Energizer Holdings, Inc. Q2 FY2022 Earnings Call

Good morning. My name is Gary, and I will be your conference operator today. At this time, I would like to welcome everyone to Energizer’s Second Quarter Fiscal Year 2022 Conference Call. After the speakers’ remarks, there will be a question-and-answer session. As a reminder, this call is being recorded. I would now like to turn the conference over to Jackie Burwitz, Vice President, Investor Relations. You may begin your conference.

Good morning. And welcome to Energizer’s second quarter fiscal 2022 conference call. Joining me today are Mark LaVigne, President and Chief Executive Officer; and John Drabik, Chief Financial Officer. A replay of this call will be available on the Investor Relations section of our website, energizerholdings.com. During this call we will make forward-looking statements about the company’s future business and financial performance among other matters. These statements are based on management’s current expectations and are subject to risks and uncertainties, including those resulting from the ongoing conflict between Russia and Ukraine, as well as the COVID-19 pandemic, which may cause actual results to differ materially from these statements. We do not undertake to update these forward-looking statements. Other factors that could cause actual results to differ materially from these statements are included in the reports we file with the SEC. We also refer in our presentation to non-GAAP financial measures. A reconciliation of non-GAAP financial measures to GAAP measures is shown in our press release issued earlier today, which is available on our website. Information concerning our categories and estimated market share discussed on this call relates to categories where we compete and is based on Energizer’s internal data, data from industry analysis and estimates we believe to be reasonable. The battery category information includes both brick and mortar and e-commerce retail sales. Unless otherwise noted, all comments regarding the quarter and year pertain to Energizer’s fiscal year and all comparisons to prior year relate to the same period in fiscal 2021. With that, I’d like to turn the call over to Mark.

Thanks, Jackie, and good morning, everyone. As you saw in our release posted earlier today, we delivered a strong second quarter, which is a testament to our team’s dedication and resilience. Due to the hard work of our colleagues around the world, we are very well positioned and excited about the prospects for our business. Let me start by highlighting some key themes and headlines to take away from today’s call. First, we successfully executed pricing actions and growth plans, which generated healthy organic topline growth. As a result of our performance in the first half of the year and the benefits of pricing, we are increasing our top line guidance to low single-digit growth for the full year. Second, while we remain focused on preserving gross profit dollars, the combination of our pricing efforts and internal cost savings initiatives should begin to drive gross margin expansion in the back half of the year. From a category standpoint, we operate in categories that are meaningfully larger than pre-pandemic levels, with both volume and value considerably up on a two-year stack. And finally, the investments we are making in our global supply chain are paying off. Bill rates are steadily improving, and we have enhanced visibility and connectivity from our digital transformation. These improvements are designed to drive efficiencies to reduce working capital, allowing us to return to normalized free cash flow generation in the back half of the year. Let me take each of these in turn. First, we delivered organic growth of 1.3%, driven by a combination of global price increases and strong growth in auto care. This is over and above the almost 13% organic growth we saw in the prior year quarter. In the Battery segment, we experienced normalization in net sales, as volumes declined compared to the elevated prior-year period. This volume decline was partially offset by pricing, as well as distribution growth in key markets. Our Auto Care business delivered organic sales growth of nearly 20% in the quarter, with double-digit growth across both North America and International, more than offsetting the organic decline in battery. This growth was driven by a combination of pricing, timing of refrigerant shipments, and expanded distribution, particularly internationally, as we continue to execute our international growth plans behind Armor All and our portfolio of iconic Auto Care brands. Turning to margins, the macro environment we are operating in remains volatile. We recognize the need to generate improved insights early in the pandemic, and our investments in data and analytics have enabled steadily improving fill rates. That improved connectivity is now allowing us to see the inflationary impacts earlier and take quick action on pricing to ensure we are offsetting the dollar cost of these headwinds. Those insights are also highlighting areas where we can be even more efficient, which will drive margin expansion over the balance of the year. Our latest round of broad-based pricing actions took effect in each of our categories towards the end of the quarter. We also announced another round of targeted pricing in areas that continue to experience cost inflation. In general, these pricing actions have lagged the impact of the cost increases we have seen, and as they take full effect, we anticipate meaningful margin improvement in the second half of the fiscal year. Third, our categories continue to perform well and remain larger than pre-pandemic levels. In the Battery category, both volume and value remain up double digits on a two-year stack basis. While we saw declines in the latest three-month data, we expect price increases executed across the category will drive an increase in value over the balance of the year. Our iconic brands outpaced the category, resulting in a 2.8 share point gain versus last year, with growth across each region in total batteries. In particular, we experienced growth in the U.S. driven by expanded distribution, as well as strong performance internationally, including share gains in 17 of our top 20 markets. Turning now to Auto Care, where the fundamentals of the category remain healthy. The number of cars in the car park, the average age of vehicles, and the miles driven are all growing compared to pre-pandemic levels. As we look ahead, we are excited about the growth engine we are creating in Auto. Our business continues to grow rapidly, and the platform is designed to support our future growth aspirations while also improving margins. The growth will come from a robust innovation pipeline, which is full of products containing new exciting technology designed to deliver the performance, value, and convenience expected by our consumers. We are also connecting with consumers through marketing communication and efforts to drive engagement with our brands. A great example of how all of this comes together is our Armor All partnership with the Formula One champion Red Bull Racing team and Formula One racing legends Jenson Button. Formula One is truly a global sport and resonates in every market, and our sponsorship has led to millions of impressions through everything from new in-store displays to social media in markets around the world. We have the right combination of product innovation, marketing efforts, and operational excellence to continue to grow this business in the years ahead. And finally, we are starting to see some early dividends from our investments in digital transformation. I talked earlier about the benefits of greater visibility and faster insights on our margins. We also expect these investments to enable us to maintain acceptable fill rates while prudently reducing our inventory levels as we continue to see stability in the global supply chain. While our heightened inventory levels remain important to serving our customers and consumers, we believe this combination of a stabilizing global supply chain and better data and analytics will enable us to decrease inventory towards the end of the fiscal year, unlocking free cash flow to continue to invest in our business and reduce debt. As you can see from our results, our business is strong, and our strategy is paying off. We have overcome significant challenges, and the investments we have made position us well for the future and will allow us to emerge stronger than before the pandemic. I am incredibly proud of our colleagues around the world and the results we delivered this quarter, which are a testament to our team’s commitment to success. Now let me turn the call over to John to provide additional details about our financial performance.

Good morning, everyone. I will start this morning with some highlights on the progress we are making in a few focus areas, followed by an overview of our financial performance this quarter and our outlook for the remainder of the year. We, like many others, have experienced significant cost pressures as inflation has proven to be more permanent and pervasive than many anticipated. As such, we are redoubling our efforts to address the drivers of gross margin across our businesses and regions. We have historically employed dedicated teams focused on pricing and revenue management, as well as ongoing efforts to optimize costs in our supply chain; given the fast-paced environment we have been operating in, we consolidated those efforts to prioritize the preservation and expansion of gross margin. By bringing those teams together at the beginning of the year, we were able to execute incremental pricing and focused cost savings projects that we expect to help deliver the outlook we initially provided in November, despite continued inflationary pressures. By further coordinating these efforts and expanding cross-functional involvement, we were able to deploy resources towards our highest ROI opportunities. We have already identified a substantial pipeline that we can undertake over the balance of this fiscal year and future years to enhance our portfolios, improve pricing and reduce costs. This program is designed to ensure we maintain the healthy growth in both Batteries and Auto Care while accelerating margin improvement. Based on the work we have done to date, we already expect incremental gross margin improvement in the back half of the year and remain on track to deliver the full year gross margin rate as guided in our first quarter earnings. Our working capital has been elevated throughout the course of the pandemic. The increase was primarily due to incremental investments in inventory attributable to inflation. The impact of a more elongated supply chain has increased safety stock and more recently prevailed for the auto care season. These investments were critical to ensure customer service in the volatile environment of the last two years. However, improved visibility from our digital investments, as well as improved stability in the global supply chain, should allow us to reduce the heightened levels of inventory and lower our working capital needs. As a result, we expect to return to more normalized free cash flow generation in the second half of the year, and we will prioritize debt reduction as our cash flows recover. Finally, over the last two years, we have made significant strides in our digital transformation, which has elevated the quality of our data, the visibility we have over multiple aspects of our business, and our analytic capabilities. As you have already heard, these tools are yielding substantial benefits, and as we seek to implement new tools and capabilities, we will remain focused on areas with the highest return potential. For instance, we have been able to greatly improve the quality of the analytics on our ocean freight spend and have identified areas to reduce transportation costs and optimize container utilization, which can lead to cost reductions as well as more efficient inventory management. We have stayed disciplined and focused on short- and long-term priorities while managing through the crisis. Our digital transformation is starting to pay dividends by focusing our efforts on high-priority areas like gross margin and working capital management. And by continuing to develop our digital capabilities, we are confident that we will continue to generate improvement in our results in the quarters and years to come. Now turning to our financial results, reported sales of $685.4 million were essentially flat, while organic revenues were up 1.3%. Pricing actions globally delivered roughly 5% to organic growth, and additional distribution contributed another 1%. While volumes were better than expected during the quarter, they declined roughly 4.5% as we lapped elevated COVID-related demand in the prior year. Looking at our two segments, Battery and Lights organic revenue was down 3.5%, primarily due to elevated comps with the prior year quarter as last year grew roughly 15% driven by that elevated COVID-related demand. We were able to partially offset these volume declines with our first round of pricing actions and distribution gains. As a reminder, our first round of pricing went into effect in the December quarter, and we have executed additional pricing that went into effect mid-March. Auto Care continued its strong performance with organic sales up 19.4%, primarily due to pricing actions, a shift in timing of A/C PRO shipments from the third quarter to second quarter, and distribution gains in both the U.S. and international markets. We have implemented numerous price increases across our portfolio, with the most recent round going into effect in early April. As expected, adjusted gross margin decreased 560 basis points to 34.9% as increased input costs including material transportation and labor were partially offset by the impact of our pricing actions. A&P as a percent of net sales was 2.9% for the quarter and 4.7% for the first six months. While the second quarter is typically our lowest quarter for A&P spend due to the seasonality of both of our businesses, this year we made a conscious decision to shift more of our Auto Care investment into the third and fourth quarters as both periods created higher ROI for our investments last year. As a result, we anticipate A&P spending for the full year to trend more towards our historical norm as we continue to prioritize investment in our brands. Excluding costs associated with the acquisition and integration and exiting the Russian market, SG&A as a percent of net sales was 17.2%, up from 16.7% in the prior year. On an absolute dollar basis, SG&A increased $3.5 million, due primarily to higher IT spend related to our digital transformation. Similar to the first quarter, segment profit for both Battery and Lights and Auto Care benefited from continued strong demand, pricing actions, and distribution gains. However, inflationary input cost pressures more than offset the stronger-than-expected topline performance, resulting in segment profit declines of $30.1 million for Battery and $4.6 million in Auto Care. Interest expense declined roughly $800,000, as the benefit of our refinancing over the last year more than offset an increase in debt, which was used to finance investments in incremental inventory. In March, we took the opportunity to term out our revolver and completed a $300 million bond offering at 6.5%. As a result, we expect slightly higher interest expense in the remainder of the year. Our debt capital structure is now 86% fixed at a blended average interest rate of 4.2% with minimal maturities prior to 2027, which positions us well in the current rising interest rate environment. As we mentioned on our last call, our mandatory convertible preferred stock converted to approximately 4.7 million common shares on January 18th. Weighted average shares outstanding were 71.6 million for the quarter, and for fiscal 2022, we are anticipating weighted average shares outstanding to be approximately 72 million. Based on our outperformance on the topline in the first half of the year, and the success of our pricing actions across the globe, we are increasing our outlook for net sales to low-single digits. While the operating environment remains volatile, the pricing actions we have taken along with cost management efforts are expected to offset inflationary pressures. As a result, we are reaffirming our outlook for adjusted earnings per share of $3 to $3.30 and adjusted EBITDA of $560 million to $590 million. I do want to note that these results exclude any one-time charges related to the exit of our Russian operations during the second quarter. Now I would like to turn the call back to Mark for closing remarks.

Thanks, John. Through the first half of the year, our team’s execution has been exceptional, our categories continue to perform well globally, and our pricing initiatives have delivered as expected. We have laid the groundwork over the last several quarters to restore the profitability and cash flow generation this business is capable of, and we are optimistic about the days ahead. We remain well-positioned in the marketplace and have complete confidence in our team’s ability to win the day by staying focused on the consumer, delivering for our customers, and doing so despite any challenges which may come our way. With that, I will open the call for questions.

Our first question is from Wendy Nicholson with Citi. Please go ahead.

Hi. Good morning. I had two questions if that’s okay. First on the battery business, it sounds like your market shares are strong there, which is awesome. I am curious if you see any or even just recently any tick up in private label shares just given the economic situation and maybe increasing price sensitivity on the part of consumers, so anything that you are seeing there would be helpful? And then on the Auto business, again demand I know you said it was really strong, but I am wondering if you anticipate in the summer months when it’s seasonally a bigger business, again just with the higher gas prices, are you hearing from the trade any comments that they expect fewer people to be on the road, fewer people driving for vacation, anything like that just given where gas prices are? Thank you so much.

Good morning, Wendy. I will start and then I will turn it over to John maybe to talk about the growth expectations we have in the back half. On your first question as it relates to trade down, we really haven’t seen it yet. We may have seen a slight trade down in terms of pack sizes, but the consumers are really sticking with premium brands. In fact, private label and batteries were down in the U.S. about 2.5 share points and globally just over 2 share points. That’s obviously something we are not going to take for granted; we are going to watch it carefully to the extent it happens. If any trade down were to happen, we have value brands in our portfolio and can leverage those as we move forward. On Auto Care, the underlying fundamentals of the category are really healthy. The number of miles driven exceeds pre-pandemic levels, the size of the car park is also going up, as well as the age of the fleet now exceeds 12 years old. All of those factors are healthy drivers for category growth, and as a result, we expect great things for this business over the balance of the fiscal year. John, do you want to talk about sort of growth in Q3 and Q4?

I think we called up organic growth for the rest of the year, Wendy, and that is driven in large part by what Mark had talked about. So I think we are pretty optimistic about the pricing that we have taken and the continued performance. So we are expecting that growth to happen in the back half.

Perfect. That’s very helpful. Thank you so much.

Thanks, Wendy.

The next question is from Bill Chappell with Truist Securities. Please go ahead.

Thanks. Good morning.

Good morning, Bill.

Hi, Bill.

On the Auto Care, certainly a good start. Can you maybe just quantify the pull-forward? Maybe I missed that. And also has there been any negative impact from just weather we have seen from the garden companies and some of the pet companies? It’s been a late start to the spring season, colder, wetter than expected coming in the southern half of the country, so could the numbers even get better?

Well, I think let's break down the growth on that 20%. It’s about a little more than half was pricing, a little bit less than half was that pull-forward of the A/C PRO, and that’s a shift from the prior year where I think we were having trouble getting our hands on some of that. So we shipped earlier this year than we did last year. So I think it was a good quarter. I don’t know if there were things left on the table, and I haven’t heard that we have really been impacted by weather to this point, although it has been pulled.

Q2, Q3, Bill, always tends to be a bit of an inflection point in terms of shipments for us, and they tend to shift back and forth year-to-year. It has been a little bit from a weather standpoint, a later start to the season, but it’s really starting to pick up. You are seeing the weather turn. And if you recall a couple of years ago, we had an unusually long and cold spring and as a result sales suffered. We are not seeing that same dynamic play out. Retailers, to the point of John on pull-forward, have continued to invest in inventory to be ready for when the season starts. So Q3 is really when it gets going, and if the weather cooperates, we should be fine.

Got it. And then on the distribution gains, is there I think you alluded, it’s primarily international? Are you seeing distribution gains in battery? And then maybe kind of any thoughts on how Rayovac is doing in terms of that trade down?

Rayovac has been holding steady. As we mentioned, we haven’t seen trade down yet in the category. To the extent that we have taken pricing and the pricing continues to go into effect. Typically you may see some trade down, and we are prepared for that with both Rayovac and Eveready value brands in our portfolio. Distribution gains of batteries are fairly broad-based; you are seeing in just about every international trade group, you are seeing share gains across both modern, developing, and distributor markets. We are also seeing share gains in the U.S. Our distribution gains in the U.S. should start to cycle off late Q3, and as a result, we should plateau; we wouldn’t expect it to go down and will be in line with the category.

Great. Thank you.

Thanks, Bill.

The next question is from Andrea Teixeira with JPMorgan. Please go ahead.

Thank you. I wanted to discuss the pricing you outlined for the quarter and gain some insight into the second half. What is your pricing strategy, and how much of that is related to trade? Additionally, I noticed you mentioned some distribution gains, and I'm curious if you expect a shift in battery sales moving into positive territory. It seems like Auto Care may not continue on its current path due to tough comparisons, so I'm looking for your thoughts on that. Regarding A/C PRO shipments from last year, could you provide clarification on how we should assess the Auto Care segment and what factors to consider as we approach the third quarter? Thank you.

I will start there, Andrea. I think in terms of pricing, all pricing that we have initiated with retailers is built into the outlook. We have also built in the historical elasticities associated with price increases into that outlook. And in terms of Auto Care, as you mentioned, we do have tough comps, in large part because the pricing actions we have taken on batteries and auto care. We do expect organic growth for both of those businesses going forward. John, any other color?

In the second half of the year, we were approximately flat during the first six months, but we are optimistic about our revenue growth. We anticipate organic growth in the second half to be in the mid to high single digits, indicating a significant increase due to our pricing strategies.

No. That’s great and best of luck. Thank you both.

Thanks, Andrea.

Thank you.

Your next question is from Lauren Lieberman with Barclays. Please go ahead.

Good morning. I have two questions. First, could you explain how your inflation forecast has changed? While you maintain expectations for the bottom line, I am curious about the impact of macro-level inflation on your business compared to how much you are hedged, considering you are not experiencing inflation. Second, as you begin to work through your existing inventory, how should we think about operating leverage during this process? It seems like this will start happening at the end of the year, looking ahead to 2023. Should we anticipate any drag on margins from managing that inventory? Thank you.

We are currently aligned with our previous estimate of nearly $250 million in inflationary cost pressures for the full year 2022. As we conclude this quarter, we believe we have reached a plateau in inflation, with some costs increasing while others have decreased. Looking ahead, we will take measures to reduce inventory, which we have factored into our outlook for 2022. While we won't provide guidance for 2023 just yet, we are aware of the potential impacts of slowing processes to manage inventory. We plan to offer a clearer outlook at the end of the year, and this is an area we are actively addressing.

Okay. Great. All right. Thank you.

Thanks, Lauren.

Your next question is from Javier Escalante with Evercore ISI. Please go ahead.

Hi. Good morning, everyone. My question is to see whether you can give us a breakdown or a bridge of gross margin change in the second quarter versus year ago. The impact of commodities, logistics and the benefit of pricing, and how that looks into the second half where margins are going to just expand? Secondly, and related to that is the run rate of pricing, so it’s 5% in Q2. What was the exit rate? What is the level that you are aiming at with the third round, and whether that round is enough to get you back to gross margin recovery? Thank you.

Regarding the last point, Javier, I will address it briefly and then hand it over to John to discuss the changes in the quarters. About the third round of pricing we mentioned, it's a targeted price increase in certain categories, and we will keep monitoring those. I would say that regarding our overall price increases, our initial expectation is to enhance our gross margin dollars, and over time we will look to improve our gross margin rate moving forward. John, can you provide the breakdown?

Yeah. Javier, so we had growth about 920 basis points of cost increases; that was really transportation of about 470, raw materials of 340, and labor of 110. We were able to offset about 60 basis points with productivity improvements, and then we took pricing of a little under 300 basis points that came through. And as Mark talked about earlier, that’s rolling in over time. So we will look for that to continue to improve as the year goes on. I think what we are expecting, if you look at our first half gross margin rate, we think that the back half will be up about 200 basis points and roughly in line with where we had said we would be kind of at the end of the first quarter. So we are calling for that mid 37% and 37.5% range.

Could you clarify your comments on the inflation situation? Are you referring to the logistics aspect, such as freight and the extended supply chain, or are you discussing the spot prices for raw materials? Thank you.

Yeah. Well, I would say it’s both. So we have seen some plateauing in some opportunities on ocean freight, and I think we mentioned in the prepared remarks, there’s a lot of work we are doing on ocean freight and other areas where we have seen dramatic increases over the last year to try to drive those down as much as we can. So I think both macro and our own actions we see some opportunity there. So I think we are in pretty good shape.

Javier, I think on the ocean freight rates, for instance, as well as the in North America freight rates, you are starting to see premiums come down; you are starting to see a reduction in the asset royalties that you will incur as a result of that. To other rate, the base rates may be plateauing staying the same; you are seeing some favorability in terms of the premiums you are having to pay in order to move goods.

Thank you very much.

The next question is from William Reuter with Bank of America. Please go ahead.

Good morning. Last quarter, you had mentioned that you had about 30% of your cost fixed for the remainder of the year. At this point, based upon what either contracted inputs or hedges you have in place, where are you guys in terms of how much exposure is left on those items?

That’s right, Bill. For fiscal 2022, we should be mostly fixed. We have got pretty good visibility to our cost structure for the rest of the year, and that’s a combination of inventory on hand and a little bit of hedging that we have got in place.

Okay. Secondly, you have gained some increased shelf space. Is there an expectation that, given the strong velocity of units you have experienced, you might gain additional space? Are there any ongoing RFP processes or thoughts on that?

I would say that our commercial teams around the world are actively working on this. We are continuously seeking improved visibility and expanded distribution while partnering with retailers to bring that vision to life. All changes in distribution have been incorporated into our outlook. Over the past 12 months, we have experienced significant share gains. However, we anticipate that this expanded distribution will begin to stabilize in the third quarter, and as a result, we expect our share gains to level off. Nevertheless, we do not foresee a decline, as we maintain strong distribution and will continue to strive for more.

Got it. Helpful commentary. Thank you.

Thank you.

The next question is from Carla Casella with JPMorgan. Please go ahead.

Hi. On the inventory front, could you give us a sense for how much of the increase is units versus costs and if we should expect that to be up through the remainder of the year in a similar degree?

Yeah. So as we break it down, a fair amount of the increase this year is cost; a lot of those cost increases came through in the fall into the next turn of inventory. Obviously it went up. So the other part would be more days driven, and that’s elongation of the supply chain; that’s safety stock that we have built. So I think a lot of that’s going to hang around for the good portion of the year. Although we are looking to address that as much as we can, obviously, in the macro environment, that will be tough, but we are continuing to push there.

Okay. Great. Are you expecting to be past the peak of revolver borrowings at this point?

Yeah. So revolver borrowings, I think, as of today are zero, and I mentioned, we termed out most of that short-term debt during the quarter. I think what we are expecting is to return to free cash flow generation in the back half, and we are going to prioritize debt pay down as that starts to happen.

Okay. Great. Did you provide your comments on zinc? I may have missed it. What are the sequential trends in zinc?

Yeah. Zinc is one of those commodities that it’s been pretty volatile. It has gone up a lot over the last year and continues to go up throughout the quarter. We have seen it come back a little bit, but it has been one that has gone up.

Okay. Great. And but as raw material is still around 40% of COGS or is it ticking up just given all the raw material inflation?

I think it’s roughly 40%. That’s right.

Okay. Great. Thanks.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark LaVigne for any closing remarks.

Thanks everyone for joining and have a good rest of the day.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.