

 

Total current assets

     276,202        211,357   

Investments in consolidated subsidiaries

     2,001,800        1,517,241   

Advances to consolidated subsidiaries

     9,434        58,773   

Properties, net

     302        410   

Deferred charges and other assets

     11,571        14,543   
  

 

 

   

 

 

 

Total assets

   $ 2,299,309      $ 1,802,324   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY   

Accounts payable

   $ 734      $ 366   

Accrued and other current liabilities

     61,701        33,844   
  

 

 

   

 

 

 

Total current liabilities

     62,435        34,210   

Long-term debt

     497,739        497,168   

Equity conversion feature of preferred stock

     231,950        75,350   

Employee benefit obligations

     5,119        6,055   

Deferred income taxes

     4,925        1,343   

Other liabilities

     319        320   
  

 

 

   

 

 

 

Total liabilities

     802,487        614,446   
  

 

 

   

 

 

 

Temporary equity:

    

Redeemable preferred stock

     319,225        292,437   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock

     1,402        1,393   

Additional paid-in capital

     861,191        872,683   

Accumulated deficit

     (98,168     (128,083

Accumulated other comprehensive income

     413,172        149,448   
  

 

 

   

 

 

 

Total stockholders’ equity

     1,177,597        895,441   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 2,299,309      $ 1,802,324   
  

 

 

   

 

 

 

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-95


SCHEDULE II

(continued)

 

HARBINGER GROUP INC. (Registrant Only)

STATEMENTS OF OPERATIONS

(In thousands)

 

     Year Ended
September 30,
    Period from
June 16, 2010 (a)
through
September 30,
2010
 
     2012     2011    

Revenues

   $ —        $ —        $ —     

Cost of revenues

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Gross profit

     —          —          —     

Operating expenses:

      

General and administrative

     48,377        13,883        1,438   

Acquisition related charges

     3,729        8,696        6,649   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     52,106        22,579        8,087   
  

 

 

   

 

 

   

 

 

 

Operating loss

     (52,106     (22,579     (8,087

Other income (expense):

      

Equity in net income (losses) of subsidiaries

     354,628        75,014        (55,772

Interest expense

     (56,565     (39,005     —     

(Increase) decrease in fair value of equity conversion feature of preferred stock

     (156,600     27,910        —     

Other, net

     190        723        195   
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     89,547        42,063        (63,664

Income tax (benefit) expense

     (9     4        6   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     89,556        42,059        (63,670

Less: Preferred stock dividends and accretion

     59,641        19,833        —     
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common and participating preferred stockholders

   $ 29,915      $ 22,226      $ (63,670
  

 

 

   

 

 

   

 

 

 

 

(a)

Date from which the registrant’s results of operations are included in the accompanying consolidated financial statements, as discussed further in Note 1 to the consolidated financial statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-96


SCHEDULE II

(continued)

 

HARBINGER GROUP INC. (Registrant Only)

STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended September 30,     Period from
June 16, 2010
through
September 30,
2010
 
     September 30, 2012     September 30, 2011    

Cash flows from operating activities:

      

Net income (loss)

   $ 89,556      $ 42,059      $ (63,670

Adjustments to reconcile net income (loss) to net cash used in operating activities:

      

Depreciation of properties

     133        91        19   

Stock-based compensation

     1,886        116        34   

Amortization of debt issuance costs

     2,856        1,770        —     

Amortization of debt discount

     571        613        —     

Deferred income taxes

     3,582        376        881   

Equity in net (income) losses of subsidiaries

     (354,628     (75,014     55,772   

Dividends from subsidiaries

     69,470        20,000        —     

Increase (decrease) in fair value of equity conversion feature of preferred stock

     156,600        (27,910     —     

Changes in operating assets and liabilities:

      

Prepaid expenses and other current assets

     (4,640     62        (561

Accounts payable and accrued and other current liabilities

     27,042        15,697        989   

Other operating

     (1,652     1,797        701   
  

 

 

   

 

 

   

 

 

 

Net cash used in operating activities

     (9,224     (20,343     (5,835
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Proceeds from investments sold, matured or repaid

     108,887        101,006        30,094   

Cost of investments acquired

     (67,983     (121,930     (3,989

Capital contributions to consolidated subsidiaries

     (36,330     (727,162     —     

Return of capital from subsidiary

     88,000        —          —     

(Advances to) repayments from consolidated subsidiaries

     49,339        (49,339     —     

Capital expenditures

     (26     (345     (58
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     141,887        (797,770     26,047   
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Dividends paid on preferred stock

     (31,670     —          —     

Proceeds from senior secured notes

     —          498,459        —     

Proceeds from preferred stock issuance, net of issuance costs

     —          385,973        —     

Debt issuance costs

     —          (16,207     —     

Other financing activities

     —          416     
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (31,670     868,641        —     
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     100,993        50,528        20,212   

Cash and cash equivalents at beginning of period

     134,790        84,262        64,050   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 235,783      $ 134,790      $ 84,262   
  

 

 

   

 

 

   

 

 

 

 

(a)

Date from which the registrant’s results of operations are included in the accompanying consolidated financial statements, as discussed further in Note 1 to the consolidated financial statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-97


SCHEDULE III

HARBINGER GROUP INC. AND SUBSIDIARIES

Supplementary Insurance Information

(In thousands)

 

     As of or for the year ended
September 30,
 
     2012     2011  

Life Insurance (single segment):

    

Deferred acquisition costs

   $ 169,223      $ 38,107   

Future policy benefits, losses, claims and loss expenses

     3,614,788        3,598,208   

Unearned premiums

     —          —     

Other policy claims and benefits payable

     91,082        56,650   

Premium revenue

     55,297        39,002   

Net investment income

     716,176        369,840   

Benefits, claims, losses and settlement expenses

     (777,372     (247,632

Amortization of deferred acquisition costs

     (15,219     (899

Other operating expenses

     (119,913     (72,390

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-98


SCHEDULE IV

HARBINGER GROUP INC. AND SUBSIDIARIES

Reinsurance

(Dollars in thousands)

 

For the year ended September 30, 2012

  Gross Amount     Ceded to other
companies
    Assumed from
other companies
    Net Amount     Percentage
of amount
assumed to net
 

Life insurance in force

  $ 2,436,312      $ (1,929,017   $ 22,812      $ 530,107        4.30

Premiums and other considerations:

         

Traditional life insurance premiums

  $ 297,964      $ (289,846   $ 47,179      $ 55,297        85.32

Annuity product charges

    117,881        (79,603     —          38,278        0.00
 

 

 

   

 

 

   

 

 

   

 

 

   

Total premiums and other considerations

  $ 415,845      $ (369,449   $ 47,179      $ 93,575        50.42
 

 

 

   

 

 

   

 

 

   

 

 

   

 

For the year ended September 30, 2011

  Gross Amount     Ceded to other
companies
    Assumed from
other companies
    Net Amount     Percentage
of amount
assumed to net
 

Life insurance in force

  $ 2,256,696      $ (1,180,412   $ 22,641      $ 1,098,925        2.06

Premiums and other considerations:

         

Traditional life insurance premiums

  $ 157,772      $ (141,628   $ 22,858      $ 39,002        58.61

Annuity product charges

    68,436        (18,776     —          49,660        0.00
 

 

 

   

 

 

   

 

 

   

 

 

   

Total premiums and other considerations

  $ 226,208      $ (160,404   $ 22,858      $ 88,662        25.78
 

 

 

   

 

 

   

 

 

   

 

 

   

See accompanying Report of Independent Registered Public Accounting Firm.

 

F-99


HARBINGER GROUP INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS OF CERTAIN SUBSIDIARIES INCLUDED PURSUANT TO

RULE 3-16 OF REGULATION S-X

 

1) Spectrum Brands Holdings, Inc. and Subsidiaries Consolidated Financial Statements

     S-2   

2) Harbinger F&G, LLC and Subsidiaries Consolidated Financial Statements

     S-56   

3) HGI Funding LLC Financial Statements

     S-106   

 

S-1


1.

SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Report of Independent Registered Public Accounting Firm

     S-3   

Consolidated Statements of Financial Position

     S-4   

Consolidated Statements of Operations

     S-5   

Consolidated Statements of Shareholders’ Equity (Deficit) and Comprehensive Income (Loss)

     S-6   

Consolidated Statements of Cash Flows

     S-7   

Notes to Consolidated Financial Statements

     S-8   

Schedule II — Valuation and Qualifying Accounts

     S-55   

 

S-2


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Spectrum Brands Holdings, Inc.:

We have audited the accompanying consolidated statements of financial position of Spectrum Brands Holdings, Inc. and subsidiaries (the Company) as of September 30, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity (deficit) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended September 30, 2012. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spectrum Brands Holdings, Inc. and subsidiaries as of September 30, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Milwaukee, Wisconsin

November 21, 2012

 

S-3


SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Position

September 30, 2012 and September 30, 2011

(In thousands, except per share amounts)

 

     2012     2011  
Assets     

Current assets:

    

Cash and cash equivalents

   $ 157,961      $ 142,414   

Receivables:

    

Trade accounts receivable, net of allowances of $21,870 and $14,128, respectively

     335,301        356,605   

Other

     38,116        37,678   

Inventories

     452,633        434,630   

Deferred income taxes

     28,143        28,170   

Prepaid expenses and other

     49,273        48,792   
  

 

 

   

 

 

 

Total current assets

     1,061,427        1,048,289   

Property, plant and equipment, net

     214,017        206,389   

Deferred charges and other

     27,711        36,824   

Goodwill

     694,245        610,338   

Intangible assets, net

     1,714,929        1,683,909   

Debt issuance costs

     39,320        40,957   
  

 

 

   

 

 

 

Total assets

   $ 3,751,649      $ 3,626,706   
  

 

 

   

 

 

 
Liabilities and Shareholders’ Equity     

Current liabilities:

    

Current maturities of long-term debt

   $ 16,414      $ 16,090   

Accounts payable

     325,023        323,171   

Accrued liabilities:

    

Wages and benefits

     82,119        70,945   

Income taxes payable

     30,272        31,606   

Accrued interest

     30,473        30,467   

Other

     126,330        134,633   
  

 

 

   

 

 

 

Total current liabilities

     610,631        606,912   

Long-term debt, net of current maturities

     1,652,886        1,535,522   

Employee benefit obligations, net of current portion

     89,994        83,802   

Deferred income taxes

     377,465        337,336   

Other

     31,578        44,637   
  

 

 

   

 

 

 

Total liabilities

     2,762,554        2,608,209   

Commitments and contingencies

    

Shareholders’ equity:

    

Common stock, $.01 par value, authorized 200,000 shares; issued 52,799 and 52,431 shares; outstanding 51,483 and 52,226 shares at September 30, 2012 and September 30, 2011, respectively

     528        525   

Additional paid-in capital

     1,399,261        1,374,097   

Accumulated deficit

     (340,647     (336,063

Accumulated other comprehensive loss

     (33,435     (14,446
  

 

 

   

 

 

 
     1,025,707        1,024,113   

Less treasury stock at cost, 1,316 and 205 shares, respectively

     (36,612     (5,616
  

 

 

   

 

 

 

Total shareholders’ equity

     989,095        1,018,497   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,751,649      $ 3,626,706   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

S-4


SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

Years ended September 30, 2012, 2011 and 2010

(In thousands, except per share amounts)

 

     2012      2011     2010  

Net sales

   $ 3,252,435       $ 3,186,916      $ 2,567,011   

Cost of goods sold

     2,126,922         2,050,208        1,638,451   

Restructuring and related charges

     9,835         7,841        7,150   
  

 

 

    

 

 

   

 

 

 

Gross profit

     1,115,678         1,128,867        921,410   

Operating expenses:

       

Selling

     521,191         536,535        466,813   

General and administrative

     218,832         241,631        199,386   

Research and development

     33,087         32,901        31,013   

Acquisition and integration related charges

     31,066         36,603        38,452   

Restructuring and related charges

     9,756         20,803        16,968   

Intangible asset impairment

     —           32,450        —     
  

 

 

    

 

 

   

 

 

 
     813,932         900,923        752,632   
  

 

 

    

 

 

   

 

 

 

Operating income

     301,746         227,944        168,778   

Interest expense

     191,911         208,329        277,015   

Other expense, net

     878         2,491        12,300   
  

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations before reorganization items and income taxes

     108,957         17,124        (120,537

Reorganization items expense, net

     —           —          3,646   
  

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     108,957         17,124        (124,183

Income tax expense

     60,385         92,295        63,189   
  

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations

     48,572         (75,171     (187,372

Loss from discontinued operations, net of tax

     —           —          (2,735
  

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 48,572       $ (75,171   $ (190,107
  

 

 

    

 

 

   

 

 

 

Basic net income (loss) per common share:

       

Income (loss) from continuing operations

   $ 0.94       $ (1.47   $ (5.20

Loss from discontinued operations

     —           —          (0.08
  

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 0.94       $ (1.47   $ (5.28
  

 

 

    

 

 

   

 

 

 

Weighted average shares of common stock outstanding

     51,608         51,092        36,000   

Diluted net income (loss) per common share:

       

Income (loss) from continuing operations

   $ 0.91       $ (1.47   $ (5.20

Loss from discontinued operations

     —           —          (0.08
  

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 0.91       $ (1.47   $ (5.28
  

 

 

    

 

 

   

 

 

 

Weighted average shares of common stock and common stock equivalents outstanding

     53,309         51,092        36,000   

Cash dividends declared per common share

     1.00         —          —     

See accompanying notes to consolidated financial statements.

 

S-5


SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity (Deficit) and Comprehensive Income (Loss)

Years ended September 30, 2012, 2011 and 2010

(In thousands)

 

     Common Stock      Additional
Paid-In

Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Income (Loss),

net of tax
    Treasury
Stock
    Total
Shareholders’
Equity

(Deficit)
 
     Shares     Amount             

Balances at September 30, 2009

     30,000      $ 300       $ 724,796      $ (70,785   $ 6,568      $ —        $ 660,879   

Net loss

     —          —           —          (190,107     —          —          (190,107

Adjustment of additional minimum pension liability

     —          —           —          —          (17,773     —          (17,773

Valuation allowance adjustment

     —          —           —          —          (2,398     —          (2,398

Translation adjustment

     —          —           —          —          12,596        —          12,596   

Other unrealized loss

     —          —           —          —          (6,490     —          (6,490
               

 

 

 

Comprehensive loss

                  (204,172

Issuance of common stock

     20,433        205         574,998        —          —          —          575,203   

Issuance of restricted stock

     939        9         (9     —          —          —          —     

Unvested restricted stock units, not issued or outstanding

     (271     —           —          —          —          —          —     

Treasury shares surrendered

     (81     —           —          —          —          (2,207     (2,207

Amortization of unearned compensation

     —          —           16,676        —          —          —          16,676   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2010

     51,020      $ 514       $ 1,316,461      $ (260,892   $ (7,497   $ (2,207   $ 1,046,379   

Net loss

     —          —           —          (75,171     —          —          (75,171

Adjustment of additional minimum pension liability

     —          —           —          —          (4,299     —          (4,299

Valuation allowance adjustment

     —          —           —          —          2,706        —          2,706   

Translation adjustment

     —          —           —          —          (10,115     —          (10,115

Other unrealized gains

     —          —           —          —          4,759        —          4,759   
               

 

 

 

Comprehensive loss

                  (82,120

Issuance of common stock

     1,150        11         29,840        —          —          —          29,851   

Vesting of restricted stock units

     180        —           —          —          —          —          —     

Treasury shares surrendered

     (124     —           —          —          —          (3,409     (3,409

Amortization of unearned compensation

     —          —           30,389        —          —          —          30,389   

Restricted stock units surrendered

     —          —           (2,593     —          —          —          (2,593
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

     52,226      $ 525       $ 1,374,097      $ (336,063   $ (14,446   $ (5,616   $ 1,018,497   

Net income

     —          —           —          48,572        —          —          48,572   

Adjustment of additional minimum pension liability

     —          —           —          —          (11,150     —          (11,150

Valuation allowance adjustment

     —          —           —          —          126        —          126   

Translation adjustment

     —          —           —          —          (8,602     —          (8,602

Other unrealized gains

     —          —           —          —          637        —          637   
               

 

 

 

Comprehensive income

                  29,583   

Vesting of restricted stock units

     368        3         (3     —          —          —          —     

Treasury stock purchases

     (1,111     —           —          —          —          (30,996     (30,996

Amortization of unearned compensation

     —          —           29,164        —          —          —          29,164   

Restricted stock units surrendered

     —          —           (3,997     —          —          —          (3,997

Dividend declared

     —          —           —          (53,156     —          —          (53,156
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

     51,483      $ 528       $ 1,399,261      $ (340,647   $ (33,435   $ (36,612   $ 989,095   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

S-6


SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended September 30, 2012, 2011 and 2010

(In thousands)

 

     2012     2011     2010  

Cash flows from operating activities:

      

Net income (loss)

   $ 48,572      $ (75,171   $ (190,107

Loss from discontinued operations, net of tax

     —          —          (2,735
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     48,572        (75,171     (187,372

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation

     40,950        47,065        54,822   

Amortization of intangibles

     63,666        57,695        45,920   

Amortization of unearned restricted stock compensation

     29,164        30,389        16,676   

Amortization of debt issuance costs

     9,922        13,198        9,030   

Intangible asset impairment

     —          32,450        —     

Administrative related reorganization items

     —          —          3,646   

Payments for administrative related reorganization items

     —          —          (47,173

Non-cash increase to cost of goods sold due to fresh-start reporting inventory valuation

     —          —          34,865   

Non-cash interest expense on 12% Notes

     —          —          24,555   

Write off of unamortized (premium) discount on retired debt

     (466     8,950        59,162   

Write off of debt issuance costs

     2,946        15,420        6,551   

Non-cash restructuring and related charges

     5,195        15,143        16,359   

Non-cash debt accretion

     722        4,773        18,302   

Changes in assets and liabilities:

      

Accounts receivable

     22,892        12,969        12,702   

Inventories

     (11,642     96,406        (66,127

Prepaid expenses and other current assets

     561        815        2,025   

Accounts payable and accrued liabilities

     1,424        (60,505     86,497   

Deferred taxes and other

     40,909        27,792        (21,881
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities of continuing operations

     254,815        227,389        68,559   

Net cash used by operating activities of discontinued operations

     —          —          (11,221
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     254,815        227,389        57,338   

Cash flows from investing activities:

      

Purchases of property, plant and equipment

     (46,809     (36,160     (40,316

Acquisition of Black Flag

     (43,750     —          —     

Acquisition of FURminator, net of cash acquired

     (139,390     —          —     

Acquisition of Seed Resources, net of cash acquired

     —          (11,053     —     

Proceeds from sale of assets held for sale

     —          6,997        —     

Other investing activity

     (1,545     (5,480     (2,189
  

 

 

   

 

 

   

 

 

 

Net cash used by investing activities

     (231,494     (45,696     (42,505

Cash flows from financing activities:

      

Proceeds from issuance of 6.75% Notes

     300,000        —          —     

Payment of 12% Notes, including tender and call premium

     (270,431     —          —     

Proceeds from issuance of 9.5% Notes, including premium

     217,000        —          —     

Proceeds from senior credit facilities, excluding ABL revolving credit facility, net of discount

     —          —          1,474,755   

Payment of senior credit facilities, excluding ABL revolving credit facility

     (155,061     (224,763     (1,278,760

Prepayment penalty of term loan facility

     —          (5,653     —     

Reduction of other debt

     (4,112     —          (8,456

Other debt financing, net

     392        5,788        13,688   

Debt issuance costs, net of refund

     (11,231     (12,616     (55,024

ABL revolving credit facility, net

     —          —          (33,225

Payments of supplemental loan

     —          —          (45,000

Cash dividends paid

     (51,450     —          —     

Treasury stock purchases

     (30,996     (3,409     (2,207

Net proceeds from equity offering

     —          29,851        —     

Other financing activities

     (953     —          —     
  

 

 

   

 

 

   

 

 

 

Net cash (used) provided by financing activities

     (6,842     (210,802     65,771   

Effect of exchange rate changes on cash and cash equivalents due to Venezuela hyperinflation

     —          —          (8,048

Effect of exchange rate changes on cash and cash equivalents

     (932     909        258   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     15,547        (28,200     72,814   

Cash and cash equivalents, beginning of period

     142,414        170,614        97,800   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 157,961      $ 142,414      $ 170,614   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

      

Cash paid for interest

   $ 185,384      $ 171,577      $ 136,429   

Cash paid for income taxes, net

     39,173        37,171        36,951   

See accompanying notes to consolidated financial statements.

 

S-7


SPECTRUM BRANDS HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(1) Description of Business

Spectrum Brands Holdings, Inc., a Delaware corporation (“SB Holdings”), is a diversified global branded consumer products company and was created in connection with the combination of Spectrum Brands, Inc. (“Spectrum Brands”), a global branded consumer products company and Russell Hobbs, Inc. (“Russell Hobbs”), a global branded small appliance company, to form a new combined company (the “Merger”). The Merger was consummated on June 16, 2010. As a result of the Merger, both Spectrum Brands and Russell Hobbs are wholly-owned subsidiaries of SB Holdings and Russell Hobbs is a wholly-owned subsidiary of Spectrum Brands. SB Holdings’ common stock trades on the New York Stock Exchange (the “NYSE”) under the symbol “SPB.”

Unless the context indicates otherwise, the term the “Company,” is used to refer to SB Holdings and its subsidiaries subsequent to the Merger and Spectrum Brands prior to the Merger.

The Company’s operations include the worldwide manufacturing and marketing of alkaline, zinc carbon and hearing aid batteries, as well as aquariums and aquatic health supplies and the designing and marketing of rechargeable batteries, battery-powered lighting products, electric shavers and accessories, grooming products and hair care appliances. The Company’s operations also include the manufacturing and marketing of specialty pet supplies. The Company also manufactures and markets herbicides, insecticides and insect repellents in North America. The Company also designs, markets and distributes a broad range of branded small appliances and personal care products. The Company’s operations utilize manufacturing and product development facilities located in the United States (“U.S.”), Europe, Latin America and Asia.

The Company sells its products in approximately 140 countries through a variety of trade channels, including retailers, wholesalers and distributors, hearing aid professionals, industrial distributors and original equipment manufacturers and enjoys name recognition in its markets under the Rayovac, VARTA and Remington brands, each of which has been in existence for more than 80 years, and under the Tetra, 8-in-1, Dingo, Nature’s Miracle, Spectracide, Cutter, Hot Shot, Black & Decker, George Foreman, Russell Hobbs, Farberware, Black Flag, FURminator and various other brands.

The Company’s global branded consumer products have positions in six major product categories: consumer batteries; small appliances; pet supplies; electric shaving and grooming; electric personal care; and home and garden controls. Effective October 1, 2010, the Company’s chief operating decision-maker manages the businesses of the Company in three vertically integrated, product-focused reporting segments: (i) Global Batteries & Appliances, which consists of the Company’s worldwide battery, electric shaving and grooming, electric personal care and small appliances primarily in the kitchen and home product categories (“Global Batteries & Appliances”); (ii) Global Pet Supplies, which consists of the Company’s worldwide pet supplies business (“Global Pet Supplies”); and (iii) Home and Garden Business, which consists of the Company’s home and garden and insect control business (the “Home and Garden Business”). The current reporting segment structure reflects the combination of the former Global Batteries & Personal Care segment (“Global Batteries & Personal Care”), which consisted of the worldwide battery, electric shaving and grooming and electric personal care products, with substantially all of the former Small Appliances segment (“Small Appliances”), which consisted of the Russell Hobbs business acquired on June 16, 2010, to form the Global Batteries & Appliances segment. In addition, certain pest control and pet products included in the former Small Appliances segment have been reclassified into the Home and Garden Business and Global Pet Supplies segments, respectively. Management reviews the performance of the Company based on these segments. The presentation of all historical segment data herein has been changed to conform to this segment reporting structure, which reflects the manner in which the Company’s management monitors performance and allocates resources. For information pertaining to our business segments, see Note 11, “Segment Information”.

 

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On October 8, 2012, the Company entered into an agreement with Stanley Black & Decker, Inc. (“Stanley Black & Decker”) to acquire the residential hardware and home improvement business (the “HHI Business”) currently operated by Stanley Black & Decker and certain of its subsidiaries for $1,400,000, consisting of (i) the equity interests of certain subsidiaries of Stanley Black & Decker engaged in the business and (ii) certain assets of Stanley Black & Decker used or held for use in connection with the business (the “Hardware Acquisition”). The Hardware Acquisition, when completed, will include the purchase of shares and assets of certain subsidiaries of Stanley Black & Decker involved in the HHI Business. Furthermore, the Hardware Acquisition, when completed, will also include the purchase of certain assets of Tong Lung Metal Industry Co. Ltd., a Taiwan Corporation (“TLM Taiwan”), which is involved in the production of residential locksets. For further information pertaining to this transaction, see Note 17, “Subsequent Events”.

(2) Significant Accounting Policies and Practices

(a) Principles of Consolidation and Fiscal Year End

The consolidated financial statements include the financial statements of Spectrum Brands Holdings, Inc. and its subsidiaries and are prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). All intercompany transactions have been eliminated. The Company’s fiscal year ends September 30. References herein to Fiscal 2012, 2011 and 2010 refer to the fiscal years ended September 30, 2012, 2011 and 2010, respectively.

(b) Revenue Recognition

The Company recognizes revenue from product sales generally upon delivery to the customer or the shipping point in situations where the customer picks up the product or where delivery terms so stipulate. This represents the point at which title and all risks and rewards of ownership of the product are passed, provided that: there are no uncertainties regarding customer acceptance; there is persuasive evidence that an arrangement exists; the price to the buyer is fixed or determinable; and collectibility is deemed reasonably assured. The Company is generally not obligated to allow for, and its general policy is not to accept, product returns for battery sales. The Company does accept returns in specific instances related to its shaving, grooming, personal care, home and garden, small appliances and pet products. The provision for customer returns is based on historical sales and returns and other relevant information. The Company estimates and accrues the cost of returns, which are treated as a reduction of Net sales.

The Company enters into various promotional arrangements, primarily with retail customers, including arrangements entitling such retailers to cash rebates from the Company based on the level of their purchases, which require the Company to estimate and accrue the estimated costs of the promotional programs. These costs are treated as a reduction of Net sales.

The Company also enters into promotional arrangements that target the ultimate consumer. The costs associated with such arrangements are treated as either a reduction of Net sales or an increase of Cost of goods sold, based on the type of promotional program. The income statement presentation of the Company’s promotional arrangements complies with Accounting Standards Codification (“ASC”) Topic 605: “Revenue Recognition.” For all types of promotional arrangements and programs, the Company monitors its commitments and uses various measures, including past experience, to determine amounts to be recorded for the estimate of the earned, but unpaid, promotional costs. The terms of the Company’s customer-related promotional arrangements and programs are tailored to each customer and are documented through written contracts, correspondence or other communications with the individual customers.

The Company also enters into various arrangements, primarily with retail customers, which require the Company to make upfront cash, or “slotting” payments, in order to secure the right to distribute through such customers. The Company capitalizes slotting payments; provided the payments are supported by a time or volume based arrangement with the retailer, and amortizes the associated payment over the appropriate time or volume based

 

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term of the arrangement. The amortization of slotting payments is treated as a reduction in Net sales and a corresponding asset is reported in Deferred charges and other in the accompanying Consolidated Statements of Financial Position.

(c) Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(d) Cash Equivalents

For purposes of the accompanying Consolidated Statements of Financial Position and Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.

(e) Concentrations of Credit Risk and Major Customers

Trade receivables subject the Company to credit risk. Trade accounts receivable are carried at net realizable value. The Company extends credit to its customers based upon an evaluation of the customer’s financial condition and credit history, but generally does not require collateral. The Company monitors its customers’ credit and financial condition based on changing economic conditions and will make adjustments to credit policies as required. Provisions for losses on uncollectible trade receivables are determined based on ongoing evaluations of the Company’s receivables, principally on the basis of historical collection experience and evaluations of the risks of nonpayment for a given customer.

The Company has a broad range of customers including many large retail outlet chains, one of which accounts for a significant percentage of its sales volume. This major customer represented approximately 23%, 24% and 22% of the Company’s Net sales during Fiscal 2012, Fiscal 2011 and Fiscal 2010. This major customer also represented approximately 13% and 16% of the Company’s Trade accounts receivable, net as of September 30, 2012 and September 30, 2011, respectively.

Approximately 46%, 44% and 44% of the Company’s Net sales during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, occurred outside of the United States. These sales and related receivables are subject to varying degrees of credit, currency, and political and economic risk. The Company monitors these risks and makes appropriate provisions for collectibility based on an assessment of the risks present.

(f) Displays and Fixtures

Temporary displays are generally disposable cardboard displays shipped to customers to facilitate display of the Company’s products. Temporary displays are generally disposed of after a single use by the customer.

Permanent fixtures are more permanent in nature, are generally made from wire or other longer-lived materials, and are shipped to customers for use in displaying the Company’s products. These permanent fixtures are restocked with the Company’s product multiple times over the fixture’s useful life.

The costs of both temporary and permanent displays are capitalized as a prepaid asset until shipped to the customer and are included in Prepaid expenses and other in the accompanying Consolidated Statements of Financial Position. The costs of temporary displays are expensed in the period in which they are shipped to customers and the costs of permanent fixtures are amortized over an estimated useful life of one to two years from the date they are shipped to customers and are reflected in Deferred charges and other in the accompanying Consolidated Statements of Financial Position.

 

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(g) Inventories

The Company’s inventories are valued at the lower of cost or net realizable value. Cost of inventories is determined using the first-in, first-out (FIFO) method.

(h) Property, Plant and Equipment

Property, plant and equipment are recorded at cost or at fair value if acquired in a purchase business combination. Depreciation on plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Depreciable lives by major classification are as follows:

 

Building and improvements

     20-40 years   

Machinery, equipment and other

     2-15 years   

Plant and equipment held under capital leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset and is included in depreciation expense.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

(i) Intangible Assets

Intangible assets are recorded at cost or at fair value if acquired in a purchase business combination. In connection with fresh-start reporting, Intangible Assets were recorded at their estimated fair value on August 30, 2009. Customer lists, proprietary technology and certain trade name intangibles are amortized, using the straight-line method, over their estimated useful lives of approximately 1 to 20 years. Excess of cost over fair value of net assets acquired (goodwill) and indefinite-lived intangible assets (certain trade name intangibles) are not amortized. Goodwill is tested for impairment at least annually, at the reporting unit level with such groupings being consistent with the Company’s reportable segments. If impairment is indicated, a write-down to fair value (normally measured by discounting estimated future cash flows) is recorded. Indefinite-lived trade name intangibles are tested for impairment at least annually by comparing the fair value, determined using a relief from royalty methodology, with the carrying value. Any excess of carrying value over fair value is recognized as an impairment loss in income from operations.

ASC Topic 350: “Intangibles-Goodwill and Other,” (“ASC 350”) requires that goodwill and indefinite-lived intangible assets be tested for impairment annually, or more often if an event or circumstance indicates that an impairment loss may have been incurred. The Company’s management uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel, and acts by governments and courts may signal that an asset has become impaired.

During Fiscal 2012, Fiscal 2011 and Fiscal 2010, the Company’s goodwill and trade name intangibles were tested for impairment as of the Company’s August financial period end, the Company’s annual testing date, as well as in certain interim periods where an event or circumstance occurred that indicated an impairment loss may have been incurred.

Intangibles with Indefinite Lives

In accordance with ASC 350, the Company conducts impairment testing on the Company’s goodwill. To determine fair value during Fiscal 2012, Fiscal 2011 and Fiscal 2010, the Company used the discounted estimated future cash flows methodology and third party valuations. Assumptions critical to the Company’s fair

 

S-11


value estimates under the discounted estimated future cash flows methodology are: (i) the present value factors used in determining the fair value of the reporting units and trade names; (ii) projected average revenue growth rates used in estimating future cash flows for the reporting unit; and (iii) projected long-term growth rates used in the derivation of terminal year values. These and other assumptions are impacted by economic conditions and expectations of management and will change in the future based on period specific facts and circumstances. The Company also tested the aggregate estimated fair value of its reporting units for reasonableness by comparison to the total market capitalization of the Company, which includes both its equity and debt securities.

In addition, in accordance with ASC 350, as part of the Company’s annual impairment testing, the Company tested its indefinite-lived trade name intangible assets for impairment by comparing the carrying amount of such trade names to their respective fair values. Fair value was determined using a relief from royalty methodology. Assumptions critical to the Company’s fair value estimates under the relief from royalty methodology were: (i) royalty rates, (ii) projected average revenue growth rates, and (iii) applicable discount rates.

In connection with the Company’s annual goodwill impairment testing performed during Fiscal 2012, Fiscal 2011 and Fiscal 2010 the first step of such testing indicated that the fair value of the Company’s reporting segments were in excess of their carrying amounts and, accordingly, no further testing of goodwill was required.

During Fiscal 2012, the Company concluded that the fair value of its intangible assets exceeded their carrying value. Additionally, during Fiscal 2012 the Company reclassified $3,450 of certain trade names from indefinite lived to definite lived. These trade names are being amortized over the remaining useful lives, which have been estimated to be 1-3 years.

A triggering event occurred in Fiscal 2011 which required the Company to test its indefinite-lived intangible assets for impairment between annual impairment dates. As more fully discussed above in Note 1, Description of Business, on October 1, 2010, the Company realigned its operating segments into three vertically integrated, product-focused reporting segments. The realignment of the Company’s operating segments constituted a triggering event for impairment testing. In connection with this interim test, the Company compared the fair value of its reporting segments to their carrying amounts both before and after the change in segment composition, and determined the fair values were in excess of their carrying amounts and, accordingly, no further testing of goodwill was required. The Company also tested the recoverability of its identified indefinite-lived intangibles in connection with the realignment of its operating segments and concluded that the fair values of these assets exceeded their carrying values.

In connection with its annual impairment testing of indefinite-lived intangible assets during Fiscal 2011, the Company concluded that the fair values of certain trade name intangible assets were less than the carrying amounts of those assets. As a result, during Fiscal 2011 the Company recorded a non-cash pretax intangible asset impairment charge of approximately $32,450 which was equal to the excess of the carrying amounts of the intangible assets over the fair value of such assets. This non-cash impairment of trade name intangible assets has been recorded as a separate component of Operating expenses. During Fiscal 2010 the Company concluded that the fair value of its intangible assets exceeded their carrying value.

The above impairment of trade name intangible assets was primarily attributed to lower current and forecasted profits, reflecting more conservative growth rates versus those originally assumed by the Company at the time of acquisition or upon adoption of fresh start reporting.

Intangibles with Definite or Estimable Useful Lives

The Company assesses the recoverability of intangible assets with definite or estimable useful lives whenever an event or circumstance occurs that indicates an impairment loss may have been incurred. The Company assesses the recoverability of these intangible assets by determining whether their carrying value can be recovered through projected undiscounted future cash flows. If projected undiscounted future cash flows indicate that the carrying value of the assets will not be recovered, an adjustment would be made to reduce the carrying value to an amount equal to estimated fair value determined based on projected future cash flows discounted at the

 

S-12


Company’s incremental borrowing rate. The cash flow projections used in estimating fair value are based on historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions.

Impairment reviews are conducted at the judgment of management when it believes that a change in circumstances in the business or external factors warrants a review. Circumstances such as the discontinuation of a product or product line, a sudden or consistent decline in the sales forecast for a product, changes in technology or in the way an asset is being used, a history of operating or cash flow losses, or an adverse change in legal factors or in the business climate, among others, may trigger an impairment review.

(j) Debt Issuance Costs

Debt issuance costs are capitalized and amortized to interest expense using the effective interest method over the lives of the related debt agreements.

(k) Accounts Payable

Included in accounts payable are book overdrafts, net of deposits on hand, on disbursement accounts that are replenished when checks are presented for payment.

(l) Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Accrued interest expense and penalties related to uncertain tax positions are recorded in Income tax expense.

(m) Foreign Currency Translation

Local currencies are considered the functional currencies for most of the Company’s operations outside the United States. Assets and liabilities of the Company’s foreign subsidiaries are translated at the rate of exchange existing at year-end, with revenues, expenses, and cash flows translated at the average of the monthly exchange rates. Adjustments resulting from translation of the financial statements are recorded as a component of Accumulated other comprehensive income (loss) (“AOCI”). Also included in AOCI are the effects of exchange rate changes on intercompany balances of a long-term nature.

As of September 30, 2012 and September 30, 2011, accumulated (losses) gains related to foreign currency translation adjustments of $(225) and $8,377, respectively, were reflected in the accompanying Consolidated Statements of Financial Position in AOCI.

Foreign currency transaction gains and losses related to assets and liabilities that are denominated in a currency other than the functional currency are reported in the Consolidated Statements of Operations in the period they occur. Exchange losses on foreign currency transactions aggregating $1,654, $3,370 and $13,336 for Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, are included in Other expense (income), net, in the accompanying Consolidated Statements of Operations.

 

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(n) Shipping and Handling Costs

The Company incurred shipping and handling costs of $198,152, $201,480 and $161,148 during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. Shipping and handling costs, which are included in Selling expenses in the accompanying Consolidated Statements of Operations, include costs incurred with third-party carriers to transport products to customers and salaries and overhead costs related to activities to prepare the Company’s products for shipment at the Company’s distribution facilities.

(o) Advertising Costs

The Company incurred advertising costs of $20,706, $30,673 and $37,520 during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. Such advertising costs are included in Selling expenses in the accompanying Consolidated Statements of Operations and include agency fees and other costs to create advertisements, as well as costs paid to third parties to print or broadcast the Company’s advertisements.

(p) Research and Development Costs

Research and development costs are charged to expense in the period they are incurred.

(q) Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares outstanding for the period. Basic net income (loss) per common share does not consider the effect of dilutive common stock equivalents. As long as their effect is not anti-dilutive, diluted net income (loss) per common share reflects the dilution that would occur if employee stock units and restricted stock awards were exercised or converted into common shares or resulted in the issuance of common shares that then shared in the net income (loss) of the entity. The computation of diluted net income (loss) per common share uses the “treasury stock” method to reflect dilution. The difference between the number of shares used in the calculations of basic and diluted net income (loss) per share is due to the effects of restricted stock and assumed conversion of employee stock unit awards.

Net income (loss) per common share is calculated based upon the following shares:

 

     Year Ended  
     September 30, 2012      September 30, 2011      September 30, 2010  

Basic

     51,608         51,092         36,000   

Effect of restricted stock

     1,701         —           —     
  

 

 

    

 

 

    

 

 

 

Diluted

     53,309         51,092         36,000   
  

 

 

    

 

 

    

 

 

 

During Fiscal 2011 and Fiscal 2010, the Company has not assumed the exercise of common stock equivalents as the impact would be antidilutive.

On June 16, 2010, the Company issued 20,433 shares of its common stock in conjunction with the Merger. Additionally, all shares of its wholly owned subsidiary Spectrum Brands, were converted to shares of SB Holdings on June 16, 2010. On July 20, 2011, the Company issued an additional 1,150 shares of its common stock. See also, Note 15, Acquisitions, for additional discussion of the Merger.

(r) Environmental Expenditures

Environmental expenditures that relate to current ongoing operations or to conditions caused by past operations are expensed or capitalized as appropriate. The Company determines its liability for environmental matters on a site-by-site basis and records a liability at the time when it is probable that a liability has been incurred and such liability can be reasonably estimated. The estimated liability is not reduced for possible recoveries from insurance carriers. Estimated environmental remediation expenditures are included in the determination of the net realizable value recorded for assets held for sale.

 

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(s) Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or accumulated deficit.

(t) Comprehensive Income

Comprehensive income includes foreign currency translation gains and losses on assets and liabilities of foreign subsidiaries, effects of exchange rate changes on intercompany balances of a long-term nature and transactions designated as a hedge of a net investment in a foreign subsidiary, deferred gains and losses on derivative financial instruments designated as cash flow hedges and additional minimum pension liabilities associated with the Company’s pension plans. Except for gains and losses resulting from exchange rate changes on intercompany balances of a long-term nature, and prior to September 30, 2011, the Company did not provide income taxes on currency translation adjustments, as earnings from international subsidiaries were considered to be permanently reinvested. As of the beginning of Fiscal 2012, the Company is no longer permanently reinvested on current and future earnings from international subsidiaries, except for locations precluded by certain restrictions from repatriating earnings.

The following is a roll forward of the amounts recorded in AOCI:

 

    Unrealized
Gains
(Losses)
    Adjustment of
minimum
pension
liability
    Translation
Adjustments
    Total  

Balance at September 30, 2009

  $ 851      $ (190   $ 5,907      $ 6,568   

Gross change before reclassification adjustment

    (15,621     (28,032     11,511        (32,142

Net reclassification adjustment for losses (gains) included in earnings

    6,356        1,355        —          7,711   
 

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

  $ (9,265   $ (26,677   $ 11,511      $ (24,431

Deferred tax effect

    2,775        8,904        1,085        12,764   

Deferred tax valuation allowance

    (116     (2,763     481        (2,398
 

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

  $ (6,606   $ (20,536   $ 13,077      $ (14,065
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2010

  $ (5,755   $ (20,726   $ 18,984      $ (7,497

Gross change before reclassification adjustment

    (5,992     (6,344     (12,857     (25,193

Net reclassification adjustment for losses (gains) included in earnings

    13,422        8        —          13,430   
 

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

  $ 7,430      $ (6,336   $ (12,857   $ (11,763

Deferred tax effect

    (2,671     2,037        2,742        2,108   

Deferred tax valuation allowance

    (331     3,529        (492     2,706   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

  $ 4,428      $ (770   $ (10,607   $ (6,949
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

  $ (1,327   $ (21,496   $ 8,377      $ (14,446

Gross change before reclassification adjustment

    (1,824     (15,682     (8,602     (26,108

Net reclassification adjustment for losses (gains) included in earnings

    3,097        900        —          3,997   
 

 

 

   

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

  $ 1,273      $ (14,782   $ (8,602   $ (22,111

Deferred tax effect

    (636     3,632        —          2,996   

Deferred tax valuation allowance

    908        (782     —          126   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

  $ 1,545      $ (11,932   $ (8,602   $ (18,989
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

  $ 218      $ (33,428   $ (225   $ (33,435
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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(u) Stock Compensation

The Company measures the cost of its stock-based compensation plans, which include restricted stock awards and restricted stock units, based on the fair value of its employee stock awards at the date of grant and recognizes these costs over the requisite service period of the awards.

In September 2009, SB Holdings’ board of directors (the “Board”) adopted the 2009 Spectrum Brands Inc. Incentive Plan (the “2009 Plan”). In conjunction with the Merger the 2009 Plan was assumed by SB Holdings. Prior to October 21, 2010, up to 3,333 shares of common stock, net of forfeitures and cancellations, could have been issued under the 2009 Plan. After October 21, 2010, no further awards may be made under the 2009 Plan.

In conjunction with the Merger, SB Holdings adopted the Spectrum Brands Holdings, Inc. 2007 Omnibus Equity Award Plan (formerly known as the Russell Hobbs Inc. 2007 Omnibus Equity Award Plan, as amended on June 24, 2008) (the “2007 RH Plan”). Prior to October 21, 2010, up to 600 shares of common stock, net of forfeitures and cancellations, could have been issued under the RH Plan. After October 21, 2010, no further awards may be made under the 2007 RH Plan.

On October 21, 2010, SB Holdings’ Board of Directors adopted the Spectrum Brands Holdings, Inc. 2011 Omnibus Equity Award Plan (the “2011 Plan”), which was approved at the Annual Meeting of Stockholders on March 1, 2011. Up to 4,626 shares of common stock of SB Holdings, net of cancellations, may be issued under the 2011 Plan.

Total stock compensation expense associated with restricted stock awards recognized by the Company during Fiscal 2012 was $29,164 or $18,956, net of taxes. The amounts before tax are included in General and administrative expenses in the accompanying Consolidated Statements of Operations, of which $131 or $85 net of taxes, related to the accelerated vesting of certain awards to terminated employees.

Total stock compensation expense associated with restricted stock units recognized by the Company during Fiscal 2011 was $30,389 or $19,753, net of taxes. The amounts before tax are included in General and administrative expenses in the accompanying Consolidated Statements of Operations, of which $467 or $304 net of taxes, related to the accelerated vesting of certain awards to terminated employees.

Total stock compensation expense associated with restricted stock awards recognized by the Company during Fiscal 2010 was $16,676 or $10,839, net of taxes. The amounts before tax are included in General and administrative expenses and Restructuring and related charges in the accompanying Consolidated Statements of Operations, of which $2,141 or $1,392 net of taxes, was included in Restructuring and related charges primarily related to the accelerated vesting of certain awards to terminated employees.

The Company granted approximately 863 restricted stock units during Fiscal 2012. Of these grants, 160 restricted stock units are time-based and vest over a period ranging from one year to two years. The remaining 703 restricted stock units are both performance and time-based and vest over a one year performance-based period followed by a one year time-based period. The total market value of the restricted stock units on the date of the grant was approximately $24,408.

The Company granted approximately 1,674 restricted stock units during Fiscal 2011. Of these grants, 93 restricted stock units are time-based and vest over a period ranging from one year to three years. The remaining 1,581 restricted stock units are both performance and time-based and vest as follows: (i) 699 stock units vest over a one year performance-based period followed by a one year time-based period and (ii) 882 stock units vest over a two year performance-based period followed by a one year time-based period. The total market value of the restricted stock units on the date of the grant was approximately $48,530.

 

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The fair value of restricted stock and restricted stock unit awards is determined based on the market price of the Company’s shares on the grant date. A summary of the Company’s restricted stock and restricted stock unit award activity for Fiscal 2012 and Fiscal 2011, and the non-vested awards outstanding as of September 30, 2012 is as follows:

 

Restricted Stock Awards

   Shares     Weighted
Average
Grant Date
Fair Value
     Fair Value
at Grant
Date
 

Restricted stock awards at September 30, 2010

     446      $ 23.56       $ 10,508   

Vested

     (323     23.32         (7,531
  

 

 

      

 

 

 

Restricted stock awards at September 30, 2011

     123      $ 24.20       $ 2,977   

Vested

     (110     23.75         (2,613
  

 

 

      

 

 

 

Restricted stock awards at September 30, 2012

     13      $ 28.00       $ 364   
  

 

 

      

 

 

 

 

Restricted Stock Units

   Shares     Weighted
Average
Grant Date
Fair Value
     Fair Value
at Grant
Date
 

Restricted stock units at September 30, 2010

     249      $ 28.22       $ 7,028   

Granted

     1,674        28.99         48,530   

Forfeited

     (43     29.47         (1,267

Vested

     (235     28.23         (6,635
  

 

 

      

 

 

 

Restricted stock units at September 30, 2011

     1,645      $ 28.97       $ 47,656   

Granted

     863        28.28         24,408   

Forfeited

     (57     28.49         (1,624

Vested

     (520     29.83         (15,509
  

 

 

      

 

 

 

Restricted stock units at September 30, 2012

     1,931      $ 28.45       $ 54,931   
  

 

 

      

 

 

 

(v) Restructuring and Related Charges

Restructuring charges are recognized and measured in accordance with the provisions of ASC Topic 420: “Exit or Disposal Cost Obligations,” (“ASC 420”). Under ASC 420, restructuring charges include, but are not limited to, termination and related costs consisting primarily of one-time termination benefits such as severance costs and retention bonuses, and contract termination costs consisting primarily of lease termination costs. Related charges, as defined by the Company, include, but are not limited to, other costs directly associated with exit and integration activities, including impairment of property and other assets, departmental costs of full-time incremental integration employees, and any other items related to the exit or integration activities. Costs for such activities are estimated by management after evaluating detailed analyses of the costs to be incurred. The Company presents restructuring and related charges on a combined basis. (See also Note 14, Restructuring and Related Charges, for a more complete discussion of restructuring initiatives and related costs).

(w) Acquisition and Integration Related Charges

Acquisition and integration related charges reflected in Operating expenses include, but are not limited to, transaction costs such as banking, legal, accounting and other professional fees directly related to both consummated acquisitions and acquisition targets, termination and related costs for transitional and certain other employees, integration related professional fees and other post business combination expenses associated with mergers and acquisitions.

 

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The following table summarizes acquisition and integration related charges incurred by the Company during Fiscal 2012, Fiscal 2011 and Fiscal 2010:

 

     2012      2011      2010  

Russell Hobbs

        

Integration costs

   $ 10,168       $ 23,084       $ 3,777   

Employee termination charges

     3,900         8,105         9,713   

Legal and professional fees

     1,495         4,883         24,962   
  

 

 

    

 

 

    

 

 

 

Merger related Acquisition and integration related charges

   $ 15,563       $ 36,072       $ 38,452   

FURminator

     7,938         —           —     

Black Flag

     3,379         —           —     

Other

     4,186         531         —     
  

 

 

    

 

 

    

 

 

 

Total Acquisition and integration related charges

   $ 31,066       $ 36,603       $ 38,452   
  

 

 

    

 

 

    

 

 

 

(3) Inventory

Inventories consist of the following:

 

     September 30,  
     2012      2011  

Raw materials

   $ 58,515       $ 59,928   

Work-in-process

     23,434         25,465   

Finished goods

     370,684         349,237   
  

 

 

    

 

 

 
   $ 452,633       $ 434,630   
  

 

 

    

 

 

 

(4) Property, Plant and Equipment

Property, plant and equipment consist of the following:

 

     September 30,  
     2012      2011  

Land, buildings and improvements

   $ 88,580       $ 101,303   

Machinery, equipment and other

     247,065         202,309   

Construction in progress

     18,366         10,134   
  

 

 

    

 

 

 
     354,011         313,746   

Less accumulated depreciation

     139,994         107,357   
  

 

 

    

 

 

 
   $ 214,017       $ 206,389   
  

 

 

    

 

 

 

 

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(5) Goodwill and Intangible Assets

Intangible assets consist of the following:

 

    Global Batteries
& Appliances
    Global Pet
Supplies
    Home and
Garden
Business
    Total  

Goodwill:

       

Balance at September 30, 2010

  $ 268,420      $ 159,985      $ 171,650      $ 600,055   

Additions

    —          10,029        255        10,284   

Effect of translation

    (272     271        —          (1
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

  $ 268,148      $ 170,285      $ 171,905      $ 610,338   

Additions

    —          70,023        15,852        85,875   

Effect of translation

    408        (2,376     —          (1,968
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

  $ 268,556      $ 237,932      $ 187,757      $ 694,245   
 

 

 

   

 

 

   

 

 

   

 

 

 

Intangible Assets:

       

Trade names Not Subject to Amortization

       

Balance at September 30, 2010

  $ 569,945      $ 211,533      $ 76,000      $ 857,478   

Additions

    —          2,630        150        2,780   

Intangible asset impairment

    (23,200     (8,600     (650     (32,450

Effect of translation

    (941     (72     —          (1,013
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

  $ 545,804      $ 205,491      $ 75,500      $ 826,795   

Additions

    —          14,000        8,000        22,000   

Reclassification to intangible assets subject to amortization

    (920     (2,530     —          (3,450

Effect of translation

    542        (4,819     —          (4,277
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

  $ 545,426      $ 212,142      $ 83,500      $ 841,068   
 

 

 

   

 

 

   

 

 

   

 

 

 

Intangible Assets Subject to Amortization

       

Balance at September 30, 2010, net

  $ 516,324      $ 230,248      $ 165,310      $ 911,882   

Additions

    —          4,193        —          4,193   

Amortization during period

    (33,184     (15,599     (8,912     (57,695

Effect of translation

    (1,667     401        —          (1,266
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011, net

  $ 481,473      $ 219,243      $ 156,398      $ 857,114   

Additions

    —          65,118        17,000        82,118   

Reclassification from intangible assets not subject to amortization

    920        2,530        —          3,450   

Amortization during period

    (32,892     (19,503     (11,271     (63,666

Effect of translation

    (2,389     (2,766     —          (5,155
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012, net

  $ 447,112      $ 264,622      $ 162,127      $ 873,861   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Intangible Assets, net at September 30, 2012

  $ 992,538      $ 476,764      $ 245,627      $ 1,714,929   
 

 

 

   

 

 

   

 

 

   

 

 

 

Intangible assets subject to amortization include proprietary technology, customer relationships and certain trade names, which were recognized in connection with acquisitions and from the application of fresh-start reporting. The useful life of the Company’s intangible assets subject to amortization are 4 to 9 years for technology assets related to the Global Pet Supplies segment, 9 to 17 years for technology assets associated with the Global Batteries & Appliances segment, 15 to 20 years for customer relationships of the Global Batteries & Appliances segment, 20 years for customer relationships of the Home and Garden Business and Global Pet Supplies segments, 1 to 12 years for trade names within the Global Batteries & Appliances segment and 3 years for trade names within the Global Pet Supplies segment.

 

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The carrying value and accumulated amortization for intangible assets subject to amortization are as follows:

 

     September 30,
2012
    September 30,
2011
 

Technology Assets Subject to Amortization:

    

Gross balance

   $ 90,924      $ 71,805   

Accumulated amortization

     (22,768     (13,635
  

 

 

   

 

 

 

Carrying value, net

   $ 68,156      $ 58,170   
  

 

 

   

 

 

 

Trade Names Subject to Amortization:

    

Gross balance

   $ 150,829      $ 149,700   

Accumulated amortization

     (28,347     (16,320
  

 

 

   

 

 

 

Carrying value, net

   $ 122,482      $ 133,380   
  

 

 

   

 

 

 

Customer Relationships Subject to Amortization:

    

Gross balance

   $ 796,235      $ 738,937   

Accumulated amortization

     (113,012     (73,373
  

 

 

   

 

 

 

Carrying value, net

   $ 683,223      $ 665,564   
  

 

 

   

 

 

 

Total Intangible Assets Subject to Amortization

   $ 873,861      $ 857,114   
  

 

 

   

 

 

 

ASC 350 requires companies to test goodwill and indefinite-lived intangible assets for impairment annually, or more often if an event or circumstance indicates that an impairment loss may have incurred. During Fiscal 2012, Fiscal 2011 and Fiscal 2010 the Company conducted impairment testing of goodwill and indefinite-lived intangible assets. As a result of this testing, the Company recorded non-cash pretax intangible asset impairment charges of approximately $32,450 during Fiscal 2011 related to impaired trade name intangible assets. (See also Note 2(i), Significant Accounting Policies—Intangible Assets, for further details on the impairment charges).

The amortization expense related to intangible assets subject to amortization for Fiscal 2012, Fiscal 2011 and Fiscal 2010 is as follows:

 

     2012      2011      2010  

Proprietary technology amortization

   $ 9,133       $ 6,817       $ 6,305   

Trade names amortization

     14,347         12,558         3,750   

Customer relationship amortization

     40,186         38,320         35,865   
  

 

 

    

 

 

    

 

 

 
   $ 63,666       $ 57,695       $ 45,920   
  

 

 

    

 

 

    

 

 

 

The Company estimates annual amortization expense for the next five fiscal years will approximate $63,600 per year.

 

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(6) Debt

Debt consists of the following:

 

     September 30, 2012     September 30, 2011  
     Amount      Rate     Amount     Rate  

Term Loan, U.S. Dollar, expiring June 17, 2016

   $ 370,175         5.1   $ 525,237        5.1

9.5% Notes, due June 15, 2018

     950,000         9.5     750,000        9.5

6.75% Notes, due March 15, 2020

     300,000         6.8     —          —     

12% Notes, due August 28, 2019

     —           —          245,031        12.0

ABL Facility, expiring May 3, 2016

     —           4.3     —          2.5

Other notes and obligations

     18,059         10.9     19,333        10.5

Capitalized lease obligations

     26,683         6.2     24,911        6.2
  

 

 

      

 

 

   
     1,664,917           1,564,512     

Original issuance premiums (discounts) on debt

     4,383           (12,900  

Less current maturities

     16,414           16,090     
  

 

 

      

 

 

   

Long-term debt

   $ 1,652,886         $ 1,535,522     
  

 

 

      

 

 

   

The Company’s aggregate scheduled maturities of debt and capital lease payments as of September 30, 2012 are as follows:

 

     Maturities of
Debt
 

2013

   $ 16,414   

2014

     13,164   

2015

     8,063   

2016

     361,222   

2017

     1,500   

Thereafter

     1,264,554   
  

 

 

 
   $ 1,664,917   
  

 

 

 

The Company’s aggregate capitalized lease obligations included in the amounts above are payable in installments of $3,097 in 2013, $3,153 in 2014, $2,513 in 2015, $1,866 in 2016, $1,500 in 2017 and $14,554 thereafter.

The Company has the following debt instruments outstanding at September 30, 2012: (i) a senior secured U.S. dollar term loan (the “Term Loan”) pursuant to a senior credit agreement (the “Senior Credit Agreement”); (ii) 9.5% secured notes (the “9.5% Notes”); (iii) 6.75% unsecured notes (the “6.75% Notes”); and (iv) a $300,000 asset based lending revolving credit facility (the “ABL Facility”) and, together with the Term Loan, the 9.5% Notes and the 6.75% Notes, (the “Senior Credit Facilities”).

The 9.5% Notes were issued by Spectrum Brands. SB/RH Holdings, LLC, a wholly-owned subsidiary of SB Holdings, and the wholly owned domestic subsidiaries of Spectrum Brands are the guarantors under the 9.5% Notes. SB Holdings is not an issuer or guarantor of the 9.5% Notes. SB Holdings is also not a borrower or guarantor under the Company’s Term Loan or the ABL Facility. Spectrum Brands is the borrower under the Term Loan and its wholly owned domestic subsidiaries along with SB/RH Holdings, LLC are the guarantors under that facility. Spectrum Brands and its wholly owned domestic subsidiaries are the borrowers under the ABL Facility and SB/RH Holdings, LLC is a guarantor of that facility.

Term Loan

On December 15, 2011 and June 14, 2012, the Company amended its Term Loan. As a result, the aggregate incremental amount by which the Company, subject to compliance with financial covenants and certain other

 

S-21


conditions, may increase the amount of the commitment under the Term Loan has been increased from $100,000 to $250,000. Certain covenants in respect to indebtedness, liens and interest coverage were also amended to provide for dollar limits more favorable to the Company and, subject to compliance with financial covenants and certain other conditions, to allow for the incurrence of incremental unsecured indebtedness.

On February 1, 2011, the Company completed the refinancing of its Term Loan, which was initially established in connection with the Merger and had an aggregate amount outstanding of $680,000 upon refinancing, with an amended and restated credit agreement. In connection with the refinancing, the Term Loan was issued at par with a maturity date of June 17, 2016. Subject to certain mandatory prepayment events, the Term Loan is subject to repayment according to a scheduled amortization, with the final payment of all amounts outstanding, plus accrued and unpaid interest, due at maturity. Among other things, the Term Loan provides for interest at a rate per annum equal to, at the Company’s option, the LIBO rate (adjusted for statutory reserves) subject to a 1.00% floor plus a margin equal to 4.00%, or an alternate base rate plus a margin equal to 3.00%.

The Term Loan contains financial covenants with respect to debt, including, but not limited to, a maximum leverage ratio and a minimum interest coverage ratio, which covenants, pursuant to their terms, become more restrictive over time. In addition, the Term Loan contains customary restrictive covenants, including, but not limited to, restrictions on the Company’s ability to incur additional indebtedness, create liens, make investments or specified payments, give guarantees, pay dividends, make capital expenditures and merge or acquire or sell assets. Pursuant to a guarantee and collateral agreement, the Company and its domestic subsidiaries have guaranteed the respective obligations under the Term Loan and related loan documents and have pledged substantially all of their respective assets to secure such obligations. The Term Loan also provides for customary events of default, including payment defaults and cross-defaults on other material indebtedness.

In connection with the amendments, the Company recorded $792 of fees in connection with the Term Loan during Fiscal 2012. The fees are classified as Debt issuance costs within the accompanying Consolidated Statements of Financial Position and are amortized as an adjustment to interest expense over the remaining life of the Term Loan. In connection with the amendments, the Company also recorded cash charges of $531 as an increase to interest expense during Fiscal 2012. In connection with voluntary prepayments of $150,000 of the Term Loan during Fiscal 2012, the Company recorded accelerated amortization of portions of the unamortized discount totaling $2,824 as an adjustment to increase interest expense.

The Company recorded $10,545 of fees in connection with the refinancing of the Term Loan during Fiscal 2011. The fees are classified as Debt issuance costs within the accompanying Consolidated Statements of Financial Position and are amortized as an adjustment to interest expense over the remaining life of the Term Loan. In connection with the refinancing, included in Fiscal 2011 Interest expense are cash charges of $4,954 and accelerated amortization of portions of the unamortized discount and unamortized Debt issuance costs totaling $24,370. In connection with voluntary prepayments of $220,000 of the Term Loan during Fiscal 2011, the Company recorded cash charges of $700 and accelerated amortization of portions of the unamortized discount and unamortized Debt issuance costs totaling $7,521 as an adjustment to increase interest expense.

9.5% Notes

On November 2, 2011, the Company offered $200,000 aggregate principal amount of 9.5% Notes at a price of 108.5% of the par value; these notes are in addition to the $750,000 aggregate principal amount of 9.5% Notes that were already outstanding. The additional notes are guaranteed by SB/RH Holdings, LLC, as well as by existing and future domestic restricted subsidiaries and secured by liens on substantially all of the Company’s and the guarantors’ assets. The additional notes will vote together with the existing 9.5% Notes.

The Company may redeem all or a part of the 9.5% Notes, upon not less than 30 or more than 60 days notice, at specified redemption prices. Further, the indenture governing the 9.5% Notes (the “2018 Indenture”) requires the Company to make an offer, in cash, to repurchase all or a portion of the applicable outstanding notes for a

 

S-22


specified redemption price, including a redemption premium, upon the occurrence of a change of control of the Company, as defined in such indenture.

The 2018 Indenture contains customary covenants that limit, among other things, the incurrence of additional indebtedness, payment of dividends on or redemption or repurchase of equity interests, the making of certain investments, expansion into unrelated businesses, creation of liens on assets, merger or consolidation with another company, transfer or sale of all or substantially all assets, and transactions with affiliates.

In addition, the 2018 Indenture provides for customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to make payments on or acceleration of certain other indebtedness, and certain events of bankruptcy and insolvency. Events of default under the 2018 Indenture arising from certain events of bankruptcy or insolvency will automatically cause the acceleration of the amounts due under the 9.5% Notes. If any other event of default under the 2018 Indenture occurs and is continuing, the trustee for the 2018 Indenture or the registered holders of at least 25% in the then aggregate outstanding principal amount of the 9.5% Notes may declare the acceleration of the amounts due under those notes.

The 9.5% Notes offered in Fiscal 2010 were issued at a 1.37% discount and were recorded net of the $10,245 amount incurred. The discount is reflected as an adjustment to the carrying value of principal, and is being amortized with a corresponding charge to interest expense over the remaining life of the 9.5% Notes. During Fiscal 2012 and Fiscal 2010, the Company recorded $3,581 and $20,823, respectively, of fees in connection with the issuance of the 9.5% Notes. The fees are classified as Debt issuance costs within the accompanying Consolidated Statements of Financial Position and are amortized as an adjustment to interest expense over the remaining life of the 9.5% Notes.

6.75% Notes

On March 15, 2012, the Company offered $300,000 aggregate principal amount of 6.75% Notes at a price of 100% of the par value. The 6.75% Notes are unsecured and guaranteed by SB/RH Holdings, LLC, as well as by existing and future domestic restricted subsidiaries.

The Company may redeem all or a part of the 6.75% Notes, upon not less than 30 or more than 60 days notice, at specified redemption prices. Further, the indenture governing the 6.75% Notes (the “2020 Indenture”) requires the Company to make an offer, in cash, to repurchase all or a portion of the applicable outstanding notes for a specified redemption price, including a redemption premium, upon the occurrence of a change of control of the Company, as defined in such indenture.

In addition, the 2020 Indenture contains customary covenants that limit, among other things, the incurrence of additional indebtedness, payment of dividends on or redemption or repurchase of equity interests, the making of certain investments, expansion into unrelated businesses, creation of liens on assets, merger or consolidation with another company, transfer or sale of all or substantially all assets, and transactions with affiliates.

In addition, the 2020 Indenture provides for customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to make payments when due or on acceleration of certain other indebtedness, and certain events of bankruptcy and insolvency. Events of default under the 2020 Indenture arising from certain events of bankruptcy or insolvency will automatically cause the acceleration of the amounts due under the 6.75% Notes. If any other event of default under the 2020 Indenture occurs and is continuing, the trustee for the 2020 Indenture or the registered holders of at least 25% in the then aggregate outstanding principal amount of the 6.75% Notes may declare the acceleration of the amounts due under those notes.

The Company recorded $6,265 of fees in connection with the offering of the 6.75% Notes during Fiscal 2012. The fees are classified as Debt issuance costs within the accompanying Consolidated Statements of Financial Position and are amortized as an adjustment to interest expense over the remaining life of the 6.75% Notes.

 

S-23


12% Notes

On March 1, 2012, the Company launched a cash tender offer (the “Tender Offer”) and consent solicitation (the “Consent Solicitation”) with respect to any and all of its outstanding 12% Senior Subordinated Toggle Notes due 2019 (the “12% Notes”). Pursuant to the Consent Solicitation, the Company received consents to the adoption of certain amendments to the indenture governing the 12% Notes to, among other things, eliminate substantially all of the restrictive covenants, certain events of default and other related provisions. The terms of the Tender Offer provided that holders of the 12% Notes who tendered their 12% Notes prior to the expiration of a consent solicitation period, which ended March 14, 2012, would receive tender offer consideration and a consent payment. Holders tendering their 12% Notes subsequent to expiration of the consent solicitation period, but prior to the March 28, 2012 expiration of the Tender Offer period, would receive only tender offer consideration. As of the expiration of the consent solicitation period, holders of the 12% Notes had tendered approximately $231,421 of the 12% Notes. Following the expiration of the Tender Offer period, an additional $88 of the 12% Notes were tendered. Following expiration of the Tender Offer period, the Company paid the trustee principal, interest and a call premium sufficient to redeem the remaining approximately $13,522 of the 12% Notes not tendered on the first redemption date, August 28, 2012. The trustee under the indenture governing the 12% Notes accepted those funds in trust for the benefit of the holders of the 12% Notes and has acknowledged the satisfaction and discharge of the 12% Notes and the indenture governing the 12% Notes.

In connection with the Tender Offer, the Company recorded $23,777 of fees and expenses as a cash charge to Interest expense in the Consolidated Statements of Operations during Fiscal 2012. In connection with the satisfaction and discharge process, the Company recorded cash charges of $1,623 to Interest expense in the Consolidated Statements of Operations during Fiscal 2012. In addition, $2,097 of debt issuance costs and unamortized premium related to the 12% Notes were written off as a non-cash charge to Interest expense in the Consolidated Statements of Operations during Fiscal 2012.

ABL Facility

On May 24, 2012, the Company amended its ABL Facility. As a result, the maturity date was extended from April 21, 2016 to May 3, 2016.

The amended facility carries an interest rate at the option of the Company, which is subject to change based on availability under the facility, of either: (a) the base rate plus (currently) 0.75% per annum or (b) the reserve-adjusted LIBOR rate plus (currently) 1.75% per annum. No principal amortizations are required with respect to the ABL Facility. Pursuant to the credit and security agreement, the obligations under the ABL Facility are secured by certain current assets of the guarantors, including, but not limited to, deposit accounts, trade receivables and inventory.

The ABL Facility is governed by a credit agreement (the “ABL Credit Agreement”) with Bank of America as administrative agent. The ABL Facility consists of revolving loans (the “Revolving Loans”), with a portion available for letters of credit and a portion available as swing line loans, in each case subject to the terms and limits described therein.

The Revolving Loans may be drawn, repaid and re-borrowed without premium or penalty. The proceeds of borrowings under the ABL Facility are to be used for costs, expenses and fees in connection with the ABL Facility, working capital requirements of the Company and its subsidiaries, restructuring costs, and for other general corporate purposes.

The ABL Credit Agreement contains various representations and warranties and covenants, including, without limitation, enhanced collateral reporting, and a maximum fixed charge coverage ratio. The ABL Credit Agreement also provides for customary events of default, including payment defaults and cross-defaults on other material indebtedness.

 

S-24


During Fiscal 2010, the Company recorded $9,839 of fees in connection with the ABL Facility. During Fiscal 2011 and Fiscal 2012, the Company recorded $2,071 and $525, respectively, of fees in connection with the amendments to the ABL Facility. The fees are classified as Debt issuance costs within the accompanying Consolidated Statements of Financial Position and are amortized as an adjustment to interest expense over the remaining life of the ABL Facility. In connection with the amendment, the Company also recorded cash charges of $482 as an increase to interest expense during Fiscal 2012. In addition, $382 of debt issuance costs were written off in connection with the amendment as a non-cash charge to Interest expense in the Consolidated Statements of Operations during Fiscal 2012. Pursuant to the credit and security agreement, the obligations under the ABL Credit Agreement are secured by certain current assets of the guarantors, including, but not limited to, deposit accounts, trade receivables and inventory.

As a result of borrowings and payments under the ABL Facility at September 30, 2012, the Company had aggregate borrowing availability of approximately $198,209, net of lender reserves of $7,942 and outstanding letters of credit of $25,302.

At September 30, 2011, the Company had aggregate borrowing availability of approximately $176,612, net of lender reserves of $48,769 and outstanding letters of credit of $32,962.

(7) Derivative Financial Instruments

Derivative financial instruments are used by the Company principally in the management of its interest rate, foreign currency exchange rate and raw material price exposures. The Company does not hold or issue derivative financial instruments for trading purposes. When hedge accounting is elected at inception, the Company formally designates the financial instrument as a hedge of a specific underlying exposure if such criteria are met, and documents both the risk management objectives and strategies for undertaking the hedge. The Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in the forecasted cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the forecasted cash flows of the underlying exposures being hedged. Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in earnings. For derivatives that are not designated as cash flow hedges, or do not qualify for hedge accounting treatment, the change in the fair value is also immediately recognized in earnings.

The Company discloses its derivative instruments and hedging activities in accordance with ASC Topic 815: “Derivatives and Hedging,” (“ASC 815”).

 

S-25


The fair value of outstanding derivative contracts recorded as assets in the accompanying Consolidated Statements of Financial Position were as follows:

 

Asset Derivatives

      September 30, 2012     September 30, 2011  

Derivatives designated as hedging instruments under ASC 815:

     

Commodity contracts

  Receivables —
Other
  $ 985      $ 274   

Commodity contracts

  Deferred charges
and other
    1,017        —     

Foreign exchange contracts

  Receivables —
Other
    1,194        3,189   
   

 

 

   

 

 

 

Total asset derivatives designated as hedging instruments under ASC 815

    $ 3,196      $ 3,463   
   

 

 

   

 

 

 

Derivatives not designated as hedging instruments under ASC 815:

     

Foreign exchange contracts

  Receivables —
Other
    41        —     
   

 

 

   

 

 

 

Total asset derivatives

    $ 3,237      $ 3,463   
   

 

 

   

 

 

 

The fair value of outstanding derivative contracts recorded as liabilities in the accompanying Consolidated Statements of Financial Position were as follows:

 

Liability Derivatives

        September 30, 2012     September 30, 2011  

Derivatives designated as hedging instruments under ASC 815:

     

Interest rate contracts

    Accounts payable      $ —        $ 1,246   

Interest rate contracts

    Accrued interest        —          708   

Commodity contracts

    Accounts payable        9        1,228   

Commodity contracts

   
 
Other long term
liabilities
  
  
    —          4   

Foreign exchange contracts

    Accounts payable        3,063        2,698   
   

 

 

   

 

 

 

Total liability derivatives designated as hedging instruments under ASC 815

    $ 3,072      $ 5,884   
   

 

 

   

 

 

 

Derivatives not designated as hedging instruments under ASC 815:

     

Foreign exchange contracts

    Accounts payable        3,967        10,945   

Foreign exchange contracts

   
 
Other long term
liabilities
  
  
    2,926        12,036   
   

 

 

   

 

 

 

Total liability derivatives

    $ 9,965      $ 28,865   
   

 

 

   

 

 

 

Changes in AOCI from Derivative Instruments

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

 

S-26


The following table summarizes the impact of derivative instruments on the accompanying Consolidated Statements of Operations for Fiscal 2012:

 

Derivatives in ASC 815 Cash
Flow Hedging Relationships

  Amount of
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective Portion)
    Location of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
  Amount of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
    Location of
Gain (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and Amount
Excluded  from
Effectiveness
Testing)
  Amount of
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
 

Commodity contracts

  $ 1,606      Cost of goods sold   $ (1,148   Cost of goods sold   $ 94   

Interest rate contracts

    15      Interest expense     (864   Interest expense     —     

Foreign exchange contracts

    61      Net sales     (474   Net sales     —     

Foreign exchange contracts

    (3,506   Cost of goods sold     (611   Cost of goods sold     —     
 

 

 

     

 

 

     

 

 

 

Total

  $ (1,824     $ (3,097     $ 94   
 

 

 

     

 

 

     

 

 

 

The following table summarizes the impact of derivative instruments on the accompanying Consolidated Statements of Operations for Fiscal 2011:

 

Derivatives in ASC 815 Cash
Flow Hedging Relationships

  Amount of
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective Portion)
    Location of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
  Amount of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
    Location of
Gain (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and Amount
Excluded  from
Effectiveness
Testing)
  Amount of
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
 

Commodity contracts

  $ (1,750   Cost of goods sold   $ 2,617      Cost of goods sold   $ (47

Interest rate contracts

    (88   Interest expense     (3,319   Interest expense     (205 )(A) 

Foreign exchange contracts

    (487   Net sales     (131   Net sales     —     

Foreign exchange contracts

    (3,667   Cost of goods sold     (12,384   Cost of goods sold     —     
 

 

 

     

 

 

     

 

 

 

Total

  $ (5,992     $ (13,217     $ (252
 

 

 

     

 

 

     

 

 

 

 

(A)

Reclassified from AOCI associated with the prepayment of portions of the Senior Credit Facility. See also Note 6, Debt, for a more complete discussion of the Company’s refinancing of its Senior Credit Facility.

 

S-27


The following table summarizes the impact of derivative instruments on the accompanying Consolidated Statements of Operations for Fiscal 2010:

 

Derivatives in ASC 815
Cash Flow Hedging
Relationships

  Amount of
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective Portion)
    Location of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
  Amount of
Gain (Loss)
Reclassified from
AOCI into Income
(Effective Portion)
    Location of
Gain (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and Amount
Excluded  from
Effectiveness
Testing)
  Amount of
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
 

Commodity contracts

  $ 3,646      Cost of goods sold   $ 719      Cost of goods sold   $ (1

Interest rate contracts

    (13,955   Interest expense     (4,439   Interest expense     (6,112 )(A) 

Foreign exchange contracts

    (752   Net sales     (812   Net sales     —     

Foreign exchange contracts

    (4,560   Cost of goods sold     2,481      Cost of goods sold     —     
 

 

 

     

 

 

     

 

 

 

Total

  $ (15,621     $ (2,051     $ (6,113
 

 

 

     

 

 

     

 

 

 

 

(A)

Includes $(4,305) reclassified from AOCI associated with the refinancing of the Senior Credit Facility. (See also Note 6, Debt, for a more complete discussion of the Company’s refinancing of its Senior Credit Facility.)

Other Changes in Fair Value of Derivative Contracts

For derivative instruments that are used to economically hedge the fair value of the Company’s third party and intercompany payments and interest rate payments, the gain (loss) associated with the derivative contract is recognized in earnings in the period of change.

During Fiscal 2012 the Company recognized the following gains on derivative contracts:

 

     Amount of Gain (Loss)
Recognized
in Income on  Derivatives
     Location of Gain or (Loss)
Recognized in
Income on Derivatives
 

Foreign exchange contracts

   $ 5,916         Other expense, net   
  

 

 

    

During Fiscal 2011 the Company recognized the following losses on derivative contracts:

 

     Amount of Gain (Loss)
Recognized in
Income on  Derivatives
    Location of Gain or (Loss)
Recognized in
Income on Derivatives
 

Foreign exchange contracts

   $ (5,052     Other expense, net   
  

 

 

   

During Fiscal 2010 the Company recognized the following gains (losses) on derivative contracts:

 

     Amount of Gain
(Loss) Recognized in
Income on  Derivatives
    Location of Gain or  (Loss)
Recognized in
Income on Derivatives

Commodity contracts

   $ 153      Cost of goods sold

Foreign exchange contracts

     (42,039   Other expense, net
  

 

 

   

Total

   $ (41,886  
  

 

 

   

 

S-28


Credit Risk

The Company is exposed to the risk of default by the counterparties with which it transacts and generally does not require collateral or other security to support financial instruments subject to credit risk. The Company monitors counterparty credit risk on an individual basis by periodically assessing each such counterparty’s credit rating exposure. The maximum loss due to credit risk equals the fair value of the gross asset derivatives which are primarily concentrated with two foreign financial institution counterparties. The Company considers these exposures when measuring its credit reserve on its derivative assets, which was $46 and $18, respectively, at September 30, 2012 and September 30, 2011.

The Company’s standard contracts do not contain credit risk related contingencies whereby the Company would be required to post additional cash collateral as a result of a credit event. However, the Company is typically required to post collateral in the normal course of business to offset its liability positions. At September 30, 2012 and September 30, 2011, the Company had posted cash collateral of $50 and $418, respectively, related to such liability positions. At September 30, 2012, the Company had no standby letters of credit, compared to posted letters of credit of $2,000 at September 30, 2011, related to such liability positions. The cash collateral is included in Receivables — Other within the accompanying Consolidated Statements of Financial Position.

Derivative Financial Instruments

Cash Flow Hedges

The Company has used interest rate swaps to manage its interest rate risk. The swaps are designated as cash flow hedges with the changes in fair value recorded in AOCI and as a derivative hedge asset or liability, as applicable. The swaps settle periodically in arrears with the related amounts for the current settlement period payable to, or receivable from, the counter-parties included in accrued liabilities or receivables, respectively, and recognized in earnings as an adjustment to interest expense from the underlying debt to which the swap is designated. At September 30, 2012, the Company did not have any interest rate swaps outstanding. At September 30, 2011, the Company had a portfolio of U.S. dollar-denominated interest rate swaps outstanding which effectively fixed the interest on floating rate debt, exclusive of lender spreads as follows: 2.25% for a notional principal amount of $200,000 through December 2011 and 2.29% for a notional principal amount of $300,000 through January 2012. During Fiscal 2010, in connection with the refinancing of its senior credit facilities, the Company terminated a portfolio of Euro-denominated interest rate swaps at a cash loss of $3,499 which was recognized as an adjustment to interest expense. At September 30, 2012, the Company did not have any unrecognized gains or losses related to interest rate swaps recorded in AOCI. The derivative net loss on the U.S. dollar swap contracts recorded in AOCI by the Company at September 30, 2011 was $879, net of tax benefit of $0. At September 30, 2012, no derivative net losses are estimated to be reclassified from AOCI into earnings by the Company over the next 12 months.

In connection with the Company’s merger with Russell Hobbs and the refinancing of the Company’s existing senior credit facilities associated with the closing of the Merger, the Company assessed the prospective effectiveness of its interest rate cash flow hedges during Fiscal 2010. As a result, during Fiscal 2010, the Company ceased hedge accounting and recorded a loss of $1,451 as an adjustment to interest expense for the change in fair value of its U.S. dollar swaps from the date of de-designation until the U.S. dollar swaps were re-designated. The Company also evaluated whether the amounts recorded in AOCI associated with the forecasted U.S. dollar swap transactions were probable of not occurring and determined that occurrence of the transactions was still reasonably possible. Upon the refinancing of the existing senior credit facility associated with the closing of the Merger, the Company re-designated the U.S. dollar swaps as cash flow hedges of certain scheduled interest rate payments on the new $750,000 U.S. Dollar Term Loan expiring June 17, 2016.

 

S-29


The Company’s interest rate swap derivative financial instruments at September 30, 2012 and September 30, 2011 are summarized as follows:

 

     2012      2011  
     Notional
Amount
     Remaining
Term
     Notional
Amount
     Remaining
Term
 

Interest rate swaps-fixed

   $ —           —         $ 200,000         .28 years   

Interest rate swaps-fixed

   $ —           —         $ 300,000         .36 years   

The Company periodically enters into forward foreign exchange contracts to hedge the risk from forecasted foreign denominated third party and intercompany sales or payments. These obligations generally require the Company to exchange foreign currencies for U.S. Dollars, Euros, Pounds Sterling, Australian Dollars, Brazilian Reals, Canadian Dollars or Japanese Yen. These foreign exchange contracts are cash flow hedges of fluctuating foreign exchange related to sales of product or raw material purchases. Until the sale or purchase is recognized, the fair value of the related hedge is recorded in AOCI and as a derivative hedge asset or liability, as applicable. At the time the sale or purchase is recognized, the fair value of the related hedge is reclassified as an adjustment to Net sales or purchase price variance in Cost of goods sold.

At September 30, 2012 the Company had a series of foreign exchange derivative contracts outstanding through September 2013 with a contract value of $202,453. At September 30, 2011 the Company had a series of foreign exchange derivative contracts outstanding through September 2012 with a contract value of $223,417. The derivative loss on these contracts recorded in AOCI by the Company at September 30, 2012 was $1,409, net of tax benefit of $565. The derivative net gain on these contracts recorded in AOCI by the Company at September 30, 2011 was $238, net of tax expense of $148. At September 30, 2012, the portion of derivative net losses estimated to be reclassified from AOCI into earnings by the Company over the next 12 months is $1,409, net of tax.

The Company is exposed to risk from fluctuating prices for raw materials, specifically zinc used in its manufacturing processes. The Company hedges a portion of the risk associated with these materials through the use of commodity swaps. The hedge contracts are designated as cash flow hedges with the fair value changes recorded in AOCI and as a hedge asset or liability, as applicable. The unrecognized changes in fair value of the hedge contracts are reclassified from AOCI into earnings when the hedged purchase of raw materials also affects earnings. The swaps effectively fix the floating price on a specified quantity of raw materials through a specified date. At September 30, 2012 the Company had a series of such swap contracts outstanding through September 2014 for 15 tons with a contract value of $29,207. At September 30, 2011 the Company had a series of such swap contracts outstanding through December 2012 for 9 tons with a contract value of $18,858. The derivative net gain on these contracts recorded in AOCI by the Company at September 30, 2012 was $1,627, net of tax expense of $320. The derivative net loss on these contracts recorded in AOCI by the Company at September 30, 2011 was $686, net of tax benefit of $121. At September 30, 2012, the portion of derivative net gains estimated to be reclassified from AOCI into earnings by the Company over the next 12 months is $796, net of tax.

Derivative Contracts

The Company periodically enters into forward and swap foreign exchange contracts to economically hedge the risk from third party and intercompany payments resulting from existing obligations. These obligations generally require the Company to exchange foreign currencies for U.S. Dollars, Euros or Australian Dollars. These foreign exchange contracts are economic hedges of a related liability or asset recorded in the accompanying Consolidated Statements of Financial Position. The gain or loss on the derivative hedge contracts is recorded in earnings as an offset to the change in value of the related liability or asset at each period end. At September 30, 2012 and September 30, 2011 the Company had $172,581 and $265,974, respectively, of such foreign exchange derivative notional value contracts outstanding.

 

S-30


(8) Fair Value of Financial Instruments

ASC Topic 820: “Fair Value Measurements and Disclosures” (“ASC 820”), establishes a framework for measuring fair value and expands related disclosures. Broadly, the ASC 820 framework requires fair value to be determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. ASC 820 establishes market or observable inputs as the preferred source of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The Company utilizes valuation techniques that attempt to maximize the use of observable inputs and minimize the use of unobservable inputs. The determination of the fair values considers various factors, including closing exchange or over-the-counter market pricing quotations, time value and credit quality factors underlying options and contracts. The fair value of certain derivative financial instruments is estimated using pricing models based on contracts with similar terms and risks. Modeling techniques assume market correlation and volatility, such as using prices of one delivery point to calculate the price of the contract’s different delivery point. The nominal value of interest rate transactions is discounted using applicable forward interest rate curves. In addition, by applying a credit reserve which is calculated based on credit default swaps or published default probabilities for the actual and potential asset value, the fair value of the Company’s derivative financial instrument assets reflects the risk that the counterparties to these contracts may default on the obligations. Likewise, by assessing the requirements of a reserve for non-performance which is calculated based on the probability of default by the Company, the Company adjusts its derivative contract liabilities to reflect the price at which a potential market participant would be willing to assume the Company’s liabilities. The Company has not changed its valuation techniques in measuring the fair value of any financial assets and liabilities during the year.

The valuation techniques required by ASC 820 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions made by the Company. These two types of inputs create the following fair value hierarchy:

Level 1 — Unadjusted quoted prices for identical instruments in active markets.

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 — Significant inputs to the valuation model are unobservable.

The Company maintains policies and procedures to value instruments using the best and most relevant data available. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls must be determined based on the lowest level input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. In addition, the Company has risk management teams that review valuation, including independent price validation for certain instruments. Further, in other instances, the Company retains independent pricing vendors to assist in valuing certain instruments.

The Company’s derivatives are valued on a recurring basis using internal models, which are based on market observable inputs including interest rate curves and both forward and spot prices for currencies and commodities.

 

S-31


The Company’s net derivative portfolio as of September 30, 2012, contains Level 2 instruments and consists of commodity and foreign exchange contracts. The fair values of these instruments as of September 30, 2012 were as follows:

 

     Level 1      Level 2     Level 3      Total  

Assets:

          

Commodity contracts, net

   $ —         $ 1,993      $ —         $ 1,993   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Assets

   $ —         $ 1,993      $ —         $ 1,993   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Foreign exchange contracts, net

   $ —         $ (8,721   $ —         $ (8,721
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Liabilities

   $ —         $ (8,721   $ —         $ (8,721
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company’s net derivative portfolio as of September 30, 2011, contains Level 2 instruments and consists of commodity, interest rate and foreign exchange contracts. The fair values of these instruments as of September 30, 2011 were as follows:

 

     Level 1      Level 2     Level 3      Total  

Total Assets

   $ —         $ —        $ —         $ —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Interest rate contracts

   $ —         $ (1,954   $ —         $ (1,954

Commodity contracts

     —           (958     —           (958

Foreign exchange contracts, net

     —           (22,490     —           (22,490
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Liabilities

   $ —         $ (25,402   $ —         $ (25,402
  

 

 

    

 

 

   

 

 

    

 

 

 

The carrying values of cash and cash equivalents, accounts and notes receivable, accounts payable and short-term debt approximate fair value. The fair values of long-term debt and derivative financial instruments are generally based on quoted or observed market prices.

The carrying values of goodwill, intangible assets and other long-lived assets are tested annually, or more frequently if an event occurs that indicates an impairment loss may have been incurred, using fair value measurements with unobservable inputs (Level 3). The Company recorded impairment charges related to intangible assets during Fiscal 2011. (See also Note 2(i), Significant Accounting Policies — Intangible Assets, for further details on impairment testing.)

The carrying amounts and fair values of the Company’s financial instruments are summarized as follows ((liability)/asset):

 

     September 30, 2012     September 30, 2011  
     Carrying
Amount
    Fair Value     Carrying
Amount
    Fair Value  

Total debt

   $ (1,669,300   $ (1,804,831   $ (1,551,612   $ (1,635,528

Interest rate swap agreements

     —          —          (1,954     (1,954

Commodity swap and option agreements

     1,993        1,993        (958     (958

Foreign exchange forward agreements

     (8,721     (8,721     (22,490     (22,490

 

S-32


(9) Income Taxes

Income tax expense was calculated based upon the following components of income (loss) from continuing operations before income tax:

 

     2012     2011     2010  

Pretax income (loss):

      

United States

   $ (66,102   $ (119,984   $ (230,262

Outside the United States

     175,059        137,108        106,079   
  

 

 

   

 

 

   

 

 

 

Total pretax income (loss)

   $ 108,957      $ 17,124      $ (124,183
  

 

 

   

 

 

   

 

 

 

The components of income tax expense are as follows:

 

     2012     2011      2010  

Current:

       

Foreign

   $ 38,113      $ 32,649       $ 44,481   

State

     (361     2,332         2,907   
  

 

 

   

 

 

    

 

 

 

Total current

     37,752        34,981         47,388   
  

 

 

   

 

 

    

 

 

 

Deferred:

       

Federal

     20,884        20,247         22,119   

Foreign

     5,190        28,054         (6,514

State

     (3,441     9,013         196   
  

 

 

   

 

 

    

 

 

 

Total deferred

     22,633        57,314         15,801   
  

 

 

   

 

 

    

 

 

 

Income tax expense

   $ 60,385      $ 92,295       $ 63,189   
  

 

 

   

 

 

    

 

 

 

The following reconciles the total income tax expense, based on the Federal statutory income tax rate of 35%, with the Company’s recognized income tax expense:

 

     2012     2011     2010  

Statutory federal income tax expense (benefit)

   $ 38,135      $ 5,994      $ (43,464

Permanent items

     8,595        10,607        4,828   

Exempt foreign income

     (5,760     (380     (9

Foreign statutory rate vs. U.S. statutory rate

     (15,211     (14,132     (9,601

State income taxes, net of federal benefit

     (2,164     1,242        (4,979

Residual tax on foreign earnings

     29,844        18,943        6,609   

FURminator purchase accounting benefit

     (14,511     —          —     

Valuation allowance

     26,003        68,615        90,977   

Reorganization items

     —          —          7,553   

Unrecognized tax (benefit) expense

     (4,386     (2,793     3,234   

Inflationary adjustments

     (803     (1,472     3,409   

Correction of immaterial prior period error

     —          4,873        5,900   

Other, net

     643        798        (1,268
  

 

 

   

 

 

   

 

 

 

Income tax expense

   $ 60,385      $ 92,295      $ 63,189   
  

 

 

   

 

 

   

 

 

 

 

S-33


The tax effects of temporary differences, which give rise to significant portions of the deferred tax assets and deferred tax liabilities, are as follows:

 

     September 30,  
     2012     2011  

Current deferred tax assets:

    

Employee benefits

   $ 16,399      $ 14,188   

Restructuring

     8,054        10,682   

Inventories and receivables

     22,495        21,521   

Marketing and promotional accruals

     8,270        8,911   

Other

     14,440        14,742   

Valuation allowance

     (29,808     (28,772
  

 

 

   

 

 

 

Total current deferred tax assets

     39,850        41,272   

Current deferred tax liabilities:

    

Inventories and receivables

     (2,618     (5,015

Unrealized gains

     (1,153     (2,382

Other

     (7,936     (5,705
  

 

 

   

 

 

 

Total current deferred tax liabilities

     (11,707     (13,102
  

 

 

   

 

 

 

Net current deferred tax assets

   $ 28,143      $ 28,170   
  

 

 

   

 

 

 

Noncurrent deferred tax assets:

    

Employee benefits

   $ 34,927      $ 30,177   

Restructuring and purchase accounting

     371        2,269   

Net operating loss and credit carry forwards

     572,857        525,394   

Prepaid royalty

     7,006        7,346   

Property, plant and equipment

     3,255        5,240   

Unrealized losses

     2,521        9,000   

Long-term debt

     3,976        22,602   

Intangibles

     4,282        4,749   

Other

     7,866        5,743   

Valuation allowance

     (354,992     (345,121
  

 

 

   

 

 

 

Total noncurrent deferred tax assets

     282,069        267,399   

Noncurrent deferred tax liabilities:

    

Property, plant, and equipment

     (15,337     (16,593

Unrealized gains

     (15,803     (11,619

Intangibles

     (596,199     (571,454

Taxes on unremitted foreign earnings

     (29,231     —     

Other

     (2,964     (5,069
  

 

 

   

 

 

 

Total noncurrent deferred tax liabilities

     (659,534     (604,735
  

 

 

   

 

 

 

Net noncurrent deferred tax liabilities

   $ (377,465   $ (337,336
  

 

 

   

 

 

 

Net current and noncurrent deferred tax liabilities

   $ (349,322   $ (309,166
  

 

 

   

 

 

 

Effective October 1, 2012, the Company began recording residual U.S. and foreign taxes on current foreign earnings as a result of its change in position regarding future repatriation and the requirements of ASC 740. To the extent necessary, the Company intends to utilize earnings of foreign subsidiaries generated after September 30, 2011, to support management’s plans to voluntarily accelerate pay down of U.S. debt, fund distributions to shareholders, fund U.S. acquisitions, and satisfy ongoing U.S. operational cash flow requirements. As a result, earnings of the Company’s non-U.S. subsidiaries after September 30, 2011 are not considered to be permanently reinvested, except in jurisdiction where repatriation is either precluded or restricted by law. Accordingly, the Company is providing residual U.S. and foreign deferred taxes to these earnings to the

 

S-34


extent they cannot be repatriated in a tax-free manner. Accordingly during Fiscal 2012, the Company has provided residual taxes on approximately $97,638 of foreign earnings resulting in an increase in tax expense, net of a corresponding adjustment to the Company’s domestic valuation allowance, of approximately $3,278, including $2,465 of expected tax on $76,475 of earnings not yet taxed in the U.S. During Fiscal 2011, the Company recorded residual U.S. and foreign taxes on approximately $39,391 of distributions of foreign earnings resulting in an increase in tax expense, net of a corresponding adjustment to the Company’s domestic valuation allowance, of approximately $771. The Fiscal 2011 distributions were primarily non-cash deemed distributions under U.S. tax law. During Fiscal 2010, the Company recorded residual U.S. and foreign taxes on approximately $26,600 of actual and deemed distributions of foreign earnings resulting in an increase in tax expense, net of a corresponding adjustment to the Company’s domestic valuation allowance, of approximately $0. The Fiscal 2010 distributions were primarily non-cash deemed distributions under U.S. tax law.

Remaining undistributed earnings of the Company’s foreign operations are approximately $415,713 at September 30, 2012, and are intended to remain permanently invested. Accordingly, no residual income taxes have been provided on those earnings at September 30, 2012. If at some future date these earnings cease to be permanently invested, the Company may be subject to U.S. income taxes and foreign withholding and other taxes on such amounts, which cannot be reasonably estimated at this time.

The Company, as of September 30, 2012, has U.S. federal and state net operating loss carryforwards of approximately $1,304,763 and $1,340,761, respectively. These net operating loss carryforwards expire through years ending in 2032. The Company has foreign loss carryforwards of approximately $119,100 which will expire beginning in 2016. Certain of the foreign net operating losses have indefinite carryforward periods. The Company is subject to an annual limitation on the use of its net operating losses that arose prior to its emergence from bankruptcy. The Company has had multiple changes of ownership, as defined under Section 382 of the Internal Revenue Code of 1986, as amended, that subject the Company’s U.S. federal and state net operating losses and other tax attributes to certain limitations. The annual limitation is based on a number of factors including the value of the Company’s stock (as defined for tax purposes), on the date of the ownership change, its net unrealized built in gain position on that date, the occurrence of realized built in gains in years subsequent to the ownership change, and the effects of subsequent ownership changes (as defined for tax purposes) if any. Due to these limitations, the Company estimates that $301,202 of the total U.S. federal and $385,159 of the state net operating loss would expire unused even if the Company generates sufficient income to otherwise use all its NOLs. In addition, separate return year limitations apply to limit the Company’s utilization of the acquired Russell Hobbs U.S. federal and state net operating losses to future income of the Russell Hobbs subgroup. The Company also projects that $110,794 of the total foreign loss carryforwards will expire unused. The Company has provided a full valuation allowance against these deferred tax assets.

A valuation allowance is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets depends on the ability of the Company to generate sufficient taxable income of the appropriate character in the future and in the appropriate taxing jurisdictions. As of September 30, 2012 and September 30, 2011, the Company’s valuation allowance, established for the tax benefit that may not be realized, totaled approximately $384,800 and $373,893, respectively. As of September 30, 2012 and September 30, 2011, approximately $349,316 and $338,538, respectively, related to U.S. net deferred tax assets, and approximately $35,484 and $35,354, respectively, related to foreign net deferred tax assets. The increase in the valuation allowance for deferred tax assets during Fiscal 2012 totaled approximately $10,907, of which approximately $10,778 related to an increase in the valuation allowance against U.S. net deferred tax assets, and approximately $130 related to an increase in the valuation allowance against foreign net deferred tax assets. As a result of the purchase of FURminator, the Company was able to release $14,511 of U.S. valuation allowance during Fiscal 2012. The release was attributable to $14,511 of net deferred tax liabilities recorded on the FURminator acquisition date balance sheet that offset other U.S. net deferred tax assets. During Fiscal 2011, the Company determined that a valuation allowance was required against deferred tax assets related to net operating losses in Brazil, and thus recorded a $25,877 charge to increase the valuation allowance.

 

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The total amount of unrecognized tax benefits on the Company’s Consolidated Statements of Financial Position at September 30, 2012 and September 30, 2011 are $5,877 and $9,013, respectively. If recognized in the future, the entire amount of unrecognized tax benefits will affect the effective tax rate. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2012 and September 30, 2011 the Company had approximately $3,564 and $4,682, respectively, of accrued interest and penalties related to uncertain tax positions. The impact related to interest and penalties on the Consolidated Statement of Operations for Fiscal 2012 was a net decrease to income tax expense of $(1,184). The impact related to interest and penalties on the Consolidated Statement of Operations for Fiscal 2011 was a net decrease to income tax expense of $(1,422). The impact related to interest and penalties on the Consolidated Statement of Operations for Fiscal 2010 was a net increase to income tax expense of $1,527. In connection with the Merger, the Company recorded additional unrecognized tax benefits of approximately $3,299 as part of purchase accounting.

As of September 30, 2012, certain of the Company’s legal entities are undergoing income tax audits. The Company cannot predict the ultimate outcome of the examinations; however, it is reasonably possible that during the next 12 months some portion of previously unrecognized tax benefits could be recognized.

The following table summarizes the changes to the amount of unrecognized tax benefits of Company for Fiscal 2012, Fiscal 2011, and Fiscal 2010:

 

Unrecognized tax benefits at September 30, 2009

   $ 7,765   

Russell Hobbs acquired unrecognized tax benefits

     3,251   

Gross decrease — tax positions in prior period

     (904

Gross increase — tax positions in current period

     3,390   

Lapse of statutes of limitations

     (694
  

 

 

 

Unrecognized tax benefits at September 30, 2010

   $ 12,808   

Gross increase — tax positions in prior period

     1,658   

Gross decrease — tax positions in prior period

     (823

Gross increase — tax positions in current period

     596   

Settlements

     (1,850

Lapse of statutes of limitations

     (3,376
  

 

 

 

Unrecognized tax benefits at September 30, 2011

   $ 9,013   

Gross increase — tax positions in prior period

     773   

Gross decrease — tax positions in prior period

     (1,308

Gross increase — tax positions in current period

     776   

Settlements

     (1,737

Lapse of statutes of limitations

     (1,640
  

 

 

 

Unrecognized tax benefits at September 30, 2012

   $ 5,877   
  

 

 

 

The Company files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions and is subject to ongoing examination by the various taxing authorities. The Company’s major taxing jurisdictions are the U.S., United Kingdom, and Germany. In the U.S., federal tax filings for years prior to and including the Company’s fiscal year ended September 30, 2008 are closed. However, the federal net operating loss carryforwards from the Company’s fiscal years ended September 30, 2008 and prior are subject to Internal Revenue Service (“IRS”) examination until the year that such net operating loss carryforwards are utilized and those years are closed for audit. The Company’s fiscal years ended September 30, 2009, 2010, 2011 and 2012 remain open to examination by the IRS. Filings in various U.S. state and local jurisdictions are also subject to audit and to date no significant audit matters have arisen.

In the U.S., federal tax filings for years prior to and including Russell Hobbs year ended June 30, 2008 are closed. However, the federal net operating loss carryforwards for Russell Hobbs fiscal years ended June 30, 2008 and prior are subject to examination by the IRS until the year that such net operating losses are utilized and those years are closed for audit.

 

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During Fiscal 2011 we recorded the correction of an immaterial prior period error in our consolidated financial statements related to the effective state income tax rates for certain U.S. subsidiaries. During Fiscal 2010 we recorded the correction of an immaterial prior period error in our consolidated financial statements related to deferred taxes in certain foreign jurisdictions. We believe the correction of these errors to be both quantitatively and qualitatively immaterial to our annual results for Fiscal 2011, Fiscal 2010 or to the financial statements of any previous period. The impact of the corrections was an increase to income tax expense and an increase to deferred tax liabilities in Fiscal 2011 of approximately $4,873 and an increase to income tax expense and a decrease to deferred tax assets in Fiscal 2010 of approximately $5,900.

(10) Employee Benefit Plans

Pension Benefits

The Company has various defined benefit pension plans covering some of its employees in the United States and certain employees in other countries, primarily the United Kingdom and Germany. Plans generally provide benefits of stated amounts for each year of service. The Company funds its U.S. pension plans in accordance with the requirements of the defined benefit pension plans and, where applicable, in amounts sufficient to satisfy the minimum funding requirements of applicable laws. Additionally, in compliance with the Company’s funding policy, annual contributions to non-U.S. defined benefit plans are equal to the actuarial recommendations or statutory requirements in the respective countries.

The Company also sponsors or participates in a number of other non-U.S. pension arrangements, including various retirement and termination benefit plans, some of which are covered by local law or coordinated with government-sponsored plans, which are not significant in the aggregate and therefore are not included in the information presented below. The Company also has various nonqualified deferred compensation agreements with certain of its employees. Under certain of these agreements, the Company has agreed to pay certain amounts annually for the first 15 years subsequent to retirement or to a designated beneficiary upon death. It is management’s intent that life insurance contracts owned by the Company will fund these agreements. Under the remaining agreements, the Company has agreed to pay such deferred amounts in up to 15 annual installments beginning on a date specified by the employee, subsequent to retirement or disability, or to a designated beneficiary upon death.

Other Benefits

Under the Rayovac postretirement plan, the Company provides certain health care and life insurance benefits to eligible retired employees. Participants earn retiree health care benefits after reaching age 40 over the next 10 succeeding years of service, and remain eligible until reaching age 65. The plan is contributory; retiree contributions have been established as a flat dollar amount with contribution rates expected to increase at the active medical trend rate. The plan is unfunded. The Company is amortizing the transition obligation over a 20-year period.

 

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The following tables provide additional information on the Company’s pension and other postretirement benefit plans:

 

     Pension and Deferred
Compensation Benefits
    Other Benefits  
     2012     2011     2012     2011  

Change in benefit obligation

        

Benefit obligation, beginning of year

   $ 209,472      $ 214,977      $ 542      $ 527   

Service cost

     2,048        2,543        12        11   

Interest cost

     10,593        10,380        27        27   

Actuarial (gain) loss

     29,834        (9,027     (14     (21

Participant contributions

     182        189        —          —     

Benefits paid

     (9,354     (8,685     (1     (2

Foreign currency exchange rate changes

     (1,969     (905     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Benefit obligation, end of year

   $ 240,806      $ 209,472      $ 566      $ 542   
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in plan assets

        

Fair value of plan assets, beginning of year

   $ 130,641      $ 125,566      $ —        $ —     

Actual return on plan assets

     20,112        (100     —          —     

Employer contributions

     12,587        14,486        1        2   

Employee contributions

     182        189        —          —     

Benefits paid

     (9,354     (8,685     (1     (2

Plan expenses paid

     —          (226     —          —     

Foreign currency exchange rate changes

     (241     (589     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Fair value of plan assets, end of year

   $ 153,927      $ 130,641      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Accrued Benefit Cost

   $ (86,879   $ (78,831   $ (566   $ (542
  

 

 

   

 

 

   

 

 

   

 

 

 

Range of assumptions:

        

Discount rate

     4.0% -13.5%        4.2% - 13.6%        4.0     5.0

Expected return on plan assets

     4.0% - 7.8%        3.0% - 7.8%        N/A        N/A   

Rate of compensation increase

     2.3% - 5.5%        0.0% - 5.5%        N/A        N/A   

The net underfunded status as of September 30, 2012 and September 30, 2011 of $86,879 and $78,831, respectively, is recognized in the accompanying Consolidated Statements of Financial Position within Employee benefit obligations, net of current portion. Included in the Company’s AOCI as of September 30, 2012 and September 30, 2011 are unrecognized net losses of $33,428, net of tax benefit of $4,392 and $21,496, net of tax benefit of $1,542, respectively, which have not yet been recognized as components of net periodic pension cost. The net loss in AOCI expected to be recognized during Fiscal 2013 is $2,084.

At September 30, 2012, the Company’s total pension and deferred compensation benefit obligation of $240,806 consisted of $75,580 associated with U.S. plans and $165,226 associated with international plans. The fair value of the Company’s pension and deferred compensation benefit assets of $153,927 consisted of $51,721 associated with U.S. plans and $102,206 associated with international plans. The weighted average discount rate used for the Company’s domestic plans was approximately 4.3% and approximately 5.3% for its international plans. The weighted average expected return on plan assets used for the Company’s domestic plans was approximately 7.8% and approximately 5.4% for its international plans.

 

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At September 30, 2011, the Company’s total pension and deferred compensation benefit obligation of $209,472 consisted of $67,611 associated with U.S. plans and $141,861 associated with international plans. The fair value of the Company’s pension and deferred compensation benefit assets of $130,641 consisted of $43,582 associated with U.S. plans and $87,059 associated with international plans. The weighted average discount rate used for the Company’s domestic plans was approximately 5.0% and approximately 4.9% for its international plans. The weighted average expected return on plan assets used for the Company’s domestic plans was approximately 7.6% and approximately 5.4% for its international plans.

 

     Pension and Deferred Compensation Benefits        
         2012             2011             2010           2012         2011         2010    

Components of net periodic benefit cost

            

Service cost

   $ 2,048      $ 2,543      $ 2,479      $ 12      $ 11      $ 9   

Interest cost

     10,593        10,380        8,239        27        27        26   

Expected return on assets

     (8,225     (7,829     (5,774     —          —          —     

Amortization of prior service cost

     72        —          535        —          —          —     

Amortization of transition obligation

     —          —          207        —          —          —     

Recognized net actuarial (gain) loss

     828        8        613        (54     (52     (58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 5,316      $ 5,102      $ 6,299      $ (15   $ (14   $ (23
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The discount rate is used to calculate the projected benefit obligation. The discount rate used is based on the rate of return on government bonds as well as current market conditions of the respective countries where such plans are established.

Below is a summary allocation of all pension plan assets as of the measurement date.

 

     Weighted Average
Allocation
 
     Target     Actual  

Asset Category

   2012     2012     2011  

Equity Securities

     0 -60     49     46

Fixed Income Securities

     0 -40     20     21

Other

     0 -100     31     33
  

 

 

   

 

 

   

 

 

 

Total

     100     100     100
  

 

 

   

 

 

   

 

 

 

The weighted average expected long-term rate of return on total assets is 6.2%.

The Company has established formal investment policies for the assets associated with these plans. Policy objectives include maximizing long-term return at acceptable risk levels, diversifying among asset classes, if appropriate, and among investment managers, as well as establishing relevant risk parameters within each asset class. Specific asset class targets are based on the results of periodic asset/liability studies. The investment policies permit variances from the targets within certain parameters. The weighted average expected long-term rate of return is based on a Fiscal 2012 review of such rates. The plan assets currently do not include holdings of SB Holdings common stock.

 

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The following table sets forth the fair value of the Company’s pension plan assets as of September 30, 2012 segregated by level within the fair value hierarchy. See Note 8, “Fair Value of Financial Instruments”, for discussion of the fair value hierarchy and fair value principles:

 

     Level 1      Level 2      Level 3      Total  

U.S. Defined Benefit Plan Assets:

           

Common collective trust — equity

   $ 20,520       $ 16,667       $ —         $ 37,187   

Common collective trust — fixed income

     —           14,534         —           14,534   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total U.S. Defined Benefit Plan Assets

   $ 20,520       $ 31,201       $ —         $ 51,721   
  

 

 

    

 

 

    

 

 

    

 

 

 

International Defined Benefit Plan Assets:

           

Common collective trust — equity

   $ —         $ 38,507       $ —         $ 38,507   

Common collective trust — fixed income

     —           15,661         —           15,661   

Insurance contracts — general fund

     —           40,651         —           40,651   

Other

     —           7,387         —           7,387   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total International Defined Benefit Plan Assets

   $ —         $ 102,206       $ —         $ 102,206   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s Fixed Income Securities portfolio is invested primarily in commingled funds and managed for overall return expectations rather than matching duration against plan liabilities; therefore, debt maturities are not significant to the plan performance.

The Company’s Other portfolio consists of all pension assets, primarily insurance contracts, in the United Kingdom, Germany and the Netherlands.

The Company’s expected future pension benefit payments for Fiscal 2013 through its fiscal year 2022 are as follows:

 

2013

   $ 9,697   

2014

     8,783   

2015

     9,122   

2016

     9,492   

2017

     9,775   

2018-2022

     56,072   

The Company sponsors a defined contribution pension plan for its domestic salaried employees, which allows participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. The Company also sponsors defined contribution pension plans for employees of certain foreign subsidiaries. Company contributions charged to operations, including discretionary amounts, for Fiscal 2012, Fiscal 2011 and Fiscal 2010 were $1,935, $4,999 and $3,464, respectively.

(11) Segment Information

The Company manages its business in three vertically integrated, product-focused reporting segments: (i) Global Batteries & Appliances; (ii) Global Pet Supplies; and (iii) the Home and Garden Business. See Note 1, “Description of Business”, for additional information regarding the Company’s realignment of its reporting segments.

Global strategic initiatives and financial objectives for each reportable segment are determined at the corporate level. Each reportable segment is responsible for implementing defined strategic initiatives and achieving certain financial objectives, and has a general manager responsible for the sales and marketing initiatives and financial results for product lines within that segment.

 

S-40


Net sales and Cost of goods sold to other business segments have been eliminated. The gross contribution of intersegment sales is included in the segment selling the product to the external customer. Segment net sales are based upon the segment from which the product is shipped.

The operating segment profits do not include restructuring and related charges, acquisition and integration related charges, impairment charges, reorganization items expense, net, interest expense, interest income and income tax expense. Expenses associated with certain general and administrative functions necessary to reflect the operating segments on a standalone basis have also been excluded in the determination of reportable segment profits. Corporate expenses primarily include general and administrative expenses and the costs of global long-term incentive compensation plans which are evaluated on a consolidated basis and not allocated to the Company’s operating segments. All depreciation and amortization included in income from operations is related to operating segments or corporate expense. Costs are identified to operating segments or corporate expense according to the function of each cost center.

All capital expenditures are related to operating segments. Variable allocations of assets are not made for segment reporting.

Segment information for the Company for Fiscal 2012, Fiscal 2011 and Fiscal 2010, is as follows:

Net sales to external customers

 

     2012      2011      2010  

Global Batteries & Appliances

   $ 2,249,939       $ 2,254,153       $ 1,658,123   

Global Pet Supplies

     615,508         578,905         566,335   

Home and Garden Business

     386,988         353,858         342,553   
  

 

 

    

 

 

    

 

 

 

Total segments

   $ 3,252,435       $ 3,186,916       $ 2,567,011   
  

 

 

    

 

 

    

 

 

 

Depreciation and amortization

 

     2012      2011      2010  

Global Batteries & Appliances

   $ 63,618       $ 68,084       $ 57,557   

Global Pet Supplies

     27,702         24,274         28,538   

Home and Garden Business

     13,296         12,375         14,418   
  

 

 

    

 

 

    

 

 

 

Total segments

     104,616         104,733         100,513   

Corporate

     29,164         30,416         16,905   
  

 

 

    

 

 

    

 

 

 

Total Depreciation and amortization

   $ 133,780       $ 135,149       $ 117,418   
  

 

 

    

 

 

    

 

 

 

Segment profit

 

     2012      2011      2010  

Global Batteries & Appliances

   $ 244,442       $ 238,864       $ 171,298   

Global Pet Supplies

     85,866         75,564         57,675   

Home and Garden Business

     73,609         65,180         51,192   
  

 

 

    

 

 

    

 

 

 

Total segments

     403,917         379,608         280,165   

Corporate expenses

     51,514         53,967         48,817   

Acquisition and integration related charges

     31,066         36,603         38,452   

Restructuring and related charges

     19,591         28,644         24,118   

Intangible asset impairment

     —           32,450         —     

Interest expense

     191,911         208,329         277,015   

Other expense, net

     878         2,491         12,300   
  

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations before reorganization items and income taxes

   $ 108,957       $ 17,124       $ (120,537
  

 

 

    

 

 

    

 

 

 

 

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The Global Batteries & Appliances segment does business in Venezuela through a Venezuelan subsidiary. At January 4, 2010, the beginning of the Company’s second quarter of Fiscal 2010, the Company determined that Venezuela met the definition of a highly inflationary economy under GAAP. As a result, beginning January 4, 2010, the U.S. dollar is the functional currency for the Company’s Venezuelan subsidiary. Accordingly, subsequent to January 4, 2010, currency remeasurement adjustments for this subsidiary’s financial statements and other transactional foreign exchange gains and losses are reflected in earnings. Through January 3, 2010, prior to being designated as highly inflationary, translation adjustments related to the Venezuelan subsidiary were reflected in Shareholders’ equity as a component of AOCI.

In addition, on January 8, 2010, the Venezuelan government announced its intention to devalue its currency, the Bolivar fuerte, relative to the U.S. dollar. As a result, the Company remeasured the local statement of financial position of its Venezuela entity during the second quarter of Fiscal 2010 to reflect the impact of the devaluation to the official exchange rate of 4.3 Bolivar fuerte per U.S. dollar. Based on actual exchange activity as of September 30, 2010, the Company determined that the most likely method of exchanging its Bolivar fuertes for U.S. dollars would be to formally apply with the Venezuelan government to exchange through commercial banks at the SITME rate specified by the Central Bank of Venezuela. The SITME rate as of September 30, 2010 was quoted at 5.3 Bolivar fuerte per U.S. dollar. Therefore, the Company changed the rate used to remeasure Bolivar fuerte denominated transactions as of September 30, 2010 from the official exchange rate to the 5.3 SITME rate in accordance with ASC Topic 830: “Foreign Currency Matters” (“ASC 830) as it was the expected rate at which exchanges of Bolivar fuerte to U.S. dollars would be settled.

The designation of the Company’s Venezuela entity as a highly inflationary economy and the devaluation of the Bolivar fuerte resulted in a $1,486 reduction to the Company’s operating income during Fiscal 2010. The Company also reported a foreign exchange loss in Other expense, net, of $10,102 during Fiscal 2010 related to Bolivar fuerte denominated transactions.

As of September 30, 2011, the Company no longer exchanged its Bolivar fuertes for U.S. dollars through the SITME mechanism as the SITME was no longer the most likely method of exchanging its Bolivar fuertes for U.S. dollars. Therefore, the Company changed the rate used to remeasure Bolivar fuerte denominated transactions as of September 30, 2011 from the 5.3 SITME rate to the 4.3 official exchange rate in accordance with ASC 830, as it is the expected exchange rate of Bolivar fuertes to U.S. dollars. The Company reported a foreign exchange gain in Other expense, net, of $(1,293) during Fiscal 2011 related to the change to the official exchange rate.

Segment total assets

 

     September 30,  
     2012      2011  

Global Batteries & Appliances

   $ 2,243,472       $ 2,275,076   

Global Pet Supplies

     956,043         828,202   

Home and Garden Business

     508,083         476,381   
  

 

 

    

 

 

 

Total segments

     3,707,598         3,579,659   

Corporate

     44,051         47,047   
  

 

 

    

 

 

 

Total assets at year end

   $ 3,751,649       $ 3,626,706   
  

 

 

    

 

 

 

 

S-42


Segment long-lived assets (A)

 

     September 30,  
     2012      2011  

Global Batteries & Appliances

   $ 1,434,392       $ 1,468,617   

Global Pet Supplies

     768,140         647,953   

Home and Garden Business

     445,774         417,078   
  

 

 

    

 

 

 

Total segments

     2,648,306         2,533,648   

Corporate

     41,916         44,770   
  

 

 

    

 

 

 

Long-lived assets at year end

   $ 2,690,222       $ 2,578,418   
  

 

 

    

 

 

 

 

(A)

Includes all of the Company’s non-current assets.

Capital expenditures

 

     2012      2011      2010  

Global Batteries & Appliances

   $ 36,271       $ 25,471       $ 28,496   

Global Pet Supplies

     7,447         7,059         7,920   

Home and Garden Business

     3,091         3,630         3,890   
  

 

 

    

 

 

    

 

 

 

Total segments

     46,809         36,160         40,306   

Corporate

     —           —           10   
  

 

 

    

 

 

    

 

 

 

Total Capital expenditures

   $ 46,809       $ 36,160       $ 40,316   
  

 

 

    

 

 

    

 

 

 

Geographic Disclosures — Net sales to external customers

 

     2012      2011      2010  

United States

   $ 1,772,138       $ 1,780,127       $ 1,444,779   

Outside the United States

     1,480,297         1,406,789         1,122,232   
  

 

 

    

 

 

    

 

 

 

Total net sales to external customers

   $ 3,252,435       $ 3,186,916       $ 2,567,011   
  

 

 

    

 

 

    

 

 

 

Geographic Disclosures — Long-lived assets (A)

 

     September 30,  
     2012      2011  

United States

   $ 1,988,632       $ 1,843,869   

Outside the United States

     701,590         734,549   
  

 

 

    

 

 

 

Long-lived assets at year end

   $ 2,690,222       $ 2,578,418   
  

 

 

    

 

 

 

 

(A)

Includes all of the Company’s non-current assets.

(12) Commitments and Contingencies

The Company has provided for the estimated costs associated with environmental remediation activities at some of its current and former manufacturing sites. The Company believes that any additional liability in excess of the amounts provided of approximately $5,432, which may result from resolution of these matters, will not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

 

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The Company is a defendant in various other matters of litigation generally arising out of the ordinary course of business. The Company does not believe that any of these other matters or proceedings presently pending will have a material adverse effect on its results of operations, financial condition, liquidity or cash flows.

The Company’s minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease. Future minimum rental commitments under non-cancelable operating leases, principally pertaining to land, buildings and equipment, are as follows:

 

2013

   $ 32,623   

2014

     27,731   

2015

     22,296   

2016

     21,549   

2017

     16,823   

Thereafter

     43,199   
  

 

 

 

Total minimum lease payments

   $ 164,221   
  

 

 

 

All of the leases expire between October 2012 and July 2023. The Company’s total rent expense was $34,327, $40,298 and $30,218 during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

(13) Related Party Transactions

Merger Agreement and Exchange Agreement

On June 16, 2010 (the “Closing Date”), SB Holdings completed the Merger pursuant to the Agreement and Plan of Merger, dated as of February 9, 2010, as amended on March 1, 2010, March 26, 2010 and April 30, 2010, by and among SB Holdings, Russell Hobbs, Spectrum Brands, Battery Merger Corp., and Grill Merger Corp. (the “Merger Agreement”). As a result of the Merger, each of Spectrum Brands and Russell Hobbs became a wholly-owned subsidiary of SB Holdings. At the effective time of the Merger, (i) the outstanding shares of Spectrum Brands common stock were canceled and converted into the right to receive shares of SB Holdings common stock, and (ii) the outstanding shares of Russell Hobbs common stock and preferred stock were canceled and converted into the right to receive shares of SB Holdings common stock.

Pursuant to the terms of the Merger Agreement, on February 9, 2010, Spectrum Brands entered into support agreements with Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situations Fund, L.P. and Global Opportunities Breakaway Ltd. (together the “Harbinger Parties”) and Avenue International Master, L.P. and certain of its affiliates (the “Avenue Parties”), in which the Harbinger Parties and the Avenue Parties agreed to vote their shares of Spectrum Brands common stock acquired before the date of the Merger Agreement in favor of the Merger and against any alternative proposal that would impede the Merger.

Immediately following the consummation of the Merger, the Harbinger Parties owned approximately 64% of the outstanding SB Holdings common stock and the stockholders of Spectrum Brands (other than the Harbinger Parties) owned approximately 36% of the outstanding SB Holdings common stock.

On January 7, 2011, the Harbinger Parties contributed 27,757 shares of SB Holdings common stock to Harbinger Group Inc. (“HRG”) and received in exchange for such shares an aggregate of 119,910 shares of HRG common stock (such transaction, the “Share Exchange”), pursuant to a Contribution and Exchange Agreement (the “Exchange Agreement”). Immediately following the Share Exchange, (i) HRG owned approximately 54.4% of the outstanding shares of SB Holding’s common stock and the Harbinger Parties owned approximately 12.7% of the outstanding shares of SB Holdings common stock, and (ii) the Harbinger Parties owned 129,860 shares of HRG common stock, or approximately 93.3% of the outstanding HRG common stock.

 

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On June 28, 2011 the Company filed a Form S-3 registration statement with the SEC under which 1,150 shares of its common stock and 6,320 shares of the Company’s common stock held by Harbinger Capital Partners Master Fund I, Ltd. were offered to the public.

In November 2011, HRG announced a stock purchase program for the Company’s common stock, with an authorization of $30,000 under the program. This purchase program was completed in March 2012. Following the completion of the secondary offering of the Company’s common stock in August 2011 by Harbinger Capital Partners Master Fund I, Ltd. and the completion of the HRG stock purchase program for the Company’s common stock noted above, HRG owned approximately 57% of the Company’s common stock, and the Harbinger Parties owned less than 1 percent of the Company’s common stock.

In August 2012, HRG announced a share repurchase program of up to 1,000 shares of the Company’s common stock.

In connection with the Merger, the Harbinger Parties and SB Holdings entered into a stockholder agreement, dated February 9, 2010 (the “Stockholder Agreement”), which provides for certain protective provisions in favor of minority stockholders and provides certain rights and imposes certain obligations on the Harbinger Parties, including:

 

   

for so long as the Harbinger Parties and their affiliates beneficially own 40% or more of the outstanding voting securities of SB Holdings, the Harbinger Parties and the Company will cooperate to ensure, to the greatest extent possible, the continuation of the structure of the SB Holdings board of directors as described in the Stockholder Agreement;

 

   

the Harbinger Parties will not effect any transfer of equity securities of SB Holdings to any person that would result in such person and its affiliates owning 40% or more of the outstanding voting securities of SB Holdings, unless specified conditions are met; and

 

   

the Harbinger Parties will be granted certain access and informational rights with respect to SB Holdings and its subsidiaries.

Pursuant to a joinder to the Stockholder Agreement entered into by the Harbinger Parties and HRG, upon consummation of the Share Exchange, HRG became a party to the Stockholder Agreement, and is subject to all of the covenants, terms and conditions of the Stockholder Agreement to the same extent as the Harbinger Parties were bound thereunder prior to giving effect to the Share Exchange.

Certain provisions of the Stockholder Agreement terminate on the date on which the Harbinger Parties or HRG no longer constitutes a Significant Stockholder (as defined in the Stockholder Agreement). The Stockholder Agreement terminates when any person (including the Harbinger Parties or HRG) acquires 90% or more of the outstanding voting securities of SB Holdings.

Also in connection with the Merger, the Harbinger Parties and SB Holdings entered into a registration rights agreement, dated as of February 9, 2010 (the “SB Holdings Registration Rights Agreement”), pursuant to which the Harbinger Parties have, among other things and subject to the terms and conditions set forth therein, certain demand and so-called “piggy back” registration rights with respect to their shares of SB Holdings common stock. On September 10, 2010, the Harbinger Parties and HRG entered into a joinder to the SB Holdings Registration Rights Agreement, pursuant to which, effective upon the consummation of the Share Exchange, HRG became a party to the SB Holdings Registration Rights Agreement, entitled to the rights and subject to the obligations of a holder thereunder.

Other Agreements

In connection with the Merger, Russell Hobbs and Harbinger Master Fund entered into an indemnification agreement, dated as of February 9, 2010 (the “Indemnification Agreement”), by which Harbinger Master Fund

 

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agreed, among other things and subject to the terms and conditions set forth therein, to guarantee the obligations of Russell Hobbs to pay (i) a reverse termination fee to Spectrum Brands under the merger agreement and (ii) monetary damages awarded to Spectrum Brands in connection with any willful and material breach by Russell Hobbs of the Merger Agreement. The maximum amount payable by Harbinger Master Fund under the Indemnification Agreement was $50,000 less any amounts paid by Russell Hobbs or the Harbinger Parties, or any of their respective affiliates, as damages under any documents related to the Merger. No such amounts became due under the Indemnification Agreement. Harbinger Master Fund also agreed to indemnify Russell Hobbs, SB Holdings and their subsidiaries for out-of-pocket costs and expenses above $3,000 in the aggregate that became payable after the consummation of the Merger and that related to the litigation arising out of Russell Hobbs’ business combination transaction with Applica. In February 2011, the parties to the litigation reached a full and final settlement of their disputes. Neither the Company, Applica or any other subsidiary of the Company was required to make any payments in connection with the settlement.

(14) Restructuring and Related Charges

The Company reports restructuring and related charges associated with manufacturing and related initiatives in Cost of goods sold. Restructuring and related charges reflected in Cost of goods sold include, but are not limited to, termination, compensation and related costs associated with manufacturing employees, asset impairments relating to manufacturing initiatives, and other costs directly related to the restructuring or integration initiatives implemented.

The Company reports restructuring and related charges relating to administrative functions in Operating expenses, such as initiatives impacting sales, marketing, distribution, or other non-manufacturing functions. Restructuring and related charges reflected in Operating expenses include, but are not limited to, termination and related costs, any asset impairments relating to the functional areas described above, and other costs directly related to the initiatives.

The following table summarizes restructuring and related charges incurred by segment:

 

     2012      2011      2010  

Cost of goods sold:

        

Global Batteries & Appliances

   $ 5,094       $ 756       $ 3,275   

Global Pet Supplies

     4,741         7,085         3,837   

Home and Garden Business

     —           —           38   
  

 

 

    

 

 

    

 

 

 

Total restructuring and related charges in cost of goods sold

   $ 9,835       $ 7,841       $ 7,150   
  

 

 

    

 

 

    

 

 

 

Operating expense:

        

Global Batteries & Appliances

   $ 2,487       $ 5,338       $ 251   

Global Pet Supplies

     5,395         9,567         2,917   

Home and Garden Business

     912         2,704         8,419   

Corporate

     962         3,194         5,381   
  

 

 

    

 

 

    

 

 

 

Total restructuring and related charges in operating expense

   $ 9,756       $ 20,803       $ 16,968   
  

 

 

    

 

 

    

 

 

 

Total restructuring and related charges

   $ 19,591       $ 28,644       $ 24,118   
  

 

 

    

 

 

    

 

 

 

 

S-46


The following table summarizes restructuring and related charges incurred by type of charge:

 

     2012      2011      2010  

Costs included in cost of goods sold:

        

Global Cost Reduction initiatives:

        

Termination benefits

   $ 2,941       $ 1,679       $ 2,630   

Other associated costs

     6,894         5,889         2,273   

Other restructuring initiatives:

        

Termination benefits

     —           —           201   

Other associated costs

     —           273         2,046   
  

 

 

    

 

 

    

 

 

 

Total included in cost of goods sold

   $ 9,835       $ 7,841       $ 7,150   

Costs included in operating expenses:

        

Global Cost Reduction initiatives:

        

Termination benefits

   $ 3,079       $ 10,155       $ 4,268   

Other associated costs

     5,776         7,761         9,272   

Other restructuring initiatives:

        

Termination benefits

     —           956         5,269   

Other associated costs

     901         1,931         (1,841
  

 

 

    

 

 

    

 

 

 

Total included in operating expenses

   $ 9,756       $ 20,803       $ 16,968   
  

 

 

    

 

 

    

 

 

 

Total restructuring and related charges

   $ 19,591       $ 28,644       $ 24,118   
  

 

 

    

 

 

    

 

 

 

Global Cost Reduction Initiatives Summary

During the fiscal year ended September 30, 2009, the Company implemented a series of initiatives within the Global Batteries & Appliances segment, the Global Pet Supplies segment and the Home and Garden Business segment to reduce operating costs, and to evaluate opportunities to improve the Company’s capital structure (the “Global Cost Reduction Initiatives”). These initiatives included headcount reductions and the exit of certain facilities within each of the Company’s segments. These initiatives also included consultation, legal and accounting fees related to the evaluation of the Company’s capital structure. Costs associated with these initiatives, which are expected to be incurred through January 31, 2015, are projected to total approximately $88,700.

The Company recorded $18,690, $25,484 and $18,443 of pretax restructuring and related charges during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, related to the Global Cost Reduction Initiatives.

The following table summarizes the remaining accrual balance associated with the Global Cost Reduction Initiatives and activity that occurred during Fiscal 2012:

 

     Termination
Benefits
    Other
Costs
    Total  

Accrual balance at September 30, 2011

   $ 8,795      $ 3,021      $ 11,816   

Provisions

     2,095        (169     1,926   

Cash expenditures

     (7,765     (1,353     (9,118

Non-cash items

     127        (404     (277
  

 

 

   

 

 

   

 

 

 

Accrual balance at September 30, 2012

   $ 3,252      $ 1,095      $ 4,347   
  

 

 

   

 

 

   

 

 

 

Expensed as incurred (A)

   $ 3,926      $ 12,838      $ 16,764   

 

(A)

Consists of amounts not impacting the accrual for restructuring and related charges.

 

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The following table summarizes the expenses incurred by the Company during Fiscal 2012, the cumulative amount incurred from inception of the initiative through September 30, 2012 and the total future costs expected to be incurred associated with the Global Cost Reduction Initiatives by operating segment:

 

     Global
Batteries and
Appliances
     Global Pet
Supplies
     Home and
Garden
     Corporate      Total  

Restructuring and related charges incurred during Fiscal 2012

   $ 7,642       $ 10,136       $ 912       $ —         $ 18,690   

Restructuring and related charges incurred since initiative inception

   $ 20,809       $ 36,998       $ 17,620       $ 7,591       $ 83,018   

Total future estimated restructuring and related charges expected to be incurred

   $ 1,501       $ 2,575       $ 1,521       $ —         $ 5,597   

In connection with other restructuring efforts, the Company recorded $901, $3,160 and $5,675 of pretax restructuring and related charges during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

(15) Acquisitions

In accordance with ASC Topic 805, “Business Combinations” (“ASC 805”), the Company accounts for acquisitions by applying the acquisition method of accounting. The acquisition method of accounting requires, among other things, that the assets acquired and liabilities assumed in a business combination be measured at their fair values as of the closing date of the acquisition.

Russell Hobbs

On June 16, 2010, the Company consummated the Merger, pursuant to which Spectrum Brands became a wholly-owned subsidiary of the Company and Russell Hobbs became a wholly owned subsidiary of Spectrum Brands. Russell Hobbs is a designer, marketer and distributor of a broad range of branded small household appliances. Russell Hobbs markets and distributes small kitchen and home appliances, pet and pest products and personal care products. Russell Hobbs has a broad portfolio of recognized brand names, including Black & Decker, George Foreman, Russell Hobbs, Toastmaster, LitterMaid, Farberware, Breadman and Juiceman. Russell Hobbs’ customers include mass merchandisers, specialty retailers and appliance distributors primarily in North America, South America, Europe and Australia.

The results of Russell Hobbs operations since June 16, 2010 are included in the Company’s Consolidated Statements of Operations. Effective October 1, 2010, substantially all of the financial results of Russell Hobbs are reported within the Global Batteries & Appliances segment. In addition, certain pest control and pet products included in the former Small Appliances segment have been reclassified into the Home and Garden Business and Global Pet Supplies segments, respectively.

 

S-48


Supplemental Pro Forma Information (Unaudited)

The following reflects the Company’s pro forma results had the results of Russell Hobbs been included for the entirety of Fiscal 2010.

 

     2010  

Net sales:

  

Reported Net sales

   $ 2,567,011   

Russell Hobbs adjustment

     543,952   
  

 

 

 

Pro forma Net sales

   $ 3,110,963   
  

 

 

 

Loss from continuing operations:

  

Reported loss from continuing operations

   $ (187,372

Russell Hobbs adjustment

     (5,504
  

 

 

 

Pro forma loss from continuing operations

   $ (192,876
  

 

 

 

Basic and diluted earnings per share from continuing operations (A) :

  

Reported basic and diluted loss per share from continuing operations

   $ (5.20

Russell Hobbs adjustment

     (0.16
  

 

 

 

Pro forma basic and diluted loss per share from continuing operations

   $ (5.36
  

 

 

 

 

(A)

The Company has not assumed the exercise of common stock equivalents as the impact would be antidilutive.

Black Flag

On October 31, 2011, the Company completed the $43,750 cash acquisition of the Black Flag and TAT trade names from The Homax Group, Inc. (“Black Flag”), a portfolio company of Olympus Partners. The Black Flag and TAT product lines consist of liquids, aerosols, baits and traps that control ants, spiders, wasps, bedbugs, fleas, flies, roaches, yellow jackets and other insects. This acquisition was not significant individually.

The results of Black Flag’s operations since October 31, 2011 are included in the Company’s Consolidated Statements of Operations and are reported as part of the Home and Garden Business segment.

Acquisition Accounting

The assets acquired and liabilities assumed in the Black Flag acquisition have been measured at their fair values at October 31, 2011 as set forth below. The excess of the purchase price over the fair values of the net tangible assets and identifiable intangible assets was recorded as goodwill. The amounts recorded in connection with the acquisition of Black Flag are as follows:

 

Inventory

   $ 2,509   

Property, plant and equipment

     301   

Intangible assets

     25,000   

Goodwill

     15,852   

Other assets

     88   
  

 

 

 

Total consideration

   $ 43,750   
  

 

 

 

 

S-49


The Company performed a valuation of the acquired assets of Black Flag at October 31, 2011. Significant matters related to the determination of the fair values of the acquired identifiable intangible assets are summarized as follows:

 

   

Certain indefinite-lived intangible assets were valued using a relief from royalty methodology. Customer relationships and certain definite-lived intangible assets were valued using a multi-period excess earnings method. The total fair value of indefinite and definite lived intangibles was $25,000 as of October 31, 2011. A summary of the significant key inputs is as follows:

 

   

The Company valued customer relationships using the income approach, specifically the multi-period excess earnings method. In determining the fair value of the customer relationship, the multi-period excess earnings approach values the intangible asset at the present value of the incremental after-tax cash flows attributable only to the customer relationship after deducting contributory asset charges. The incremental after-tax cash flows attributable to the subject intangible asset are then discounted to their present value. Only expected sales from current customers were used, which included an expected growth rate of 3%. The Company assumed a customer retention rate of approximately 95%, which was supported by historical retention rates. Income taxes were estimated at 40% and amounts were discounted using a rate of 13.5%. The customer relationships were valued at $17,000 under this approach and will be amortized over 20 years.

 

   

The Company valued trade names using the income approach, specifically the relief from royalty method. Under this method, the asset value was determined by estimating the hypothetical royalties that would have to be paid if the trade name was not owned. Royalty rates were selected based on consideration of several factors, including other similar trademark licensing and transaction agreements and the relative profitability and perceived contribution of the trademarks and trade names. Royalty rates used in the determination of the fair values of trade names were in the range of 2%-4% of expected net sales related to the respective trade name. The Company anticipates using the trade names for an indefinite period as demonstrated by the sustained use of each subject trademark. In estimating the fair value of the trade names, net sales for the trade names were estimated to grow at a rate of (15)%-8% annually with a terminal year growth rate of 3%. Income taxes were estimated at 40% and amounts were discounted using a rate of 13.5%. Trade names were valued at $8,000 under this approach.

The Company’s estimates and assumptions for Black Flag are subject to change as the Company obtains additional information for its estimates during the measurement period. The primary areas of acquisition accounting that are not yet finalized relate to certain legal matters and residual goodwill.

FURminator

On December 22, 2011, the Company completed the $141,745 cash acquisition of FURminator, Inc. from HKW Capital Partners III, L.P. (“FURminator”). FURminator is a leading worldwide provider of branded and patented pet deshedding products. This acquisition was not significant individually.

The results of FURminator operations since December 22, 2011 are included in the Company’s Consolidated Statements of Operations and are reported as part of the Global Pet Supplies business segment.

 

S-50


Acquisition Accounting

The assets acquired and liabilities assumed in the FURminator acquisition have been measured at their fair values at December 22, 2011 as set forth below. The excess of the purchase price over the fair values of the net tangible assets and identifiable intangible assets was recorded as goodwill. The amounts recorded in connection with the acquisition of FURminator are as follows:

 

Current assets

   $ 9,240   

Property, plant and equipment

     648   

Intangible assets

     79,000   

Goodwill

     68,531   
  

 

 

 

Total assets acquired

   $ 157,419   

Current liabilities

     758   

Long-term liabilities

     14,916   
  

 

 

 

Total liabilities assumed

   $ 15,674   
  

 

 

 

Total consideration

   $ 141,745   
  

 

 

 

The Company performed a valuation of the assets and liabilities of FURminator at December 22, 2011. Significant matters related to the determination of the fair values of the acquired identifiable intangible assets are summarized as follows:

 

   

Certain indefinite-lived intangible assets were valued using a relief from royalty methodology. Customer relationships and certain definite-lived intangible assets were valued using a multi-period excess earnings method. The total fair value of indefinite and definite lived intangibles was $79,000 as of December 22, 2011. A summary of the significant key inputs is as follows:

 

   

The Company valued customer relationships using the income approach, specifically the multi-period excess earnings method. In determining the fair value of the customer relationship, the multi-period excess earnings approach values the intangible asset at the present value of the incremental after-tax cash flows attributable only to the customer relationship after deducting contributory asset charges. The incremental after-tax cash flows attributable to the subject intangible asset are then discounted to their present value. Only expected sales from current customers were used, which included an expected growth rate of 3%. The Company assumed a customer retention rate of approximately 95%, which was supported by historical retention rates. Income taxes were estimated at 40% and amounts were discounted using a rate of 14%. The customer relationships were valued at $46,000 under this approach and will be amortized over 20 years.

 

   

The Company valued trade names using the income approach, specifically the relief from royalty method. Under this method, the asset value was determined by estimating the hypothetical royalties that would have to be paid if the trade name was not owned. Royalty rates were selected based on consideration of several factors, including other similar trademark licensing and transaction agreements and the relative profitability and perceived contribution of the trademarks and trade names. Royalty rates used in the determination of the fair values of trade names were in the range of 4%-5% of expected net sales related to the respective trade name. The Company anticipates using the trade names for an indefinite period as demonstrated by the sustained use of each subject trade name. In estimating the fair value of the trade names, net sales for the trade names were estimated to grow at a rate of 2%-12% annually with a terminal year growth rate of 3%. Income taxes were estimated at 40% and amounts were discounted using a rate of 14%. Trade names were valued at $14,000 under this approach.

 

   

The Company valued technology using the income approach, specifically the relief from royalty method. Under this method, the asset value was determined by estimating the hypothetical royalties that would have to be paid if the technology was not owned. Royalty rates used in the

 

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determination of the fair values of technologies were 10%-12% of expected net sales related to the respective technology. The Company anticipates using these technologies through the legal life of the underlying patent and therefore the expected life of these technologies was equal to the remaining legal life of the underlying patents, which is approximately 9 years. In estimating the fair value of the technologies, net sales were estimated to grow at a rate of 2%-12% annually. Income taxes were estimated at 40% and amounts were discounted using a rate of 14%. The technology assets were valued at $19,000 under this approach.

The Company’s estimates and assumptions for FURminator are subject to change as the Company obtains additional information for its estimates during the measurement period. The primary areas of acquisition accounting that are not yet finalized relate to certain legal matters, income and non-income based taxes and residual goodwill.

(16) New Accounting Pronouncements

Fair Value Measurement

In May 2011, the Financial Accounting Standards Board (the “FASB”) issued amended accounting guidance to achieve a consistent definition of and common requirements for measurement of and disclosure concerning fair value between GAAP and International Financial Reporting Standards. This amended guidance was effective for the Company beginning in the second quarter of its fiscal year ended September 30, 2012. The new accounting guidance did not have a material effect on the Company’s consolidated financial statements.

Presentation of Comprehensive Income

In June 2011, the FASB issued new accounting guidance which requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. This accounting guidance is effective for the Company for the fiscal year beginning October 1, 2012. Early adoption is permitted. The Company is currently evaluating the impact of this new accounting guidance on its consolidated financial statements.

Impairment Testing

During September 2011, the FASB issued new accounting guidance intended to simplify how an entity tests goodwill for impairment. The guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting guidance is effective for the Company for the annual and any interim goodwill impairment tests performed for the fiscal year beginning October 1, 2012. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a significant impact on its consolidated financial statements.

Additionally, in July 2012, the FASB issued new accounting guidance intended to simplify how an entity tests indefinite-lived intangible assets for impairment. The guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An entity will no longer be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting guidance is effective for the Company for the annual and any interim indefinite-lived intangible asset impairment tests performed for the fiscal year beginning October 1, 2012. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a significant impact on its consolidated financial statements.

 

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(17) Subsequent Events

ASC 855, “Subsequent Events,” (“ASC 855”), establishes general standards of accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 requires the Company to evaluate events that occur after the balance sheet date through the date the Company’s financial statements are issued, and to determine whether adjustments to or additional disclosures in the financial statements are necessary. The Company has evaluated subsequent events through the date these financial statements were issued.

Hardware Acquisition and Acquisition Financing

On October 8, 2012, the Company entered into an agreement (the “Acquisition Agreement”) with Stanley Black & Decker to acquire the HHI Business currently operated by Stanley Black & Decker and certain of its subsidiaries for $1,400,000, consisting of (i) the equity interests of certain subsidiaries of Stanley Black & Decker engaged in the business and (ii) certain assets of Stanley Black & Decker used or held for use in connection with the business. The acquisition, when completed, includes (i) the purchase of shares and assets of certain subsidiaries of Stanley Black & Decker involved in the HHI Business and (ii) the purchase of certain assets of TLM Taiwan, which is involved in the production of residential locksets.

The Acquisition Agreement contains certain termination rights for each of Stanley Black & Decker and the Company that upon termination of the Acquisition Agreement under specified circumstances, requires the Company to pay Stanley Black & Decker a termination fee of up to $78,000.

The Company will account for the acquisition in accordance with ASC 805 which requires, among other things, that the assets acquired and liabilities assumed in a business combination be measured at their fair values as of the closing date of the acquisition.

On November 16, 2012, the Company issued at par $520,000 aggregate principal amount of 6.375% Senior Notes due 2020 (the “2020 Notes”) and $570,000 aggregate principal amount of 6.625% Senior Notes due 2022 (the “2022 Notes” and together with the 2020 Notes, the “Notes”). Spectrum Brands will assume and unconditionally guarantee, together with certain of its subsidiaries, the obligations under the Notes and intends to use the proceeds of the Notes to fund a portion of the Hardware Acquisition purchase price and related fees and expenses.

Additionally, Spectrum Brands has obtained debt financing commitments for approximately $1,840,000, inclusive of the Notes, to fund the Hardware Acquisition and refinance a portion of Spectrum Brands’ indebtedness outstanding as of September 30, 2012.

Shaser Acquisition

On November 8, 2012, the Company completed a $50,000 cash acquisition of an approximately 56% interest in Shaser Biosciences, Inc. (“Shaser”), together with terms relating to a potential buyout of the remaining minority interest in Shaser. The Company will account for the acquisition in accordance with ASC 805. The Company is in the process of completing the preliminary purchase accounting.

 

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(18) Quarterly Results (unaudited)

Fiscal 2012:

 

     Quarter Ended  
     September 30, 2012      July 1, 2012      April 1, 2012     January 1, 2012  

Net sales

   $ 832,576       $ 824,803       $ 746,285      $ 848,771   

Gross profit

     279,925         291,696         260,031        284,026   

Net income (loss)

     5,513         58,649         (28,660     13,070   

Basic net income (loss) per common share

   $ 0.11       $ 1.14       $ (0.56   $ 0.25   

Diluted net income (loss) per common share

   $ 0.10       $ 1.13       $ (0.56   $ 0.25   

Fiscal 2011:

 

     Quarter Ended  
     September 30, 2011     July 3, 2011      April 3, 2011     January 2, 2011  

Net sales

   $ 827,329      $ 804,635       $ 693,885      $ 861,067   

Gross profit

     280,495        293,694         255,439        299,239   

Net (loss) income

     (33,831     28,604         (50,186     (19,758

Basic net (loss) income per common share

   $ (0.65   $ 0.56       $ (0.99   $ (0.39

Diluted net (loss) income per common share

   $ (0.65   $ 0.56       $ (0.99   $ (0.39

 

S-54


SPECTRUM BRANDS, INC. AND SUBSIDIARIES

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

For the years ended September 30, 2012, September 30, 2011 and September 30, 2010

(In thousands)

 

Column A

   Column B      Column C Additions      Column D Deductions      Column E  

Descriptions

   Balance at
Beginning
of Period
     Charged to
Costs and
Expenses
     Deductions      Other
Adjustments(A)
     Balance at
End of
Period
 

September 30, 2012:

              

Accounts receivable allowances

   $ 14,128       $ 7,742       $ —         $ —         $ 21,870   

September 30, 2011:

              

Accounts receivable allowances

   $ 4,351       $ 9,777       $ —         $ —         $ 14,128   

September 30, 2010:

              

Accounts receivable allowances

   $ 1,011       $ 3,340       $ —         $ —         $ 4,351   

 

S-55


2.

HARBINGER F&G, LLC AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Independent Auditors’ Report

     S-57   

Consolidated Balance Sheets as of September 30, 2012 and 2011

     S-58   

Consolidated Statements of Operations for the Years Ended September 30, 2012 and 2011

     S-59   

Consolidated Statements of Member’s Equity and Comprehensive Income for the Years Ended September 30, 2012 and 2011

     S-60   

Consolidated Statements of Cash Flows for the Years Ended September 30, 2012 and 2011

     S-61   

Notes to Consolidated Financial Statements

     S-62   

(1) Basis of Presentation and Nature of Operations

     S-62   

(2) Significant Accounting Policies and Practices

     S-63   

(3) Significant Risks and Uncertainties

     S-69   

(4) Investments

     S-70   

(5) Derivative Financial Instruments

     S-75   

(6) Fair Value of Financial Instruments

     S-77   

(7) Intangible Assets

     S-83   

(8) Other Liabilities

     S-84   

(9) Note Payable

     S-84   

(10) Member’s Equity

     S-85   

(11) Employee Benefit Plans

     S-85   

(12) Stock Compensation

     S-86   

(13) Income Taxes

     S-87   

(14) Commitments and Contingencies

     S-90   

(15) Reinsurance

     S-91   

(16) Related Party Transactions

     S-93   

(17) Insurance Subsidiary — Financial Information

     S-95   

(18) Acquisition

     S-95   

Schedule I — Summary of Investments — Other than Investments in Related Parties

     S-100   

Schedule II — Condensed Financial Information of Parent Only

     S-101   

Schedule III — Supplementary Insurance Information

     S-104   

Schedule IV — Reinsurance

     S-105   

 

S-56


Independent Auditors’ Report

The Board of Directors

Harbinger F&G, LLC:

We have audited the accompanying consolidated balance sheets of Harbinger F&G, LLC (the Company) and subsidiaries as of September 30, 2012 and 2011, and the related consolidated statements of operations, member’s equity and comprehensive income, and cash flows for the years then ended. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedules I to IV. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Harbinger F&G, LLC and subsidiaries as of September 30, 2012 and 2011, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Baltimore, Maryland

November 27, 2012

 

S-57


HARBINGER F&G, LLC AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

     September 30,
2012
     September 30,
2011
 
ASSETS   

Investments (Notes 4 and 5):

     

Fixed maturity securities, available-for-sale, at fair value

   $ 16,088,913       $ 15,367,474   

Equity securities, available-for-sale, at fair value

     248,087         287,043   

Derivative investments

     200,667         52,335   

Other invested assets

     18,814         44,279   
  

 

 

    

 

 

 

Total investments

     16,556,481         15,751,131   

Related party loans and investment (Note 16)

     182,069         —     

Cash and cash equivalents

     1,054,588         820,903   

Contingent purchase price reduction receivable (Note 18)

     41,000         —     

Accrued investment income

     191,577         212,848   

Reinsurance recoverable (Note 15)

     2,363,083         1,612,036   

Intangibles, net (Note 7)

     273,543         457,167   

Deferred tax assets (Note 13)

     279,636         207,729   

Other assets

     48,371         346,322   
  

 

 

    

 

 

 

Total assets

   $ 20,990,348       $ 19,408,136   
  

 

 

    

 

 

 
LIABILITIES AND MEMBER’S EQUITY   

Contractholder funds (Note 2)

   $ 15,290,475       $ 14,549,970   

Future policy benefits (Note 2)

     3,614,788         3,598,208   

Liability for policy and contract claims

     91,082         56,650   

Note payable (Note 9)

     —           95,000   

Other liabilities (Note 8)

     703,222         432,907   
  

 

 

    

 

 

 

Total liabilities

     19,699,567         18,732,735   
  

 

 

    

 

 

 

Member’s equity (Note 10)

     

Contributed capital

     415,576         379,359   

Retained earnings

     440,723         136,549   

Accumulated other comprehensive income

     434,482         159,493   
  

 

 

    

 

 

 

Total member’s equity

     1,290,781         675,401   
  

 

 

    

 

 

 

Total liabilities and member’s equity

   $ 20,990,348       $ 19,408,136   
  

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

S-58


HARBINGER F&G, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands)

 

     Year Ended September 30,  
     2012     2011  

Revenues:

    

Premiums

   $ 55,297      $ 39,002   

Net investment income (Note 4)

     716,271        369,840   

Net investment gains (losses) (Note 4)

     410,000        (166,891

Insurance and investment product fees and other

     40,251        48,915   
  

 

 

   

 

 

 

Total revenues

     1,221,819        290,866   
  

 

 

   

 

 

 

Benefits and expenses:

    

Benefits and other changes in policy reserves

     777,372        247,632   

Acquisition and operating expenses, net of deferrals

     123,920        95,778   

Amortization of intangibles (Note 7)

     160,656        (11,115
  

 

 

   

 

 

 

Total benefits and expenses

     1,061,948        332,295   
  

 

 

   

 

 

 

Operating income (loss)

     159,871        (41,429

Interest expense

     (2,556     (1,926

Bargain purchase gain from business acquisition (Note 18)

     —          158,341   

Gain on contingent purchase price reduction (Note 18)

     41,000        —     

Other income, net

     201        31   
  

 

 

   

 

 

 

Income before income taxes

     198,516        115,017   

Income tax benefit (Note 13)

     145,658        41,744   
  

 

 

   

 

 

 

Net income

   $ 344,174      $ 156,761   
  

 

 

   

 

 

 

Supplemental disclosures:

    

Total other-than-temporary impairments

   $ (24,336   $ (17,466

Less non-credit portion of other-than-temporary impairments included other comprehensive income

     (1,529     500   
  

 

 

   

 

 

 

Net other-than-temporary impairments

     (22,807     (17,966

Gains (losses) on derivative instruments

     146,052        (170,752

Other realized investment gains

     286,755        21,827   
  

 

 

   

 

 

 

Total net investment gains (losses)

   $ 410,000      $ (166,891
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

S-59


HARBINGER F&G, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF MEMBER’S EQUITY AND COMPREHENSIVE INCOME

(In thousands)

 

     Contributed
Capital
     Retained
Earnings
(Accumulated
Deficit)
    Accumulated
Other
Comprehensive
Income
    Total
Member’s
Equity
 

Balances at October 1, 2010

   $ 491       $ (212   $ —        $ 279   

Net income

     —           156,761        —          156,761   

Unrealized investment gains, net

     —           —          159,302        159,302   

Non-credit related other-than-temporary impaiments

     —           —          191        191   
         

 

 

 

Comprehensive income

            316,533   
         

 

 

 

Capital contributions from Harbinger Group Inc.

     377,152         —          —          377,152   

Capital contributions from Harbinger Capital Partners

         

Master Fund I, Ltd. to Front Street Re, Ltd.

     1,716         —          —          1,716   

Dividend

     —           (20,000     —          (20,000
  

 

 

    

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

   $ 379,359       $ 136,549      $ 159,493      $ 675,401   

Net income

     —           344,174        —          344,174   

Unrealized investment gains, net

     —           —          275,602        275,602   

Non-credit related other-than-temporary impaiments

     —           —          (613     (613
         

 

 

 

Comprehensive income

     —           —          —          619,163   
         

 

 

 

Stock compensation

     163         —          —          163   

Capital contributions from Harbinger Group Inc.

     36,054         —          —          36,054   

Dividends

     —           (40,000     —          (40,000
  

 

 

    

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

   $ 415,576       $ 440,723      $ 434,482      $ 1,290,781   
  

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

S-60


HARBINGER F&G, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

    Year Ended September 30,  
            2012                     2011          

Cash flows from operating activities:

   

Net income

  $ 344,174      $ 156,761   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

   

Bargain purchase gain from business acquisition

    —          (158,341

Gain on contingent purchase price reduction

    (41,000     —     

Net recognized gains (losses) on investments

    (410,000     166,891   

Amortization of intangibles

    160,656        (11,115

Depreciation of properties

    2,846        1,685   

Stock-based compensation

    163        —     

Amortization of fixed maturity discounts and premiums

    86,943        59,937   

Deferred income taxes

    (220,047     (40,869

Deferred policy acquisition costs

    (194,900     (41,152

Interest credited/index credits to contractholder account balances

    586,814        140,004   

Collateral returned (posted)

    49,339        (148,420

Charges assessed to contractholders for mortality and administration

    (14,932     (28,358

Cash transferred to reinsurers

    (176,770     (52,585

Changes in operating assets and liabilities:

   

Reinsurance recoverable

    (89,078     (39,446

Accrued investment income

    15,224        1,674   

Future policy benefits

    16,580        (6,337

Liability for policy and contract claims

    34,432        (3,750

Other operating

    149,581        (21,987
 

 

 

   

 

 

 

Net cash provided by (used in) operating activities

    300,025        (25,408

Cash flows from investing activities:

   

Cash acquired of $1,040,470 in 2011, net of acquisition cost of $345,000

    —          695,470   

Proceeds from investments, sold, matured or repaid:

   

Fixed maturities

    5,723,266        1,468,427   

Equity securities

    110,157        13,768   

Derivative investments and other invested assets

    157,563        86,437   

Cost of investments acquired:

   

Fixed maturities

    (5,583,495     (1,285,951

Equity securities

    (56,595     —     

Derivative investments and other invested assets

    (141,603     (66,905

Related party loans and investments

    (150,069     —     

Capital expenditures

    (6,209     (1,745

Other investing activities, net

    —          (6,642
 

 

 

   

 

 

 

Net cash provided by investing activities

    53,015        902,859   
 

 

 

   

 

 

 

Cash flows from financing activities:

   

Contractholder account deposits

    2,040,512        494,956   

Contractholder account withdrawals

    (1,979,558     (959,961

Cash capital contributions

    4,030        378,868   

Settlement of note payable

    (95,000     —     

Advances from (repayment to) Harbinger Group Inc.

    (49,339     49,339   

Dividends paid

    (40,000     (20,000
 

 

 

   

 

 

 

Net cash used in financing activities

    (119,355     (56,798
 

 

 

   

 

 

 

Net increase in cash and cash equivalents

    233,685        820,653   

Cash and cash equivalents at beginning of year

    820,903        250   
 

 

 

   

 

 

 

Cash and cash equivalents at end of year

  $ 1,054,588      $ 820,903   
 

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

   

Interest paid

  $ 2,556      $ 1,926   

Income taxes paid

    8,059        —     

See accompanying notes to consolidated financial statements.

 

S-61


HARBINGER F&G, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands)

(1) Basis of Presentation and Nature of Operations

Harbinger F&G, LLC (“HFG” and, collectively with its subsidiaries, the “Company”) is a direct, wholly-owned subsidiary of Harbinger Group Inc. (“HGI”). HGI is a diversified holding company focused on obtaining controlling equity stakes in companies that operate across a diversified set of industries. HGI’s shares of common stock trade on the New York Stock Exchange (“NYSE”) under the symbol “HRG.”

HFG was formed on August 3, 2010 under the name of Harbinger OM, LLC, a Delaware limited liability company, which was at that time wholly-owned by Harbinger Capital Partners Master Fund I, Ltd. (the “Master Fund”), a 68.4% holder of the outstanding common stock (representing a 50.8% voting interest) of HGI as of September 30, 2012. On March 9, 2011, the Master Fund contributed its 100% membership interest in Harbinger OM, LLC to HGI pursuant to a transfer agreement discussed further in Note 16. In connection therewith, the Master Fund transferred to HFG its 100% ownership of FS Holdco Ltd. (“FS Holdco”), the ultimate parent company of Front Street Re Ltd. (“Front Street”), a Bermuda-based reinsurer which commenced start-up operations in August 2010. On April 8, 2011, HGI caused the name of “Harbinger OM, LLC” to be changed to “Harbinger F&G, LLC.”

The contribution of HFG, including FS Holdco and Front Street, to HGI is considered a transaction between entities under common control of the Master Fund under Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations,” and is accounted for similar to the pooling of interest method. In accordance with the guidance in ASC Topic 805, the assets and liabilities transferred between entities under common control are recorded by the receiving entity based on their carrying amounts (or at the historical cost basis of the parent, if these amounts differ). Accordingly, FS Holdco and Front Street are reflected in the accompanying consolidated financial statements at the historical cost basis of the Master Fund, as if they were held by HFG from their inception. Other than FS Holdco and Front Street, HFG had no assets, liabilities or operations at the date it was contributed to HGI. As of September 30, 2010, Front Street had received cumulative capital contributions of $491 from the Master Fund and incurred general and administrative start-up costs of $212 which are reflected as the opening balances of contributed capital and accumulated deficit, respectively, in the accompanying consolidated statement of member’s equity for the year ended September 30, 2011.

As discussed further in Note 18, on April 6, 2011 (the “FGL Acquisition Date”), the Company acquired Fidelity & Guaranty Life Holdings, Inc. (formerly, Old Mutual U.S. Life Holdings, Inc.), a Delaware corporation (“FGL”), from OM Group (UK) Limited (“OMGUK”). Such acquisition (the “FGL Acquisition”) has been accounted for using the acquisition method of accounting. Accordingly, the results of FGL’s operations have been included in the Company’s financial statements commencing April 6, 2011.

FGL’s primary business is the sale of individual life insurance products and annuities through independent agents, managing general agents, and specialty brokerage firms and in selected institutional markets. FGL’s principal products are deferred annuities (including fixed indexed annuity (“FIA”) contracts), immediate annuities and life insurance products. FGL markets products through its wholly-owned insurance subsidiaries, Fidelity & Guaranty Life Insurance Company (“FGL Insurance”) and Fidelity & Guaranty Life Insurance Company of New York (“FGL NY Insurance”), which together are licensed in all fifty states and the District of Columbia.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

 

S-62


(2) Significant Accounting Policies and Practices

Principles of Consolidation

The accompanying audited consolidated financial statements include the accounts of HFG and all other entities in which HFG has a controlling financial interest. All intercompany accounts and transactions have been eliminated in consolidation.

Revenue Recognition

Insurance Premiums

The Company’s insurance premiums for traditional life insurance products are recognized as revenue when due from the contractholder. The Company’s traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of term life insurance and certain annuities with life contingencies.

Premium collections for fixed indexed and fixed rate annuities, indexed universal life (“IUL”) policies and immediate annuities without life contingency are reported as deposit liabilities (i.e., contractholder funds) instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liability for contractholder funds and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender and other charges deducted from contractholder funds, and net realized gains (losses) on investments.

Net Investment Income

Dividends and interest income, recorded in “Net investment income,” are recognized when earned. Amortization of premiums and accretion of discounts on investments in fixed maturity securities are reflected in “Net investment income” over the contractual terms of the investments in a manner that produces a constant effective yield.

For mortgage-backed securities, included in the fixed maturity available-for-sale securities portfolios, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from originally anticipated prepayments, the effective yield is recalculated prospectively to reflect actual payments to date plus anticipated future payments. Any adjustments resulting from changes in effective yield are reflected in “Net investment income.”

Net Investment Gains (Losses)

Net investment gains (losses) include realized gains and losses from the sale of investments, write-downs for other-than-temporary impairments of available-for-sale investments, and gains and losses on derivative investments. Realized gains and losses on the sale of investments are determined using the specific identification method.

Product Fees

Product fee revenue from indexed universal life insurance products and deferred annuities is comprised of policy and contract fees charged for the cost of insurance policy administration and is assessed on a monthly basis and recognized as revenue when assessed and earned. Product fee revenue also includes surrender charges which are recognized and collected when the policy is surrendered.

 

S-63


Cash and Cash equivalents

The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. As of September 30, 2012 and 2011, cash equivalents were $2,250 and $2,768 respectively.

Investments

Investment Securities

The Company’s investments in debt and equity securities have been designated as available-for-sale and are carried at fair value with unrealized gains and losses included in “Accumulated other comprehensive income (loss)” (“AOCI”), net of associated intangibles “shadow adjustments” (discussed in Note 7) and deferred income taxes.

Available-for-sale Securities — Other-Than-Temporary Impairments

The Company regularly reviews available-for-sale securities for declines in fair value that it determines to be other-than-temporary. For an equity security, if the Company does not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, it concludes that an other-than-temporary impairment has occurred and the cost of the equity security is written down to the current fair value, with a corresponding charge to “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations. When assessing its ability and intent to hold an equity security to recovery, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, a fundamental analysis of the liquidity, business prospects and the overall financial condition of the issuer.

For its fixed maturity available-for-sale securities, the Company generally considers the following in determining whether its unrealized losses are other-than-temporarily impaired:

 

 

The estimated range and period until recovery;

 

 

Current delinquencies and nonperforming assets of underlying collateral;

 

 

Expected future default rates;

 

 

Collateral value by vintage, geographic region, industry concentration or property type;

 

 

Subordination levels or other credit enhancements as of the balance sheet date as compared to origination; and

 

 

Contractual and regulatory cash obligations.

The Company recognizes other-than-temporary impairments on debt securities in an unrealized loss position when one of the following circumstances exists:

 

 

The Company does not expect full recovery of its amortized cost based on the estimate of cash flows expected to be collected;

 

 

The Company intends to sell a security; or

 

 

It is more likely than not that the Company will be required to sell a security prior to recovery.

If the Company intends to sell a debt security or it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis and the fair value of the security is below amortized cost, the Company will conclude that an other-than-temporary impairment has occurred and the amortized cost is written down to current fair value, with a corresponding charge to “Net investment gains (losses)” in the

 

S-64


accompanying Consolidated Statements of Operations. If the Company does not intend to sell a debt security or it is more likely than not the Company will not be required to sell a debt security before recovery of its amortized cost basis and the present value of the cash flows expected to be collected is less than the amortized cost of the security (referred to as the credit loss), an other-than-temporary impairment has occurred and the amortized cost is written down to the estimated recovery value with a corresponding charge to “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations, as this amount is deemed the credit loss portion of the other-than-temporary impairment. The remainder of the decline to fair value is recorded in AOCI as unrealized other-than-temporary impairment on available-for-sale securities, as this amount is considered a non-credit (i.e., recoverable) impairment.

When assessing the Company’s intent to sell a debt security or if it is more likely than not the Company will be required to sell a debt security before recovery of its cost basis, the Company evaluates facts and circumstances such as, but not limited to, decisions to reposition the Company’s security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing and tax planning strategies. In order to determine the amount of the credit loss for a security, the Company calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows the Company expects to recover. The discount rate is the effective interest rate implicit in the underlying security. The effective interest rate is the original purchased yield or the yield at the date the debt security was previously impaired.

When evaluating mortgage-backed securities and asset-backed securities, the Company considers a number of pool-specific factors as well as market level factors when determining whether or not the impairment on the security is temporary or other-than-temporary. The most important factor is the performance of the underlying collateral in the security and the trends of that performance. The Company uses this information about the collateral to forecast the timing and rate of mortgage loan defaults, including making projections for loans that are already delinquent and for those loans that are currently performing but may become delinquent in the future. Other factors used in this analysis include type of underlying collateral (e.g., prime, Alternative A-paper (“Alt-A”), or subprime), geographic distribution of underlying loans and timing of liquidations by state. Once default rates and timing assumptions are determined, the Company then makes assumptions regarding the severity of a default if it were to occur. Factors that impact the severity assumption include expectations for future home price appreciation or depreciation, loan size, first lien versus second lien, existence of loan level private mortgage insurance, type of occupancy and geographic distribution of loans. Once default and severity assumptions are determined for the security in question, cash flows for the underlying collateral are projected including expected defaults and prepayments. These cash flows on the collateral are then translated to cash flows on the Company’s tranche based on the cash flow waterfall of the entire capital security structure. If this analysis indicates the entire principal on a particular security will not be returned, the security is reviewed for other-than-temporary impairments by comparing the present value of expected cash flows to amortized cost. To the extent that the security has already been impaired or was purchased at a discount, such that the amortized cost of the security is less than or equal to the present value of cash flows expected to be collected, no impairment is required. The Company also considers the ability of monoline insurers to meet their contractual guarantees on wrapped mortgage-backed securities. Otherwise, if the amortized cost of the security is greater than the present value of the cash flows expected to be collected, then an impairment is recognized.

The Company includes on the face of the Consolidated Statements of Operations the total other-than-temporary impairment recognized in net investment gains (losses), with an offset for the amount of non-credit impairments recognized in AOCI. The Company discloses the amount of other-than-temporary impairments recognized in AOCI and other disclosures related to other-than-temporary impairments in Notes 4 and 10.

Derivative Financial Instruments

The Company hedges certain portions of its exposure to product related equity market risk by entering into derivative transactions. All of such derivative instruments are recognized as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. The change in fair value is recognized within “Net investment gains (losses)” in the accompanying Consolidated Statements of Operations.

 

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The Company purchases and issues financial instruments and products that may contain embedded derivative instruments. If it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host contract for measurement purposes. The embedded derivative is carried at fair value with changes in fair value reported in the accompanying Consolidated Statements of Operations.

Intangible Assets

The Company’s intangible assets include value of business acquired (“VOBA”) and deferred acquisition costs (“DAC”).

VOBA represents the estimated fair value of the right to receive future net cash flows from in-force contracts in a life insurance company acquisition at the Acquisition Date. DAC represents costs that are related directly to new or renewal insurance contracts, which may be deferred to the extent recoverable. These costs include incremental direct costs of contract acquisition, primarily commissions, as well as certain costs related directly to underwriting, policy issuance and processing. Up front bonus credits to policyholder account values, which are considered to be deferred sales inducements (“DSI”), are accounted for similarly to DAC.

The methodology for determining the amortization of VOBA and DAC varies by product type. For all insurance contracts, amortization is based on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and expected trends. US GAAP requires that assumptions for these types of products not be modified unless recoverability testing deems them to be inadequate. VOBA and DAC amortization are reported within “Amortization of intangibles” in the accompanying Consolidated Statements of Operations.

VOBA and DAC for IUL and investment-type products are generally amortized over the lives of the policies in relation to the incidence of estimated gross profits (“EGPs”) from investment income, surrender charges and other product fees, policy benefits, maintenance expenses, mortality net of reinsurance ceded and expense margins, and recognized gains (losses) on investments.

Changes in assumptions can have a significant impact on VOBA and DAC balances and amortization rates. Due to the relative size and sensitivity to minor changes in underlying assumptions of VOBA and DAC balances, the Company performs quarterly and annual analyses of VOBA and DAC for the annuity and indexed universal life businesses. The VOBA and DAC balances are also periodically evaluated for recoverability to ensure that the unamortized portion does not exceed the expected recoverable amounts. At each evaluation date, actual historical gross profits are reflected, and estimated future gross profits and related assumptions are evaluated for continued reasonableness. Any adjustment in estimated future gross profits requires that the amortization rate be revised (“unlocking”) retroactively to the date of the policy or contract issuance. The cumulative unlocking adjustment is recognized as a component of current period amortization.

The carrying amounts of VOBA and DAC are adjusted for the effects of realized and unrealized gains and losses on debt securities classified as available-for-sale and certain derivatives and embedded derivatives. Amortization expense of VOBA and DAC reflects an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, the Company performs a retrospective unlocking of VOBA and DAC amortization as actual margins vary from expected margins. This unlocking is reflected in the accompanying Consolidated Statements of Operations.

For investment-type products, the VOBA and DAC assets are adjusted for the impact of unrealized gains (losses) on investments as if these gains (losses) had been realized, with corresponding credits or charges included in AOCI.

 

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Reinsurance

The Company’s insurance subsidiaries enter into reinsurance agreements with other companies in the normal course of business. The assets, liabilities, premiums and benefits of certain reinsurance contracts are presented on a net basis in the accompanying Consolidated Balance Sheets and Consolidated Statements of Operations, respectively, when there is a right of offset explicit in the reinsurance agreements. All other reinsurance agreements are reported on a gross basis in the Company’s Consolidated Balance Sheets as an asset for amounts recoverable from reinsurers or as a component of other liabilities for amounts, such as premiums, owed to the reinsurers, with the exception of amounts for which the right of offset also exists. Premiums and benefits are reported net of insurance ceded.

Income Taxes

HFG and certain of its non-life insurance subsidiaries are included in the consolidated U.S. Federal income tax return of HGI. The Company’s life insurance subsidiaries file a consolidated life insurance income tax return. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has the ability and intent to recover in a tax-free manner assets (or liabilities) with book/tax basis differences for which no deferred taxes have been provided, in accordance with ASC Topic 740, “Income Taxes. “ Accordingly, the Company did not provide deferred income taxes on the bargain purchase gain of $158,341 on the FGL acquisition or the gain on contingent purchase price reduction of $41,000 in Fiscal 2012 and 2011, respectively.

The Company applies the accounting guidance for uncertain tax positions which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The guidance also provides information on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely to be realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Accrued interest expense and penalties related to uncertain tax positions are recorded in “Income tax expense” in the Company’s Consolidated Statements of Operations. The Company had no unrecognized tax benefits related to uncertain tax positions as of September 30, 2012 and 2011.

Contractholder Funds and Future Policy Benefits

The liabilities for contractholder funds and future policy benefits for investment contracts and IUL insurance policies consist of contract account balances that accrue to the benefit of the contractholders, excluding surrender charges. Investment contracts include FIAs, deferred annuities and immediate annuities without life contingencies. The liabilities for future insurance contract benefits and claim reserves for traditional life policies and pay-out annuity policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Assumptions for contracts in-force as of the FGL Acquisition Date were updated as of that date.

Liabilities for the secondary guarantees on IUL-type products or Investment-type contracts are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of VOBA and DAC. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of VOBA and DAC.

 

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FIA contracts are equal to the total of the policyholder account values before surrender charges, and additional reserves established on certain features offered that link interest credited to an equity index. These features create an embedded derivative that is not clearly and closely related to the host insurance contract. The embedded derivative is carried at fair value with changes in fair value reported in the accompanying Consolidated Statements of Operations.

Federal Home Loan Bank of Atlanta Agreements

Contractholder funds include funds related to funding agreements that have been issued to the Federal Home Loan Bank of Atlanta (“FHLB”) as a funding medium for single premium funding agreements issued by the Company to the FHLB.

Funding agreements were issued to the FHLB in 2003, 2004, 2005 and 2011. The funding agreements (i.e., immediate annuity contracts without life contingencies) provide a guaranteed stream of payments. Single premiums were received at the initiation of the funding agreements and were in the form of advances from the FHLB. Payments under the funding agreements extend through 2022. The reserves for the funding agreements totaled $364,140 and $169,580 at September 30, 2012 and 2011, respectively, and are included in “Contractholder funds” in the accompanying Consolidated Balance Sheets.

In accordance with the agreements, the investments supporting the funding agreement liabilities are pledged as collateral to secure the FHLB funding agreement liabilities. The collateral investments had a fair value of $390,563 and $191,331 at September 30, 2012 and September 30, 2011, respectively.

Benefits and Other Changes in Policy Reserves

Benefit expenses for deferred annuity, FIA and IUL policies include benefit claims incurred during the period in excess of contract account balances. Other changes in policy reserves also include the change in reserves for life insurance products with secondary guarantee benefits. For traditional life, policy benefit claims are charged to expense in the period that the claims are incurred.

Retrospective Adjustments

As discussed further in Note 18, in Fiscal 2012 the Company finalized the provisional acquisition accounting balances for the FGL Acquisition, resulting in retrospective adjustments which increased the bargain purchase gain and net income by $7,264 in Fiscal 2011.

Recent Accounting Pronouncements Not Yet Adopted

Presentation of Comprehensive Income

In June 2011, the Financial Accounting Standards Board (“FASB”) issued amended disclosure requirements to report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This guidance will be effective for the Company beginning in the fiscal year ending September 30, 2013. The Company does not expect the guidance to impact its consolidated financial statements, as it only requires a change in the format of presentation.

Offsetting Assets and Liabilities

In December 2011, the FASB issued amended disclosure requirements for offsetting financial assets and financial liabilities to allow investors to better compare financial statements prepared under US GAAP with financial statements prepared under International Financial Reporting Standards. The new standards are effective for the Company beginning in the first quarter of its fiscal year ending September 30, 2014. The Company is currently evaluating the impact of this new accounting guidance on the disclosures included in its consolidated financial statements.

 

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Subsequent Events

The Company evaluated subsequent events through the date when the financial statements were issued. During this period, the Company did not have any, other than disclosed herein, material recognizable, or unrecognizable, subsequent events.

(3) Significant Risks and Uncertainties

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the inherent uncertainty involved in making estimates, actual results in future periods could differ from those estimates.

The Company’s significant estimates which are susceptible to change in the near term relate to (1) recognition of deferred tax assets and related valuation allowances (see Notes 13 and 18), (2) fair value of certain invested assets and derivatives including embedded derivatives (see Notes 4, 5 and 6), (3) other-than-temporary impairments of available-for-sale investments (see Note 4), (4) amortization of intangibles (see discussion of “Intangible Assets” in Note 2 and also Note 7) and (5) estimates of reserves for loss contingencies, including litigation and regulatory reserves (see Note 14).

Concentrations of Financial Instruments

As of September 30, 2012, the Company’s most significant investment in one industry was its investment securities in the banking industry with a fair value of $2,000,355, or 12% of the invested assets portfolio. The Company’s holdings in this industry includes investments in 118 different issuers with the top ten investments accounting for 36% of the total holdings in this industry. As of September 30, 2012, the Company’s exposure to sub-prime and Alternative-A residential mortgage-backed securities was $233,318 and $121,639, respectively, or each approximately 1% of the Company’s invested assets. As of September 30, 2012 and 2011, the Company had investments in 5 and 38 issuers that exceeded 10% of stockholders equity with a fair value of $710,069 and $3,582,473, or 4% and 23% of the invested assets portfolio, respectively. Additionally, the Company’s largest concentration in any single issuer as of September 30, 2012 and 2011 had a fair value of $152,876 and $159,265, or approximately 1% of the invested assets portfolio at each date.

Concentrations of Financial and Capital Markets Risk

Financial markets in the United States and elsewhere have experienced extreme volatility and disruption for more than three years, due largely to the stresses affecting the global banking system. Like other life insurers, FGL has been adversely affected by these conditions. FGL is exposed to financial and capital markets risk, including changes in interest rates and credit spreads which have had an adverse effect on FGL’s results of operations, financial condition and liquidity prior to the FGL Acquisition. As discussed further in the following paragraph regarding risk factors, the Company expects to continue to face challenges and uncertainties that could adversely affect its results of operations and financial condition.

The Company’s exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will decrease the net unrealized gain position of the Company’s investment portfolio and, if long-term interest rates rise dramatically within a six to twelve month time period, certain of the Company’s products may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring the Company to liquidate assets in an unrealized loss position. This risk is mitigated to some extent by the high level of surrender charge protection provided by the Company’s products.

 

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Concentration of Reinsurance Risk

The Company has a significant concentration of reinsurance with Wilton Reassurance Company (“Wilton Re”) (see Note 15) that could have a material impact on the Company’s financial position in the event that Wilton Re fails to perform its obligations under the various reinsurance treaties. As of September 30, 2012, the net amount recoverable from Wilton Re was $1,317,114. FGL monitors both the financial condition of individual reinsurers and risk concentration arising from similar geographic regions, activities and economic characteristics of reinsurers to reduce the risk of default by such reinsurers.

(4) Investments

The Company’s investments at September 30, 2012 and 2011 are summarized as follows:

 

    September 30, 2012  
    Amortized Cost     Gross Unrealized
Gains
    Gross Unrealized
Losses
    Fair Value and
Carrying Value
 

Available-for-sale securities

       

Asset-backed securities

  $ 1,010,938      $ 18,553      $ (1,609   $ 1,027,882   

Commercial mortgage-backed securities

    520,043        36,178        (2,407     553,814   

Corporates

    10,211,804        807,175        (9,968     11,009,011   

Equities

    237,499        11,860        (1,272     248,087   

Hybrids

    519,009        18,836        (9,550     528,295   

Municipals

    1,083,231        141,854        (1,090     1,223,995   

Agency residential mortgage-backed securities

    149,455        5,769        (334     154,890   

Non-agency residential mortgage-backed securities

    629,122        35,799        (4,262     660,659   

U.S. Government

    917,452        12,915        —          930,367   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

    15,278,553        1,088,939        (30,492     16,337,000   

Derivative investments

    142,123        66,973        (8,429     200,667   

Other invested assets

    18,814        —          —          18,814   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

  $ 15,439,490      $ 1,155,912      $ (38,921   $ 16,556,481   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

    September 30, 2011  
    Amortized Cost     Gross Unrealized
Gains
    Gross Unrealized
Losses
    Fair Value and
Carrying Value
 

Available-for-sale securities

       

Asset-backed securities

  $ 501,469      $ 1,785      $ (2,770   $ 500,484   

Commercial mortgage-backed securities

    580,313        3,427        (18,163     565,577   

Corporates

    11,479,862        506,264        (130,352     11,855,774   

Equities

    292,112        3,964        (9,033     287,043   

Hybrids

    699,915        10,429        (51,055     659,289   

Municipals

    824,562        111,929        (7     936,484   

Agency residential mortgage-backed securities

    217,354        4,966        (295     222,025   

Non-agency residential mortgage-backed securities

    465,666        1,971        (23,120     444,517   

U.S. Government

    175,054        8,270        —          183,324   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

    15,236,307        653,005        (234,795     15,654,517   

Derivative investments

    171,612        405        (119,682     52,335   

Other invested assets

    44,279        —          —          44,279   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investments

  $ 15,452,198      $ 653,410      $ (354,477   $ 15,751,131   
 

 

 

   

 

 

   

 

 

   

 

 

 

Included in AOCI were cumulative unrealized gains of $851 and $524 and unrealized losses of $1,880 and $24 related to the non-credit portion of other-than-temporary impairments on non-agency residential mortgage-backed securities at September 30, 2012 and 2011, respectively.

 

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Securities held on deposit with various state regulatory authorities had a fair value of $20,692 and $17,867 at September 30, 2012 and 2011, respectively.

The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities, as applicable, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.

 

     September 30, 2012  
     Amortized Cost      Fair Value  

Corporate, Non-structured Hybrids, Municipal and U.S. Government securities:

     

Due in one year or less

   $ 700,491       $ 703,931   

Due after one year through five years

     3,230,602         3,324,453   

Due after five years through ten years

     3,692,333         3,995,811   

Due after ten years

     4,972,233         5,532,389   
  

 

 

    

 

 

 

Subtotal

     12,595,659         13,556,584   

Other securities which provide for periodic payments:

     

Asset-backed securities

     1,010,938         1,027,882   

Commercial-mortgage-backed securities

     520,043         553,814   

Structured hybrids

     135,837         135,084   

Agency residential mortgage-backed securities

     149,455         154,890   

Non-agency residential mortgage-backed securities

     629,122         660,659   
  

 

 

    

 

 

 

Total fixed maturity available-for-sale securities

   $ 15,041,054       $ 16,088,913   
  

 

 

    

 

 

 

As part of its ongoing securities monitoring process, the Company evaluates whether securities in an unrealized loss position could potentially be other-than-temporarily impaired. Excluding the non-credit portion of other-than-temporary impairments on non-agency residential mortgage-backed securities above, the Company has concluded that the fair values of the securities presented in the table below were not other-than-temporarily impaired as of September 30, 2012. This conclusion is derived from the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms along with the expectation that they will continue to do so. Also contributing to this conclusion is its determination that it is more likely than not that the Company will not be required to sell these securities prior to recovery, an assessment of the issuers’ financial condition, and other objective evidence. As it specifically relates to asset-backed securities and commercial mortgage-backed securities, the present value of cash flows expected to be collected is at least the amount of the amortized cost basis of the security and the Company’s management has the intent to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value.

 

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The fair value and gross unrealized losses of available-for-sale securities, aggregated by investment category, were as follows:

 

    September 30, 2012  
    Less than 12 months     12 months or longer     Total  
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
 

Available-for-sale securities

           

Asset-backed securities

  $ 169,794      $ (1,042   $ 7,533      $ (567   $ 177,327      $ (1,609

Commercial-mortgage-backed securities

    813        (853     10,716        (1,554     11,529        (2,407

Corporates

    411,310        (8,124     45,482        (1,844     456,792        (9,968

Equities

    —          —          44,513        (1,272     44,513        (1,272

Hybrids

    13,407        (339     107,707        (9,211     121,114        (9,550

Municipals

    71,160        (1,090     —          —          71,160        (1,090

Agency residential mortgage-backed securities

    1,754        (199     6,110        (135     7,864        (334

Non-agency residential mortgage-backed securities

    12,853        (289     101,777        (3,973     114,630        (4,262
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

  $ 681,091      $ (11,936   $ 323,838      $ (18,556   $ 1,004,929      $ (30,492
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total number of available-for-sale securities in an unrealized loss position

      100          56          156   
   

 

 

     

 

 

     

 

 

 

 

    September 30, 2011  
    Less than 12 months     12 months or longer     Total  
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized

Losses
 

Available-for-sale securities

           

Asset-backed securities

  $ 275,135      $ (2,770   $ —        $ —        $ 275,135      $ (2,770

Commercial-mortgage-backed securities

    338,865        (18,163     —          —          338,865        (18,163

Corporates

    3,081,556        (130,352     —          —          3,081,556        (130,352

Equities

    99,772        (9,033     —          —          99,772        (9,033

Hybrids

    450,376        (51,055     —          —          450,376        (51,055

Municipals

    1,137        (7     —          —          1,137        (7

Agency residential mortgage-backed securities

    25,820        (295     —          —          25,820        (295

Non-agency residential mortgage-backed securities

    375,349        (23,120     —          —          375,349        (23,120
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

  $ 4,648,010      $ (234,795   $ —        $ —        $ 4,648,010      $ (234,795
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total number of available-for-sale securities in an unrealized loss position

      505              505   
   

 

 

         

 

 

 

 

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As the amortized cost of all investments was adjusted to fair value as of the FGL Acquisition Date, no individual securities had been in a continuous unrealized loss position greater than twelve months as of September 30, 2011.

At September 30, 2012 and 2011, securities in an unrealized loss position were primarily concentrated in investment grade corporate debt instruments, residential mortgage-backed securities and hybrids. Total unrealized losses were $30,492 and $234,795 at September 30, 2012 and 2011, respectively. Exposure to finance-related holdings represents the largest component of the unrealized loss position in the portfolio, as spreads for holdings in this industry sector remain above historical levels. Similar risk aversion effects have impacted prices of commercial mortgage-backed securities and non-agency residential mortgage-backed securities. The Company has added to its non-agency residential mortgage-backed holdings during the year by purchasing securities with an “A” credit rating or above at discounts. As of September 30, 2012, these securities were in an unrealized gain position. The Company has not added to its commercial mortgage-backed security exposure. The improvement in unrealized loss positions in corporate debt instruments from September 30, 2011 to September 30, 2012 was primarily a result of improving conditions for corporate issues.

The combination of ongoing liquidity efforts by global central banks to stem contagion from a Eurozone slowdown, and accommodative monetary policy (especially in the U.S.) that is keeping base interest rates low, helped drive strong performance in risk assets in the September 2012 quarter. The prices of securities exposed to the residential real estate market in the U.S. also increased, which management believes is a result of the decline in risk aversion and data indicating that the housing market in the US has improved.

At September 30, 2012 and 2011, securities with a fair value of $1,192 and $31,320, respectively, were depressed greater than 20% of amortized cost, which represented less than 1% of the carrying values of all investments. The improvement in unrealized loss positions from September 30, 2011 is primarily due to two factors: (i) securities at depressed prices were sold over the past fiscal year, reducing the size of holdings in an unrealized loss position and (ii) improving risk sentiment has lifted the market prices of investment grade bonds. Based upon the Company’s current evaluation of these securities in accordance with its impairment policy and its intent to retain these investments for a period of time sufficient to allow for recovery in value, the Company has determined that these securities are not other-than-temporarily impaired.

The following table provides a reconciliation of the beginning and ending balances of the credit loss portion of other-than-temporary impairments on fixed maturity securities held by the Company at September 30, 2012 and 2011, for which a portion of the other-than-temporary impairment was recognized in AOCI:

 

     Year Ended
September 30,
 
     2012      2011  

Beginning balance

   $ 667       $ —     

Increases attributable to credit losses on securities:

     

Other-than-temporary impairment was previously recognized

     112         —     

Other-than-temporary impairment was not previously recognized

     1,902         667   
  

 

 

    

 

 

 

Ending balance

   $ 2,681       $ 667   
  

 

 

    

 

 

 

For the year ended September 30, 2012, the Company recognized impairment losses in operations totaling $22,807, including credit impairments of $5,712 and change-of-intent impairments of $17,095, as well as non-credit losses in other comprehensive income totaling $1,529, for investments which experienced other-than-temporary impairments and had an amortized cost of $162,349 and a fair value of $138,013 at the time of impairment. For the year ended September 30, 2011, FGL recognized impairment losses in operations totaling $17,966, including credit impairments of $5,059 and change-of-intent impairments of $12,907, as well as non-credit gains totaling $500 in other comprehensive income, for investments which experienced other-than-temporary impairments and had an amortized cost of $103,312 and a fair value of $85,846 at the time of

 

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impairment. Details underlying write-downs taken as a result of other-than-temporary impairments that were recognized in operations and included in net realized gains on securities were as follows:

 

     Year Ended
September 30,
 
     2012      2011  

Other-than-temporary impairments recognized in net income:

     

Commercial mortgage-backed securities

   $ —         $ 20   

Corporates

     4,116         1,462   

Equities

     —           11,007   

Hybrids

     9,688         —     

Non-agency residential mortgage-backed securities

     7,531         5,059   

Asset-backed loans and other invested assets

     1,472         418   
  

 

 

    

 

 

 

Total other-than-temporary impairments

   $ 22,807       $ 17,966   
  

 

 

    

 

 

 

Net Investment Income

The major sources of “Net investment income” in the accompanying Consolidated Statements of Operations were as follows:

 

     Year Ended
September 30,
 
     2012     2011  

Fixed maturity available-for-sale securities

   $ 707,132      $ 364,771   

Equity available-for-sale securities

     13,966        10,190   

Invested cash and short-term investments

     4,921        129   

Policy loans

     707        1,511   

Other investments

     1,179        326   
  

 

 

   

 

 

 

Gross investment income

     727,905        376,927   

External investment expense

     (11,634     (7,087
  

 

 

   

 

 

 

Net investment income

   $ 716,271      $ 369,840   
  

 

 

   

 

 

 

Net Investment Gains (Losses)

Details underlying “Net investment gains (losses)” reported in the accompanying Consolidated Statements of Operations were as follows:

 

     Year Ended
September 30,
 
     2012     2011  

Net realized gains on fixed maturity available-for-sale securities

   $ 264,408      $ 16,912   

Realized gains (losses) on equity securities

     924        (10,977
  

 

 

   

 

 

 

Net realized gains on securities

     265,332        5,935   
  

 

 

   

 

 

 

Realized losses on certain derivative instruments

     (10,280     (44,776

Unrealized gains (losses) on certain derivative instruments

     156,332        (125,976
  

 

 

   

 

 

 

Change in fair value of derivatives

     146,052        (170,752
  

 

 

   

 

 

 

Realized losses on other invested assets

     (1,384     (2,074
  

 

 

   

 

 

 

Net investment gains (losses)

   $ 410,000      $ (166,891
  

 

 

   

 

 

 

 

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For the years ended September 30, 2012 and 2011, proceeds from the sale of fixed maturity available-for-sale securities, including assets transferred to Wilton Re as discussed in Note 15 totaled $4,602,958 and $1,803,964, gross gains on such sales totaled $295,923 and $41,989 and gross losses totaled $13,842 and $17,109, respectively.

Underlying write-downs taken to fixed maturity available-for-sale securities as a result of other-than-temporary impairments that were recognized in earnings and included in net realized gains on securities above were $22,807 and $17,966 for the year ended September 30, 2012 and 2011, respectively. The portion of other-than-temporary impairments recognized in AOCI is disclosed in Note 10.

(5) Derivative Financial Instruments

The carrying amounts (which equal fair value) of derivative instruments, including derivative instruments embedded in FIA contracts, is as follows:

 

     September 30,  
     2012      2011  

Assets:

     

Derivative investments:

     

Call options

   $ 200,667       $ 52,335   
  

 

 

    

 

 

 

Liabilities:

     

Contractholder funds:

     

FIA embedded derivative

   $ 1,550,805       $ 1,396,340   

Other liabilities:

     

Futures contracts

     928         3,828   

Available-for-sale embedded derivative

     —         $ 400   
  

 

 

    

 

 

 
   $ 1,551,733       $ 1,400,568   
  

 

 

    

 

 

 

The change in fair value of derivative instruments included in the accompanying Consolidated Statements of Operations is as follows:

 

     Year Ended
September 30,
 
     2012      2011  

Revenues:

     

Net investment gains (losses):

     

Call options

   $ 100,030       $ (142,665

Futures contracts

     46,022         (28,087
  

 

 

    

 

 

 
     146,052         (170,752

Net investment income:

     

Available-for-sale embedded derivatives

     400         19   
  

 

 

    

 

 

 
   $ 146,452       $ (170,733
  

 

 

    

 

 

 
     

Benefits and other changes in policy reserves:

     

FIA embedded derivatives

   $ 154,465       $ (69,968
  

 

 

    

 

 

 

 

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Additional Disclosures

FIA Contracts

The Company has FIA contracts that permit the holder to elect an interest rate return or an equity index linked component, where interest credited to the contracts is linked to the performance of various equity indices, primarily the Standard and Poor’s (“S&P”) 500 Index. This feature represents an embedded derivative under US GAAP. The FIA embedded derivative is valued at fair value and included in the liability for contractholder funds in the accompanying Consolidated Balance Sheets with changes in fair value included as a component of benefits and other changes in policy reserves in the Consolidated Statements of Operations.

The Company purchases derivatives consisting of a combination of call options and futures contracts on the applicable market indices to fund the index credits due to FIA contractholders. The call options are one, two and three year options purchased to match the funding requirements of the underlying policies. On the respective anniversary dates of the index policies, the index used to compute the interest credit is reset and the Company purchases new one, two or three year call options to fund the next index credit. The Company manages the cost of these purchases through the terms of its FIA contracts, which permit the Company to change caps or participation rates, subject to guaranteed minimums on each contract’s anniversary date. The change in the fair value of the call options and futures contracts is generally designed to offset the portion of the change in the fair value of the FIA embedded derivative related to index performance. The call options and futures contracts are marked to fair value with the change in fair value included as a component of “Net investment gains (losses).” The change in fair value of the call options and futures contracts includes the gains and losses recognized at the expiration of the instrument term or upon early termination and the changes in fair value of open positions.

Other market exposures are hedged periodically depending on market conditions and the Company’s risk tolerance. The Company’s FIA hedging strategy economically hedges the equity returns and exposes the Company to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. The Company uses a variety of techniques, including direct estimation of market sensitivities and value-at-risk to monitor this risk daily. The Company intends to continue to adjust the hedging strategy as market conditions and the Company’s risk tolerance change.

Credit Risk

The Company is exposed to credit loss in the event of nonperformance by its counterparties on the call options and reflects assumptions regarding this nonperformance risk in the fair value of the call options. The nonperformance risk is the net counterparty exposure based on the fair value of the open contracts less collateral held. The Company maintains a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.

Information regarding the Company’s exposure to credit loss on the call options it holds is presented in the following table:

 

          September 30, 2012      September 30, 2011  

Counterparty

   Credit Rating
(Moody’s/S&P)
   Notional
Amount
     Fair Value      Notional
Amount
     Fair Value  

Bank of America

   Baa2/A-    $ 1,884,047       $ 64,101       $ 1,692,142       $ 14,637   

Deutsche Bank

   A2/A+      1,816,532         61,704         1,463,596         11,402   

Morgan Stanley

   Baa1/A-      1,634,686         51,630         1,629,247         15,373   

Royal Bank of Scotland

   Baa1/A-      353,875         19,595         —           —     

Barclay’s Bank

   A2/A+      131,255         3,081         385,189         4,105   

Credit Suisse

   A2/A      10,000         556         327,095         2,785   

Nomura

   Baa2/A-      —           —           107,000         4,033   
     

 

 

    

 

 

    

 

 

    

 

 

 
      $ 5,830,395       $ 200,667       $ 5,604,269       $ 52,335   
     

 

 

    

 

 

    

 

 

    

 

 

 

 

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Collateral Agreements

The Company is required to maintain minimum ratings as a matter of routine practice under its ISDA agreements. Under some ISDA agreements, the Company has agreed to maintain certain financial strength ratings. A downgrade below these levels provides the counterparty under the agreement the right to terminate the open derivative contracts between the parties, at which time any amounts payable by the Company or the counterparty would be dependent on the market value of the underlying derivative contracts. The Company’s current rating allows multiple counterparties the right to terminate ISDA agreements. No ISDA agreements have been terminated, although the counterparties have reserved the right to terminate the ISDA agreements at any time. In certain transactions, the Company and the counterparty have entered into a collateral support agreement requiring either party to post collateral when the net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. As of September 30, 2012 and 2011, no collateral was posted by the Company’s counterparties as they did not meet the net exposure thresholds. Accordingly, the maximum amount of loss due to credit risk that the Company would incur if parties to the call options failed completely to perform according to the terms of the contracts was $200,667 and $52,335 at September 30, 2012 and 2011, respectively.

The Company held 2,835 and 2,458 futures contracts at September 30, 2012 and 2011, respectively. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). The Company provides cash collateral to the counterparties for the initial and variation margin on the futures contracts which is included in “Cash and cash equivalents” in the accompanying Consolidated Balance Sheets. The amount of collateral held by the counterparties for such contracts was $9,820 at both September 30, 2012 and 2011.

(6) Fair Value of Financial Instruments

The Company’s measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which may include the Company’s own credit risk. The Company’s estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:

Level 1 — Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.

Level 2 — Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves.

Level 3 — Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lower level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.

 

S-77


When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.

The carrying amounts and estimated fair values of the Company’s consolidated financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, with the exception of investment contracts and related party loans, are summarized according to the hierarchy previously described, as follows:

 

    September 30, 2012  
    Level 1     Level 2     Level 3     Fair Value     Carrying
Amount
 

Assets

         

Cash and cash equivalents

  $ 1,052,338      $ 2,250      $ —        $ 1,054,588      $ 1,054,588   

Contingent purchase price reduction receivable

    —          —          41,000        41,000        41,000   

Fixed maturity securities, available-for-sale:

         

Asset-backed securities

    —          1,012,027        15,855        1,027,882        1,027,882   

Commercial mortgage-backed securities

    —          548,791        5,023        553,814        553,814   

Corporates

    —          10,873,715        135,296        11,009,011        11,009,011   

Hybrids

    —          519,422        8,873        528,295        528,295   

Municipals

    —          1,223,995        —          1,223,995        1,223,995   

Agency residential mortgage-backed securities

    —          154,890        —          154,890        154,890   

Non-agency residential mortgage-backed securities

    —          660,659        —          660,659        660,659   

U.S. Government

    930,367        —          —          930,367        930,367   

Equity securities — available-for-sale

    —          248,087        —          248,087        248,087   

Derivative financial instruments

    —          200,667        —          200,667        200,667   

Related party loans

    —          —          150,069        150,069        150,069   

Related party investments

    —          —          32,000        32,000        32,000   

Other invested assets

    —          —          18,814        18,814        18,814   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets

  $ 1,982,705      $ 15,444,503      $ 406,930      $ 17,834,138      $ 17,834,138   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

         

Derivatives:

         

FIA embedded derivatives, included in contractholder funds

  $ —        $ —        $ 1,550,805      $ 1,550,805      $ 1,550,805   

Futures contracts

    —          928        —          928        928   

Investment contracts, included in contractholder funds

    —          —          12,271,882        12,271,882        13,739,670   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial liabilities

  $ —        $ 928      $ 13,822,687      $ 13,823,615      $ 15,291,403   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

S-78


    September 30, 2011  
    Level 1     Level 2     Level 3     Fair Value     Carrying
Amount
 

Assets

         

Cash and cash equivalents

  $ 818,135      $ 2,768      $ —        $ 820,903      $ 820,903   

Fixed maturity securities, available-for-sale:

         

Asset-backed securities

    —          125,966        374,518        500,484        500,484   

Commercial mortgage-backed securities

    —          565,577        —          565,577        565,577   

Corporates

    —          11,696,090        159,684        11,855,774        11,855,774   

Hybrids

    —          654,084        5,205        659,289        659,289   

Municipals

    —          936,484        —          936,484        936,484   

Agency residential mortgage-backed securities

    —          218,713        3,312        222,025        222,025   

Non-agency residential mortgage-backed securities

    —          440,758        3,759        444,517        444,517   

U.S. Government

    183,324        —          —          183,324        183,324   

Equity securities — available-for-sale

    —          287,043        —          287,043        287,043   

Derivative financial instruments

    —          52,335        —          52,335        52,335   

Other invested assets

    —          —          44,279        44,279        44,279   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets

  $ 1,001,459      $ 14,979,818      $ 590,757      $ 16,572,034      $ 16,572,034   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

         

Derivatives:

         

FIA embedded derivatives, included in contractholder funds

  $ —        $ —        $ 1,396,340      $ 1,396,340      $ 1,396,340   

Futures contracts

    —          3,828        —          3,828        3,828   

Available-for-sale embedded derivative

    —          —          400        400        400   

Investment contracts, included in contractholder funds

    —          —          11,992,013        11,992,013        13,153,630   

Note payable

    —          95,000        —          95,000        95,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial liabilities

  $ —        $ 98,828      $ 13,388,753      $ 13,487,581      $ 14,649,198   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The carrying amounts of accrued investment income and portions of other liabilities approximate fair value due to their short duration and, accordingly, they are not presented in the tables above.

The Company measures the fair value of its securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and the Company will then consistently apply the valuation methodology to measure the security’s fair value. The Company’s fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include a third-party pricing service, independent broker quotations or pricing matrices. The Company uses observable and unobservable inputs in its valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored and further market data will be acquired when certain thresholds are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. Management believes the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices.

The Company did not adjust prices received from third parties as of September 30, 2012 and 2011. However, the Company does analyze the third party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy.

 

S-79


The fair value of derivative assets and liabilities is based upon valuation pricing models, which represents what the Company would expect to receive or pay at the balance sheet date if it cancelled the options, entered into offsetting positions, or exercised the options. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). Fair values for these instruments are determined externally by an independent actuarial firm using market observable inputs, including interest rates, yield curve volatilities, and other factors. Credit risk related to the counterparty is considered when estimating the fair values of these derivatives. The fair values of the embedded derivatives in the FGL’s FIA products are derived using market indices, pricing assumptions and historical data.

Investment contracts include deferred annuities, FIAs, IUL and immediate annuities. The fair values of deferred annuities, FIA, and IUL contracts are based on their cash surrender value (i.e. the cost the Company would incur to extinguish the liability) as these contracts are generally issued without an annuitization date. The fair value of immediate annuities contracts is derived by calculating a new fair value interest rate using the updated yield curve and treasury spreads as of the respective reporting date. At September 30, 2012 and 2011, this resulted in lower fair value reserves relative to the carrying value. The Company is not required to and has not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value. The fair value of the Company’s note payable at September 30, 2011 approximated its carrying value as it was settled at such carrying value in October 2011.

The related party loans (discussed in Note 16) were recently issued, as such fair value approximates carrying value.

Quantitative information regarding significant unobservable inputs used for recurring Level 3 fair value measurements of financial instruments carried at fair value is as follows:

 

    Fair Value at
September 30,
2012
   

Valuation technique

 

Unobservable input(s)

  Range (Weighted average)

Assets

       

Contingent purchase price reduction receivable

  $ 41,000      Discounted cash flow  

Probability of collection

Expected term

Discount rate

Credit insurance risk premium

  88% - 96% (92%)

9 months

0.72%

11.7%

Asset-backed securities

    15,855      Broker-quoted   Offered quotes   100% - 109.73% (103.09%)

Corporates

    103,319      Broker-quoted   Offered quotes   0% - 140.61% (68.47%)

Corporates

    31,977      Market pricing   Quoted prices   87.50% - 158.11% (97.89%)

Hybrids

    8,873      Broker-quoted   Offered quotes   0% - 103% (25.35%)

Commercial mortgage-backed securities

    5,023      Broker-quoted   Offered quotes   100.69%

Related party investments

    32,000      Market approach   Price to book   1.0x - 1.4x
 

 

 

       

Total

  $ 238,047         
 

 

 

       

Liabilities

       

FIA embedded derivatives, included in contractholder funds

  $ 1,550,805      Discounted cash flow   Market value of option   0% - 31.05% (3.55%)
      SWAP rates   0.76% - 1.7% (1.22%)
      Mortality multiplier   70% - 70% (70%)
      Surrender rates   2% - 50% (7%)
      Non-performance spread   0.25% - 0.25% (0.25%)
 

 

 

       

Total

  $ 1,550,805         
 

 

 

       

The significant unobservable inputs used in the fair value measurement of the contingent purchase price reduction receivable are the probability of collection depending on the outcomes of litigation and regulatory action, the expected term until payment, discount rate and the credit insurance risk premium. Generally, an increase in the assumptions for the expected term, discount rate or credit insurance risk premium would decrease the fair value of the contingent purchase price receivable. An increase in the probability of collection would increase the fair value of the contingent purchase price reduction receivable.

 

S-80


The significant unobservable inputs used in the fair value measurement of FIA embedded derivatives included in contractholder funds are market value of option, interest swap rates, mortality multiplier, surrender rates, and non-performance spread. The mortality multiplier is based on the 1983 annuity table and assumes the contractholder population is 50% female and 50% male. Significant increases (decreases) in the market value of option in isolation would result in a higher (lower) fair value measurement. Significant increases (decreases) in interest swap rates, mortality multiplier, surrender rates, or non-performance spread in isolation would result in a lower (higher) fair value measurement. Generally, a change in any one unobservable input would not result in a change in any other unobservable input.

The following tables summarize changes to the Company’s financial instruments carried at fair value and classified within Level 3 of the fair value hierarchy for the years ended September 30, 2012 and 2011. This summary excludes any impact of amortization of VOBA and DAC. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.

 

    Year Ended September 30, 2012  
    Balance at
Beginning
of Period
    Total Gains (Losses)     Net
Purchases,
Sales &
Settlements
    Net
Transfer In
(Out) of
Level 3 (a)
    Balance at
End of
Period
 
      Included in
Earnings
    Included in
AOCI
       

Assets

           

Contingent purchase price reduction receivable

  $ —        $ 41,000      $ —        $ —        $ —        $ 41,000   

Fixed maturity securities, available-for-sale:

           

Asset-backed securities

    374,518        —          7,355        371,896        (737,914     15,855   

Commercial mortgage-backed securities

    —          —          24        4,999        —          5,023   

Corporates

    159,684        28        (3,662     (39,686     18,932        135,296   

Hybrids

    5,205        —          (44     —          3,712        8,873   

Municipals

    —          (2     72        10,177        (10,247     —     

Agency residential mortgage-backed securities

    3,312        —          18        —          (3,330     —     

Non-agency residential mortgage-backed securities

    3,759        (126     4        (777     (2,860     —     

Related party investment

    —          —          —          32,000        —          32,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

  $ 546,478      $ 40,900      $ 3,767      $ 378,609      $ (731,707   $ 238,047   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

           

FIA embedded derivatives, included in contractholder funds

  $ (1,396,340   $ (154,465   $ —        $ —        $ —        $ (1,550,805

Available-for-sale embedded derivatives

    (400     400        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities at Level 3 fair value

  $ (1,396,740   $ (154,065   $ —        $ —        $ —        $ (1,550,805
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

The net transfers in and out of Level 3 during the year ended September 30, 2012 were exclusively to or from Level 2.

 

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    Year Ended September 30, 2011  
    Balance at
FGL Acquisition
Date
    Total Gains (Losses)     Net
Purchases,
Sales &
Settlements
    Net
Transfer In
(Out) of
Level 3 (a)
    Balance at
End of
Period
 
      Included in
Earnings
    Included in
AOCI
       

Assets

           

Fixed maturity securities, available-for-sale:

           

Asset-backed securities

  $ 399,967      $ —        $ 863      $ (11,709   $ (14,603   $ 374,518   

Corporates

    197,573        1,993        5,408        (45,229     (61     159,684   

Hybrids

    8,305        —          (61     —          (3,039     5,205   

Agency residential mortgage-backed securities

    3,271        —          41        —          —          3,312   

Non-agency residential mortgage-backed securities

    18,519        2,364        379        (17,503     —          3,759   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

  $ 627,635      $ 4,357      $ 6,630      $ (74,441   $ (17,703   $ 546,478   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

           

FIA embedded derivatives, included in contractholder funds

  $ (1,466,308   $ 69,968      $ —        $ —        $ —        $ (1,396,340

Available-for-sale embedded derivatives

    (419     19        —          —          —          (400
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities at Level 3 fair value

  $ (1,466,727   $ 69,987      $ —        $ —        $ —        $ (1,396,740
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

The net transfers in and out of Level 3 during the year ended September 30, 2011 were exclusively to or from Level 2.

The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. There were no transfers between Level 1 and Level 2 for the years ended September 30, 2012 and 2011.

Primary market issuance and secondary market activity for certain asset-backed securities, corporates, municipals and residential mortgage-backed securities during Fiscal 2012 as well as asset-backed securities, corporates and hybrid securities during Fiscal 2011 increased the market observable inputs used to establish fair values for similar securities. These factors, along with more consistent pricing from third-party sources, resulted in the Company concluding that there is sufficient trading activity in similar instruments to support classifying these securities as Level 2 as of September 30, 2012 and 2011, respectively. Additionally, during the year a new third party began pricing the Company’s collateral loan obligations (“CLOs”) holdings included in asset-backed securities. This new pricing vendor uses market observable inputs such as actual trade prices, yields, and other market assumptions as well as observable deal, tranche and collateral information in the pricing of CLOs and therefore supported a level 2 classification of these securities as of September 30, 2012. Accordingly, the Company’s assessment resulted in a net transfer out of Level 3 of $794,012 related to asset-backed securities, corporates, hybrids, municipals and residential mortgage-backed securities during the year ended September 30, 2012 and $17,703 related to asset-backed securities, corporates and hybrids during the year ended September 30, 2011. There were also net transfers in to Level 3 of $3,712 related to hybrid securities during the year ended September 30, 2012.

 

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The following tables present the gross components of purchases, sales, and settlements, net, of Level 3 financial instruments for the years ended September 30, 2012 and 2011. There were no issuances during these periods.

 

     Year Ended September 30, 2012  
     Purchases      Sales     Settlements     Net Purchases, Sales
& Settlements
 

Assets

         

Fixed maturity, securities available-for-sale:

         

Asset-backed securities

   $ 410,707       $ —        $ (38,811   $ 371,896   

Commercial mortgage-backed securities

     4,999         —          —          4,999   

Corporates

     1,326         (26,788     (14,224     (39,686

Municipals

     10,197         —          (20     10,177   

Non-agency residential mortgage-backed securities

     —           (475     (302     (777
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 427,229       $ (27,263   $ (53,357   $ 346,609   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

     Year Ended September 30, 2011  
     Purchases      Sales     Settlements     Net Purchases, Sales
& Settlements
 

Assets

         

Fixed maturity, securities available-for-sale:

         

Asset-backed securities

   $ 2,007       $ —        $ (13,716   $ (11,709

Corporates

     10,365         (48,898     (6,696     (45,229

Non-agency residential mortgage-backed securities

     —           (15,729     (1,774     (17,503
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets at Level 3 fair value

   $ 12,372       $ (64,627   $ (22,186   $ (74,441
  

 

 

    

 

 

   

 

 

   

 

 

 

(7) Intangible Assets

Information regarding VOBA and DAC (including DSI), is as follows:

 

    VOBA     DAC     Total  

Balance at September 30, 2010

  $         $         $      

Acquisition of FGL on April 6, 2011

    577,163        —          577,163   

Deferrals

    —          41,152        41,152   

Less: Components of amortization —

     

Periodic amortization

    294        (996     (702

Interest

    14,040        —          14,040   

Unlocking

    (2,320     97        (2,223

Add: Adjustment for unrealized investment (gains), net

    (170,117     (2,146     (172,263
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

    419,060        38,107        457,167   

Deferrals

    —          194,900        194,900   

Less: Components of amortization —

     

Periodic amortization

    (171,833     (20,239     (192,072

Interest

    28,883        1,942        30,825   

Unlocking

    (2,487     3,078        591   

Add: Adjustment for unrealized investment (gains), net

    (169,303     (48,565     (217,868
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

  $ 104,320      $ 169,223      $ 273,543   
 

 

 

   

 

 

   

 

 

 

Amortization of VOBA and DAC is based on the amount of gross margins or profits recognized, including investment gains and losses. The adjustment for unrealized net investment gains represents the amount of VOBA and DAC that would have been amortized if such unrealized gains and losses had been recognized. This is

 

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referred to as the “shadow adjustments” as the additional amortization is reflected in other comprehensive income rather than the statements of operations. As of September 30, 2012 and 2011, the VOBA balance included cumulative adjustments for net unrealized investment gains of $(339,420) and $(170,117), respectively, and the DAC balances included cumulative adjustments for net unrealized investment gains of $(50,711) and $(2,146), respectively.

The above DAC balances include $9,068 and $5,048 of DSI, net of shadow adjustments, as of September 30, 2012 and 2011, respectively.

The weighted average amortization period for VOBA and DAC are approximately 5.5 and 6.3 years, respectively. Estimated amortization expense for VOBA and DAC in future fiscal years is as follows:

 

     Estimated Amortization Expense  

Fiscal Year

           VOBA                      DAC          

2013

   $ 49,851       $ 18,293   

2014

     57,552         23,090   

2015

     51,503         23,376   

2016

     47,148         22,315   

2017

     39,965         21,042   

Thereafter

     197,721         111,818   

(8) Other Liabilities

Other liabilities consisted of the following:

 

     September 30,  
     2012      2011  

Amounts payable for investment purchases

   $ 206,681       $ 13,353   

Retained asset account

     203,685         191,452   

Income taxes payable

     66,284         —     

Funds withheld from reinsurers

     54,691         52,953   

Amounts payable to reinsurers

     31,959         13,884   

Remittances and items not allocated

     29,469         34,646   

Accrued expenses

     25,199         21,952   

Derivatives — futures contracts

     928         3,828   

Amounts due to HGI (Note 15)

     —           49,339   

Other

     84,326         51,500   
  

 

 

    

 

 

 
   $ 703,222       $ 432,907   
  

 

 

    

 

 

 

(9) Note Payable

On April 7, 2011, Raven Reinsurance Company (“Raven Re”), a newly-formed wholly-owned subsidiary of FGL, issued a $95,000 surplus note to OMGUK. The surplus note was issued at par and carried a 6% fixed interest rate, as discussed further in Note 15. The note had a maturity date which was the later of (i) December 31, 2012 or (ii) the date on which all amounts due and payable to the lender have been paid in full. The note was settled in October 2011 at face value (without the payment of interest) in connection with the closing of the Raven springing amendment and replacement of the reserve facility discussed in Note 15.

 

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(10) Member’s Equity

Accumulated Other Comprehensive Income

Net unrealized gains and losses on investment securities classified as available-for-sale are reduced by deferred income taxes and adjustments to VOBA and DAC that would have resulted had such gains and losses been realized. Changes in net unrealized gains and losses on investment securities classified as available-for-sale recognized in AOCI for years ended September 30, 2012 and 2011 were as follows:

 

     Unrealized
Investment
Gains, net
    Non-credit Related
Other-than-temporary
Impairments
    Total  

Balances at September 30, 2010

   $ —        $ —        $ —     

Gross change before reclassification adjustment

     420,929        500        421,429   

Net reclassification adjustment for losses (gains) included in earnings

     (3,861     —          (3,861
  

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

     417,068        500        417,568   

Intangible assets adjustment

     (172,057     (206     (172,263

Deferred tax effect

     (85,709     (103     (85,812
  

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

     159,302        191        159,493   
  

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

   $ 159,302      $ 191      $ 159,493   

Gross change before reclassification adjustment

     906,473        (1,529     904,944   

Net reclassification adjustment for losses (gains) included in earnings

     (263,948     —          (263,948
  

 

 

   

 

 

   

 

 

 

Gross change after reclassification adjustment

     642,525        (1,529     640,996   

Intangible assets adjustment

     (218,454     586        (217,868

Deferred tax effect

     (148,469     330        (148,139
  

 

 

   

 

 

   

 

 

 

Net adjustment to AOCI

     275,602        (613     274,989   
  

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

   $ 434,904      $ (422   $ 434,482   
  

 

 

   

 

 

   

 

 

 

Cumulative components at September 30, 2012:

      

Gross amounts (after reclassification adjustments)

   $ 1,059,593      $ (1,029   $ 1,058,564   

Intangible assets adjustments

     (390,511     380        (390,131

Tax effects

     (234,178     227        (233,951
  

 

 

   

 

 

   

 

 

 
   $ 434,904      $ (422   $ 434,482   
  

 

 

   

 

 

   

 

 

 

Cumulative components at September 30, 2011:

      

Gross amounts (after reclassification adjustments)

   $ 417,068      $ 500      $ 417,568   

Intangible assets adjustments

     (172,057     (206     (172,263

Tax effects

     (85,709     (103     (85,812
  

 

 

   

 

 

   

 

 

 
   $ 159,302      $ 191      $ 159,493   
  

 

 

   

 

 

   

 

 

 

Restricted Net Assets of Subsidiaries

HFG’s equity in restricted net assets of consolidated subsidiaries was approximately $1,164,089 as of September 30, 2012, representing 90% of HFG’s consolidated member’s equity as of September 30, 2012 and consisted of net assets of FGL which were restricted as to transfer to HFG in the form of cash dividends, loans or advances under regulatory restrictions.

(11) Employee Benefit Plans

FGL sponsors a defined contribution plan in which eligible participants may defer a fixed amount or a percentage of their eligible compensation, subject to limitations, and FGL makes a discretionary matching contribution of up

 

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to 5% of eligible compensation. FGL has also established a nonqualified defined contribution plan for independent agents. FGL makes contributions to the plan based on both FGL’s and the agent’s performance. Contributions are discretionary and evaluated annually. Aggregate contributions charged to operations for the defined contribution plans, including discretionary amounts, were $812 and $319 for the years ended September 30, 2012 and 2011, respectively.

(12) Stock Compensation

Total stock compensation expense associated with stock option awards recognized by the Company during Fiscal 2012 was $163 ($106, net of related tax expense). No stock compensation expense was incurred during Fiscal 2011. The stock compensation expense is included in “Acquisition and operating expenses, net of deferrals” in the Consolidated Statements of Operations.

A summary of the Company’s outstanding stock options as of September 30, 2012, and changes during the year, is as follows:

 

Stock Option Awards

   Options     Weighted
Average
Exercise Price
     Weighted
Average Grant
Date Fair Value
 

Stock options outstanding at September 30, 2011

     —        $ —         $ —     

Granted

     207        38.20         3.90   

Exercised

     —          —           —     

Forfeited or expired

     (6     38.14         3.90   
  

 

 

      

Stock options outstanding at September 30, 2012

     201        38.20         3.90   
  

 

 

      

Vested and exercisable at September 30, 2012

     —          —           —     
  

 

 

      

Outstanding and expected to vest at September 30, 2012

     161        38.20         3.90   
  

 

 

      

The total compensation cost related to non-vested awards not yet recognized as of September 30, 2012 totaled $464 and will be recognized over a weighted-average period of 2.1 years.

On November 2, 2011, FGL’s compensation committee (on behalf of its board of directors) approved a long-term stock-based incentive plan that permits the grant of options to purchase shares of FGL’s common stock to key employees of FGL. On November 2, 2011, FGL’s compensation committee also approved a dividend equivalent plan that permits holders of these options the right to receive a payment in cash in an amount equal to the ordinary dividends declared and paid or debt service payments to HGI by FGL in each calendar year, divided by the total number of FGL common shares outstanding, starting in the year in which the dividend equivalent is granted through the year immediately prior to the year in which the dividend equivalent vests with respect to a participant’s option shares.

During Fiscal 2012, FGL granted 207 stock option awards under the terms of the plan. These stock options vest over a period of 3 years and expire on the seventh anniversary of the grant. The total fair value of the grants on their grant dates was approximately $807. As of September 30, 2012, FGL determined it was probable that the dividend equivalent plan will vest and recorded a provision of $504 for the ratable recognition of such projected liability over the option vesting period.

 

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The following assumptions were used in the determination of these grant date fair values using the Black-Scholes option pricing model:

 

     2012

Risk-free interest rate

   0.8%

Assumed dividend yield

   10.0%

Expected option term

   4.5 years

Volatility

   35.0%

(13) Income Taxes

Income Taxes

HFG is a limited liability company wholly owned by HGI. For income tax purposes, HFG and its non-life insurance subsidiaries (exclusive of FGL’s non-life subs) (collectively “HFGNL”) are disregarded entities and taxed as if they were part of HGI. As a result, income tax expense or benefit resulting from their operations is not recorded in the Company’s financial statements. If HFGNL were a separate taxable entity, its income tax expense would be computed on a standalone basis in accordance with ASC Topic 740 and, on a pro forma basis, would have been $4,612 for Fiscal 2012, consisting of a $3,334 current tax expense and a $1,278 deferred tax expense, and $441 for Fiscal 2011, consisting of a $1,961 current tax expense partially offset by a $1,520 deferred tax benefit.

The financial statement income tax accounts reflect income tax benefit (expense) solely for FGL, as follows.

Income tax benefit was calculated based upon the following components of income before income taxes:

 

     Year Ended September 30,  
             2012                     2011          

Pretax income (loss):

    

United States

   $ 201,647      $ 119,376   

Outside the United States

     (3,131     (4,359
  

 

 

   

 

 

 

Total pretax income

   $ 198,516      $ 115,017   
  

 

 

   

 

 

 

The components of income tax benefit were as follows:

 

     Year Ended September 30,  
             2012                     2011          

Current:

    

Federal

   $ (74,388   $ 875   

State

     —          —     
  

 

 

   

 

 

 

Total current

     (74,388     875   
  

 

 

   

 

 

 

Deferred:

    

Federal

     220,046        40,869   

State

     —          —     
  

 

 

   

 

 

 

Total deferred

     220,046        40,869   
  

 

 

   

 

 

 

Income tax benefit

   $ 145,658      $ 41,744   
  

 

 

   

 

 

 

 

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The difference between income taxes expected at the U.S. Federal statutory income tax rate of 35% and reported income tax benefit is summarized as follows:

 

    Year Ended September 30,  
            2012                     2011          

Expected income tax (expense) at Federal statutory rate

  $ (69,481   $ (40,256

Income tax expense of HFGNL at Federal statutory rate

    20,377        51,965   

Valuation allowance for deferred tax assets

    197,798        30,064   

Other

    (3,036     (29
 

 

 

   

 

 

 

Reported income tax benefit

  $ 145,658      $ 41,744   
 

 

 

   

 

 

 

Effective tax rate

    (73.4 )%      (36.3 )% 
 

 

 

   

 

 

 

For the year ended September 30, 2012, the Company’s effective tax rate of (73.4)%, representing a tax benefit despite pretax income, was positively impacted by the partial release of valuation allowance attributed to the Company’s determination that certain of its deferred tax assets are more likely than not realizable, and the gain on contingent purchase price reduction incurred by HFGNL, which is reflected in the effect of its income excluded in the above table.

For the year ended September 30, 2011, the Company’s effective tax rate of (36.3)%, representing a tax benefit despite pretax income, was positively impacted by the partial release of valuation allowance attributed to the Company’s determination that certain of its deferred tax assets are more likely than not realizable, and the bargain purchase gain incurred by HFGNL, which is reflected in the effect of its income excluded in the above table.

The following table is a summary of the components of deferred income tax assets and liabilities:

 

     September 30,  
     2012     2011  

Noncurrent deferred tax assets:

    

Net operating loss, credit and capital loss carryforwards

   $ 283,988      $ 475,248   

Deferred acquisition costs

     9,906        74,175   

Insurance reserves and claim related adjustments

     620,285        408,214   

Other

     19,680        22,214   

Valuation allowance

     (177,508     (375,306
  

 

 

   

 

 

 

Total noncurrent deferred tax assets

     756,351        604,545   
  

 

 

   

 

 

 

Noncurrent deferred tax liabilities:

    

Value of business acquired

     (36,512     (148,876

Investments

     (438,655     (246,632

Other

     (1,548     (1,308
  

 

 

   

 

 

 

Total noncurrent deferred tax liabilities

     (476,715     (396,816
  

 

 

   

 

 

 

Net current and noncurrent deferred tax assets

   $ 279,636      $ 207,729   
  

 

 

   

 

 

 

At September 30, 2012, the Company’s deferred tax assets were primarily the result of U.S. net operating loss (“NOL”), capital loss and tax credit carryforwards and insurance reserves. Its net deferred tax asset position at September 30, 2012 and 2011, before consideration of its recorded valuation allowance, totaled $457,144 and $583,035, respectively. A valuation allowance of $177,508 and $375,306 was recorded against its gross deferred tax asset balance at September 30, 2012 and 2011, respectively. The Company’s net deferred tax asset position at September 30, 2012 and 2011, after taking into consideration the valuation allowance, is $279,636 and $207,729, respectively. For the years ended September 30, 2012 and 2011, the Company recorded a net valuation allowance release of $197,798 (comprised of a full year valuation release of $204,736 related to the life insurance

 

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companies, partially offset by an increase to valuation allowance of $6,938 related to FGL’s non-life companies) and $30,064, respectively, based on management’s reassessment of the amount of its deferred tax assets that are more-likely-than-not realizable.

At September 30, 2012, the Company’s valuation allowance of $177,508 consisted of a partial valuation allowance of $145,854 on capital loss carryforwards and a full valuation allowance of $31,654 on FGL’s non-life insurance net deferred taxes. At September 30, 2011, the Company’s valuation allowance of $375,306 consisted of a partial valuation allowance of $138,257 on capital loss carryforwards, a full valuation allowance of $24,716 on FGL’s non-life insurance net deferred taxes and a partial valuation allowance of $212,333 on other net deferred taxes, including NOLs.

As a consequence of FGL’s acquisition, certain tax attributes (carry-forwards) became limited at the FGL Acquisition Date. In addition, FGL experienced cumulative losses during the three year period preceding its acquisition. These are among the factors the Company considered in establishing a valuation allowance against FGL’s deferred tax asset position at the FGL Acquisition Date.

At each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets. As of September 30, 2012, management considered the following positive and negative evidence concerning the future realization of FGL’s deferred tax assets:

Positive Evidence:

 

   

FGL has three years of cumulative US GAAP pre-tax income;

 

   

FGL’s internal projections of taxable income estimated in future periods reflect a continuation of this trend;

 

   

FGL has projected that the reversal of taxable temporary timing differences will unwind in the twenty year projection period;

 

   

FGL has refined tax planning strategies to utilize capital loss carryforwards by selling acquisition date built-in gains;

 

   

FGL has a history of utilizing all significant tax attributes before they expire; and

 

   

FGL’s inventory of limited attributes has been significantly reduced as a result of amending certain tax returns.

Negative Evidence:

 

   

Tax rules limit the ability to use carryforwards in future years;

 

   

There is a brief carryback/carryforward period for life insurance company capital losses (i.e. 3-year carryback/ 5-year carryforward)

Based on an assessment of the evidence above, management determined that sufficient positive evidence exists as of September 30, 2012 to conclude that it is “more likely than not” that additional deferred taxes of FGL are more-likely-than-not realizable and, therefore, reduced the valuation allowance accordingly.

At September 30, 2012 and 2011, FGL has NOL carryforwards of $86,978 and $428,005, respectively, which, if unused, will expire in years 2026 through 2032. FGL has capital loss carryforwards totaling $551,897 and $717,267 at September 30, 2012 and 2011, respectively, which if unused, will expire in years 2013 through 2017. In addition, at September 30, 2012 and 2011, FGL has low income housing tax credit carryforwards totaling $52,780 and $68,099, respectively, which, if unused, will expire in years 2017 through 2032 and alternative minimum tax credits of $7,602 and $6,304, respectively, that may be carried forward indefinitely. Certain tax

 

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attributes are subject to an annual limitation as a result of the acquisition of FGL by the Company, which constitutes a change of ownership, as defined under IRC Section 382.

U.S. Federal income tax returns of FGL for years prior to 2008 are no longer subject to examination by the taxing authorities. With limited exception, FGL is no longer subject to state and local income tax audits for years prior to 2008. However, Federal NOL carryforwards from tax years ended June 30, 2006 and December 31, 2006, respectively, continue to be subject to Internal Revenue Service examination until the statute of limitations expires for the years in which these NOL carryforwards are ultimately utilized.

(14) Commitments and Contingencies

Lease Commitments

The Company leases office space under non-cancelable operating leases that expire in May 2021. The Company also leased office furniture and office equipment under non-cancelable operating leases that expired in 2012. For the years ended September 30, 2012 and 2011, the Company’s total rent expense was $2,301 and $1,346, respectively. As of September 30, 2012, the minimum rental commitments under the non-cancelable leases are as follows:

 

Fiscal Year

   Amount  

2013

   $ 1,158   

2014

     1,192   

2015

     1,227   

2016

     1,263   

2017

     1,249   

Thereafter

     5,184   
  

 

 

 

Total

   $ 11,273   
  

 

 

 

Contingencies

Regulatory and Litigation Matters

FGL is assessed amounts by the state guaranty funds to cover losses to policyholders of insolvent or rehabilitated insurance companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. At September 30, 2012, FGL has accrued $5,909 for guaranty fund assessments which is expected to be offset by estimated future premium tax deductions of $4,213.

The Company has received inquiries from a number of state regulatory authorities regarding its use of the U.S. Social Security Administration’s Death Master File (“Death Master File”) and compliance with state claims practices regulation and unclaimed property and escheatment laws. To date, the Company has received inquiries from authorities in Maryland, Minnesota and New York. The New York Insurance Department issued a letter and subsequent regulation requiring life insurers doing business in New York to use the Death Master File or similar databases to determine if benefits were payable under life insurance policies, annuities and retained asset accounts. Legislation requiring insurance companies to use the Death Master File to identify potential claims has recently been enacted in FGL’s state of domicile (Maryland) and other states. As a result of these legislative and regulatory developments, in May 2012 the Company undertook an initiative to use the Death Master File and other publicly available databases to identify persons potentially entitled to benefits under life insurance policies, annuities and retained asset accounts. During Fiscal 2012, the Company incurred an $11,000 benefit expense, net of reinsurance, to increase reserves to cover potential benefits payable resulting from this ongoing effort. Based on its analysis to date and management’s estimate, the Company believes the remaining accrual will cover the reasonably estimated liability arising out of these developments. Additional costs that cannot be reasonably estimated as of the date of this filing are possible as a result of ongoing regulatory developments and other future requirements related to this matter.

 

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The Company is involved in various pending or threatened legal proceedings, including purported class actions, arising in the ordinary course of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. In the opinion of management and in light of existing insurance and other potential indemnification, reinsurance and established reserves, such litigation is not expected to have a material adverse effect on the Company’s financial position, although it is possible that the results of operations and cash flows could be materially affected by an unfavorable outcome in any one period.

Guarantees

The First Amended and Restated Stock Purchase Agreement, dated February 17, 2011 (the “F&G Stock Purchase Agreement”) between HFG and OMGUK includes a Guarantee and Pledge Agreement which creates certain obligations for FGL as a grantor and also grants a security interest to OMGUK of FGL’s equity interest in FGL Insurance in the event that HFG fails to perform in accordance with the terms of the F&G Stock Purchase Agreement. The Company is not aware of any events or transactions that resulted in non-compliance with the Guarantee and Pledge Agreement.

(15) Reinsurance

The Company reinsures portions of its policy risks with other insurance companies. The use of reinsurance does not discharge an insurer from liability on the insurance ceded. The insurer is required to pay in full the amount of its insurance liability regardless of whether it is entitled to or able to receive payment from the reinsurer. The portion of risks exceeding the Company’s retention limit is reinsured with other insurers. The Company seeks reinsurance coverage in order to limit its exposure to mortality losses and enhance capital management. The Company follows reinsurance accounting when there is adequate risk transfer. Otherwise, the deposit method of accounting is followed. The Company also assumes policy risks from other insurance companies.

The effect of reinsurance on premiums earned, benefits incurred and reserve changes for the years ended September 30, 2012 and 2011 were as follows:

 

     Year Ended September 30,  
     2012     2011  
     Net Premiums
Earned
    Net Benefits
Incurred and
Reserve Changes
    Net Premiums
Earned
    Net Benefits
Incurred and
Reserve Changes
 

Direct

   $ 297,964      $ 1,033,336      $ 157,772      $ 392,073   

Assumed

     47,179        34,940        22,858        19,571   

Ceded

     (289,846     (290,904     (141,628     (164,012
  

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 55,297      $ 777,372      $ 39,002      $ 247,632   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts payable or recoverable for reinsurance on paid and unpaid claims are not subject to periodic or maximum limits. During the years ended September 30, 2012 and 2011, the Company did not write off any reinsurance balances nor did it commute any ceded reinsurance.

No policies issued by the Company have been reinsured with any foreign company, which is controlled, either directly or indirectly, by a party not primarily engaged in the business of insurance.

The Company has not entered into any reinsurance agreements in which the reinsurer may unilaterally cancel any reinsurance for reasons other than non-payment of premiums or other similar credit issues.

 

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The Company has the following significant reinsurance agreements as of September 30, 2012:

Reserve Facility

Pursuant to the F&G Stock Purchase Agreement, on April 7, 2011, FGL Insurance recaptured all of the life insurance business ceded to Old Mutual Reassurance (Ireland) Ltd. (“OM Re”), an affiliate of OMGUK. OM Re transferred assets with a fair value of $653,684 to FGL Insurance in settlement of all of OM Re’s obligations under these reinsurance agreements. The fair value of the transferred assets, which was based on the economic reserves, was approved by the Maryland Insurance Administration. No gain or loss was recognized in connection with the recapture. The fair value of the assets acquired and liabilities assumed is reflected in the FGL purchase price allocation. See Note 18 for additional details.

On April 7, 2011, FGL Insurance ceded to Raven Re, on a coinsurance basis, a significant portion of the business recaptured from OM Re. Raven Re was capitalized by a $250 capital contribution from FGL Insurance and a surplus note (i.e., subordinated debt) issued to OMGUK in the principal amount of $95,000 (see Note 9 for the terms of such note). The proceeds from the surplus note issuance and the surplus note are reflected in the FGL purchase price allocation. Raven Re financed $535,000 of statutory reserves for this business with a letter of credit facility provided by Nomura and guaranteed by OMGUK and HFG.

On April 7, 2011, FGL Insurance entered into a reimbursement agreement with Nomura to establish a reserve facility and Nomura charged an upfront structuring fee (the “Structuring Fee”). The Structuring Fee was in the amount of $13,750 and is related to the retrocession of the life business recaptured from OM Re and related credit facility. The Structuring Fee was deferred and was fully amortized as of September 30, 2011 as a result of the termination of the reserve facility in connection with FGL Insurance accelerating the effective date of the amended and restated Raven Springing Amendment which is described in the Wilton Agreement discussion below.

Wilton Agreement

On January 26, 2011, HFG entered into a commitment agreement (the “Commitment Agreement”) with Wilton Re U.S. Holdings, Inc. (“Wilton”) committing Wilton Re, a wholly-owned subsidiary of Wilton and a Minnesota insurance company, to enter into one of two amendments to an existing reinsurance agreement with FGL Insurance. On April 8, 2011, FGL Insurance ceded significantly all of the remaining life insurance business that it had retained to Wilton Re under the first of the two amendments with Wilton. FGL Insurance transferred assets with a fair value of $535,826, net of ceding commission, to Wilton Re. The Company considered the effects of the first amendment in the opening balance sheet and purchase price allocation as of FGL Acquisition Date. Effective April 26, 2011, HFG elected the second of the two amendments under the Commitment Agreement (the “Raven Springing Amendment”), which committed FGL Insurance to cede to Wilton Re all of the business (the “Raven Block”) then reinsured with Raven Re on or before December 31, 2012, subject to regulatory approval. The Raven Springing Amendment was intended to mitigate the risk associated with HFG’s obligation under the F&G Stock Purchase Agreement, by replacing the Raven Re reserve facility by December 31, 2012. On September 9, 2011, FGL Insurance and Wilton Re executed an amended and restated Raven Springing Amendment whereby the recapture of the business ceded to Raven Re by FGL Insurance and the re-cession to Wilton Re closed on October 17, 2011 with an effective date of October 1, 2011. In connection with the closing, FGL Insurance transferred assets with a fair value of $580,683, including ceding commission, to Wilton Re.

In September 2012, Wilton Re and FGL Insurance reached a final agreement on the initial settlements associated with the reinsurance transactions FGL Insurance entered into subsequent to the FGL Acquisition. The final settlement amounts did not result in any material adjustments to the amounts reflected in the financial statements. FGL Insurance recognized a net pre-tax gain of $18,029 on these reinsurance transactions which has been deferred and is being amortized over the remaining life of the underlying reinsured contracts.

 

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Commissioners Annuity Reserve Valuation Method Facility (“CARVM”)

Effective September 30, 2008, FGL Insurance entered into a yearly renewable term quota share reinsurance agreement with OM Re, whereby OM Re assumed a portion of the risk that policyholders exercise the “waiver of surrender charge” features on certain deferred annuity policies. This agreement did not meet risk transfer requirements to qualify as reinsurance under US GAAP. Under the terms of the agreement, the Company expensed net fees of $4,004 and $1,809 for the years ended September 30, 2012 and 2011, respectively. Although this agreement did not provide reinsurance for reserves on a US GAAP basis, it did provide for reinsurance of reserves on a statutory basis. The statutory reserves were secured by a letter of credit with Old Mutual plc of London, England (“OM”), OMGUK’s parent.

Effective October 1, 2012, FGL Insurance recaptured the CARVM reinsurance agreement from OM Re and simultaneously ceded the business to Raven Re. The recapture of the OM Re CARVM reinsurance agreement satisfies the Company’s obligation under the F&G Stock Purchase Agreement to replace the letter of credit provided by OM no later than December 31, 2015. In connection with the new CARVM reinsurance agreement, FGL and Raven Re entered into an agreement with Nomura Bank International plc (“Nomura”) to establish a $295,000 reserve financing facility in the form of a letter of credit issued by Nomura and Nomura charged an upfront structuring fee in the amount of $2,800. The structuring fee was paid by FGL Insurance and will be deferred and amortized over the expected life of the facility.

(16) Related Party Transactions

Since its inception, the Company has utilized the services of the management and staff of HGI and also shares office space with HGI. The Company recorded approximately $25 as contributed capital for such services for the year ended September 30, 2012. The Company believes these allocations were made on a reasonable basis; however, they do not necessarily represent the costs that would have been incurred by the Company on a stand-alone basis. The Company did not record a cost for these services for the year ended September 30, 2011, as the amount was inconsequential.

FGL participates in loans originated by Salus Capital Partners LLC (“Salus”), an affiliated company indirectly owned by HGI that provides asset-based financing. Salus has assets of $195,000 (unaudited) and liabilities of $163,000 (unaudited) as of September 30, 2012. As part of the participation agreement entered into with Salus, FGL has committed to participate in its share of up to $182,371 of the loans originated by Salus, of which $52,904 remains undrawn as of September 30, 2012 and $129,467 of loan participations and accrued interest of $602 are included in “Related party loans and investment” in the Consolidated Balance Sheet as of September 30, 2012. In addition to the participation in loans originated by Salus, FGL also agreed to provide Salus with financing in the form of a revolving loan of $20,000, which is also included in “Related party loans and investment” in the Consolidated Balance Sheet as of September 30, 2012. For Fiscal 2012, FGL earned interest of $2,041 and undrawn line fees of $67 on the revolving loan with Salus, which is included in “Net investment income” in the Consolidated Statement of Operations.

On September 15, 2012, Harbinger Asset Management, LLC (“HAM”), an affiliated company, transferred its account interest in Salus to FS Holdco. The account interest consists of HAM’s contributed capital to Salus of $32,000 and an annual preferred dividend of 8%. HAM retained its interest in Salus’ residual profits and its ability to direct Salus’ operations. After the transfer of the account interest, Salus is considered to be a variable-interest entity. HAM was determined to be the primary beneficiary of Salus’ operations, based on its ability to direct Salus’ activities that most significantly impact economic performance and the conclusion that the operations of HAM and Salus are more closely related under the related party tie-breaker test, and therefore continues to consolidate Salus. HFG accounted for the transfer at HAM’s carrying value since the transaction was between entities under common control. The account interest of $32,000 is included in “Related party loans and investment” in the Consolidated Balance Sheet as of September 30, 2012, as an equity investment carried at fair value through accumulated other comprehensive income. The Company’s loss exposure at Salus is limited to the recoverability of the interest and principle of its investments and loans carried on the Balance Sheet.

 

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HGI had advanced amounts to the Company to fund collateral posted by the Company under the Nomura reserve facility described in Note 15. As of September 30, 2011, the amounts that were due to HGI, which were included in “Other liabilities,” aggregated $49,339, which was subsequently repaid in October 2011 upon the termination of the reserve facility and return of the collateral.

On March 7, 2011, HGI entered into an agreement (the “Transfer Agreement”) with the Master Fund whereby on March 9, 2011, (i) HGI acquired from the Master Fund a 100% membership interest in HFG, which was the buyer under the F&G Stock Purchase Agreement, between HFG and OMGUK, pursuant to which HFG agreed to acquire all of the outstanding shares of capital stock of FGL and certain intercompany loan agreements between OM Group, as lender, and FGL, as borrower, and (ii) the Master Fund transferred to HFG the sole issued and outstanding Ordinary Share of FS Holdco, a Cayman Islands exempted limited company (together, the “Insurance Transaction”). In consideration for the interests in HFG and FS Holdco, HGI agreed to reimburse the Master Fund for certain expenses incurred by the Master Fund in connection with the Insurance Transaction (up to a maximum of $13,300) and to submit certain expenses of the Master Fund for reimbursement by OM Group under the F&G Stock Purchase Agreement. The Transfer Agreement and the transactions contemplated thereby, including the F&G Stock Purchase Agreement, was approved by HGI’s Board of Directors upon a determination by a special committee (the “FGL Special Committee”) comprised solely of directors who were independent under the rules of the NYSE and represented by independent counsel and other advisors, that it was in the best interests of HGI and its stockholders (other than the Master Fund and its affiliates) to enter into the Transfer Agreement and proceed with the Insurance Transaction. On April 6, 2011, the Company completed the FGL Acquisition.

FS Holdco is a holding company, which is the indirect parent company of Front Street. FS Holdco has not engaged in any significant business other than transactions contemplated in connection with the Insurance Transaction.

On May 19, 2011, the FGL Special Committee unanimously determined that it is (i) in the best interests of HGI for Front Street and FGL to enter into a reinsurance agreement (the “Reinsurance Agreement”), pursuant to which Front Street would reinsure up to $3,000,000 of insurance obligations under annuity contracts of FGL and (ii) in the best interests of HGI for Front Street and Harbinger Capital Partners II LP (“HCP II”), an affiliate of the Master Fund, to enter into an investment management agreement (the “Investment Management Agreement”), pursuant to which HCP II would be appointed as the investment manager of up to $1,000,000 of assets securing Front Street’s reinsurance obligations under the Reinsurance Agreement, which assets would be deposited in a reinsurance trust account for the benefit of FGL pursuant to a trust agreement (the “Trust Agreement”). On May 19, 2011, HGI’s board of directors approved the Reinsurance Agreement, the Investment Management Agreement, the Trust Agreement and the transactions contemplated thereby. The FGL Special Committee’s consideration of the Reinsurance Agreement, the Trust Agreement, and the Investment Management Agreement was contemplated by the terms of the Transfer Agreement. In considering the foregoing matters, the FGL Special Committee was advised by independent counsel and received an independent third-party fairness opinion. As discussed further in Note 18, the Reinsurance Agreement required approval of the Maryland Insurance Administration (the “MIA”), which ultimately was not received.

The Company’s pre-closing and closing obligations under the F&G Stock Purchase Agreement, including payment of the purchase price, were guaranteed by the Master Fund. Pursuant to the Transfer Agreement, HGI entered into a Guaranty Indemnity Agreement (the “Guaranty Indemnity”) with the Master Fund, pursuant to which HGI agreed to indemnify the Master Fund for any losses incurred by it or its representatives in connection with the Master Fund’s guaranty of the Company’s pre-closing and closing obligations under the F&G Stock Purchase Agreement.

 

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(17) Insurance Subsidiary — Financial Information

The Company’s insurance subsidiaries file financial statements with state insurance regulatory authorities and the National Association of Insurance Commissioners (“NAIC”) that are prepared in accordance with Statutory Accounting Principles (“SAP”) prescribed or permitted by such authorities, which may vary materially from US GAAP. Prescribed SAP includes the Accounting Practices and Procedures Manual of the NAIC as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with US GAAP are that statutory financial statements do not reflect VOBA and DAC, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contractholder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the US GAAP basis financial statements for comparable items. For example, in accordance with the US GAAP acquisition method of accounting, the amortized cost of FGL’s invested assets was adjusted to fair value as of the FGL Acquisition Date while it was not adjusted for statutory reporting. Thus, the net unrealized gains on a statutory basis were $1,245,445 (unaudited) and $697,825 (unaudited) as of September 30, 2012 and 2011, respectively, compared to net unrealized gains of $1,058,447 and $418,210, respectively, on a US GAAP basis, as reported in Note 4.

The Company’s insurance subsidiaries’ statutory financial statements are based on a December 31 year end. The total statutory capital and surplus of FGL Insurance was $861,588 (unaudited) and $801,945 (unaudited) as of September 30, 2012 and 2011, respectively, and $846,434 and $902,118 as of December 31, 2011 and 2010, respectively. The total adjusted statutory capital of FGL Insurance was $901,371 (unaudited) and $830,225 (unaudited) at September 30, 2012 and 2011, respectively. FGL Insurance had statutory net income of $88,437 (unaudited) and $22,094 (unaudited) for the nine months ended September 30, 2012 and 2011, respectively and $110,264 and $245,849 for the years ended December 31, 2011 and 2010, respectively.

Life insurance companies are subject to certain Risk-Based Capital (“RBC”) requirements as specified by the NAIC. The RBC is used to evaluate the adequacy of capital and surplus maintained by an insurance company in relation to risks associated with: (i) asset risk, (ii) insurance risk, (iii) interest rate risk and (iv) business risk. The Company monitors the RBC of FGL’s insurance subsidiaries. As of September 30, 2012 and 2011, each of FGL’s insurance subsidiaries had exceeded the minimum RBC requirements.

The Company’s insurance subsidiaries are restricted by state laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders, depositors or investors. Any dividends in excess of limits are deemed “extraordinary” and require approval. Based on statutory results as of December 31, 2011, in accordance with applicable dividend restrictions, the Company’s subsidiaries could pay “ordinary” dividends of $84,643 to FGL in 2012 less any dividends paid during the 12 month period from the last dividend payment. On September 26, 2012, FGL Insurance paid a dividend to FGL in the amount of $20,000 with respect to its 2011 results. On September 29, 2011 and December 22, 2011, FGL Insurance paid dividends to FGL in the amount of $20,000 and $20,000, respectively, with regard to its 2010 results. Based on its 2011 calendar year statutory results, FGL Insurance is able to declare an ordinary dividend up to $24,643 through September 29, 2012 (taking into account the dividend payments of $20,000 on September 29, 2011, December 22, 2011 and September 26, 2012), and $44,643 after September 29, 2012 (taking into account the dividend payments of $20,000 on December 22, 2011 and September 26, 2012). In addition, after December 22, 2012, FGL Insurance will be able to declare an additional ordinary dividend of $20,000 with respect to its 2011 statutory results (for an aggregate ordinary dividend of $64,643), subject to management’s discretion.

(18) Acquisition

FGL

On April 6, 2011, the Company acquired all of the outstanding shares of capital stock of FGL and certain intercompany loan agreements between the seller, as lender, and FGL, as borrower, for cash consideration of

 

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$350,000, which amount could be reduced by up to $50,000 post closing (as discussed further below). The Company incurred $18,300 of expenses related to the FGL Acquisition, including $5,000 of the $350,000 cash purchase price which has been re-characterized as an expense since the seller made a $5,000 expense reimbursement to the Master Fund upon closing of the FGL Acquisition. Such expenses are included in “Acquisition and operating expenses” in the Consolidated Statement of Operations for the year ended September 30, 2011. The FGL Acquisition continued HGI’s strategy of obtaining controlling equity stakes in companies that operate across a diversified set of industries.

Net Assets Acquired

The acquisition of FGL has been accounted for under the acquisition method of accounting which requires the total purchase price to be allocated to the assets acquired and liabilities assumed based on their estimated fair values. The fair values assigned to the assets acquired and liabilities assumed are based on valuations using management’s best estimates and assumptions and were preliminary pending the completion of the valuation analysis of selected assets and liabilities. During the measurement period (which is not to exceed one year from the acquisition date), the Company is required to retrospectively adjust the provisional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets or liabilities as of that date. Effective April 1, 2012, the Company finalized such provisional amounts which were previously disclosed as of September 30, 2011.

The following table summarizes the provisional and final amounts recognized at fair value for each major class of assets acquired and liabilities assumed as of the FGL Acquisition Date:

 

     Provisional
Amounts
     Fiscal 2012
Measurement
Period
Adjustments
    Final Amounts  

Investments, cash and accrued investment income, including cash acquired of $1,040,470

   $ 17,705,419       $ —        $ 17,705,419   

Reinsurance recoverable

     929,817         15,246        945,063   

Intangible assets (VOBA)

     577,163         —          577,163   

Deferred tax assets

     256,584         (3,912     252,672   

Other assets

     72,801         —          72,801   
  

 

 

    

 

 

   

 

 

 

Total assets acquired

     19,541,784         11,334        19,553,118   
  

 

 

    

 

 

   

 

 

 

Contractholder funds and future policy benefits

     18,415,022         —          18,415,022   

Liability for policy and contract claims

     60,400         —          60,400   

Note payable

     95,000         —          95,000   

Other liabilities

     475,285         4,070        479,355   
  

 

 

    

 

 

   

 

 

 

Total liabilities assumed

     19,045,707         4,070        19,049,777   
  

 

 

    

 

 

   

 

 

 

Net assets acquired

     496,077         7,264        503,341   

Cash consideration, net of $5,000 re-characterized as expense

     345,000         —          345,000   
  

 

 

    

 

 

   

 

 

 

Bargain purchase gain

   $ 151,077       $ 7,264      $ 158,341   
  

 

 

    

 

 

   

 

 

 

The application of acquisition accounting resulted in a bargain purchase gain of $158,341, which is reflected in the Consolidated Statement of Operations for the year ended September 30, 2011. The amount of the bargain purchase gain is equal to the amount by which the fair value of net assets acquired exceeded the consideration transferred. The Company believes that the resulting bargain purchase gain is reasonable based on the following circumstances: (a) the seller was highly motivated to sell FGL, as it had publicly announced its intention to do so approximately a year prior to the sale, (b) the fair value of FGL’s investments and statutory capital increased between the date that the purchase price was initially negotiated and the FGL Acquisition Date, (c) as a further inducement to consummate the sale, the seller waived, among other requirements, any potential upward

 

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adjustment of the purchase price for an improvement in FGL’s statutory capital between the date of the initially negotiated purchase price and the FGL Acquisition Date and (d) an independent appraisal of FGL’s business indicated that its fair value was in excess of the purchase price.

Reinsurance Transactions

As discussed in Note 15, pursuant to the F&G Stock Purchase Agreement on April 7, 2011, FGL recaptured all of the life business ceded to OM Re. OM Re transferred assets with a fair value of $653,684 to FGL in settlement of all of OM Re’s obligations under these reinsurance agreements. Such amounts are reflected in FGL’s purchase price allocation. Further, on April 7, 2011, FGL ceded on a coinsurance basis a significant portion of this business to Raven Re. Certain transactions related to Raven Re such as the surplus note issued to OMGUK in the principal amount of $95,000, which was used to partially capitalize Raven Re and the Structuring Fee of $13,750 are also reflected in FGL’s purchase price allocation. Pursuant to the terms of the Raven Springing Amendment, the amount payable to Wilton at the closing of such amendment was adjusted to reflect the economic performance for the Raven Block from January 1, 2011 until the effective time of the closing of the Raven Springing Amendment. The estimated economic performance for the period from January 1, 2011 to April 6, 2011 was considered in FGL’s opening balance sheet and purchase price allocation. Of the ongoing settlement adjustments resolved with Wilton Re, as discussed in Note 15, it was determined that $11,176, less $3,912 of deferred income taxes, related to the pre-acquisition period, and were reflected as measurement period adjustments to the initial purchase price allocation. Such adjustments have been retrospectively reflected in the accompanying consolidated financial statements as of and for the year ended September 30, 2011.

Contingent Purchase Price Reduction

As contemplated by the terms of the F&G Stock Purchase Agreement, Front Street sought to enter into the Reinsurance Agreement with the Company whereby Front Street would reinsure up to $3,000,000 of insurance obligations under annuity contracts of FGL, and HCP II would be appointed the investment manager of up to $1,000,000 of assets securing Front Street’s reinsurance obligations under the Reinsurance Agreement. These assets would be deposited in a reinsurance trust account for the benefit of FGL.

The Reinsurance Agreement required the approval of the MIA. The F&G Stock Purchase Agreement provides that the seller may be required to pay up to $50,000 as a post-closing reduction in purchase price if, among other things, the Reinsurance Agreement is not approved by the MIA or is approved subject to certain restrictions or conditions. FGL received written notice, dated January 10, 2012, from the MIA, rejecting the Reinsurance Agreement, as proposed by the respective parties. HGI is pursuing all available options to recover the full purchase price reduction, including the commencement of litigation against the seller; however, the outcome of any such action is subject to risk and uncertainty and there can be no assurance that any or all of the $50,000 purchase price reduction will be obtained by HGI.

Prior to the receipt of the written rejection notice from the MIA, management believed, based on the facts and circumstances at that time, that the likelihood was remote that the purchase price would be required to be reduced. Therefore a fair value of zero had been assigned to the contingent purchase price reduction as of the FGL Acquisition Date and at each subsequent quarterly remeasurement date through January 1, 2012. Management now believes that it is near certain that the purchase price will be required to be reduced by the full $50,000 amount and has estimated a fair value of $41,000 for the contingent receivable as of September 30, 2012, reflecting appropriate discounts for potential litigation and regulatory action, length of time until expected payment is received and a credit insurance risk premium. Such $41,000 estimated fair value of the contingent receivable has been reflected in the Consolidated Balance Sheet as of September 30, 2012 with a corresponding credit to “Gain on contingent purchase price reduction” in the Consolidated Statement of Operations for the year ended September 30, 2012. Changes in the estimated fair value of the contingent consideration resulting from events after the acquisition date are accounted for in earnings upon each remeasurement date, until such time as the contingency is resolved.

 

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Intangible Assets

VOBA represents the estimated fair value of the right to receive future net cash flows from in-force contracts in a life insurance company acquisition at the acquisition date. VOBA is being amortized over the expected life of the contracts in proportion to either gross premiums or gross profits, depending on the type of contract. Total gross profits include both actual experience as it arises and estimates of gross profits for future periods. FGL will regularly evaluate and adjust the VOBA balance with a corresponding charge or credit to earnings for the effects of actual gross profits and changes in assumptions regarding estimated future gross profits. The amortization of VOBA is reported in “Amortization of intangibles” in the Consolidated Statements of Operations. The proportion of the VOBA balance attributable to each of the product groups as of the FGL Acquisition Date was as follows: 80.4% related to FIA’s, and 19.6% related to deferred annuities.

Refer to Note 7 for FGL’s historical and estimated future amortization of VOBA, net of interest.

Deferred Taxes

The future tax effects of temporary differences between financial reporting and tax bases of assets and liabilities are measured at the balance sheet date and are recorded as deferred income tax assets and liabilities. The acquisition of FGL is considered a non-taxable acquisition under tax accounting criteria, therefore, the tax basis of assets and liabilities reflect an historical (carryover) basis at the FGL Acquisition Date. However, since assets and liabilities reported under US GAAP are adjusted to fair value as of the FGL Acquisition Date, the deferred tax assets and liabilities are also adjusted to reflect the effects of those fair value adjustments. This resulted in shifting FGL into a significant net deferred tax asset position at the FGL Acquisition Date, principally due to the write-off of DAC and the establishment of a significantly lesser amount of VOBA which resulted in reducing the associated deferred tax liabilities and thereby shifting FGL’s net deferred tax position. This shift, coupled with the application of certain tax limitation provisions that apply in the context of a change in ownership transaction, most notably Section 382 of the Internal Revenue Code (the “IRC”), relating to “Limitation in Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change,” as well as other applicable provisions under Sections 381-384 of the IRC, require FGL to reconsider the realization of FGL’s gross deferred tax asset position and the need to establish a valuation allowance against it. Management determined that a valuation allowance against a portion of the gross deferred tax asset (“DTA”) would be required as of the FGL Acquisition Date.

The components of the net deferred tax assets as of the FGL Acquisition Date (updated for measurement period adjustments) are as follows:

 

Deferred tax assets:

  

DAC

   $ 96,764   

Insurance reserves and claim related adjustments

     401,659   

Net operating losses

     128,437   

Capital losses (carryovers and deferred)

     267,468   

Tax credits

     75,253   

Other deferred tax assets

     24,066   
  

 

 

 

Total deferred tax assets

     993,647   

Valuation allowance

     (405,370
  

 

 

 

Deferred tax assets, net of valuation allowance

     588,277   
  

 

 

 

Deferred tax liabilities:

  

VOBA

     202,007   

Investments

     121,160   

Other deferred tax liabilities

     12,438   
  

 

 

 

Total deferred tax liabilities

     335,605   
  

 

 

 

Net deferred tax assets

   $ 252,672   
  

 

 

 

 

S-98


2011 Results of FGL since the FGL Acquisition Date

The following table presents selected financial information reflecting results for FGL that are included in the Consolidated Statement of Operations for the year ended September 30, 2011:

 

     For the period
April 6, 2011 to
September 30, 2011
 

Total revenues

   $ 290,886   

Income, net of taxes

   $ 23,703   

Supplemental Pro Forma Information — Unaudited

The following table reflects the Company’s unaudited pro forma results as if the FGL Acquisition was completed on October 1, 2009 and the results of FGL had been included in the respective full twelve month periods.

 

     Year Ended September 30,  
Pro forma:          2011                  2010        

Total revenues

   $ 976,633       $ 953,911   

Net income (loss)

   $ 246,670       $ (166,843

Pro forma total revenues and net income for Fiscal 2011 include the actual reported results of FGL for the approximate six month period subsequent to April 6, 2011. Reported net income also includes the $158,341 non-recurring bargain purchase gain which was recorded as of the FGL Acquisition Date, and reflects the retrospective measurement period adjustments disclosed above.

The pro forma information primarily reflects the following pro forma adjustments applied to FGL’s historical results:

 

 

Reduction in net investment income to reflect amortization of the premium on fixed maturity securities — available-for-sale resulting from the fair value adjustment of these assets;

 

 

Reversal of amortization associated with the elimination of FGL’s historical DAC;

 

 

Amortization of VOBA associated with the establishment of VOBA arising from the acquisition;

 

 

Adjustments to reflect the impacts of the recapture of the life business from OM Re and the retrocession of the majority of the recaptured business and the reinsurance of certain life business previously not reinsured to an unaffiliated third party reinsurer, including amortization of the related $13,750 Structuring Fee;

 

 

Adjustments to eliminate interest expense on notes payable to seller and add interest expense on the new $95,000 surplus note payable (which was subsequently settled in October 2011); and

 

 

Reversal of the change in the deferred tax valuation allowance included in the income tax provision.

Acquisition Related Charges

Acquisition related charges of $18,300 are reflected in “Acquisition and operating expenses” in the Consolidated Statement of Operations for the year ended September 30, 2011 and relate to the FGL Acquisition. Such charges consist of the $13,300 of expenses reimbursed to the Master Fund discussed in Note 16, and the $5,000 portion of the cash purchase price recharacterized as an expense, as discussed above.

 

S-99


SCHEDULE I

HARBINGER F&G, LLC AND SUBSIDIARIES

Summary of Investments — Other than Investments in Related Parties

September 30, 2012

(In thousands)

 

     Amortized
Cost  (a)
     Fair
Value
     Amount at which
shown in the balance
sheet
 

Fixed maturities:

        

Bonds:

        

United States Government and government agencies and authorities

   $ 1,435,556       $ 1,466,488       $ 1,466,488   

States, municipalities and political subdivisions

     1,083,774         1,224,554         1,224,554   

Foreign governments

     672         815         815   

Public utilities

     2,166,720         2,400,804         2,400,804   

Convertibles and bonds with warrants attached

     —           —           —     

All other corporate bonds

     10,354,332         10,996,252         10,996,252   

Redeemable preferred stock

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total fixed maturities

     15,041,054         16,088,913         16,088,913   
  

 

 

    

 

 

    

 

 

 

Equity securities:

        

Common stocks:

        

Public utilities

     —           —           —     

Banks, trust, and insurance companies

     67,452         68,692         68,692   

Industrial, miscellaneous and all other

     —           —           —     

Nonredeemable preferred stock

     170,047         179,395         179,395   
  

 

 

    

 

 

    

 

 

 

Total equity securities

     237,499         248,087         248,087   
  

 

 

    

 

 

    

 

 

 

Derivative investments

     142,123         200,667         200,667   

Policy loans

     11,758         11,758         11,758   

Other long-term investments

     7,056         7,056         7,056   
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 15,439,490       $ 16,556,481       $ 16,556,481   
  

 

 

    

 

 

    

 

 

 

 

(a)

Represents (i) original cost reduced by repayments and other-than-temporary impairments and adjusted for amortization of premiums and accrual of discounts for fixed maturity securities, (ii) original cost reduced by other-than-temporary impairments for equity securities and (iii) original cost for derivative investments.

See accompanying Independent Auditors’ Report.

 

S-100


SCHEDULE II

HARBINGER F&G, LLC (Parent Only)

CONDENSED BALANCE SHEETS

(In thousands)

 

     September 30,
2012
     September 30,
2011
 
ASSETS   

Investments in consolidated subsidiaries

   $ 1,026,471       $ 433,041   

Notes and accrued interest receivable from insurance subsidiary

     224,363         243,918   

Contingent purchase price reduction receivable

     41,000         —     

Collateral posted on behalf of insurance subsidiary

     —           49,339   
  

 

 

    

 

 

 

Total assets

   $ 1,291,834       $ 726,298   
  

 

 

    

 

 

 
LIABILITIES AND MEMBER’S EQUITY   

Amounts due to Harbinger Group, Inc. (Parent)

   $ —         $ 49,339   

Accounts payable and accrued expenses

     1,053         1,558   
  

 

 

    

 

 

 

Total liabilities

     1,053         50,897   
  

 

 

    

 

 

 

Member’s equity

     

Contributed capital

     415,576         379,359   

Retained earnings

     440,723         136,549   

Accumulated other comprehensive income

     434,482         159,493   
  

 

 

    

 

 

 

Total member’s equity

     1,290,781         675,401   
  

 

 

    

 

 

 

Total liabilities and member’s equity

   $ 1,291,834       $ 726,298   
  

 

 

    

 

 

 

See accompanying Independent Auditors’ Report.

 

S-101


SCHEDULE II

(continued)

 

HARBINGER F&G, LLC (Parent Only)

CONDENSED STATEMENTS OF OPERATIONS

(In thousands)

 

     Year Ended September 30,  
           2012                 2011        

Revenues

   $ —        $ —     

Cost of revenues

     —          —     
  

 

 

   

 

 

 
     —          —     
  

 

 

   

 

 

 

Operating expenses:

    

General and administrative expenses

     666        580   

Acquisition related charges

     —          18,300   
  

 

 

   

 

 

 

Total operating expenses

     666        18,880   
  

 

 

   

 

 

 

Operating loss

     (666     (18,880

Other income (expense):

    

Equity in net income of subsidiaries

     282,931        3,812   

Interest income from subsidiary

     23,485        15,414   

Interest expense

     (2,556     (1,926

Bargain purchase gain from business acquisition

     —          158,341   

Gain on contingent purchase price reduction

     41,000        —     

Other expense, net

     (20     —     
  

 

 

   

 

 

 

Income before income taxes

     344,174        156,761   

Income tax expense

     —          —     
  

 

 

   

 

 

 

Net income

   $ 344,174      $ 156,761   
  

 

 

   

 

 

 

See accompanying Independent Auditors’ Report.

 

S-102


SCHEDULE II

(continued)

 

HARBINGER F&G, LLC (Parent Only)

CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended September 30,  
     2012     2011  

Cash flows from operating activities:

    

Net income

   $ 344,174      $ 156,761   

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Bargain purchase gain from business acquisition

     —          (158,341

Gain on contingent purchase price reduction

     (41,000  

Equity in net income of subsidiaries

     (282,931     (3,812

Collateral returned (posted)

     49,339        (49,339

Accrued interest from subsidiary

     3,761        4,586   

(Decrease) increase in accounts payable and accrued expenses

     (498     1,558   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     72,845        (48,587
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Acquisition of insurance subsidiary

     —          (345,000

Net repayment of notes from subsidiary

     15,794        —     

Cash capital contributions to subsidiaries

     (3,330     (12,904
  

 

 

   

 

 

 

Net cash used in investing activities

     12,464        (357,904
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Cash capital contributions from parent

     4,030        377,152   

Advances from (repayments to) Harbinger Group Inc.

     (49,339     49,339   

Dividends paid

     (40,000     (20,000
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (85,309     406,491   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     —          —     

Cash and cash equivalents at beginning of year

     —          —     
  

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ —        $ —     
  

 

 

   

 

 

 

See accompanying Independent Auditors’ Report.

 

S-103


SCHEDULE III

HARBINGER F&G, LLC AND SUBSIDIARIES

Supplementary Insurance Information

(In thousands)

 

     As of or for the year ended
September 30,
 
     2012     2011  

Life Insurance (single segment):

    

Deferred acquisition costs

   $ 169,223      $ 38,107   

Future policy benefits, losses, claims and loss expenses

     3,614,788        3,598,208   

Unearned premiums

     —          —     

Other policy claims and benefits payable

     91,082        56,650   

Premium revenue

     55,297        39,002   

Net investment income

     716,176        369,840   

Benefits, claims, losses and settlement expenses

     (777,372     (247,632

Amortization of deferred acquisition costs

     (15,219     (899

Other operating expenses

     (119,913     (72,390

See accompanying Independent Auditors’ Report

 

S-104


SCHEDULE IV

HARBINGER F&G, LLC AND SUBSIDIARIES

Reinsurance

(Dollars in thousands)

 

For the year ended September 30, 2012

  Gross Amount     Ceded to other
companies
    Assumed from
other companies
    Net
Amount
    Percentage
of amount
assumed to net
 

Life insurance in force

  $ 2,436,312      $ (1,929,017   $ 22,812      $ 530,107        4.30

Premiums and other considerations:

         

Traditional life insurance premiums

  $ 297,964      $ (289,846   $ 47,179      $ 55,297        85.32

Annuity product charges

    117,881        (79,603     —          38,278        0.00
 

 

 

   

 

 

   

 

 

   

 

 

   

Total premiums and other considerations

  $ 415,845      $ (369,449   $ 47,179      $ 93,575        50.42
 

 

 

   

 

 

   

 

 

   

 

 

   

 

For the year ended September 30, 2011

  Gross Amount     Ceded to other
companies
    Assumed from
other companies
    Net
Amount
    Percentage
of amount
assumed to net
 

Life insurance in force

  $ 2,256,696      $ (1,180,412   $ 22,641      $ 1,098,925        2.06

Premiums and other considerations:

         

Traditional life insurance premiums

  $ 157,772      $ (141,628   $ 22,858      $ 39,002        58.61

Annuity product charges

    68,436        (18,776     —          49,660        0.00
 

 

 

   

 

 

   

 

 

   

 

 

   

Total premiums and other considerations

  $ 226,208      $ (160,404   $ 22,858      $ 88,662        25.78
 

 

 

   

 

 

   

 

 

   

 

 

   

See accompanying Independent Auditors’ Report

 

S-105


3.

HGI FUNDING LLC FINANCIAL STATEMENTS

INDEX TO FINANCIAL STATEMENTS

 

Independent Auditors’ Report

     S-107   

Balance Sheets as of September 30, 2012 and 2011

     S-108   

Statements of Operations for the Year Ended September  30, 2012 and for the Period from January 12, 2011 (Inception) through September 30, 2011

     S-109   

Statements of Member’s Equity for the Year Ended September  30, 2012 and for the Period from January 12, 2011 (Inception) through September 30, 2011

     S-110   

Statements of Cash Flows for the Year Ended September  30, 2012 and for the Period from January 12, 2011 (Inception) through September 30, 2011

     S-111   

Notes to Consolidated Financial Statements

     S-112   

(1) Basis of Presentation and Nature of Business

     S-112   

(2) Significant Accounting Policies and Practices

     S-112   

(3) Significant Risks and Uncertainties

     S-113   

(4) Investments

     S-114   

(5) Fair Value of Financial Instruments

     S-115   

(6) Income Taxes

     S-116   

(7) Commitments and Contingencies

     S-116   

(8) Related Party Transactions

     S-116   

(9) Subsequent Events

     S-116   

 

S-106


Independent Auditors’ Report

The Board of Directors

HGI Funding LLC:

We have audited the accompanying balance sheets of HGI Funding LLC (the “Company”) as of September 30, 2012 and 2011 and the related statements of operations, member’s equity, and cash flows for the year ended September 30, 2012 and the period from January 12, 2011 (Inception) through September 30, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2012 and 2011, and the results of their operations and their cash flows for the year ended September 30, 2012 and the period from January 12, 2011 (Inception) through September 30, 2011 in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

New York, New York

November 27, 2012

 

S-107


HGI FUNDING LLC

BALANCE SHEETS

(In thousands)

 

     September 30,
2012
    September 30,
2011
 
ASSETS   

Investments, at fair value (Notes 4 and 5):

    

Non-affiliates

   $ 146,842      $ 274,750   

Affiliate

     71,174        —     
  

 

 

   

 

 

 
     218,016        274,750   

Cash and cash equivalents

     9,337        38,512   

Broker receivable (Note 2)

     —          14,874   

Dividends and interest receivable

     —          111   
  

 

 

   

 

 

 

Total assets

   $ 227,353      $ 328,247   
  

 

 

   

 

 

 
LIABILITIES AND MEMBER’S EQUITY   

Securities sold, not yet purchased (Note 2)

   $ —        $ 296   

Broker payable (Note 2)

     4        4,465   

Other liabilities (Note 2)

     4,442        14,492   
  

 

 

   

 

 

 

Total liabilities

     4,446        19,253   

Commitments and contingencies (Note 7)

    

Member’s equity:

    

Contributed capital

     262,232        350,000   

Accumulated deficit

     (39,325     (41,006
  

 

 

   

 

 

 

Total member’s equity

     222,907        308,994   
  

 

 

   

 

 

 

Total liabilities and member’s equity

   $ 227,353      $ 328,247   
  

 

 

   

 

 

 

See accompanying notes to financial statements.

 

S-108


HGI FUNDING LLC

STATEMENTS OF OPERATIONS

(In thousands)

 

     Year Ended
September 30,
2012
    Period from
January 12, 2011
(Inception) through
September 30, 2011
 

Investment income:

    

Dividend and interest income:

    

Non-affiliates

   $ 5,041      $ 344   

Affiliate

     1,779        —     
  

 

 

   

 

 

 
     6,820        344   
  

 

 

   

 

 

 

Expenses:

    

Investment fees

     118        10   

Interest expense

     96        38   

General and administrative expenses

     232        —     
  

 

 

   

 

 

 

Total expenses

     446        48   
  

 

 

   

 

 

 

Net investment income

     6,374        296   
  

 

 

   

 

 

 

Realized and unrealized gains and losses on investments:

    

Net realized gains (losses) on sale of investments

     (20,500     2,273   

Unrealized gain on investment in affiliate

     17,120        —     

Net unrealized losses on investments in non-affiliates

     (2,048     (42,965

Net realized and unrealized foreign exchange gains (losses) on investments

     1,078        (1,504

Net realized and unrealized foreign exchange gains (losses) on cash and futures contracts

     (343     894   
  

 

 

   

 

 

 

Net recognized losses on investments

     (4,693     (41,302
  

 

 

   

 

 

 

Income (loss) before income taxes

     1,681        (41,006

Income tax expense (Note 6)

     —          —     
  

 

 

   

 

 

 

Net income (loss)

   $ 1,681      $ (41,006
  

 

 

   

 

 

 

See accompanying notes to financial statements.

 

S-109


HGI FUNDING LLC

STATEMENTS OF MEMBER’S EQUITY

(In thousands)

 

     Contributed
Capital
    Accumulated
Deficit
    Total
Member’s Equity
 

Balances at January 12, 2011 (Inception)

   $ —        $ —        $ —     

Cash capital contributions from Harbinger Group Inc.

     350,000        —          350,000   

Net loss and comprehensive loss

     —          (41,006     (41,006
  

 

 

   

 

 

   

 

 

 

Balances at September 30, 2011

   $ 350,000      $ (41,006   $ 308,994   

Return of capital to Harbinger Group Inc.

     (88,000     —          (88,000

Contributed capital from Harbinger Group Inc. for unreimbursed management services (Note 8)

     232        —          232   

Net income and comprehensive income

     —          1,681        1,681   
  

 

 

   

 

 

   

 

 

 

Balances at September 30, 2012

   $ 262,232      $ (39,325   $ 222,907   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to financial statements.

 

S-110


HGI FUNDING LLC

STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended
September 30,
2012
    Period from
January 12, 2011
(Inception) through
September 30, 2011
 

Cash flows from operating activities:

    

Net income (loss)

   $ 1,681      $ (41,006

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Net realized and unrealized losses on investments

     5,428        40,692   

Realized and unrealized foreign exchange (gains) losses on investments

     (1,078     1,504   

Cost of trading securities acquired for resale

     (643,763     (770,453

Proceeds from trading securities sold

     766,120        756,986   

Contributed capital from Harbinger Group Inc. for unreimbursed management services

     232        —     

Changes in operating assets and liabilities:

    

Broker receivable

     14,874        (14,874

Dividends and interest receivable

     111        (111

Broker payable

     (4,461     4,465   

Other liabilities

     (10,050     14,492   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     129,094        (8,305
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Cost of investments acquired for holding

     (122,289     (332,715

Purchase of common stock of an affiliate

     (54,054     —     

Proceeds from sales of investments acquired for holding

     106,074        29,532   
  

 

 

   

 

 

 

Net cash used in investing activities

     (70,269     (303,183
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Return of capital to Harbinger Group Inc.

     (88,000     —     

Capital contributions

     —          350,000   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (88,000     350,000   
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (29,175     38,512   

Cash and cash equivalents at beginning of period

     38,512        —     
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 9,337      $ 38,512   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for interest

   $ 96        38   

Cash paid for income taxes

     —          —     

See accompanying notes to financial statements.

 

S-111


HGI FUNDING LLC

NOTES TO FINANCIAL STATEMENTS

(Amounts in thousands, except per share figures)

(1) Basis of Presentation and Nature of Business

HGI Funding LLC (“HGI Funding” or the “Company”) is a direct, wholly-owned subsidiary of Harbinger Group Inc. (“HGI”). HGI is a diversified holding company focused on obtaining controlling equity stakes in companies that operate across a diversified set of industries. HGI’s shares of common stock trade on the New York Stock Exchange (“NYSE”) under the symbol “HRG.”

HGI Funding, a Delaware Limited Liability Company, was formed on January 12, 2011 to manage a portion of HGI’s available cash by investing in equity and debt instruments and to acquire positions in potential acquisition targets. The Company operates in one segment and has a fiscal year-end of September 30. Fiscal 2012 represents the year ended September 30, 2012. Fiscal 2011 represents the period from January 12, 2011 through September 30, 2011.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

(2) Significant Accounting Policies and Practices

The following is a summary of significant accounting policies followed by the Company.

Investments

The Company’s investments consist of marketable equity and debt securities classified as trading and carried at fair value with unrealized gains and losses recognized in earnings, including certain securities for which the Company has elected the fair value option under Accounting Standards Codification (“ASC”) Topic 825, “Financial Instruments,” which would otherwise have been classified as available-for-sale or an equity method investment. Investment transactions are accounted for as of the trade date and any realized gains or losses from such transactions are calculated on a first in, first out (“FIFO”) basis and are included in the appropriate caption in the Statements of Operations.

The Company’s investments in marketable equity securities classified as trading and carried at fair value include common stock of Spectrum Brands Holdings, Inc. (“Spectrum Brands”), an affiliated company under common control of the Company’s parent, HGI. The Company held 3.46% of Spectrum Brands’ outstanding common stock as of September 30, 2012 and had two common directors on Spectrum Brands’ board of directors. As a result, the Company had significant influence over the financial and operating decisions of Spectrum Brands. As a consequence of having significant influence, the Company’s interest in Spectrum Brands is considered an equity method investment under ASC Topic 323, “Investments — Equity Method and Joint Ventures,” for which the Company has elected the fair value option under ASC Topic 825. The Company did not hold any Spectrum Brands stock at September 30, 2011.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. The Company did not hold any such cash equivalent instruments as of September 30, 2012 or 2011.

Broker Receivable and Broker Payable

Broker receivable includes amounts receivable for securities not yet delivered by the Company to the purchaser prior to the settlement date. Broker payable includes amounts payable for securities not yet received by the Company prior to the settlement date.

 

S-112


Securities Sold, Not Yet Purchased

Securities sold, not yet purchased consist of equity and debt securities that the Company has sold short. In order to facilitate a short sale, the Company borrows the securities from a third party and delivers the securities to the buyer. The Company will be required to “cover” its short sale in the future through the purchase of the security in the market at the prevailing market price and deliver it to the counterparty from which it borrowed. The Company is exposed to a loss to the extent that the security price increases during the time from when the Company borrowed the security to when the Company purchases it in the market to cover the short sale.

The Company did not hold any securities sold, not yet purchased as of September 30, 2012. As of September 30, 2011, the Company had securities sold, not yet purchased with a cost basis of $305 and accumulated net unrealized loss of $9.

Other Liabilities

Other liabilities consist of cash short balances payable for unsettled securities and margin transactions held at the clearing brokers.

Revenue Recognition

Dividends and interest income are recorded in “Dividend and interest income” and are recognized when earned. Amortization of premiums and accretion of discounts on investments in fixed maturity securities are reflected in “Dividend and interest income” over the contractual terms of the investments in a manner that produces a constant effective yield.

Foreign Currency

Foreign currency balances that are monetary items have been remeasured into U.S. Dollars at the rate of exchange existing at the respective balance sheet date. Foreign currency transactions are remeasured into U.S. Dollars at the rate of exchange on the date of the transaction. Any realized or unrealized foreign exchange remeasurements are included in the appropriate caption in the Statements of Operations.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or accumulated deficit.

(3) Significant Risks and Uncertainties

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the inherent uncertainty involved in making estimates, actual results in future periods could differ from those estimates.

Credit Risk

Credit risk arises from the potential inability of counterparties to perform under the terms of the contract. The maximum amount of credit risk loss is represented by the carrying amounts of investments.

Bankruptcy or insolvency of security custodians may cause the Company’s rights to be delayed with respect to the cash and cash equivalents and investments held in the custodial relationship. The Company monitors the

 

S-113


credit quality and financial position of its custodians, and should it decline significantly, the Company will move cash holdings and custodial relationships to another institution. The Company has a policy to only enter into custodial relationships with financial institutions with a Standard & Poor’s rating of at least “A” when it is designated.

Market Risk

Market risk is the risk of loss of fair value resulting from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and equity prices. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying financial instruments are traded.

The Company is exposed to equity price risk since it invests in marketable equity securities, which as of September 30, 2012 and 2011 are all classified as trading securities. The Company follows an investment policy approved by the board of directors of HGI which sets certain restrictions on the amounts and types of investments it may make.

Investment Concentration Risk

As of September 30, 2012, the Company’s portfolio was primarily comprised of equity securities of three companies in the energy sector, with an aggregate fair value of $146,498, or 67% of the Company’s invested assets, and its investment in Spectrum Brands (consumer products sector), with a fair value of $71,174, or 33% of invested assets.

(4) Investments

The Company’s investments are summarized as follows:

 

     September 30,  
     2012      2011  

Trading:

     

Marketable equity securities

   $ 218,016       $ 262,085   

Marketable debt securities

     —           12,665   
  

 

 

    

 

 

 

Total

   $ 218,016       $ 274,750   
  

 

 

    

 

 

 

Included in marketable equity securities as of September 30, 2012, above, were 1,779 shares of Spectrum Brands, an affiliate under common control, an equity method investee carried at fair market value ($71,174 as of September 30, 2012) using the fair value option under ASC Topic 820. The increase in the fair market value of the Company’s investment in Spectrum Brands for the year ended on September 30, 2012 of $17,120 is reported in earnings as “Unrealized gain on investment in affiliate.” There were $27,884 and $44,030 of net unrealized losses recognized in “Investments” that relate to trading securities held at September 30, 2012 and 2011, respectively, including the $17,120 unrealized gain on the Company’s investment in Spectrum Brands at September 30, 2012.

The following table presents summarized financial information derived from Spectrum Brands’ consolidated financial statements:

 

     September 30,  
     2012      2011  

Balance sheet data:

     

Current assets

   $ 1,061,427       $ 1,048,289   

Non-current assets

     2,690,222         2,578,417   

Current liabilities

     610,631         606,912   

Non-current liabilities

     2,151,923         2,001,297   

Stockholder’s equity

     989,095         1,018,497   

 

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     Year ended September 30,  
     2012      2011  

Operating data:

     

Net sales

   $ 3,252,435       $ 3,186,916   

Gross profit

     1,115,678         1,128,867   

Operating income

     301,746         227,944   

Net income (loss)

     48,572         (75,171

Basic net income (loss) per common share

     0.94         (1.47

Diluted net income (loss) per common share

     0.91         (1.47

Dividends paid per common share

     1.00         —     

(5) Fair Value of Financial Instruments

The Company’s measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which may include the Company’s own credit risk. The Company’s estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:

Level 1 — Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.

Level 2 — Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves.

Level 3 — Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.

The carrying amounts and estimated fair values of the Company’s financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, are summarized according to the hierarchy previously described as follows:

 

     September 30, 2012  
     Level 1      Level 2      Level 3      Fair Value      Carrying
Amount
 

Assets

              

Investments

   $ 218,016       $ —         $ —         $ 218,016       $ 218,016   

Cash and cash equivalents

     9,337         —           —           9,337         9,337   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total financial assets

   $ 227,353       $ —         $ —         $ 227,353       $ 227,353   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

              

Other liabilities (cash short positions)

   $ 4,442       $ —         $ —         $ 4,442       $ 4,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total financial liabilities

   $ 4,442       $ —         $ —         $ 4,442       $ 4,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     September 30, 2011  
     Level 1      Level 2      Level 3      Fair Value      Carrying
Amount
 

Assets

              

Investments

   $ 238,062       $ 36,688       $ —         $ 274,750       $ 274,750   

Cash and cash equivalents

     38,512         —           —           38,512         38,512   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total financial assets

   $ 276,574       $ 36,688       $ —         $ 313,262       $ 313,262   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

              

Securities sold, not yet purchased

   $ 296          $ —         $ 296       $ 296   

Other liabilities (cash short positions)

     14,492         —           —           14,492         14,492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total financial liabilities

   $ 14,788       $ —         $ —         $ 14,788       $ 14,788   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The carrying amounts of broker receivables and payables as well as dividend and interest receivable approximate fair value due to their short duration and, accordingly, they are not presented in the table above. The fair values of investments, cash and cash equivalents, securities sold, not yet purchased and cash short positions, which are included in other liabilities, are generally based on quoted or observed market prices.

(6) Income Taxes

HGI Funding is a limited liability company wholly owned by HGI. For income tax purposes, the Company is a disregarded entity. Accordingly, the results of its operations are taxed as if the Company were part of HGI. As a result, income tax expense (benefit) is not recorded in the Company’s financial statements.

If the Company were a separate taxable entity, its income tax expense would be computed in accordance with ASC Topic 740, “Income Taxes,” and, on a pro forma basis, would have been $8,615 for the period ended September 30, 2012, of which $835 would have been current and $7,780 would have been deferred. On a pro forma basis, for the period ended September 30, 2011, income tax expense would have been $1,376, all of which would have been current.

(7) Commitments and Contingencies

The Company does not have any commitments or contingencies that it believes may be material to its financial statements.

(8) Related Party Transactions

Since its inception, the Company has utilized the services of the management and staff of HGI and Harbinger Capital Partners, an affiliate of HGI. As many of these transactions are conducted between entities under common control, amounts charged for these services have not necessarily been based upon arms-length negotiations. It is not practicable to determine whether the amounts charged for such services represent amounts that might have been incurred on a stand-alone basis for the Company. For Fiscal 2012, the Company recorded $232 as contributed capital for these services. For Fiscal 2011, the Company incurred an inconsequential amount of management expenses.

During the year ended September 30, 2012, the Company acquired 1,779 shares of common stock of Spectrum Brands on the open market for an aggregate cost of $54,054.

(9) Subsequent Events

The Company evaluated subsequent events through the date when these financial statements were issued. During this period, the Company did not have any material recognizable, or unrecognizable, subsequent events, other than the following matter:

On October 22, 2012, the Company made a return of capital of $91,000 to HGI, the Company’s sole member, representing principally proceeds from the subsequent sale of one of the Company’s significant investments in the energy sector.

 

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PART IV

 

Item 15. Exhibits, Financial Statements and Schedules

(a) List of Documents Filed

1) Financial Statements

See Index to Consolidated Financial Statements on Page F-1 following this Part IV.

2) Financial Statement Schedules

Schedule I — Summary of Investments — Other than Investments in Related Parties

Schedule II — Condensed Financial Information of Registrant

Schedule III — Supplementary Insurance Information

Schedule IV — Reinsurance

All other schedules have been omitted since they are either not applicable or the information is contained within the accompanying consolidated financial statements or the financial schedules included pursuant to Rule 3-16 of Section S-X as noted under Item 8.

(b) List of Exhibits. The following is a list of exhibits filed, furnished or incorporated by reference as a part of this Annual Report on Form 10-K/A.

 

Exhibit No.

  

Description of Exhibits

  2.1   

Contribution and Exchange Agreement, dated as of September 10, 2010, by and among Harbinger Group Inc., Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situations Fund, L.P. and Global Opportunities Breakaway Ltd. (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed September 14, 2010 (File No. 1-4219)).

  2.2   

Amendment, dated as of November 5, 2010, to the Contribution and Exchange Agreement, dated as of September 10, 2010, by and among Harbinger Group Inc., Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Special Situations Fund, L.P. and Global Opportunities Breakaway Ltd. (incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 filed November 9, 2010 (File No. 1-4219)).

  2.3   

Unit Purchase and Contribution Agreement dated as of November 5, 2012 by and among EXCO Resources, Inc., EXCO Operating Company, LP, EXCO/HGI JV Assets, LLC, and HGI Energy Holdings, LLC (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed November 9, 2012 (File No. 1-4219)).

  3.1   

Certificate of Incorporation of Harbinger Group Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed December 28, 2009 (File No. 1-4219)).

  3.2   

Bylaws of Harbinger Group Inc. (incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed December 28, 2009 (File No. 1-4219)).

  4.1   

Indenture governing the 10.625% Senior Secured Notes due 2015, dated as of November 15, 2010, by and among Harbinger Group Inc. and Wells Fargo, National Association, as trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 filed January 28, 2011, as amended (File No. 333-171924)).

  4.2   

Form of Exchange Note (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 filed January 28, 2011, as amended (File No. 333-171924)).

 

1


Exhibit No.

  

Description of Exhibits

  4.3   

Registration Rights Agreement, dated as of November 16, 2010, between Harbinger Group Inc. and certain initial purchasers named therein (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 filed January 28, 2011, as amended (File No. 333-171924)).

  4.4   

Security Agreement, dated as of January 7, 2011, between Harbinger Group Inc. and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 filed January 28, 2011, as amended (File No. 333-171924)).

  4.5   

Collateral Trust Agreement, dated as of January 7, 2011, between Harbinger Group Inc. and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 filed January 28, 2011, as amended (File No. 333-171924)).

  4.6   

Registration Rights Agreement, dated as of September 10, 2010, by and among Harbinger Group Inc., Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situations Fund, L.P. and Global Opportunities Breakaway Ltd. (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed September 14, 2010 (File No. 1-4219)).

  4.7   

Certificate of Designation of Series A Participating Convertible Preferred Stock of Harbinger Group Inc., adopted on May 12, 2011 (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed May 13, 2011 (File No. 1-4219)).

  4.8   

Registration Rights Agreement, dated as of May 12, 2011, by and among Harbinger Group Inc., CF Turul LLC, an affiliate of funds managed by Fortress Investment Group LLC or its affiliates, Providence TMT Debt Opportunity Fund II, L.P., PECM Strategic Funding L.P. and Wilton Re Holdings Limited (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed May 13, 2011 (File No. 1-4219)).

  4.9   

Supplemental Indenture, dated June 22, 2011, to the indenture governing the Company’s 10.625% Senior Secured Notes due 2015, dated November 15, 2010, by and between the Company and Wells Fargo Bank, National Association, a national banking association, as trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed June 22, 2011 (File No. 1-4219)).

  4.10   

Second Supplemental Indenture, dated as of June 28, 2011, to the indenture governing the Company’s 10.625% Senior Secured Notes due 2015, dated as of November 15, 2010, by and between the Company and Wells Fargo Bank, National Association, a national banking association, as trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed June 28, 2011 (File No. 1-4219)).

  4.11   

Certificate of Designation of Series A-2 Participating Convertible Preferred Stock of Harbinger Group Inc. (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed August 5, 2011 (File No. 1-4219)).

  4.12   

Certificate of Amendment of Certificate of Designation of Series A Participating Convertible Preferred Stock of Harbinger Group Inc. (incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed August 5, 2011 (File No. 1-4219)).

10.1†   

Zapata Supplemental Pension Plan effective as of April 1, 1992 (incorporated herein by reference to Exhibit 10(b) to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 1-4219)).

10.2†   

Zapata Amended and Restated 1996 Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 3, 2007 (File No. 1-4219)).

 

2


Exhibit No.

  

Description of Exhibits

10.3   

Investment and Distribution Agreement between Zap.Com and Zapata (incorporated herein by reference to Exhibit No. 10.1 to Zap.Com’s Registration Statement on Form S-1 filed April 13, 1999, as amended (File No. 333-76135)).

10.4   

Services Agreement between Zap.Com and Zapata (incorporated herein by reference to Exhibit No. 10.2 to Zap.Com’s Registration Statement on Form S-1 filed April 13, 1999, as amended (File No. 333-76135)).

10.5   

Tax Sharing and Indemnity Agreement between Zap.Com and Zapata (incorporated herein by reference to Exhibit No. 10.3 to Zap.Com’s Annual Report on Form 10-K for the year ended December 31, 2007 filed March 7, 2008 (File No. 000-27729)).

10.6   

Registration Rights Agreement between Zap.Com and Zapata (incorporated herein by reference to Exhibit No. 10.4 to Zap.Com’s Registration Statement on Form S-1 filed April 13, 1999, as amended (File No. 333-76135)).

10.7†   

Form of February 28, 2003 Indemnification Agreement by and among Zapata and the directors and officers of the Company (incorporated herein by reference to Exhibit 10(q) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 filed March 26, 2003 (File No. 1-4219)).

10.8†   

Form of March 1, 2002 Director Stock Option Agreement by and among Zapata and the non-employee directors of the Company (incorporated herein by reference to Exhibit 10(r) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 filed March 26, 2003 (File No. 1-4219)).

10.9†   

Summary of Zapata Corporation Senior Executive Retiree Health Care Benefit Plan (incorporated herein by reference to Exhibit 10(u) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 filed March 13, 2007 (File No. 1-4219)).

10.10†   

Form of Indemnification Agreement by and among Zapata and Zap.Com Corporation and the Directors or Officers of Zapata and Zap.Com Corporation. (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 31, 2009 filed November 4, 2009 (File No. 1-4219)).

10.11†   

Form of Indemnification Agreement by and among Zapata and the Directors or Officers of Zapata only (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 31, 2009 filed November 4, 2009 (File No. 1-4219)).

10.12†   

Form of Indemnification Agreement by and among Harbinger Group Inc. and its Directors or Officers (incorporated herein by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 filed March 9, 2010 (File No. 1-4219)).

10.13†   

Employment Agreement, dated as of the 24th day of December, 2009, by and between Francis T. McCarron and Harbinger Group Inc., a Delaware corporation (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed December 28, 2009 (File No. 1-4219)).

10.14   

Management and Advisory Services Agreement, entered into as of March 1, 2010, by and between Harbinger Capital Partners LLC, a Delaware limited liability company, and Harbinger Group Inc. (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed March 5, 2010 (File No. 1-4219)).

10.15   

Form of lock-up letter delivered to Harbinger Group Inc. by Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situations Fund, L.P. and Global Opportunities Breakaway Ltd. to Harbinger Group Inc. (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September 14, 2010 (File No. 1-4219)).

 

3


Exhibit No.

  

Description of Exhibits

10.16   

Stockholder Agreement, dated as of February 9, 2010, by and among Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situation Fund, L.P., Global Opportunities Breakaway Ltd. and Spectrum Brands Holdings, Inc.; Harbinger Group Inc. became a party to this agreement on January 7, 2011 (incorporated herein by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed November 5, 2010 (File No. 1-4219)).

10.17   

Registration Rights Agreement, dated as of February 9, 2010, by and among Harbinger Capital Partners Master Fund I, Ltd., Harbinger Capital Partners Special Situations Fund, L.P., Global Opportunities Breakaway Ltd., Avenue International Master, L.P., Avenue Investments, L.P., Avenue Special Situations Fund IV, L.P., Avenue Special Situations Fund V, L.P., Avenue-CDP Global Opportunities Fund, L.P. and Spectrum Brands Holdings, Inc.; Harbinger Group Inc. became a party to this agreement on January 7, 2011 (incorporated herein by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed November 5, 2010 (File No. 1-4219)).

10.18†   

Form of Indemnification Agreement by and among Harbinger Group Inc. and its Directors and Officers, as amended and restated on February 23, 2011 (incorporated herein by reference to Exhibit 10.21 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 filed March 11, 2011 (File No. 1-4219)).

10.19   

Transfer Agreement, dated as of March 7, 2011, between Harbinger Group Inc., a Delaware corporation, and Harbinger Capital Partners Master Fund I, Ltd., a Cayman Islands exempted limited company (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed March 9, 2011 (File No. 1-4219)).

10.20   

First Amended and Restated Stock Purchase Agreement, dated as of February 17, 2011, between Harbinger OM, LLC, a Delaware limited liability company, and OM Group (UK) Limited, a private limited company incorporated in England and Wales (incorporated herein by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed March 9, 2011 (File No. 1-4219)).

10.21   

Letter Agreement, dated April 6, 2011, between OM Group (UK) Limited and Harbinger OM, LLC; Letter Agreement, dated April 6, 2011, from Old Mutual PLC and OM Group (UK) Limited to Harbinger OM, LLC (incorporated herein by reference to Exhibits 2.2 and 2.3 to the Company’s Current Report on Form 8-K filed April 11, 2011 (File No. 1-4219)).

10.22   

Securities Purchase Agreement, dated as of May 12, 2011, by and among Harbinger Group Inc., CF Turul LLC, an affiliate of funds managed by Fortress Investment Group LLC or its affiliates, Providence TMT Debt Opportunity Fund II, L.P., PECM Strategic Funding L.P. and Wilton Re Holdings Limited (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed May 13, 2011 (File No. 1-4219)).

10.23   

Securities Purchase Agreement, dated as of August 1, 2011, by and among Harbinger Group Inc., Quantum Partners LP, a Cayman Islands exempted limited partnership, JHL Capital Group Master Fund L.P., a Cayman Islands exempted limited partnership, and certain funds and/or accounts managed and/or advised by DDJ Capital Management, LLC and First Amendment to Securities Purchase Agreement, dated as of August 4, 2011, by and among the parties to the Securities Purchase Agreement dated as of August 1, 2011 and Luxor Capital Partners, LP, a Delaware limited partnership, Luxor Wavefront, LP, a Delaware limited partnership, Luxor Capital Partners Offshore Fund, LP, a Cayman Islands limited partnership, OC 19 Master Fund, L.P. — LCG, a Cayman Islands limited partnership, and GAM Equity Six Inc., a British Virgin Islands company (incorporated herein by reference to Exhibits 10.1 and 10.2 to the Company’s Current Report on Form 8-K filed August 5, 2011 (File No. 1-4219)).

10.24†   

Employment Agreement, dated as of January 9, 2012, by and between Harbinger Group Inc. and Omar Asali (incorporated herein by reference to Exhibit 10.1 to the Company’s Amendment No. 1 to Annual Report on Form 10-K filed January 30, 2012 (File No. 1-4219)).

 

4


Exhibit No.

 

Description of Exhibits

10.25†  

Employment Agreement, dated as of January 11, 2012, by and between Harbinger Group Inc. and David M. Maura (incorporated herein by reference to Exhibit 10.2 to the Company’s Amendment No. 1 to Annual Report on Form 10-K filed January 30, 2012 (File No. 1-4219)).

10.26†  

Harbinger Group Inc. 2011 Omnibus Equity Award Plan, adopted as of September 15, 2011 (incorporated herein by reference to Exhibit 10.4 to the Company’s Amendment No. 1 to Annual Report on Form 10-K filed January 30, 2012 (File No. 1-4219)).

10.27†  

Harbinger Group Inc. 2011 Omnibus Equity Award Plan Form of Restricted Stock Agreement (incorporated herein by reference to Exhibit 10.5 to the Company’s Amendment No. 1 to Annual Report on Form 10-K filed January 30, 2012 (File No. 1-4219)).

10.28†  

Harbinger Group Inc. 2011 Omnibus Equity Award Plan Form of Employee Nonqualified Option Agreement (incorporated herein by reference to Exhibit 10.6 to the Company’s Amendment No. 1 to Annual Report on Form 10-K filed January 30, 2012 (File No. 1-4219)).

10.29†  

Transition Services Agreement dated as of February 15, 2012, by and between Francis T. McCarron and Harbinger Group Inc., (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed February 17, 2012 (File No. 1-4219)).

10.30†  

Employment Agreement dated as of February 24, 2012 by and between Harbinger Group Inc., a Delaware corporation, and Thomas A. Williams (incorporated herein by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended April 1, 2012 (File No. 1-4219)).

10.31  

Temporary Employment Agreement, dated as of July 13, 2012, by and between Richard Hagerup and Harbinger Group Inc. (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed July 17, 2012 (File No. 1-4219)).

10.32†  

Employment Agreement dated as of November 1, 2012 by and between Harbinger Group, Inc. and Michael Sena (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed November 5, 2012 (File No. 1-4219)).

10.33  

Form of Amended and Restated Agreement of Limited Partnership of EXCO/HGI Production Partners, LP by and among EXCO/HGI GP, LLC, EXCO Holding MLP, Inc. and HGI Energy Holdings, LLC (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed November 9, 2012 (File No. 1-4219)).

10.34  

Form of Amended and Restated Limited Liability Company Agreement of EXCO/HGI GP, LLC, by and among EXCO Holding MLP, Inc. and HGI Energy Holdings, LLC (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed November 9, 2012 (File No. 1-4219)).

10.35  

Appalachia Letter Agreement, dated as of November 5, 2012, by and among EXCO Resources, Inc., EXCO Operating Company, LP, HGI Energy Holdings, LLC and Harbinger Group Inc. (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed November 9, 2012 (File No. 1-4219)).

10.36***  

Services Agreement, by and between Harbinger Capital Partners LLC and Harbinger Group Inc.

  21.1***  

Subsidiaries of the Registrant.

  23.1***  

Consent of KPMG LLP.

  31.1*  

Certification of CEO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

5


Exhibit No.

 

Description of Exhibits

  31.2*  

Certification of CFO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  32.1**  

Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

  32.2**  

Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS  

XBRL Instance Document.****

101.SCH  

XBRL Taxonomy Extension Schema.****

101.CAL  

XBRL Taxonomy Extension Calculation Linkbase.****

101.DEF  

XBRL Taxonomy Definition Linkbase.****

101.LAB  

XBRL Taxonomy Extension Label Linkbase.****

101.PRE  

XBRL Taxonomy Extension Presentation Linkbase.****

 

 

Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 15(a)(3) of Form 10-K.

*

Filed herewith

**

Furnished herewith

***

Exhibit was previously filed with the original Annual Report on Form 10-K for the fiscal year ended September 30, 2012.

****

Exhibit was previously furnished with the original Annual Report on Form 10-K for the fiscal year ended September 30, 2012.

 

6


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 25, 2013

 

HARBINGER GROUP INC.

By:

 

/s/ THOMAS A. WILLIAMS

 

Thomas A. Williams

Executive Vice President and Chief Financial Officer

 

7