Spectrum Brands Holdings, Inc. (NYSE:SPB) Q2 2023 Earnings Call Transcript May 12, 2023

Spectrum Brands Holdings, Inc. misses on earnings expectations. Reported EPS is $-0.14 EPS, expectations were $-0.05.

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 speaker’s presentation there’ll be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded. I would now like to turn the conference over to your speaker today, Faisal Qadir. Please go ahead.

Faisal Qadir: Thank you. Good morning, and welcome to Spectrum Brands Holdings Q2 2023 earnings conference call and webcast. I’m Faisal Qadir, Vice President of Strategic Finance and Enterprise Reporting, 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 at www.spectrumbrands.com. The document will remain there following our call. Starting with Slide 2 of the presentation, 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. Turning to Slide 3 and 4, 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: 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. If I could get everyone to move to Slide 6, let me first start with a very positive achievement on the strategic front. As many of know and you’ve already learned from our press release last week, we’ve 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 30th, 2023. We are particularly pleased that our hardware asset and employees are going to such a great home in Assa Abloy. I have not only the utmost respect for them as a company, but 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 likely in the history of Spectrum Brands, as the receipt of the HHI sale proceeds will materially strengthen our balance sheet, enhance our capital allocation strategy, and in fact, will 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.

This will also allow the team to devote all of our resources to, and to prioritize, the long-term growth of the remaining businesses. We remain committed to finding a strategic and organic way to enhance the value of our Home & Personal Care business. As we have previously communicated, we will use the proceeds from this transaction to delever and to strengthen our balance sheet. We will start that process by paying off the term loan and the revolver facility immediately following the close of the HHI sale. We also 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. I’d like to focus on two key messages today.

First, our renewed focus on profitability, working capital management, and cost management, continues to pay off despite a difficult and unpredictable market dynamic and the macroeconomic headwinds we and our peers have been facing. While these headwinds are challenging to manage, we remain confident in our long-term strategy and our ability to deliver value to our customers. And secondly, we continue to face short-term headwinds related to consumer inventory actions, particularly in our Home & Garden business that are more severe than we expected, and that will impact our fiscal ‘23 results more than we previously anticipated. Building on the first message, our focus on cash generation continues to pay off. We reduced inventory by another $170 million in the quarter, including our HHI business, following a reduction of $170 million in the preceding six months.

That means, since turning our attention to running our business for cash and prioritizing cash flow and inventory reduction over earnings, we have now reduced our inventory by over $340 million US, including HHI during the last nine months. We continue to focus our operating priorities to maximize cash over earnings and reduce our overall inventory levels. The strategy is clearly working, as this effort has resulted in positive free cash flow so far in the current fiscal year, but we will continue to focus on working capital management and strengthening our balance sheet. Our inventory is now approaching appropriate levels to support the demand in the marketplace, and further reductions will come from rebalancing our inventory profile to minimize excess inventory.

On the cost side, we remain focused on simplifying our business model and reducing cost to operate as a leaner organization, with a renewed financial discipline. To that end, we have made further fixed cost reductions and have eliminated additional headcount in certain focused areas of the organization. With all the cost actions in place, we believe we are well positioned to face the short-term headwinds, while still maintaining key capabilities necessary to continue to invest in the long-term growth of the businesses. Now, building on my second message regarding these short-term headwinds, as expected, the consumer demand environment remained challenging compared to the strong COVID-related demand growth over a year ago, especially for the hard goods categories, where demand is continuing to normalize to pre-pandemic levels.

And our retail partners remain focused on inventory reductions in those categories. Additionally, our key retail partners in our Home & Garden business changed their strategy to reduce inventory in the quarter compared to a 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 financial results obviously reflect these conditions, as our total sales declined 9.7%, while organic sales declined 10.81%. And Jeremy will provide more details by business unit in his comments.

While this volume decrease was the main contributor of the EBITDA decline in the quarter, EBITDA was also pressured by unfavorable FX year-over-year, as well as the impact of selling down our higher cost inventory accumulated during the prior year periods. As a reminder, we started this fiscal year with approximately $55 million in excess capitalized variances on our opening balance sheet, and we expected to roll through our income statement in the first half of fiscal ‘23. We have now substantially sold all of that inventory, and we are exceeding currently the expected profitability inflection point in our recent monthly results. If I can move your attention now to Slide seven and our high-level fiscal ‘23 earnings framework. We remain very 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 also remain very confident in the long-term strategy for our Home & Garden business, but with the change in retailer inventory strategy that we experienced in the just completed quarter, we expect sales in that business to be well below the POS levels in the fiscal year, and therefore, below our previous expectations. With the additional sales pressure, we now expect the H&G business will not reach its full earnings potential during this fiscal year, and will fall short of our previous EBITDA expectation for that business. Based on this additional revenue pressure, we need to update our earnings framework. We now expect the topline for the year to decline by mid-single digits to last year. As a consequence of this sales decline, we expect our adjusted EBITDA to be down in the low mid-single digits.

Before I turn the call over to Jeremy, I would like to thank our teams around the world who’ve worked tirelessly throughout a period of uncertainty related to the almost two-year pending HHI transaction, and while facing all the while the current market headwinds and making some very difficult short-term decisions to prepare our business for long-term success. Now, you’ll hear more from Jeremy on the financials and our 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: 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, with the dollar increase 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, and that continued in the second quarter, along with overall spend management. The operating loss of $77 million was driven by the impact of the sale declined, and the intangible asset impairment charge I mentioned. 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. Turning to Slide 10, 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. Separately, share and incentive-based compensation decreased $2.1 million. 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. Additionally, pro forma net leverage was 6.3x compared to 6.2x at the end of the previous quarter, as the trailing 12-month EBITDA declined sequentially. Now, let’s get into the review of each business unit to provide details on the underlying performance drivers of our operational results. I’ll start with Global Pet Care, which is Slide 11. Reported net sales increased 0.5%. Excluding unfavorable foreign currency impact of $7.6 million, organic sales increased 3.1%.

Net sales improved in the second quarter as compared to the first quarter, which was pressured by customers’ focus on inventory management, leading to lower replenishment orders. Organic sales in both the US and internationally increased over last year, as demand for companion animal categories remained strong, offsetting softness in the aquatics category occurring across all markets. Sales were also helped by new price increases in EMEA and by the impact of pricing actions taken globally throughout last year. Our EMEA sales were adversely impacted by unfavorable foreign exchange rates as the dollar strengthened against the British pound and the Euro compared to last year. Adjusted for FX, sales increased in EMEA due to growth in the companion animal category, mainly driven by our dog and cat food sales, which offset declines in aquatics, as we continue to compare to strong prior year aquatic environment and equipment sales.

Most of the planned price increases in EMEA announced during the first quarter have been successfully implemented, with a few starting in the third quarter. The price increases are offsetting cost pressure from unfavorable FX and energy inflation that we continue to experience in our international business, which are in line with our expectations. Sales in the Americas also benefited from strong growth in our companion animal categories, offset by declines in aquatics due to challenging prior year comps. However, while our overall aquatic sales declined, sales for aquatics nutrition products continued to show growth. On the cost side, we experienced inflation in line with our expectations, and are encouraged by the fact that costs have either stabilized, or in some cases, are starting to retreat.

That said, we will continue to closely monitor input costs and strategically price as necessary. Fueled by innovation, our global Dog Chews business recently achieved an exciting milestone by surpassing $1 billion in retail sales. Exciting innovation, unique form factors and flavors, seasonal offerings, and global expansion, have fueled that growth. In Q2, we launched innovation in the highly digestible Rawhide segment through the Good ‘n’ Fit brand in the US, which has already gained distribution in mass and drug channels. In Europe, earlier in the year, we launched the Tough ‘n’ Tasty line under the Good Boy brand have seen success in both the UK and in Germany, which is a new market for the brand. Additionally, in Europe, we launched new flavors and sizes in the IAMS brand have expanded the Eukanuba brand into the Wet Cat Food segment.

Both have been well received, and are one of the catalysts behind the strong growth our dog and cat food business is experiencing. Adjusted EBITDA for GPC increased to $46.3 million. The increase of $5.7 million was primarily driven by favorable pricing, including the incremental pricing actions in the EMEA region and our continued focus on cost reduction measures, including the fixed cost restructuring we initiated last year, and further cost action during the first half of this year. This was partially offset by lower volume, the unfavorable impact of FX, and the impact of capitalized variances, as we continue to sell our high-cost inventory from last year. On a positive note, the unfavorable impact of capitalized variances from the prior year high-cost inventory is now behind us, and we are already seeing our margin profile improve.

We expect to see the positive sales trend continue in the second half of the year. We remain cautious about performance of certain categories within the pet specialty channels such as aquatic environments and hard goods within companion animal, as the rates of new entrants settle to pre-pandemic levels, but we expect the positive trends in companion animal consumable categories to more than offset these pressures. Overall, the category fundamentals remain strong, especially within consumables. This is encouraging as our business is becoming more aligned to consumable products for your pet, which represents over 80% of our total revenues. The GPC team remains focused on the execution of our long-term strategy, which is centered around inspiring more trust through the delivery of unique and innovative products in order to drive demand for our portfolio of leading brands.

Our pet business is a historically recession-resistant business with tremendous upside potential, which is why we remain bullish about the continued growth of this business. Moving now to Home & Garden, which is 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 late in the quarter also negatively impacted the pest controls category POS, and resulted in lower replenishment orders. This was partially offset by the impact of price increases. Sales of cleaning and restoration products also decreased due to POS decline in our relevant categories, as well as comparison to last year inventory loads during the quarter.

Slower start to the spring-cleaning season also contributed to the POS decline in the quarter. The weather has been a mixed story so far this year, with some very positive POS weeks, mixed in with negative POS weeks due to cooler weather. As I mentioned earlier, there is a shift in the retailer strategy, and our key retailers are maintaining significantly lower inventory levels compared to last year in the second quarter. We now expect this trend to continue, leading to further retail inventory decline in the third quarter to pre-COVID levels. This reduction will directly impact our sales expectations in the second half. That said, we still expect high single-digit POS growth in the second half of the year, and believe that consumer demand will remain strong, with the weather outlook pointing to a more normal season, with higher temperatures and humidity.

As a reminder, on average, around 70% of POS is achieved in the second half of our fiscal year. We continue to believe in our strong innovation that is reflected in new products that are now being rolled out to the marketplace. On our Spectracide brand, we now have available the new One-Shot platform, a program designed to bring to market new ingredient technologies and superior delivery systems across several categories. First product under this platform is One-Shot Premium Weed and Grass Killer, a product designed for a highly demanding consumer that is willing to pay a premium for superior results. Traditionally, Spectracide has focused on consumers looking for strong results at a great value, and our One-Shot platform allows consumers to find also a superior performance option with the brand they trust.

In repellents, we now offer new Zone Mosquito Repellent Devices, Cutter Eclipse and Repel Realm. Although our brands have a strong presence in area repellents, the device-driven outdoor diffusers is a new segment for us. We are excited to offer these new products, as it allows us to enter a segment where we feel confident about bringing disruptive technologies and superior devices to protect and delight our consumers and their families. We are excited about this launch and the future for our brands in this area. We are carefully monitoring POS and coordinating with our retail partners to ensure we can appropriately supply the products to meet consumer demand. As I referenced earlier, we expect further retail inventory reduction actions in the second half.

We have made strong progress driving agility and speed into the organization, as it will be required to effectively ramp up production and meet the expected increase in retailer demand as the spring and summer season continues. Adjusted EBITDA for our H&G business was $15.1 million. The EBITDA decrease was primarily driven by the sales decline and impact of selling through prior year high-cost inventory. This was partially offset by the benefits of fixed cost restructuring and operational cost reductions initiated during the second half of last year. We experienced higher product costs from raw materials, labor, and freight, in line with our expectations. As we look forward to the balance of fiscal ‘23, we still expect sales growth in the second half of the year, but not enough to make up for the first half performance.

As a result, we expect sales to be down for the full year. Although we believe that the fundamentals of the consumer market remain strong, this will likely be a difficult year for the Home & Garden business because of the challenges posed by the retail channel inventory strategy. And finally, Home & Personal Care, which is Slide 13. Reported net sales decreased 11.7%. Excluding the unfavorable foreign exchange impact of $11.8 million and the impact of the Tristar acquisition, organic net sales decreased 14.9%. The organic net sales decrease was driven by category decline from lower consumer demand, particularly in kitchen appliances and continued retail inventory reductions. Sales were also lower in personal care appliances and garment categories.

North America retail inventory is particularly high on our PowerXL air fryers as demand remains well below pandemic highs. We expect continued pressure for the remainder of the year for this product line as retailers work down inventory through suppressed replenishment orders. On the positive side, our hair care category grew in the second quarter. EMEA region sales also declined, primarily driven by FX and reduced consumer demand. Net of FX, personal care category registered growth in the EMEA region, while small kitchen appliances continued to see the most pressure from consumer demand. Despite the difficult market conditions that the small appliances face, we are having success with our new launch of Russell Hobbs Air fryers, which is quickly becoming an important category in EMEA, growing significantly from its launch last year.

We’ve also successfully launched PowerXL in EMEA, which is rapidly growing versus last year. Adjusted EBITDA decreased to a loss of $1.9 million. Lower adjusted EBITDA margin was driven by lower volumes, the impact of unfavorable foreign exchange rates, and higher cost of sales as we continue to sell our high-cost inventory from last year. Some of this EBITDA pressure was offset by our continued focus on cost reduction measures, including the fixed cost restructuring we undertook during the second half of last year, and additional re restructuring actions initiated during the second quarter this year. Looking forward to the second half of the fiscal year, we continue to expect softer consumer demand, particularly in the kitchen appliances category, and expect US retailers to continue their focus on inventory reduction.

Such, we have also maintained our internal focus on inventory reduction, and have further slowed down and in some cases stopped incoming orders. This focus on inventory reduction has paid off, and has already resulted in a substantial decrease in the inventory levels in the HPC business. We believe HPC inventory levels are now appropriate to support the demand in the marketplace and we do not foresee further significant inventory reduction here. Commercially, our renewed focus remains on driving fewer, bigger, better consumer-relevant innovations that enhance our current market position, and simplify the operating model of the business. Turning now to Slide 14 and our expectations for 2023. Given the change in expectations for our H&G business, we now expect fiscal ‘23 net sales to decline by mid-single digits to last year.

Foreign exchange is expected to have a negative impact based upon current rates. We expect adjusted EBITDA to be down by low to mid-single digits, primarily due to additional sales pressure with inflation headwinds, offset by the annualization of prior year pricing actions and additional price increases already implemented during the current year, as well as additional productivity gains and the benefits of our cost reduction actions. Now, on to Slide 15. Depreciation and amortization is expected to be between $105 million and $115 million, including stock-based compensation of approximately $7 million to $12 million. Full year interest expense is expected to be between $120 million and $125 million, including approximately $5 million of non-cash items.

Cash payments towards restructuring, optimization, and strategic transaction costs are expected to be between $65 million and $70 million. Capital expenditures are expected to be between $55 million and $65 million. And cash taxes, excluding any gain on the sale of the HHI business, are expected to be between $25 million and $35 million. For adjusted EPS, we use a tax rate of 25%, including State taxes. To end my section, I want to echo David and thank all of our global employees for their strong efforts during these challenging times and for staying committed to our long-term strategic initiatives. Now, back to David.

David Maura: Thanks, Jeremy. Thanks, everybody, for joining us on today’s call. Let me just take a couple of minutes here to recap the key takeaways on Slide 17. Look, first, the resolution of the DOJ challenge of Assa Abloy’s acquisition of our HHI unit is our most significant achievement. We’re well on our way now to completing this transaction on or before June 30th. With the successful completion of this transaction, we will be able to meaningfully strengthen the balance sheet, and we’ll immediately start the process of deleveraging. This transaction will also bring us much closer to our long-term goal of becoming a faster growing, higher margin pure play pet and home and garden company, and it’ll allow the team to now devote resources and prioritize long-term growth of the remaining businesses in the company.

Second, while we’re facing some headwinds in our Home & Garden business related to a change in retailer inventory strategy, and the fact that they were more severe than we anticipated, that’s now going to impact our fiscal ‘23 results more than we originally planned. But we remain confident in the long-term strategy and our ability to deliver value to our consumers and customers worldwide. Last, we have successfully pivoted the teams to focus on profitability, working capital discipline, and cost management, as evident from our inventory reduction and cashflow generation thus far in the fiscal year, as well as the positive results of our fixed cost reduction actions. I want to close today by reiterating that I remain very optimistic about the future of our company, and I believe we are well positioned to execute on our operational goals, generate cash flow in fiscal ‘23.

I’m very excited about the strategic pivot that we’re on now and we’re going through as we sell HHI to Assa. And I want everyone to know the future of Spectrum Brands is brighter than ever. I’m going to now turn the call back to Faisal, and we can begin Q&A.

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

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Peter Grom with UBS. Your line is open. Please go ahead.

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.

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.

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.

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.

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.

Operator: Thank you. And one moment for our next question, and our next question comes from the line of Stephen Powers with Deutsche Bank. Your line is open. Please go ahead.

Faisal Qadir: Thanks, Steve. Operator, I think we have time for one more.

Operator: All right, one moment. Our last question is going to come from the line of Michael O’Brien with Wolfe Research. Your line is open. Please go ahead.

Operator: Thank you. And I would like to turn the conference back over to Faisal Qadir for closing remarks.

Faisal Qadir: 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: This concludes today’s conference call. Thank you for participating. You may now disconnect.