Earnings Call Transcript - SPB Q2 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the Spectrum Brands Holdings, Inc. Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there'll be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Faisal Qadir. Please go ahead.

Faisal Qadir, Vice President of Strategic Finance and Enterprise Reporting

Thank you. Good morning, and welcome to Spectrum Brands Holdings Q2 2023 earnings conference call and webcast. I’m Faisal Qadir, and I will moderate today’s call. To help you follow our comments, we have placed a Slide presentation on the Event Calendar page in the Investor Relations section of our website. The document will remain there following our call. Starting with Slide 2, our call will be led by David Maura, our Chairman and Chief Executive Officer; and Jeremy Smeltser, Chief Financial Officer. After opening remarks, we will conduct the Q&A. Our comments today include forward-looking statements, which are based upon management's current expectations, projections, and assumptions, and are by nature uncertain. Actual results may differ materially. Due to that risk, Spectrum Brands encourages you to review the risk factors and cautionary statements outlined in our press release dated May 12, 2023, our most recent SEC filings, and Spectrum Brands Holdings' most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q. We assume no obligation to update any forward-looking statement. Also, please note that we will discuss certain non-GAAP financial measures in this call. Reconciliations on a GAAP basis for these measures are included in today's press release and 8-K filing, which are both available on our website in the Investor Relations sections. Now, I'll turn the call over to David Maura. Over to you, David.

David Maura, Chairman and Chief Executive Officer

Thank you, Faisal. Good morning, everyone. Thank you for joining us today for our second quarter earnings update. We appreciate everyone attending. I'll begin with an update of the company's strategic initiatives, followed by an overview of the operating environment. Jeremy, as usual, will then provide a more detailed financial and operational update, including a discussion of the specific business unit results. Moving to Slide 6, let me first start with a very positive achievement on the strategic front. We have agreed to a stipulation with the Department of Justice to settle their challenge of Assa Abloy’s $4.3 billion acquisition of our Hardware and Home Improvement segment. We remain confident that the transaction will close on or before June 30, 2023. We are particularly pleased that our hardware asset and employees are going to Assa Abloy. I have the utmost respect for them as a company, and their culture is excellent. They are a high-performance business with impeccable character. I am confident that our employees and brands will flourish in Assa's hands as they take HHI to the next level operationally. This is the most significant strategic pivot in the history of Spectrum Brands. The receipt of the HHI sale proceeds will materially strengthen our balance sheet, enhance our capital allocation strategy, and make us a net debt-free company. This transaction will also bring us closer to our long-term goal of becoming a faster-growing, higher margin, pure play Global Pet Care and Home & Garden company, allowing the team to prioritize the long-term growth of the remaining businesses. We remain committed to enhancing the value of our Home & Personal Care business. We will use the proceeds from this transaction to delever and strengthen our balance sheet, starting with paying off the term loan and the revolver facility immediately following the close of the HHI sale. We plan to return cash to our shareholders through share repurchases. Our long-term leverage target remains to be between 2x to 2.5x on a net levered basis. Now, let's move to our operating environment and the financial results. First, our renewed focus on profitability, working capital management, and cost management, continues to pay off despite the unpredictable market dynamics and macroeconomic headwinds we and our peers are facing. While these headwinds are challenging to manage, we remain confident in our long-term strategy and ability to deliver value to our customers. Secondly, we continue to face short-term headwinds related to consumer inventory actions, particularly in our Home & Garden business, which are more severe than we expected and will impact our fiscal ‘23 results more than we previously anticipated. Our focus on cash generation continues to pay off. We reduced inventory by another $170 million in the quarter, following a reduction of $170 million in the preceding six months. Since turning our attention to cash flow and inventory reduction over earnings, we have reduced our inventory by over $340 million, including HHI in the last nine months. We continue to focus on maximizing cash over earnings and reducing our overall inventory levels. This effort has resulted in positive free cash flow so far in the current fiscal year, and we will continue to focus on working capital management and strengthening our balance sheet. Our inventory is now approaching appropriate levels to support market demand, and further reductions will come from rebalancing our inventory profile. On the cost side, we remain focused on simplifying our business model and reducing costs to operate as a leaner organization. We've made further fixed cost reductions and eliminated additional headcount in focused areas of the organization. With all the cost actions in place, we believe we are well-positioned to face short-term headwinds while maintaining key capabilities necessary for long-term growth. Building on my second message regarding these short-term headwinds, the consumer demand environment remained challenging compared to the strong COVID-related demand growth over a year ago, especially for hard goods categories that are returning to pre-pandemic levels. Our retail partners remain focused on inventory reductions in those categories. Additionally, our key retail partners in the Home & Garden business changed their strategy to reduce inventory in the quarter compared to the strong prior year pre-build ahead of the season. While our Global Pet Care and Home & Personal Care businesses performed in line or better than expectations, we were disappointed with the results in our Home & Garden business for this quarter, which were also impacted by adverse weather conditions in key markets late in the quarter. Our total sales declined 9.7%, while organic sales declined 10.1%. This volume decrease was a main contributor to the EBITDA decline in the quarter. EBITDA was also pressured by unfavorable FX year-over-year and the impact of selling down our higher-cost inventory accumulated during prior year periods. We have substantially sold all that inventory and are exceeding the expected profitability inflection point in our recent monthly results. Moving your attention to Slide 7 and our high-level fiscal ‘23 earnings framework. We are pleased with the performance of our Global Pet Care business, and we continue to see improvements in our Home & Personal Care business despite the anticipated headwinds in its end markets. We remain confident in the long-term strategy for our Home & Garden business, but we expect that sales in that business will fall short of our previous expectations due to additional sales pressure. We now expect the topline for the year to decline by mid-single digits from last year, leading to adjusted EBITDA being down in the low mid-single digits. Before I turn the call over to Jeremy, thank you to our teams around the world who've worked tirelessly throughout periods of uncertainty related to the almost two-year pending HHI transaction, while facing current market headwinds and making difficult short-term decisions to prepare our business for long-term success. Now, you'll hear more from Jeremy on the financials and additional business unit results, and then we'll join you in the Q&A. So, I'll turn the call over to you, Jeremy.

Jeremy Smeltser, Chief Financial Officer

Thanks, David. Let's turn to Slide 9 for a review of Q2 results from continuing operations. Net sales decreased 9.7%. Excluding the impact of $19.4 million of unfavorable foreign exchange and acquisition sales of $22.1 million, organic net sales decreased 10.1% from reduced customer replenishment orders as they maintained focus on inventory reduction, particularly in Home & Garden and kitchen appliances product categories, and from lower consumer demand for hard goods and consumer durables categories compared to last year. Gross profit decreased $41.1 million, and gross margin of 29.4% declined 220 basis points from a year ago from the reduction in volume and from sales of higher-cost inventory accumulated during the prior year, partially offset by positive pricing. Operating expenses of $291.5 million increased 10.5% at 40% of net sales, driven by the recognition of intangible asset impairments on our Rejuvenate and PowerXL brands of $67 million combined, offset by the positive impact of fixed cost reduction efforts initiated in the prior year. The operating loss of $77 million was driven by the impact of sales decline and the intangible asset impairment charge mentioned earlier. The GAAP net loss and decrease in diluted earnings per share were primarily driven by the increase in operating loss and higher interest expense. Adjusted EBITDA was $51 million, declining due to the decrease in volume and unfavorable foreign exchange impact, offset by favorable price and fixed cost reductions. Adjusted diluted EPS declined to a loss of $0.14 per share, driven by lower adjusted EBITDA and higher interest expense. Q2 interest expense from continuing operations of $31.6 million increased $6.9 million due to a higher interest rate on our variable-rate debt. Cash taxes during the quarter of $5.7 million were $6.7 million lower than last year. Depreciation and amortization from continuing operations of $22.4 million was $3.3 million lower than the prior year. Capital expenditures were $15.9 million in Q2 versus $10.2 million last year. Cash payments towards strategic transactions, restructuring-related projects, and other unusual non-recurring adjustments were $22.5 million versus $28.7 million last year. Moving to the balance sheet, the company had a quarter-end cash balance of $328 million, and $362 million available on its $1.1 billion cash flow revolver. Total debt outstanding was approximately $3.2 billion, consisting of $2 billion of senior unsecured notes, $1.1 billion of term loans and revolver draws, and $91 million of finance leases and other obligations. Pro forma net leverage was 6.3x compared to 6.2x at the end of the previous quarter. Now, let's get into the review of each business unit to provide details on the underlying performance drivers of our operational results. Starting with Global Pet Care on Slide 11. Reported net sales increased 0.5%. Excluding the unfavorable foreign currency impact of $7.6 million, organic sales increased 3.1%. Sales improved in the second quarter compared to the first quarter despite customers' focus on inventory management. Our EMEA sales were adversely impacted by unfavorable foreign exchange rates, though adjusted for FX, sales increased due to growth in the companion animal category. Sales in the Americas benefited from strong growth in companion animal categories, though declines in aquatics were noted. On the cost side, we experienced inflation in line with our expectations, but we are encouraged by the stabilization and reduction in costs. Our global Dog Chews business surpassed $1 billion in retail sales due to innovation, unique form factors, and global expansion. Adjusted EBITDA for GPC increased to $46.3 million, a $5.7 million increase driven by favorable pricing and cost reduction measures. While we expect trends to continue positively, we remain cautious about certain categories within pet specialty channels. Moving to Home & Garden on Slide 12, net sales decreased 22% in the second quarter, driven by a higher-than-expected reduction in retail inventory compared to a strong prior year build ahead of the season. Adverse weather conditions negatively impacted the pest controls category POS, leading to lower replenishment orders. We expect further retail inventory decline in the third quarter. We still expect high single-digit POS growth in the second half of the year. Our innovation reflects in new products being rolled out, like the One-Shot Premium Weed and Grass Killer product. Adjusted EBITDA for our H&G business was $15.1 million, primarily driven by the sales decline but partially offset by operational cost reductions. In Home & Personal Care on Slide 13, reported net sales decreased 11.7%, driven by category decline from lower consumer demand and continued retail inventory reductions. Adjusted EBITDA decreased to a loss of $1.9 million, with pressures from lower volumes and foreign exchange impacts. We expect softer consumer demand to persist. Given the challenges of retail strategy and timing, we expect fiscal '23 net sales to decline by mid-single digits relative to last year, and adjusted EBITDA to be down by low to mid-single digits. Now, on to Slide 15. We're excited about our strong team efforts during challenging times. Thank you for your continued support.

David Maura, Chairman and Chief Executive Officer

Thanks, Jeremy. Thanks, everyone, for joining us. To recap the key takeaways: the resolution of the DOJ challenge of Assa Abloy's acquisition of our HHI unit is significant. We're on track to complete this transaction on or before June 30. With successful completion, we will strengthen our balance sheet, and start the process of deleveraging. This will help us move towards our long-term goal of becoming a faster-growing, higher margin pure play pet and home and garden company. Although we are facing headwinds in our Home & Garden business related to retailer inventory strategy, we remain confident in our long-term strategy and ability to deliver value to our consumers and customers worldwide. We've successfully pivoted our teams to focus on profitability, working capital discipline, and cost management. I remain optimistic about the future of our company, and I believe we are well-positioned to execute on our operational goals and generate cash flow in fiscal ’23. Exciting times are ahead for Spectrum Brands. Now I'll turn the call back to Faisal for Q&A.

Faisal Qadir, Vice President of Strategic Finance and Enterprise Reporting

Thank you, David. Operator, we can go to the question queue now.

Operator, Operator

Thank you. Our first question comes from Peter Grom with UBS. Your line is open. Please go ahead.

Peter Grom, Analyst

Thanks, operator. Good morning, everyone. So, David, it's been a while since you really discussed the use of proceeds in detail. I appreciate the commentary around targeting net leverage in the 2x to 2.5x range and that you plan to return cash to shareholders via buyback. But have you given any consideration to the size of the buyback and what the program could look like at this point?

David Maura, Chairman and Chief Executive Officer

Hey, Peter, thanks for the question. The lower the share price, the bigger the buyback is my answer. At the end of the day, we still haven't closed. We just got through DOJ last week. It's been the board and today's earnings calls. We are confident in closing this deal on or before June 30. The last nine months have aimed at getting the balance sheet healthy. I believe we will pivot this balance sheet quickly and focus on P&L and getting profits up. I would like to meaningfully shrink our flow. But I don't want to pigeonhole myself right now. I want to get to a close, recapitalize the balance sheet, and then communicate then, but we will be buying shares.

Peter Grom, Analyst

Okay. That's helpful. On the deal, it seems like the press release mentioned there was one regulatory approval outstanding in Mexico. Is that something we need to be worried about? Is it progressing in line with expectations?

David Maura, Chairman and Chief Executive Officer

Yes, Mexico needs to approve the deal. We think they will, and we don't expect any issues with it. We intend to close the deal on or before June 30.

Operator, Operator

Thank you. And one moment for our next question. Our next question comes from the line of Bob Labick with CJS Securities. Your line is open. Please go ahead.

Bob Labick, Analyst

Good morning and congratulations on the DOJ settlement.

Jeremy Smeltser, Chief Financial Officer

Hey, Bob. Thank you.

David Maura, Chairman and Chief Executive Officer

Thanks Bob. Long time coming.

Bob Labick, Analyst

Yes, no, it was a nice theater, but it's a good outcome obviously.

David Maura, Chairman and Chief Executive Officer

I didn't enjoy the theater, but thank you.

Bob Labick, Analyst

I wanted to just take a half step back and say, we're talking about a lot of macro and near-term inventory and all that kind of stuff right now. Any of the discussion on today's call impacting the calendar ‘24 outlook for the businesses? Or are we just caught up in a lot of noise?

David Maura, Chairman and Chief Executive Officer

Yes, I think there's clearly been a lot of noise. Buy stuff on the rumor, sell on the news because there's substantial cash coming into the company. A fundamental investor should zoom out and realize that supply chain elongation and pandemic spike in demand have caused a large object to need to pass through a pipeline. When you take your balance sheet up $400-500 million to help retail customers, and then that supply chain snaps back and demand drops, liquidating is difficult. I'm disappointed with our Home & Garden performance, but I believe we can restore our P&L.

Jeremy Smeltser, Chief Financial Officer

Yes, I think as I think towards the second half, we have seen a margin inflection point as the cap variances we entered the year with are gone. There might be little left in Q3, but that's it. That's not only a second half tailwind; it's a 2024 tailwind. Our sales in H&G in fiscal ‘23 will be below consumer demand as a body of work, but I would not expect that to continue in 2024.

Bob Labick, Analyst

Okay, great, thanks. And then just again, taking us back from previous calls, you’ve said you believe the pet business is a $200 million EBITDA business, and H&G is $120 million-plus. Are those still the right kind of starting points when things normalize?

Jeremy Smeltser, Chief Financial Officer

In my mind, those are the right numbers still, Bob.

David Maura, Chairman and Chief Executive Officer

Yes, absolutely.

Bob Labick, Analyst

Okay, super. All right. Fair enough. I'll get back in queue. Thanks.

Operator, Operator

Thank you. And one moment. Our next question comes from the line of Olivia Tong with Raymond James. Your line is open. Please go ahead.

Olivia Tong, Analyst

Great, thanks. Good morning. I wanted to ask first on lawn and garden. I get that the weather was unfavorable. We've seen that across other companies already. But your sales seemed to have been hit more this quarter. What's your view on how much of this is weather versus a new normal on inventory?

Jeremy Smeltser, Chief Financial Officer

I don't attribute a ton of it to weather. It really is about a shift in retail strategy that we didn't expect as we entered the year. They're going back to pre-pandemic levels, which has led to low retail orders despite fairly normal POS.

Olivia Tong, Analyst

Got it. And then wanted to ask you about HPC and your view on the timing of exploring strategic alternatives. You mentioned inventory is now right-sized, but small appliances are still under pressure. Any color on exploring exit strategy for that business to reach your long-term goal?

David Maura, Chairman and Chief Executive Officer

The post-pandemic fallout in that industry will take a couple of quarters to return to profitability. We are very interested in becoming a pure play pet and home and garden company, and will be actively pursuing that this summer going into the fall.

Operator, Operator

Thank you. And one moment please. And our next question comes from the line of Chris Carey with Wells Fargo Securities. Your line is open. Please go ahead.

Chris Carey, Analyst

Hey, everyone. Good morning. So, the debt paydown, I don't think that puts you at your leverage targets. Do you anticipate getting to your leverage targets immediately or would that happen over time? And Jeremy, do you still expect $3.5 billion net cash from the deal?

David Maura, Chairman and Chief Executive Officer

If I get $4.3 billion of cash in the door and only have $3 billion of debt, my net leverage ratio is negative. We want to stay liquid and maintain a low leverage profile as we restore our earnings power from this point on.

Jeremy Smeltser, Chief Financial Officer

Yes, I think the net proceeds will be in the $3.5 billion to $3.6 billion range.

Chris Carey, Analyst

Okay. All right, thanks. And just a follow-up on the earnings power. Are you expecting a quick snap back in your margin structure and sales, or is it more appropriate to think about a progressive build back to the earnings power?

Jeremy Smeltser, Chief Financial Officer

We expect a really nice sequential improvement, particularly in Global Pet Care, because they don't face this retail inventory strategy change. The second half looks good, while HPC is a bit different with cautious expectations. But margins will improve.

David Maura, Chairman and Chief Executive Officer

I like your word progressive. We need to get our house in order and refocus on executing consistently.

Chris Carey, Analyst

I know I’m kind of dominating here, but I get this question a lot, so I'm curious about your free cash conversion over time in a more normal environment.

Jeremy Smeltser, Chief Financial Officer

I usually model it at 50% of EBITDA in our longer-term models. In a business like ours, inventory is the real wild card in free cash conversion from EBITDA.

Operator, Operator

Thank you. And one moment for our next question. Hi, next question comes on the line of Ian Zaffino with Oppenheimer & Co. Your line is open. Please go ahead.

Ian Zaffino, Analyst

So, when I think about your proceeds, how much do you think you need to pursue tuck-in M&A, and how much do you think you need to invest in the business?

David Maura, Chairman and Chief Executive Officer

We don't have anything we want to acquire right now. We want to get the balance sheet right, shrink the float, and get consistent profit production. That's job one, two, and three.

Jeremy Smeltser, Chief Financial Officer

We will utilize the entire US NOL to protect the gain from this deal. We will become a constant US taxpayer post-deal.

Ian Zaffino, Analyst

Okay, perfect. Thank you very much.

Operator, Operator

Thank you. And one moment for our next question. Our next question comes from the line of Brian McNamara with Canaccord Genuity. Your line is open. Please go ahead.

Brian McNamara, Analyst

In terms of a potential board authorization of a buyback, is it as simple as not being able to do it until the proceeds come through?

David Maura, Chairman and Chief Executive Officer

No, we already have a $1 billion buyback. I've got $750 million available to me now. I want to get this balance sheet delevered and see where the share price is.

Brian McNamara, Analyst

Great. I'm also curious why the market isn't giving you guys credit for the HHI settlement?

David Maura, Chairman and Chief Executive Officer

Shareholder bases change over time; it's rare to find someone that looks at stocks for more than three minutes. A deal that gets as much press as this attracts a technical shareholder base that may sell with fluctuations. We need to focus on the fact that we're improving our leverage, restoring earnings power, and that takes time.

Brian McNamara, Analyst

Great. Thank you. Best of luck.

Operator, Operator

And one moment for our next question. The last question will come from the line of Stephen Powers with Deutsche Bank. Your line is open. Please go ahead.

Steve Powers, Analyst

On the long-term net leverage ratio objective, what does that mean in terms of timing? Are we looking at exiting fiscal ‘24 or longer?

David Maura, Chairman and Chief Executive Officer

I don't have a specific timing in mind. We're letting you know we want to run the business less levered. We are looking to get our earnings power healthy. We need to settle our business and invest in organic growth.

Jeremy Smeltser, Chief Financial Officer

It'll depend on market conditions and acquisition opportunities. We have a very different balance sheet to show next quarter, and we'll make smart capital allocation decisions.

Faisal Qadir, Vice President of Strategic Finance and Enterprise Reporting

Thank you. With that, we will conclude our conference call. Thank you to David, and Jeremy, and on behalf of Spectrum Brands, thank you all for your participation.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.