David Maura - Chairman, Chief Executive Officer Jeremy Smeltser - Chief Financial Officer Faisal Qadir - Vice President of Strategic Finance and Enterprise Reporting

Good day and thank you for standing by. Welcome to the First Quarter 2023 Spectrum Brands Holdings’ 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.

Thank you. Welcome to Spectrum Brands Holdings Q1, 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 two 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 three and four, 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 February 10, 2023 and 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 our forward-looking statement. Also, please note 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. David.

Thanks Faisal. Good morning, everybody. Welcome to our first quarter earnings update, and I thank everybody for joining us today. Today I'm going to kick the call off with an update on our operating - the operating environment and the company's strategic initiatives. Then I'm going to give an update on our current financial performance. Jeremy is then going to provide more financial and operational details, including discussion of the specific business unit results. If I could get everyone to turn to slide six, our financial results for the quarter demonstrate a renewed focus on profitability, financial discipline and cost management. We are pleased that our first quarter EBITDA exceeded expectations despite continued heavy inventory levels at retail, weighing on the volumes of product sold during the quarter. This was particularly evident in our HPC business where several of our competitors got excessively aggressive and sold products and material losses in the marketplace, causing overall sales to be less than expected in the quarter. This will require us to be even more aggressive in the marketplace around our clients business in the second quarter and beyond. Therefore, while our second quarter will be slightly better than our first quarter results, we still expect to liquidate large amounts of high cost inventory at aggressive prices, which we'll continue to pressure our margins in the second quarter. Based on current sales trends and our current inventory reduction plans, we believe our margin structure will materially improve starting in the month of March. We are excited to be only one month away from a profitability inflection point, and we expect our profitability to materially improve in our third fiscal quarter. As we anticipated and discussed with you during our last earnings call, our operations continue to be challenged by the difficult macroeconomic environment.…

Thanks, David. Let's turn to slide 10 for a review of Q1 results from continuing operations. Starting with net sales, which decreased 5.8%, excluding the impact of $39.6 million of unfavorable foreign exchange and acquisition sales of $67.8 million, organic net sales decreased 9.5% from reduced customer replenishment orders and they maintained focus on inventory reduction and from lower consumer demand for hard goods and consumer durables categories compared to last year. Gross profit decreased $17.4 million and gross margin of 28.3% declined 70 basis points from a year ago, from the reduction in sales and from sales of higher cost inventory accumulated during the prior year. Operating expenses of $222.1 million decreased 8.6% at 31.1% of net sales. The dollar decrease driven by the beneficial impact of fixed cost reduction efforts initiated last year and reduced spend on restructuring, optimization and strategic transaction costs. Operating loss of $20.2 million was an improvement from a year ago, due to the reduction in operating expenses, offset by a decline in gross profits. The increase in GAAP net loss and decrease in diluted earnings per share were primarily driven by the increase in interest expense, offsetting the decrease in the operating loss. Adjusted EBITDA was $39.8 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 $0.32 per share, driven by the lower adjusted EBITDA. Turning to Slide 11, Q1 interest expense from continuing operations of $33.4 million increased $11.6 million due to a higher interest rate on our variable rate debt and increased borrowing levels. Cash taxes during the quarter of $6.1 million were $600,000 lower than last year. Depreciation and amortization from continuing operations of $22.6 million was $2.9 million lower…

Hey, thank you Jeremy. Again, thanks everybody for joining us on the call today. At this point I'd like to take a couple of minutes and just recap kind of our key takeaways. You can find those on slide 18. First, as I said earlier, our Q1 financial results demonstrate our renewed focus on profitability, financial discipline and cost management. Our operating environment remains challenging. We have resolved to navigate these headwinds profitably and with financial discipline is stronger. We expect some of these headwinds to continue in the second quarter, which puts further pressure on our revenues. We have proactively taken additional actions to ensure that we maintain our profitability in fiscal ‘23. As referenced earlier, we are targeting flat net sales with low double digit EBITDA growth for the year. We expect to reduce our leverage by generating free cash flow through improved operating performance and working capital management. Secondly, we’ll maintain our focus on operating a leaner business, focused on fundamentals, free cash generation and debt reduction, built around four key pillars. First, we are streamlining our organizational structure and reenergizing our employee base. Second, we are increasing operational efficiencies and limiting risk. Third, we are protecting and deleveraging the balance sheet, strengthening liquidity. And fourth, but not the least, we are transforming this company into a pure play, Global Pet Care and Home & Garden business with faster growth and higher margins pro forma. Last, and certainly not the least, we expect to win the DOJ lawsuit and to close the HHI transaction by no later than June 2023 and collect $4.3 billion of cash. I want to close by reiterating that despite the short term challenges, I remain quite 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. I want you to know the future of Spectrum Brands remains bright and we continue to make living better at home. I'll now turn the call back over to Faisal for questions.

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

Thank you. [Operator Instructions] Our first question comes from Bob Labick with CJS Securities. Your line is open.

Good Morning. Thanks for taking our questions.

Good morning Bob. How are you doing?

Very well, thanks. Hope you guys are well too. A couple of questions. I wanted to start with – and you touched on this a little bit, but can you talk about the current inflationary environment and inflationary impact you're seeing beyond the elevated cost on the balance sheet. So kind of the go-forward environment. You know where it is? How does it compare to you know I guess pre Covid, pre – when transportation took off, and raw materials took off and you know where are we now and where is that trending?

I'll give you the broad brush, and then you know Jeremy can fill in on some more specifics. I would say look, clearly you have permanent and inflated labor costs, like across the board, right. That's from the factory floors, you know all the way through middle management. Freight rates, which continue to really burden the EBITDA, you know in Q1 and will hurt us in Q2 as well. you know they are through – they've dropped tremendously, and so that's why we believe – you know as I sit here today, we’re kind of 30 days away from seeing that inflection point actually flow through the P&L, right, because that new inventory at these lower freight costs are starting to hit the balance sheet and as we turn our inventories a little quicker, we think we'll see that margin uptick. And then look, I think certain commodities have come off. There's clearly more capacity in the factories around the world because of the slowdown of growth, particularly in the durable goods side. But you know it's only I guess the last couple of quarters we feel like we've got enough price to kind of offset the inflation. We do see some deflation now in certain materials, but you know freight has been kind of the big one, but we have yet to benefit from that in the P&L, and we're hoping that starts in the month of March and then you'll really see it kind of show up hopefully in the third quarter. Jeremy?

Yeah, I agree with all of that and I would say, I think to your last part of your question Bob is around as compared to pre-pandemic, you know really across the board everything is still materially higher than it was pre-pandemic. I mean I would tell you that our P&L, you know even at current freight rates is probably burdened by $80 million to $100 million of incremental freight as compared to pre-pandemic. All materials are higher and to David’s point, labour, you know I would view it as permanently higher than if you go back three years.

Got it. Okay, super. Thank you, I appreciate that. And then I know it's obviously easy to get fixated and caught up on both the macro, which we're kind of just discussing and the DOJ timing. So I wanted to step back to – and ask, you talked about this a little bit. Could we dig a little more into the company specific variables that you're focused on this year to grow revenue and margin? You talked a little about SKU rationalization, but just kind of refocus us on the revenue margin in your control variables this year, please?

I mean look, the two big levers that we've been executing on since we pivoted the strategy, you know starting kind of summer of last year into the fall to run the business, to maximize cash was to kind of break the back of the ever-ballooning balance sheet, which was you know elongated supply chains to try to keep our retail partners happy. You know we've made a really concerted effort to bring that down and you can see – normally we consume capital in the first quarter and you see another $60 plus million of inventory coming out of the system. We pulled $170 million I believe in inventory out of our business in the last six months, and we're going to continue to drive that down to create cash for ourselves, and so that's the – we've got these working capital in the right position finally, and that's something that's within our control. The other big thing that we've done is quite frankly, you know as the tide has gone out from the COVID demand, we've got to materially lower our cost structure. And so it's been very painful for our company, but we've taken quite a bit of fixed costs out of our operating model, and we continue to be very, very disciplined around expense management. We're trying to get through the second quarter and then pivot the profitability of the business. We really got to get the P&L going in the right direction, get EBITDA growing again year-over-year and we believe we will do that by the third quarter obviously. But you know we want to reinvest some of this money into some promotional activity, into some discounting, and really try to drive that top line sensibly. Recently I think you know meeting with some people, we're doing quite a bit of work in some of the divisions on DTC channels, digital channels, really trying to get better yields on our investments and make them truly correlated to transactions, if that makes sense? Jeremy, you want to...

I think that covers it David.

Okay.

Okay super. Thank you so much.

Thank you. And our next question comes from Peter Grom with UBS. Your line is open.

Hey, thanks operator and good morning everyone. Hope you’re doing well.

Thank you.

So, I guess I wanted to ask this – Hey Jeremy! So I guess I just wanted to ask specifically about the phasing of the year from an EBITDA perspective. Can you maybe just provide a finer point on what you mean by 2Q will be challenged year-over-year? Is that kind of as a percentage of sales or is that more just in pure dollar terms? Just any color on that would be pretty helpful. And then I just – I guess just in that context, you know the ramp implied in the back half of the year is just pretty substantial. So just – can you just talk about the confidence in that ramp and kind of the underlying assumptions embedded in that? Thanks.

Yes, I'll start Peter and David can follow on with any comments. So what we're expecting is that we'll see Q2 be down year-over-year. I think we do expect to see it improve sequentially, but you know the reality of this year is a tale of two halves with this $55 million of capital variances that we started the year. You know 90%-plus of that I think is flushed by the end of Q2. So you kind of got a $50 million benefit in the second half as compared to the first half, which by the way is something that all other things being equal would be a first half '24 benefit year-over-year as well. So that's a good thing, but it's painful to get through here in the first couple of quarters of this year. So we're very confident in that. That's math, it's in the system. We see those capitalized variances, we know as they flow out. I mean, our assumptions really are for a pretty consistent environment with what we're experiencing in the first quarter for the rest of the year, with the exception of Home & Garden, right, which we have to account for and predict some level of seasonality there, which is always challenging. And you know we've got to partner really closely with our retail channels to make sure we understand how they're thinking about, really each month to stage for the season. So there'll be some variability there, but that's kind of transparently how we're thinking about the year. We don't have an expectation that we see a strong improvement in consumer demand this fiscal year. I mean, I think current expectations for a soft landing are great, but I think we need to be prepared for even a further level of decline in the macroeconomic environment.

Great. And then maybe just like a follow-up on that, a bigger picture question around the earnings power of the company. David, I think it was back in the summer, you kind of threw out a number around $400 million in adjusted EBITDA before the company normalized, and I know we are really still in a very tough environment, but I guess, has anything changed over the last six months or so where you feel differently about the earnings power of the company. And then I guess if not, when you take into consideration the back half ramps and Jeremy’s comments around some of the benefits flowing through ’24. I mean, how quickly can the company get back to that degree of earnings power. Thanks.

Yes Peter, thank you to that. Look, I think the only delta at the current time is the appliance unit. That business has materially underperformed in the latest quarter, in the current quarter, because it’s durable product. Everybody stocked their kitchen with cooking equipment during COVID, but a lot of the competition entered the space. We acquired one of them to bolster our own platform, but there's just a lot of inventory and a lot of competition that is flushing product at very large losses. And so if you dig around, I think you'll see there will probably be some bankruptcies of some of these players you know over the next quarter or two would be my expectation, given what's going on in that space. And so look, do I think $400 million is the earnings power of RemainCo? Yes. What does that entail? It entails pet getting back to $200 million in EBITDA, and that requires pet run rating $50 million in EBITDA a quarter. You know once we get through these capitalized variances, we believe that's very achievable for pet. Secondly, it requires Home & Garden to be at least $100 million plus in EBITDA. We believe that's achievable this year, and we believe that we can grow materially above that, given our exposure to cleaning and our plans for rejuvenate, etcetera. So there's 300 of it, and then listen, appliances will not do $100 million in EBITDA this year, but it does have that earnings power potential, but you won't see that probably until fiscal '24. So that's how we'd lay it out. I would say, look, the $400 million of earnings power is intact. The big divot to you seeing it this year is going to be appliances. But Pet and Home & Garden is the future of where we're trying to take the businesses, and once we close HHI, we're going to look to solve for the appliance unit.

Great! Thanks for much for that, I’ll pass it on.

Thank you.

Thank you. One moment for our next question. Our next question comes from Ian Zaffino with Oppenheimer. Your line is open.

Hi! Great, thank you very much.

HI Ian.

How are you guys?

Good.

All right. Glad to hear the confidence in the deal closing with HHI. How are you guys actually thinking about the cash proceeds? And I guess what I mean by that is we're sitting here, you know you mentioned deleveraging, probably some buybacks, but you know you do own – basically you’re going to be receiving more cash than your market cap. So how do you handle that cash receipt? And maybe how do you think about potentially returning that to shareholders, and then I have a follow-up. Thanks.

Yeah look, we're going to go to trial in April. We're going to win a case. We're going to close the deal in June. We are going to – I'd say if the money gets wired to me on a Monday, what do I do on Tuesday? Tuesday, I probably pay off all my bank debt at a minimum. I despise our leverage position. I am working every day with the teams to drive inventory, drive working capital out of system, run the business for cash flows and so that's a big focus. But again, we've said for some time, look, there's a lot of distortion here. I think what people – you know to Peter's earlier question, you've got the slack in the system between POS can be very strong. For example, POS in January is very strong for our Home & Garden business, but we're not yet seeing the factory shipments we want to see, right. That's just retailers continuing to wait, continuing to burn off a little bit of inventory they had last year and so that causes a lot of distortion to reported numbers until we can get into an equilibrium situation. We're clearly going to get into equilibrium on Pet, Home & Garden much faster than appliances. And so that's why you're going to see such a big rebound in the back half of the year as we burn through these capitalized variances, and we see profitability restored Q3, Q4. But look, we believe our stock is materially undervalued. I know that hasn't meant a whole lot in the last nine months. The company, you know last year did trade at over $100 a share, and we quite frankly think we're worth that. And so it would be silly for us to kind of sit on an extra couple of billion dollars. We'll probably call some of our notes. But quite frankly, while our leverage is still high, the liability side of this company is actually an asset in today's capital markets environment because we have bonds at 4% and less. That's a pretty attractive rate to finance yourself when the two year note is above 4.5%. So, we need to keep our capital structure in place, pay off the banks, buy back some stock and then look to see what bonds we take out. That's how I'd answer the question today.

Okay. Perfect. And then also on the change in the revenue guidance, can you maybe bucket that for us? How much is FX? How much is incremental headwinds that you're seeing? And then when we get on to the EBITDA line, how much of that FX hit is a naturally hedged, you're not really seeing an impact of that? Thanks.

I'll let Jeremy answer your real question, I'll just tell you straight up, the real reason that revenue is coming down is the appliance business, beginning and end of story. But Jeremy, you want to take the FX piece?

Sure. Yes, I agree with David. It’s the appliance business. What we experienced in Q1 and really what we think now based on that experience for the rest of the year will look like. And then on the FX front, one, as compared to where we started the year, we've seen a benefit with the dollar weakening a bit. I think, we probably would peg at the start of the year parity with the euro. We're sitting around 107, 108 today I believe, yesterday. So that's a bit of a benefit. In general, we try to hedge 60% to 70% or so in our European businesses against FX. We fight both translation and transaction, obviously. You're not really hedging translation, so you still have some level of exposure as you go through the year. But the trend right now is a little bit positive and we reflected that in our updated forecast.

Okay. Thank you very much.

Sure. Thank you.

Okay. Our next question, one moment. It comes from Chris Carey with Wells Fargo. Your line is open.

Hey! Good morning, everyone.

Hey Chris!

So just a clarification then a question, I have another question. But Jeremy, I just wanted to clarify a prior question around EBITDA phasing. I'm looking at the Q2 consensus EBITDA of $80 million after roughly $40 million this quarter and you know commentary on headwinds persisting into Q2, margins don't inflect until March. Should we be thinking about an EBITDA number roughly at that level? And I apologize if you had said this and I missed it, but I just want to get that straight, just to make sure we're thinking about that correctly.

Yes. I didn't mention a specific number for the quarter, and we don't give quarterly guidance. But I understand the question, certainly. Yes, I mean, consensus is sitting for Q2 above our last year performance. And clearly, I said that I expect we're going to be down year-over-year, pull up sequentially. I think we could talk through that business by business as we connect but definitely today. But it's you know the reality is, I think that we're going to see a decline in HPC and most likely given our comments around the H&G timing of loading inventory at retail. We're going to see a decline there as well. So the first and second quarter are impacted by a lot of factors that are frustrating, but they are real. We also know when they, when we get relief from them, and so I agree with David's comments that come March and certainly the third and fourth quarter, we expect much better margins. But as I said earlier, just I think take solace in the fact that we are not expecting a positive sequential change of consumer demand in our forecast. We're expecting this to be a slugged out year across the board with the exception of, I think a better weather season for Home & Garden.

Okay, great. That's very helpful. And just David, you know you were just asked this and maybe I'll just pack it from a little bit different lens. But, the macro backdrop has obviously evolved a lot since the HHI deal was initially announced, and you know clearly at the time there were maybe nebulous and/or direct plans for debt pay-down and stock buybacks of potential M&A. And so obviously you still have some time to make the decisions should the deal come through as you expect. But does the backdrop change your thought process around, okay, well, we need to pay down more debt than maybe we wanted? We need to put more money into buybacks as opposed to doing M&A? Like, why would we do M&A in a volatile backdrop? Just conceptually, how does the macro impact how you're thinking about deploying capital should, and as you expect, the deal to go through? Thanks.

I appreciate the question. But the whole reason that we agreed to sell HHI to ASSA was we really believed we had been the best steward of the asset we could have been and taken it as far as we thought we could take it given that we are a diversified business. We have four different businesses now. We had six a few years back, and we have a levered balance sheet. And so the simple fact of the matter is ASSA is in a great position to bring innovation, R&D, launch new products, give consumers choice and quite frankly, bring more competition to the market. So, the original deal is constructed. I think, it’s fantastic for the American consumer. Clearly, I wish the DOJ would see it that way, but any and all questions that you could possibly raise about any sort of competitive erosion is absolutely neutered by ASSA's sale of their assets to Fortune. And so that is why I am highly confident in winning a trial, and I look forward to that. In terms of your commentary around the environment changing and how do you allocate capital from here. Look, I remain one of the largest individual shareholders of the company. I absolutely dislike a mild or our current leverage. And so as I said earlier, if like the money gets wired on a Monday, Tuesday, we're going to pay off all of our bank debt, that's for sure. Again, you know this deal, I can't believe it's taken almost two years now. But the reason we did this deal, because we wanted to have basically a debt-free balance sheet, and we wanted to have tons of liquidity in case the market fell apart, multiples contracted, we would then be in the catbird seat to do accretive tuck-in M&A. And unfortunately, we've run into this snag with the DOJ and conditions have deteriorated, but we still don't have the cash. And so yes, I think paying down debt is the number one priority given current leverage. I think buying back shares is a lot less risky than buying some other business. And then we still need to solve for the appliance unit. And so you may see us buying, I don't know, 0.5 billion of stock, 1 billion of stock, we'll see where it is when we get there. But, we'll probably keep some extra cash slashing around also, because we're committed to creating a global Pet Care and Home & Garden business. And that's going to require us to merge, spin, solve for the separation of our HPC assets. So that's current thinking. It's long winded, but hopefully it helps you out.

Yeah it did. Thank you both.

Thank you.

Thank you. Our next question comes from William Reuter with Bank of America. Your line is open.

Hi! Following up on the last question. Previously, you had a pro forma gross leverage target that was explicitly 2.5x after the deal. Is that no longer kind of in place? Are we now kind of going to rethink everything?

Yes. So you know that - what I would say there is, that was a point in time when we were trying to get the market an indication of the volume of debt reduction that we would expect. So directionally, I think that's still in the right place, though mechanically with our EBITDA declining this year as compared to where it was when we made that kind of pinpoint time announcement, that would imply something different. So I would not expect – one of the things that we talked about originally Bill, is that we have the debt, the bank debt that David talked about, and we have two callable bonds. And our longer dated paper totals about $1.1 billion in total. That level of debt is probably a reasonable place for us to end the mechanism and which notes and pieces and notes, etcetera, yes, but that's still TBD. Once we get closer to closing, we'll figure that out along with our advisers.

2.5x is still a great ratio. The amount of debt paid down might be greater than initially to anticipate it.

Great! And then just one follow-up. Jeremy, earlier, you mentioned that your freight costs have gone up by $80 million versus pre-pandemic levels, and you guys also talked about how those freight costs are now kind of on a cash basis, at pre-pandemic levels. Would we expect to see $80 million of rate come out of your P&L costs over the next year or 18 months, whatever it is, until those go through?

No. So when we talk about cap variances as explicitly as we have, that really, that includes freight inflation. So it's not incremental to that $55 million that we talked about in the first half of this year. And my comments earlier were to say that even current market rates are heavier or higher than pre-pandemic levels. And I don't see that taking a further step down unless the global economy also takes a further step down and then that kind of adds to the rest – adds more challenges to the plate. So I would not expect, an incremental $80 million to $100 million of benefit next year as compared to the $55 million of capital earnings I was talking about earlier.

Great! Okay, that’s all from me. Thank you.

Thanks Bill.

Thank you. Our next question comes from Carla Casella with JP Morgan. Your line is open.

Hi! Most of my questions have been answered, but one clarification. You talked a lot about inventory at retail and retailers destocking. Did you say, I may have missed it? Which categories are heaviest at retail and inventory and/or even on your own books that might take longer to work through?

Yes. We're trying to point you to durable goods. So where we've got toaster ovens and coffee makers, it's still heavy. And we got undercut in the holiday season by some competitors doing things even beyond our wildest estimations. Fish tanks, those types of things. But again, the bulk of the business where we play, you know we're 80% consumable and Pets. Home & Garden had a very rough year last year with weather. Again, we're pretty optimistic on Pet Home & Garden going forward here.

Yes. I would say in Home & Garden, as retailers have been slower to order, we have seen their inventory coming down. It's still a little bit higher than it was a year ago, but I don't think materially enough to impact the season as it comes.

Okay. You guys had talked about stronger December. And I'm wondering, is that just the differences in the business or you think they're discounting? Is that why you've seen more of that promotional.

Yes. I mean, it's business. They sell a lot of seed, you know growing weed. We're not in that business. We need the weeds to grow, and then we can kill them and so we're typically March to June is kind of our hotspot.

That’s super helpful. Okay and then one on this recent acquisition, where Post bought some pet food brands from Smucker. I’m wondering how are you thinking about M&A. Did you look at that deal or is there certain or things you would stay away from as you're getting this big chunk of cash in soon, hopefully?

We're not looking at any transactions, except for closing HHI, delevering the balance sheet and trying to deliver on our promises for fiscal '23. That's the reality of our situation.

Okay, great. Thanks.

Thanks Carla.

Thank you. And I'm showing no other questions at this time. I'd like to turn the call back to Faisal Qadir for closing remarks.

Thank you. With that we've reached the top of the hour, so we will conclude our conference call. Thank you, David and Jeremy and on behalf of Spectrum Brands, thank you all for your participation today.

Thanks, everybody. Thank you.

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