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. [Operator Instructions]. 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.

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.

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 30, 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…

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…

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.

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

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

Thanks, operator. Good morning, everyone. So, David, it's been a while since you really discussed the use of proceeds in detail, and 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?

Hey, Peter, thanks for the question. Look, I mean, I guess the lower the share price, the bigger the buyback, is my answer. Look, at the end of the day, right, we still haven't closed. We literally just got through DOJ last week. This week, it's been the board and today's earnings calls. We're very confident in closing this deal on or before June 30. The last nine months has really been us trying to get the balance sheet healthy. And working off a bunch of inventory here has really hurt the P&L. But I believe, look, we're going to pivot this balance sheet pretty quickly here and now we're going to really focus on pivoting the P&L and getting the profits going in the right direction. But look, I would like to meaningfully shrink our flow. And depending on where the share price is when we close the HHI deal, we'll communicate further, but I don't want to pigeonhole myself right now. I want to get to a close. I want to recapitalize the balance sheet and then we'll communicate then, but we will be buying in shares, yes.

Okay. That's helpful. And then just on the deal, it seems like the press release has said there was one regulatory approval outstanding in Mexico. Is that something we need to be worried about? Is it progressing in line with expectations? And I guess, assuming that goes through, how quickly can you close after you get that approval?

Yes, I think we’re just going to have to stick to the script here. I mean, yes, Mexico needs to approve the deal. We think they will approve the deal. We don't expect any issues with it. We intend to close the deal on or before June 30.

Great. Thanks so much. I'll pass it on.

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.

Good morning and congratulations on the DOJ settlement.

Hey, Bob. Thank you.

Thanks Bob. Long time coming.

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

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

Fair enough. 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 kind of caught up in a lot of noise because we have to be, because that's the world we live in?

Yes, look, I think I'd like to talk to investors directly, right? I think, look, there's clearly been a lot of orbs in the stock. You buy stuff on the room or you sell on the news because there's over $100 a share in cash coming into the company here in the next month or so, month or two. Look, at the end of the day, a fundamental investor should zoom out and realize that COVID pandemic, the supply chain elongation, the spike in demand from our retail customers, has caused a very large object to have to pass through the snake, right? And we ballooned our balance sheet to help our retail customers through, hopefully, in my lifetime, a once in a lifetime event. And when you take your balance sheet up $400, $500 million to try to satiate retailers' demands and then that supply chain snaps back and then demand drops off a cliff, liquidating for us a small company almost $350 million, $400 million of inventory, you're not going to do that in the most gentle way. And so, that really damages your P&L, and it's very difficult - look, I'm very upset about our Home & Garden performance in the quarter, but the reality, it's very difficult to anticipate a retail shift from, if you traditionally build inventory going into a season where you sell everything in 90 to 120 days to, well, hey, we're just not going to pre-build this year and oh, by the way, we're going to just take the inventory level down to pre-COVID levels, that's a big change in strategy that's very hard to - I just can't dig out of it in the next six months given the seasonal nature of the business. But I think if people can kind of look at the fundamentals, we're going to have a very clean balance sheet. We're going to be net debt-free, and then we're going to get this P&L going in the right direction. So, I'm actually - look, I'm disappointed that the quarter wasn't better, but I'm really excited about what we can deliver to you guys this summer in terms of cleaning up the balance sheet and showing a lot more clarity as we've gotten through the distortion, as you call it, with the inventory, balance sheet, P&L distractions.

Yes, and I'd just add, Bob, I think as I think towards first the second half, as we talked about on the call, we have seen a margin inflection point as that entire, basically the entire $55 million of cap variances we entered the year with is gone at the end of Q2. There might be $1 million left in HPC in Q3, but that's it. That's not only a second half tailwind, that's a 2024 tailwind. And then the other thing I would mention is that I don't know if we were completely explicit about it, but the reality is, our sales in H&G in fiscal ‘23 will basically be below POS as a body of work, as a body of consumer demand. And I would not expect that to continue in F ‘24. So, I think there's positive news ahead for H&G as we look to ’24. Agree with David. Unfortunate we are where we are this quarter. It would've been a really nice quarter had it been a more normal season for us.

Okay, great, thanks. And then just again, taking us back from previous calls, we've talked about, I believe you've said you believe the pet business is a $200 million EBITDA business, $200 million-plus. The H&G is $120 million-plus. Are those still the right kind of starting points when things normalize? I won't pinpoint you to a time period for it, but just in general, has anything changed materially in those businesses? Are those the right sizes for those businesses as we normalize?

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

[Multiple Speakers].

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

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.

Great, thanks. Good morning. I wanted to ask first on lawn and garden, because I get that the weather was unfavorable. We've obviously seen that across other companies already, but your sales seemed to have been hit more this quarter than they were. And I always thought relative to some of your peers that your portfolio was skewed a little bit later in the season, given the internet-controlled focus. So, what's your view on how much of this is weather versus a new normal on inventory or other factors that might be playing into that like buying closer to demand and normalization of demand? Thank you.

Yes, I don't attribute a ton of it to weather. I mean, I think we had some spotty weather that could have helped us a bit later in March. The second half of March wasn't great. POS the first half was pretty good, but it really is about a shift in retail strategy where we were really expecting to see retail inventories normalize to 2021 levels. And the reality is, to David's point earlier, they're going back to pre-pandemic levels. Think like 2019 levels. Inflation adjusted, that's even lower volumes because we do have a lot of price there. And that, as I said in reaction to Bob's question, that's led to really low retail orders on us despite POS that's fairly normal because they're taking their inventory down. Now, they've been largely successful with that in the first half of the fiscal year. They, meaning our big three retailers, though there is still some pockets we see where it's higher. I agree with your comment that as compared to some of our public peers in this space, our season is a bit later, but the strategy specific to our categories is one that we just did not expect as we entered the year.

Got it. And then wanted to ask you about HPC and your view in terms of the timing of exploring strategic alternatives. You mentioned inventory is now right-sized in your prepared remarks, but also that small appliances continue to be under pressure, especially in kitchen. So, it looks like margins will be down again this year. So, as you think about closing up, and I don't need to start to immediately go into strategic alternatives on another business before HHI closes, but any color in terms of how you're thinking about eventual exit strategy of that business so that you can get towards your longer term goal of getting to be a two-category company. Thanks.

Yes, look, I think the post-pandemic kind of fallout in that industry, it’s definitely going to take us a couple of quarters to nurse that back to a proper level of profitability and health. And so, I think you shouldn't anticipate us spinning that off or merging that the day after we close HHI. I think that's going to take multiple quarters. But we are very interested as a Board of Directors into becoming a pure play pet, home and garden company. And we'll be very actively pursuing that this summer going into the fall. But we want to be responsible. We want to nurture that business. We want to build that EBITDA back up and then we'll see what's available.

Thank you.

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.

Hey, everyone. Good morning. So, the debt paydown, right, term loan and revolver, I don't think that puts you at your leverage targets. So, I guess the first question is, do you anticipate getting to your longer-term leverage targets immediately or would that happen over time? And then Jeremy, do you still expect $3.5 billion net cash from the deal?

Well, let me back up. Your question is a little off. So, if I get $4.3 billion of cash in the door, I only have $3 billion of debt and my leverage ratio is a net debt leverage ratio. So, I'm net debt free. So, my net leverage when I close the deal is negative.

Yes, no, that's fine. So, the goal is still term loan revolver, and then the rest of the debt, you'll assess, and the residual cash will remain on the balance sheet for buybacks or other strategic initiatives. That would be the key idea here.

Yes, I mean, look, when we signed this deal, interest rates were zero, right, in terms of deposits And we have some bonds out there that are sub 4%. So, we’ve got to look at the whole cap structure, but it's a pretty good situation to be in. And we want to stay liquid. We want to have plenty of firepower to buy in shares, and we want to maintain a very low leverage profile as we restore our earnings power from this point on. So, yes, we're pretty excited to get this closed and then to be able to focus. Not trying to make excuses, but having a big asset dangling out there for sale for two years has consumed a lot of calories.

Yes, that makes sense.

Yes, I think too, Chris, so if you look at the bonds and the capital structure too, right, our highest cost bond I think is our 2025. And that has a stepdown to callable at par in July. So, that's obviously something we'll take a look at. And then as the year progresses, we kind of have a 12-month window on reinvestment with proceeds. We'll look at the whole portfolio and figure out the right strategy. To David's point, a lot more financial flexibility and timing flexibility, given where interest rates on deposits are now, which I think is a good thing for us and for our shareholders that we have time and we could be thoughtful on this.

And then just on the net cash proceeds?

Pardon? Oh, yes.

You had said …

Yes, 3.5 to 3.6 net proceeds is the ballpark.

Okay. All right. Thanks. And then just a follow-up, this conversation on earnings power I think is well taken. Clearly, cost headwinds in the front half. You're cycling high-cost inventory, and obviously the retail dynamic is something we're seeing elsewhere. I guess, I'm also looking at fiscal ‘24 EBITDA consensus, which is going to be 30% growth versus where you're effectively guiding today, which certainly seems like a high bar. The recovery here, I mean, are you expecting a quick snap back in your margin structure and sales, or is it more appropriate and maybe prudent to think about a progressive build here back to the earnings power that you had thought about for this portfolio?

Yes, I mean, I think to my comments on the cap variances that we experienced, right, so that $55 million, I think rolled off 25 and 29, Q1 and Q2, respectively. That debit, excess debit, the cost of goods sold, effectively goes to zero in Q3. So, I think you're going to see a really nice sequential improve, particularly in Global Pet Care, which doesn't face - it doesn't really face the retail inventory strategy change that Home & Garden is facing. So, I think the second half looks really good there and moves pretty quickly. HPC is a bit of a different story, to David's comments on what's happened in that category. So, a little more cautious, but we still have that sequential improvement in margins that comes from those cap variances being gone. And then you have Home & Garden, and we've obviously talked that to death here. But I think that gets better as we go into ‘24.

I like your word progressive. We need to get our house in order. We need to really get refocused and start to execute consistently. I like the word progressive, but we've got a very good outlook.

Okay. And forgive me, I know I’m kind of dominating here, but I get this question a lot, so I figure I'd just put it to you, then I'll get back in the queue. The cashflow conversion to EBITDA is phenomenal year-to-date. I realize there's the working capital dynamic with working down inventory. Do you have a sense of what your free cash conversion should be over time in a more normal environment? I don't know if just EBITDA, as a percentage of EBITDA is a great way to think about that, but any comment there on cash flow being seemingly an even bigger focus for you now, but it's atypical this year. So, what's the medium term dynamic looking like from a cash conversion standpoint?

I usually model it at 50% of EBITDA, Chris, in our longer term models. I think that's a safe assumption to use. Really confident in our revamped supply chain team. The experience that we've had the last three quarters taking inventory down $340 million, I think we're going to stay really tight on inventory. And in a business like ours with the large customers that we have, inventory is the real only wild card in free cash conversion from EBITDA. So, I think 50% is a safe way to assume it.

Okay. All right. Thanks so much.

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.

Great. Thank you very much. So, when I think about your proceeds, how much do you think you need to pursue, let's just say tuck-in M&A, how much do you think you need to invest in the business? There's a question on the buybacks and stuff like that, but I'm kind of more looking at it from an M&A perspective and then also just investment in the business. Thanks.

Look, I think going forward, we don't have anything we want to acquire right now. Zero. And these last nine months has not been any fun. And so, getting this balance sheet right, shrinking this float, and then getting some real consistent profit production, I think is job one, two, and three around here. And I think that's going to benefit shareholders tremendously. So, that's where we're going. That's the best interest of everybody on this phone. And look, I think next quarter's call you guys are going to get a lot more color around balance sheet, capital allocation, and we'll be able to talk at more liberty, right? It's just, we've got to close this deal, look at the world around us, and I just - I don't want to box myself into anything on this call. Like I said, if the share price is really low, we'll buy a lot of stock. If it's high, we'll buy less. But we want to clean this balance sheet up. And I like the other - Chris, you were asking about free cash flow, the earlier question. I mean, it's a different world when your net debt is - you're in a net debt zero position. And I just think that's a real game changer and we'll be able to talk a lot more about it, and I think people will be able to model things very differently. We'll become more of an EPS-driven stock than an EBITDA stock. This is a big deal. I don't think a lot of companies take cash proceeds in greater than their share price too often.

Okay, good. And then I know you've kind of reiterated that you've (sustained) net proceeds. How are we thinking about the NOL exiting or after the close of the sale? Is it going to be exhausted? Is there going to be anything left? And then maybe just an update on kind of like the fees that you've been facing now versus what you've been expecting. Thanks.

Jeremy will take that.

Yes. We'll essentially use the entire US NOL to protect the gain. We will become a constant US taxpayer after this deal.

Okay, good. And then the proceeds, I guess, are the same, regardless of like all the inventory adjustments and inventory changes, right?

You're asking about the net proceeds? We still think the net proceeds after taxes and fees will be in the $3.5 billion to $3.6 billion range.

Okay, perfect. Thank you very much.

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.

Hey, good morning. Thanks for taking our questions. Don't mean beat a dead horse, but in terms of a potential board authorization of a buyback, is it as simple as that just can't be done until the proceeds come through the door?

No, we already have $1 billion buyback, and I've got $750 million bucks available to me right now this morning. I've just been living with a very, very levered balance sheet, and I personally have a lot of equity at risk, and I want to get this balance sheet delevered and see where the share price is, and we'll go from there.

Got it. And then secondly, you've had a very consistent message in terms of debt paydown on the fact that your shares are inexpensive. With the stock now trading below where it closed before the HHI settlement came out last Friday evening, I'd be curious your view on why the market is not giving you guys credit for this gamechanger for your capital structure. Thanks.

I think shareholder bases change over time, and I think that today's world, it's very rare to find somebody that looks at stocks for more than three minutes, let alone three weeks. And I think that when you have a deal that gets as much press as this $4.3 billion sale to HHI, you attract a lot of quants and orbs, and we love quants and orbs, but when they see your share price pop, they tend to sell into it. There's been a lot of volume on the tape, and we're getting a lot of rotation, and that's just technical stuff. But it's - I can't do anything about it, nor can I worry about it. I can just focus on the fact that sitting here before the call, talking to my R team, I think we're going to have a very different shareholder base when you look at the - people don't like levered credits. You get leverage down to 2x and stay there consistently, you're going to attract a different shareholder base. You start growing your EPS consistently, you're going to attract a different shareholder base. So, that takes time. That's not a - you don't fix that in three days or a week. That's kind of a three, six, nine, 12-month journey, and I think that's the journey we're going to be on.

Great. Thank you. Best of luck, guys.

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.

Yes. Hey, thanks. Good morning. Most of my questions have already been addressed, so thank you. Just on the 2x to 2.5x long-term net leverage ratio objective, I guess, what does that mean in terms of timing? Like from your perspective, when do you want to kind of be at that run rate? And as you contemplate the future, is that kind of exiting fiscal ‘24? Is that longer-term than that? Just some parameters around what you mean by long-term objective would be helpful.

As I sit here this morning, I don't have a time in mind. We're simply trying to let you know we want to run the business less levered, and we put a marker out there. We don't have any acquisitions teed up. We really want to get the earnings power of the company much healthier. And again, I'm not trying to make an excuse, but having a big asset held for sale is really, really disruptive and distracting. And I think it'd be nice to just settle the business down and invest in some organic growth and really get a decent rhythm and cadence. So, we owe that to our investor base. We owe that to ourselves. And so, yes, I mean, I don't know. I mean, Jeremy, you have any thoughts on that?

No, I think that's right. It'll be dependent on what we see in the market from an acquisition perspective. It'll be dependent on economic conditions in our key markets. I think time is in our favor here. We're excited to have a very different balance sheet to show our investors next quarter. And we'll make good, smart decisions on capital allocation as this year and next year progress.

Okay. Fair enough. Thank you.

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

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.

Hi. Good morning, guys. Yes, most of my questions were already answered. One quick one. You guys have talked about in the past of putting your price increases through. I just wanted to confirm if they're all through for the year or can we expect more in the quarters ahead? I just quickly noticed that your cost of goods sold is a little higher than normal. So, I was just wondering when those margins would normalize. Thank you.

Yes, I would say, I don't see any material additional price increases based on inputs where they are now, particularly for this year. So, I think everything we need to do is in place. On the cost of goods sold front, agreed, it's elevated in Q1 and in Q2. And that goes back to the capitalized variances that I talked about earlier. That's an extra $25 million in Q1 and $29 million in Q2, I think of cost of goods sold running through the remain co-businesses that we would expect. And it is essentially gone now. So, that will basically reduce and improve margins in Q3 and Q4.

Okay. Great. Thank you.

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

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.

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