Energizer Holdings, Inc. (ENR) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Allison and I will be your conference operator today. At this time I would like to welcome everyone to Energizer's Third Quarter Fiscal 2016 Conference Call. [Operator Instructions]. I would now like to turn the conference over to Jackie Burwitz, Vice President of Investor Relations. Please go ahead.

Good morning. And thank you for joining us. During the call we will discuss our fiscal third quarter results and provide an update for our full-year outlook for fiscal 2016. With me this morning are Alan Hoskins, Chief Executive Officer and Brian Hamm, Chief Financial Officer. This call is being recorded and will be available for replay via our website energizerholdings.com. During the call we may make statements about our expectations for future plans and financial and operating performance. Any such statements are forward-looking statements which reflect our current views with respect to future events. We will also refer to non-GAAP financial measures. A reconciliation of non-GAAP financial measures to comparable GAAP is shown in the press release issued earlier today which is available in the investor relations section of our website, energizerholdings.com. Information concerning our category or market share discussed on this call relates to markets where we compete and are based on estimates using Energizer's internal data, data from industry analysis and adjustments that we believe to be reasonable. Investors should review our SEC filings for a description of the risk factors affecting our business. These risks may cause actual results to be different from our forward-looking statements. We do not undertake to update these forward-looking statements. With that, I would like to turn the call over to Alan.

Thanks Jackie and good morning everyone. July 1 marked the one-year anniversary of our spin and in our first full year as an independent company I am proud of what this organization has accomplished. We've been able to successfully execute against our three strategic priorities of leading with innovation, operating with excellence and driving productivity gains enabling us to deliver strong operating results. In addition, we executed our balanced approach to capital allocation by investing in our business, returning cash to shareholders through a competitive and meaningful dividend, opportunistically repurchasing shares and closing our first acquisition. This is consistent with the strategy we outlined at investor day last year. I'm extremely proud of our organization, our accomplishments and our ability to deliver upon our commitments to our shareholders. Turning to the third quarter. We again delivered strong performance as we continue to build on our momentum from the first half of the year, with organic revenue growth of 1.2% in the quarter and 4.4% on a year-to-date basis. Overall, business fundamentals remain solid. Global battery category value and volume were nearly flat over the latest 13 weeks. In addition, our global value share was up slightly as a result of distribution and shelf space gains. In our largest market the U.S., total category value for the 12 weeks and through July 2 was down 1.5% and volume down 0.6% percent. This is in line with our long term category outlook for developed markets. Promotional levels in the U.S. were roughly in line with prior-year levels. Consistent with global numbers, Energizer's U.S. market share was up slightly, reflecting our recent distribution and shelf space gains. Now turning to our three strategic priorities, lead with innovation, operate with excellence and drive productivity gains. In FY '16 we have launched innovation across most of our portfolio. That has allowed us to drive distributions and shelf space gains. During the quarter, we continued to increased distribution of these products by expanding into more international markets. We believe that our commitment to leading with innovation will continue to drive value for our categories, consumers and our retail partners. We also remain focused on operating with excellence, with the primary objective of driving effective category fundamentals to generate profitable share gains. As I mentioned earlier, our commercial teams continue to deliver with both our global and U.S. value shares up slightly. In addition, we've announced price increase across several markets including Canada, Russia and certain markets in Latin America, the Middle East, Africa and Asia. Competitive activity has continued to be heightened in some of our Asia-Pacific developed markets and we have and will continue to take a very disciplined, targeted and balanced approach as to how we deploy our trade investment dollars. And finally, we continue to drive productivity gains and are making good progress in our working capital, cost savings and free cash flow initiatives. We've been able to reduce working capital levels by more than half since the start of our initiative, down from 23% to 11% of sales. It's important to note that we will build inventory levels over the next two quarters as we prepare to support our customers with their hurricane response efforts, the upcoming holiday season and new business opportunities. We continue to embed zero-based budgeting as part of our culture and have imposed tight cost controls to maximize free cash flow. In the quarter we executed a planned productivity initiative in one of our manufacturing locations and we will continue to proactively look for future opportunities. And while I'm pleased with the progress we've made in driving productivity gains, there is still room for further improvement. Optimizing our cost structure has and will continue to be a top priority and focus for this organization. We will also continue to make investments in key IT systems and processes that will enable future cost savings and simplify our business. These initiatives and respective investments should help us continue to build momentum throughout the organization to drive future cost savings, enhance returns and fund future investments. In addition to the strong performance with our battery business, on July 1 we also closed on the acquisition of HandStands Holdings Corporation, a leading designer and marketer of automotive fragrance and appearance products. This acquisition adds a highly complementary business to our existing portfolio of strong consumer brands. HandStands is a market leader in a growing auto fragrance category, with a strong track record of leading with consumer-focused innovation. Their products are sold through very similar channels in the U.S., with at least 75% of sales occurring with existing Energizer retail partners. There's also strong geographic distribution overlap in our core markets, with the potential for further expansion using our existing global battery footprint. As part of our extensive to due diligence, we researched the category and HandStands' market share and retail position and we believe we can accelerate HandStands' growth both in the U.S. and globally. The category has experienced high single- to low double-digit growth over the past few years and this growth has attracted new entrants. And while new entrants and an expanded consumer base have added value to the overall category, it has negatively impacted HandStands' market share over the last few months and will continue to impact it for the next two to three quarters. However, despite this short term impact, we believe we can grow this business by leveraging our merchandising expertise to strengthen the foundation of in-store execution. In existing retail partners we have the ability to increase the number of points of distribution throughout the store in high-traffic areas and lever shopper-based solutions to orchestrate trade-up. There are also opportunities to expand these products into current Energizer retail partners, where HandStands does not have distribution. And in addition, we believe that we can accelerate HandStands' momentum by using Energizer's global battery platform, expansive channel distribution and global supply chain. As I said when we announced the deal, HandStands represents a compelling strategic, operational and cultural fit for Energizer and provides us with the opportunity to enhance our ability to drive long term shareholder value. Now turning to our outlook for the remainder of FY '16. We have worked hard to deliver solid operating results for the first nine months and as a result of this strong performance we now expect full-year adjusted earnings per share in the range of $2.20 to $2.30. This includes approximately $0.04 to $0.05 of earnings per share contribution from the newly acquired HandStands business, excluding transaction and integration charges. And now, I'm going to turn the call over to Brian for more in-depth financial review of the quarter, an update to our outlook for FY '16 and more insight into the integration of the HandStands business. Brian?

Thanks Alan and good morning everyone. I'll begin by discussing the financial overview of the quarter, provide insight into the HandStands business and our integration plans and then close with a more detailed update to our full-year outlook. As Alan mentioned, we continued our strong start to the fiscal year as organic sales increased, working capital levels improved and we executed additional productivity initiatives that we expect will drive future cost savings and margin enhancements. I'll touch on a few financial headlines in more detail. First net sales. Total net sales decreased approximately 3.6%, driven by the following, organic net sales increased 1.2% due to the net impact of distribution and space gains in North America and distribution gains and pricing actions in Latin America accounted for approximately 3% of growth, partially offset by approximately 1% due to continued heightened competitive activity in certain Asia developed markets and approximately 0.5% of retail inventory deload. As we discussed in prior quarters, retail inventory levels were elevated heading into this quarter. We began to see these levels normalize within the quarter and expect the balance of the deload to contribute in the fourth quarter. Foreign currency headwinds impacted our top line by approximately $13 million, resulting in a 3% decline. Overall for the quarter, currencies were in line with expectations; however, rates remain very volatile and we expect this to continue in the near term. The impact of our go-to-market changes, including the exit and shift to distributors in certain markets resulted in a 1% decline in net sales. Now that we have fully lapped these go-to-market changes, this will be the last quarter we experience a year-over-year impact. Looking at organic sales performance across the four segments. North America organic sales increased $4 million or 2%, as a result of distribution and shall space gains, partially offset by the anticipated retail inventory deloads. Our Europe, Middle East and Africa organic net sales decreased $1 million or 1%, in line with the overall category value performance. Latin America organic sales were up nearly $5 million or 18% driven by pricing actions across multiple markets, timing of shipments and distributor markets and new distribution gains. In Asia-Pacific organic sales were down $4 million or 4.5%, due primarily to heightened competitive activity in select developed markets. The competitive activity has been elevated for the past few quarters and we're expecting the impact to continue into the September quarter. Now on to gross margin. The gross margin rate for the quarter was 42.6% or 300 basis point below prior year. The decline was driven by a 150 basis point impact from unfavorable currencies. Excluding the currency impact, gross margin declined 150 basis points, driven by a $5 million charge related to a plan productivity initiative which resulted in a 130 basis point reduction to gross margin and increased costs and supported of innovation launched across our portfolio. These items were partially offset by favorable commodity costs and other product savings. A&P spending was below prior year by $12 million or 310 basis points on a percent-of-sales basis. The decrease in the quarter is primarily related to lapping of the increased A&P support of the EcoAdvanced product launch in the prior year and the timing of current-year advertising and promotional activities. SG&A spending in the quarter excluding spin and acquisition costs, was approximately $81 million on absolute dollar basis, consistent with prior quarter levels. However, the SG&A as a percent of sales, excluding unusuals, increased 380 basis points due to lapping a low prior-year comparative, incremental investment spending and higher compensation-related costs incurred in the current year. As we've previously highlighted, the third quarter 2015 SG&A, excluding spin and restructuring costs, was unusually low as prior-year data was based upon carve-out accounting methodology which is not necessarily representative of our standalone cost structure. We have now fully lapped the prior-year carve-out data which will make future quarter comparisons much more meaningful. Our tax rate on a year-to-date basis was 23.8% due to the favorable impact of adjustments related to the prior year provision estimates and certain spin-related adjustments of approximately $9 million. These adjustments are the primary driver of the $500,000 tax benefit reported in the third quarter. Excluding these adjustments, our year-to-date tax rate would have been approximately 30%. Consistent last quarter's full-year outlook, we expect our full-year ex-unusual tax rate to be in the range of 29% to 30%. Spin restructuring related charges in third quarter were $2.8 million of which $2 million was reported within SG&A. We've incurred $16.5 million of spin and restructuring related charges on a year-to-date basis and expect to incur up to an additional $3 million over the remainder of the fiscal year. Moving to the balance sheet. We ended the quarter with $567 million in cash, with greater than 90% of our cash held offshore. On a year-to-date basis we generated $126 million of free cash flow, reflecting our strong operating performance during the year as well as improvements in working capital. In addition, we paid a total of $46 million in dividends and repurchased 600,000 shares through the first nine months of the year. Our debt level at the end of the quarter was approximately $1 billion which equated to 3.2 times debt to EBITDA on a trailing 12 month basis. Before going into the outlook for the remainder of FY '16, I want to provide more insights to the HandStands acquisition. As Alan mentioned, we were able to close this transaction subsequent to the end of the quarter on July 1 for a purchase price of $340 million, subject to working capital adjustments. We utilized approximately $300 million of cash on hand and borrowings from available credit facilities. This leaves us with approximately $275 million in cash and leverage levels of roughly three times. We have made good progress with our integration efforts and expect that the business will be fully integrated by the end of FY '17. In total, acquisition and integration related costs are estimated to be $30 million to $35 million and charges will be incurred over the next 12 to 15 months. Breaking this out, acquisition costs are expected to be in the range of $8 million to $10 million. Integration related costs are estimated to be $14 million to $16 million and the non-cash inventory step up accounting adjustment is expected to be in the range of $8 million to $9 million. Once fully integrated we're estimating in excess of $5 million. As Alan mentioned, we're expecting the earnings per share impact, excluding the acquisition and integration costs, to be $0.04 to $0.05 in the fourth quarter. Before I turn the call back over to Alan for closing remarks, I want to provide a few comments on our base business excluding HandStands for the upcoming quarter. Although fourth quarter FY '15 organic sales were down 8%, we do not believe that will have a material impact from a year-over-year comparison standpoint, as the decline was a result of certain FY14 professional activities that were not repeated. In addition, we expect retail inventory levels to further normalize and heightened competitive activity in our Asia developed markets to continue, both of which will likely have an unfavorable impact on year-over-year net sales in the fourth quarter. We expect these items will be partially offset by the continued benefit of distribution gains achieved in the first three quarters of the fiscal year. This also be the first quarter in which our prior-year SG&A interest expense and other financing comparisons are based upon our standalone results, as we have now fully lapped the prior-year carve-out accounting data. We expect SG&A, excluding unusuals, to be near prior-year levels due to the timing of expenses and incremental investment spending. Consistent with the view outlined above and inclusive of our year-to-date results, the full-year outlook for our base business remains consistent with the assumptions we provided during last quarter's call. As Alan stated earlier, we're increasing our full year FY '16 outlook for adjusted earnings per share to be in the range of $2.20 to $2.30 to account for the accretion from the HandStands acquisition. It's important note that our outlook is based upon current foreign currency rates and trends within our competitive environment. In the event either materially change, our results may be impacted accordingly. We will provide a FY '17 outlook for our base business and HandStands during our fourth quarter earnings call in early November. Now I'd like to turn the call back over to Alan for closing remarks.

Thanks Brian. To reiterate, FY '16 is shaping up to be a strong year. The underlying fundamentals of our business remain solid and we're building a foundation to drive long term shareholder value and deliver top-tier free cash flow performance. We continue to execute a balanced approach to capital allocation by reinvesting in our business, returning cash to shareholders and adding to our portfolio through acquisitions. As discussed earlier, we continue to make investments in our business through projects and process improvements that we believe will drive earnings and free cash flow growth in future years. Including our recently announced dividend payable in September and share repurchases executed earlier in the year we will have returned nearly $85 million in cash directly to our shareholders. And as we announced on Monday, we're increasing our dividend by 10%, reflecting both the strength in our base business and our ability to successfully integrate and grow the HandStands business. Following the HandStands acquisition we're forecasting $275 million of cash remaining, giving us a healthy balance sheet with manageable debt levels to continue to balance these three drivers in order to maximize long term shareholder value. We remain committed to executing a balanced approach to capital allocation and we have delivered against all three areas in our first full year as an independent company. This completes our prepared remarks and now we'll be happy to take your questions. Operator, I'll turn it back over to you.

[Operator Instructions]. And our first question will come from Bill Chappell of SunTrust

Alan, just maybe talk a little bit about what you talk about in terms of shelf space gains recent gains that affected this quarter. Is that carryover from things you want 6 or 9 months ago that is just falling through? Or does that set you up fairly well as incrementally better as we go into the holiday season for this year?

Yes. Think about it as both Bill, it's really going to be setting up what's coming of most of the changes that we saw in distribution and really start to materialize in March and up through June. And then subsequent to that there's been additional things that have occurred that we feel will benefit the business going forward but all in I'm very pleased with the distribution gains we've seen around the world and I think you saw from the prepared remarks that was in North America where we saw both just distribution and space gains which increased the top line and LatAm and it was a combination of distribution and pricing in a hyperinflationary markets. Even in Europe where it's highly competitive we were able to gain distributions in select certain European markets.

And Bill this is Brian to build on Alan comments. From our last couple of calls we called out about a 1% benefit from distribution gains in quarter one about a 3% benefit from distribution gains in quarter two and that same 3% in quarter three. So hopefully that helps give you kind of flow as to what we're seeing flow through our top line.

And just as a kind of drilling down to that in the U.S. is at across all channels? Is there something more online that you're picking up as well? Is this trying to understand because some of the competition talked about everybody seems to be gaining share these days. So just try and understand where you're running and where others might be?

So the simplest way to say it is we're gaining share in both measured and non-measured channels. So that we're clear on that. Obviously we have focused predominately on the measure because of size and scale big of those particular customer. We've been able to do it consistent with what we’ve recommended our strategy was go forward from Investor Day. So we've been leading with innovation. Our teams have done a terrific job of leveraging that innovation with our customers to pick up new shelf space and to pick up new customers. The second part of that is something that we get asked regularly about our in-store execution. It's one of the things that Energizer does exceptionally well and it's not just the idea of bringing innovation to the table it's about the ability to execute in the stores. So it's a combination of both that we're doing and both measured and non-measured where we’re seeing growth in both. And by the way the growth is in share think about it as profitable share. I don't want share to share sake, we've got to do it by executing really strong category fundamentals and we're saying that payoff in dividends in the U.S. North America as a whole Latin America and in Europe.

Our next question will come from Bill Schmitz of Deutsche Bank. Please go ahead.

A couple things on the gross margin how much of these costs you called out the new product attributes and the productivity investments. How much of that is sort of permanent and how much of that goes away and when does it go away?

Two-part answer to the question. First for the full year, we got a gross margin down 250 basis points primarily related to currency in Venezuela that makes up about 180 of the 250 basis point decline. These productivity initiatives, so think of it as continuing to right size our cost structure, it's reduction in staffing and certain of our manufacturing locations. Year-to-date it's been about an $8 million charge within cost of goods sold, on a full-year basis that will result in about a 50 basis point impact. And so that’s a discrete item that was recorded this year $3 million in quarter two, 5 million in this quarter. Those may or may not repeat into the future. It all depends if there's an opportunity to be proactive and right size our cost structure. The investment in innovation and product improvements that is an ongoing cost that we've added that is being offset by favorability within commodity costs this year. Now our challenge it's an investment but in future years how do we continue to take cost out. So if we do nothing then that cost will stay but we've got a track record of continuing to take cost out and we will look to do that. The second part of that answer is specific to quarter three. In quarter three, gross margin was down 300 basis, half of that was currency, 130 basis points was that rightsizing of staffing within one of our manufacturing facilities. So that accounted again for 130 basis points and then again investments in innovation were offset by commodities savings. Hopefully that provide some clarity as to what's discrete one-time in nature versus what's ongoing but even the ongoing we're going to look to find ways to continue to reduce costs into the future.

And then just a follow-up, why won't that be restructuring charge is the first part of the question? Why couldn’t you exclude as restructuring? And then I was looking at your EBITDA guidance unless my numbers are way off, I had a HandStands doing like million of EBITDA per quarter, so why wouldn’t the EBITDA guidance go up by the extra $9 million from HandStands?

So a couple of things. All companies are aware is that the SEC is really trying to limit the amount of GAAP to non-GAAP adjustments. We view continuing to take cost out as part of what we're going to do and as a result sometimes there's a charge related to that. So if there is specific events as far as ongoing cost reduction efforts we're not going to spike that out, we will highlight that as far as the year over year bridge. Now if there was a major initiative like the 2013 restructuring project Transformers, obviously we will spike that out separately. But if it's just ongoing cost reduction efforts we will just highlight that in the year over year bridge. Within the press release and also with in the prepared remarks we tried to separate to provide some clarity our base business and then our HandStands business. So our base business that EBITDA outlook of 280 million to 300 million our base business that outlook isn't changing. For HandStands, we provided EPS accretion of $0.04 to $0.05 and so EBITDA will increase because of HandStands but we try to for clarity sake we try to separate base business versus HandStands.

Our next question will come from Kevin Grundy of Jefferies. Please go ahead.

I wanted to pick up on HandStands specifically the accretion guidance the $0.15 a $0.20 that you initially issued and specifically with respect to the competitive landscape given some of the near term share losses that you're seeing in U.S. mass channels. Unfortunately you [indiscernible] contain with that over the next few quarters. So a few questions around this dynamic. You view the competitive landscape in any differently now than you did perhaps even early in the year? During the due diligence process Yankee candle sounds like it's big priority to renewal and understandably so Proctor seems like it's focus on turning for [indiscernible] brand around broadly. So the risk in other channels in addition to just U.S. mass, you view the competitive landscape differently and are you still comfortable with the $0.15 to $0.20 of accretion or do believe that perhaps greater investment will be necessary to stabilize in near term trends? Thanks.

On the $0.15 a $0.20 we're comfortable, we’re there we’re holding to that. On the competitive landscape, let me take a pass that and Brian please feel free to chime in as you see fit. Here's one way to think about this is within battery and portable lights, within auto fragrance, within auto [indiscernible] and candidly in future acquisitions. Whatever category, we're always going to have formidable and aggressive competitors, some will be larger, some will be smaller but all have brands that we're going to need to compete with. So I think that going in assumption is when we did our extensive due diligence and looking at the deal we spent a significant amount of time understanding the competitive landscape, we were aware of the competitive entrance into the category but like most consumer packaged goods companies we knew that this was going to be a category where we faced aggressive competitors. So just to kind of set the landscape going forward, this will be no different than would we face in battery and potentially what we’re going to face in feature acquisitions. So let's talk specifically about HandStands now for a moment. As you think about that business there were some activities that transpired with a major U.S. retailer in the beginning of calendar year 2016 you're starting to see the impact of those planogram changes in the share results now and we see expect that to continue the next 2 to 3 quarters because this category has high low single digits low double-digit growth you can expect it's going to have new entrants into the category, it's very attractive and within general merchandise and hard lines there aren't many categories that have those types of growth rates. Now that's good for the category and it's creating an expandable consumer base unfortunately, it's had an impact on HandStands overall share. Now again that's two to three quarters we expect that to be continue. But despite that short term impact I want to be really clear, Energizer believes that we can continue to grow the HandStands business both at auto fragrance as well as at auto appearance for a number of different reasons. We believe that we've got the right merchandising expertise and that we can grow their business because of our strong in-store execution and existing retailers we actually have the ability to help them get multisite in locations in the store similar to what we do in battery. Remember these are pull categories prompted purchases, heavily reliant on multiple locations in the store. So that's where we're going to be focusing but if you think beyond that with distribution, think about our ability and given our proven track record to be able to use our expansive channel span to get distribution of HandStands products into customers and channels where they don't exist in the U.S. today. And then finally I'll be honest with you HandStands has really solid momentum internationally. Our plan is to continue to leverage our resources, our global footprint and battery infrastructure our global supply chain and our broad distributor network around the world to expand HandStands products international. We're going to do that in a very disciplined, smart and selective way, but we see that as an opportunity to help grow the business as well. So just want to step back a little bit the competitive situation and dynamic in whatever we compete is going to be there. We're going to continue go down the path and pursue the things we know how to do well, play to our strengths and again that's one of the characteristics we loved about this HandStands business strategically, it's a terrific fit. The dynamics of how you run the business are very similar to what we know how to do well in battery and portable light and we’re going play to that strength. Brain anything you would like to add?

No. Since July 1st, there's been a full-court press on integration efforts. We're getting to know the business. We're getting to know how best to compete, we're excited about the innovation pipeline that they have ahead and the three strategic priorities that we've been able to execute in battery leading with innovation, operating with excellence and driving productivity gains at the same game plan for this. Also you know from a financial perspective being able to use a significant amount of international cash and actually make this a delevering event makes this very attractive financially and we think helps add to long term shareholder value.

Our next question will come from Nik Modi of RBC Capital Markets. Please go ahead.

Question is on the cost structure. Now that you have four quarters under your belt, I guess you have better visibility. How do you guys think about communicating, you know go forward cost opportunities, [indiscernible] will this be kind of hey we're going to save x amount or will it just be part of your ongoing earnings algorithm? That's the first question. And then the second question, maybe Alan you can addresses this, is this just the tradeoff between A&P and kind of the in-store, right feet on the street, the execution stuff that you talk about. Can you just talk about kind of how you think about allocating resources between the two?

On the cost side specifically related to SG&A and cost of goods sold. We’ve talked several times of how we have launched zero-based budgeting efforts, those have already paid dividends. We’re able to offset the synergies from the spin much faster than we expected. Those efforts continue. As far as how to communicate and how we're going to communicate externally it's really going to be twofold. One, it's going to be next November as we provide annual guidance, our 2017 guidance. We're going to talk about the shape of the P&L and what are some of the expectations shareholder should take about heading into next year. And in part two it's going to be ongoing as to what we do and how we’re going to win going forward. I wouldn't view it as a Big Bang massive restructuring effort, we did that with 2013 restructuring but if we do this right we're going to continue to find ways to reduce costs and operate more effectively and efficiently on ongoing basis.

And the Nick, just to kind of follow-on the question around execution. I don't want to divulge too much -- because I don’t want chip my hand competitively but here's the way I would explain it to you think about, we have got two models, we have got direct to retail model and then we've got a distributor base model. We believe that from an execution standpoint in terms of reaching the customer we’re going to leverage both of those in both developed and developing markets. We believe those are two strengths that we have that we plan to leverage. So I'm going to dive down to a level lower now and when you start to get into the store there's two ways we can handle this. In the more modern trade we have a lot of either brokered or direct to store resources call these feet on the floor. These folks because of the adjacency to the battery category amenity stores, they have the opportunity to merchandise, gain new placements in the store, think about how they manage and expand facings, the way they get off shelf placement displays all of that work will be done by those merchandising groups and what we would consider to be developed markets and modern trade. When you think about developing markets and traditional trade a lot of the work that the distributors does is really around placement in small kiosks or [indiscernible] Philippines, it's really different market to market but their job will be to ensure that we get prime placement and exposure of the HandStands brands right alongside batteries in a lot of those locations. One of the reasons that I like this company is again when we had personal care you could have a hectare of distance between your two brands and any given supercenter. In a lot a cases these products are adjacent to each other, so there is also an efficiency play in terms of windshield time of our merchandisers in the store and the fact that we can leverage those more efficiently than we can with just batteries only.

Our next question will come from Olivia Tong from Bank of America Merrill Lynch. Please go ahead.

This is Chris [indiscernible] for Olivia. Thanks for taking her question. if I could just bring it back to organic sales, they continue to come in at a pretty solid pace pricing costs inflation has benefited but as that benefits flows what's your view kind of the ability to offset some of that. Can you maybe talk about the innovation pipeline from here and potentially the run-away for incremental distribution gains, you noted some of that in your prepared remarks whether through new channels or geographies and then I have a follow-up.

Okay. Chris this is Alan. I'll take this and ask Brian to build it if you don't mind. So let's start with the distribution as you know we're in the majority of channels that exist around the world. There are some gaps in channels where we have distribution that we're currently pursuing and those discussions with customers are currently underway. As you think about our ability to expand distribution most of that expansion will come in non-measured channels and it will come in the form of international expansion. On the international expansion and I've been very clear with the team and certainly externally we will only expand internationally where it's profitable. We went through a significant go to market structure change over the course of the last few years and we're going to be very disciplined in terms of markets where we expand our products going forward and the same will apply to HandStands but it's not profitable and I'm not sure I wanted it. As you think about how we drive our business going forward and again this will be a very consistent from investor day, this category is not only overly complicated. We'll be continued focus on effective category fundamentals, so beyond distributions which you can basically it's the equivalent of the availability, it really becomes about visibility and that means you got to have the right quality locations in the store, you got have more than your fair share of shelf in those right locations and candidly you've got to manage the mix both the price of the products and the ranging of the products where you have the distribution. It's a combination of those things plus distribution that actually allow you to drive your base share. Now you notice I didn't talk about promotion, we will do promotion as long as it aligns to our retailer strategy and that it generates an acceptable return. But we’re not going to run promotion from a promotion sake to gain share and distribution. We're going to do this the smart way and really continue to focus on effective category fundamentals. So as you think about our model going forward there is the opportunity to expand distribution, a little more limited in battery definitely advantageous for us in HandStands business from a space standpoint and the quality of the distribution in the retailers that carry it, that’s where we see a bigger opportunity and candidly given our decades of experience in leading category management we think we're well positioned to be able to capitalize on that. Any follow-up?

Yes, just if I could just to transition to a little more inorganic growth. I guess state the union on your thoughts on M&A you mentioned cash and roughly three times leverage. What is your comfort level around leverage? How do you think about that? And how soon you might be looking to potentially look for additional acquisitions in the space if they come up? Thank you.

Chris, I'll take a pass and ask Brian to chime in. Currently we're right around 3.2 times debt to EBITDA leverage, we’re comfortable in that space right now. We don't speculate on what future good be, so I won't go there. But what I will tell you around M&A and a couple of things. So HandStands certainly provides us with the platform to consider future acquisitions in auto appearance, auto fragrance and think about aftermarket auto. We believe it does provide that type of platform. We're certainly open to conversation with companies that have those types of businesses to see whether or not they would meet our business and financial characteristics. But I like to be clear on one thing. First our priority number one is a successful integration of HandStands into Energizer Holdings to make sure that we deliver on the commitments we made when we set out and announced this acquisition, that's sort of priority one. I can tell you that Brian, John and I are spending extensive time already looking at what the next potential opportunities are. Those will be in the household spaces, I’ve indicated before I don’t want to lock into just one category. We’re going to continue to look at several categories and those that meet both our business and financial characteristics will be considered as potential again with the objective of delivering long term shareholder value. But keep in mind that the M&A piece is part of a balanced approach it's one of four levers that we believe we have to pull along with investing back into the business, delivering a return of capital to shareholders both through share repo and a dividend and then certainly M&A. So I think we will keep you posted on that but I can tell you we’re continuing to look at opportunities as we think about how we broaden our portfolio and again create and deliver long term value for our shareholders.

And the only to build is and this is consistent with what Alan and I’ve said in the past. We're not going to do M&A for M&A sake, we’re going to find the right fit and so Alan and I and John are continuing to look at other opportunities. It took us a year to find HandStands and what we felt was the right fit. But also want to stress that we’re taking a balanced approach to capital allocation is really important. We just announced the double-digit or 10% increase to our dividend rate, dividend is a key part of how we're going to deliver long term value to shareholders. And in just one year since spin we've been able to execute across all three investing in the business, a meaningful and competitive dividend, we repurchase shares earlier in the year and we disclosed on our first acquisition. So it's really looking and continuing to take a balanced approach and making sure that if M&A opportunity comes about it's the right fit.

Our next question will come from Jason English of Goldman Sachs. Please go ahead.

First a quick housekeeping item and then onto another question. The gross margin drag I think I heard you in response to [indiscernible] question say that the amount is sort of reinvestment in COGS line for productivity, is this effectively gone right now's as we enter the fourth quarter? So that pressure point abates, A, is that correct and then also currency has obviously been a big drag on our [indiscernible], the gross margin drag should be cut by more than half. Going into the fourth quarter. Is that kind of kind consistent with how you see the world as well?

On the Cost of Goods Sold and the investment in the product, that’s an increase to the Cost of Goods Sold. We started seeing that impact at the end of the first quarter and now that is an ongoing increase to our average unit cost. Now we’re going to look to find ways reduce that but on a year-over-year basis that's going to continue into the quarter four and part of quarter one of next year as well. Hopefully that makes sense. As far as what is one-time in nature? That's the productivity initiative the rightsizing of headcount as an example that we executed in quarter two of $3 million and then in quarter three of $5 million. And then as far as currency goes you’re right the impact is going to lesson. We saw that in quarter three and then in quarter four it will be much more comparable. But in quarter four it still will be a headwind at the sales line of about 0.5 to 2 points. And so it will still be a headwind but the impact is lessening.

And then the bigger question. We like many others have contemplated the potential upside to earnings for you and the expansion profitable for the industry at large from trade budget optimization to abatement of price subsidization, lower promotions whatever term you want to throw at it. So my question is from where you're sitting what you think the likelihood is? Is there any early indication as you look forward to holiday were presumably you guys are locking and loading the promotional calendar as we speak. So are there any sort of early indications coming from those and then related -- you're talking about distribution when spectrum is talk about distribution wins, how should we think about the risk of sort of rocking the cart here and forcing some of the losers because for every win on your side is a loss of someone else's forcing the loser on the other side to maybe react and not necessarily play nice when it comes to trying to become a little more rational for the industry overall.

It's Alan, let me take a pass and then Brian, he will chime in for us. So for holiday as you know we generally as a rule we don't talk about specific customers. So I won't get into detail of what's going to happen at any given customer. We write our holiday plans almost a year in advance with all the majors. So these plans have been put to bed for some time. I'm very excited and believe we've got strong programs in place to compete effectively during the holiday. The key is going to be the execution to be candid and we've got our four set up to be able to execute with excellence again in line with one of our core strategic tenants as a company. So I feel good about that. As we look at distribution again those types of plans typically are decided almost a year in advance when you do joint business planning with your customers. Now decisions are made shortly after that as customer reset teams sit and agree and decide on what they're going to do differently in their mix. In this category and candidly it's no different than when I ran the personal care business everyone's buying for distribution. It's a question of the fundamentals you apply against that and the expected return you have on the distribution you're pursuing. As we think about it and I'll take Asia because I think it's a great example. There's a market where we have over 60 share, we’re able to leverage our dual band strategy in many markets. In certain Asia developed markets there have been distribution opportunities that we have [indiscernible] but candidly if we're not to make a profit and the margins aren't healthy I don't want them. There are certain situations will choose to walk away from because it's not a healthy position. In those cases you will see impacts to distribution. In other markets so take Australia as an example. Distribution may have nothing to do with the manufacturer and everything to do with new retail formats that may enter markets. So in Australia you’ve a customer like all the entering market with a strong private-label offering that particular offering certainly creates disruption from both the pricing and a mix standpoint in any given market. When that happens the regional retailers respond in kind either through pricing on their own brands or pricing on national brands. And as a result what you're seeing in that market is volume up and value lagging as a result of that. Now keep in mind in Australia as a market we have almost 70 shares so certainly it's going to impact our business. And that's why you're seeing in certain Asia developed markets Energizer share and volume lagging the category at this point. I will tell you though we certainly are addressing that situation but we're going to do it smart in-line with the trade investment guidelines and thresholds that we put in place to make sure whatever we do and pursue is profitable and helps us build our base year.

Just a couple things to build on. Obviously to your point Jason for every winner there is a loser but that's always a risk. But I think it's important to understand what's happened in the battery category. All three battery manufacturers have introduced innovation within the performance [indiscernible] segment and so that shifted some of the share to some of the branded players. We’ve also seen a mix shift into premium and performance and also specialty brands and then also specialty battery types and just an overall growth in specialty battery types and so it's not always a zero-sum game especially with the specialty increase in demand and the good news especially it relates to specialty we have a very strong share position. So we've been able take advantage of just that increased demand and growth within that subcategory.

Our next question will come from Steve Powers of UBS. Please go ahead.

So building on that a little bit and then I have a follow-up on HandStands. On the competition point, I know in the markets you site Alan in AsiaPac as begin the last some of this competition as we think about into '17, it sounds like it's going to continue but you feel like you have got a mitigation effort, so it should dissipate to some extent as impacts your business is that a fair read? Sorry go ahead. The same kind of competition angle as it relates to North America. It sounds like you're pretty comfortable where things stand but at least in the track channel data we've seen some more negative pricing dynamics last few months and I just love your take as to whether or not that’s a warning sign if you view the things situation as more stable.

Yes, so let me start with the last question first on promotion. As you think about promotion let's start with 52 weeks both depth and frequency of promotion in latest 52 weeks in the U.S. has declined. Overall volumes sold on promotion units or dollars is also down versus the prior year. For the latest 13 weeks you’re seeing promotion levels in line with the prior-year, so the trends that we're seeing if you look at the 52 weeks the average AUP's, average unit prices at retail for alkaline is actually up. So we’re very pleased with our renewed focus on the effective category fundamentals and we're going to continue down that path going forward. So to your earlier question around APAC and then we can address North America. In APAC again as I alluded to there is a dynamic there that is beyond really the manufacturer, this has more to do with new retail formats entering the market that was very used to high margin structure the way they operated as retailers and really brought assortment. This is a limited assortment retailer with laser sharp pricing, you've seen the regional players react to that that has certainly had an impact on all manufacturers and not just batteries and obviously given our strong position in that market you would expect the outcome that we saw. We're anticipating that. In terms of how we remediated I won't get into any specific details because again I think that share is a little it ticks our competitive hand and I really don't want to do that. But needless to say the choices that we make in those types of markets whether they be Korea, whether they be Australia are going to be really governed around generating profitable distribution and we will continue to that by leveraging innovation that's relevant to consumers as well as making sure that we executed appropriately in the stores. We believe taking that path will allow us not only to help our base share but it's going to help us deliver value to our retail partners in ways that traditionally manufactures would not do. We understand what works in this category and we’re going to continue to focus on those efforts. In North America, because it's closer to home for all of us, Jason there's an example where you may want to walk the stores yourself and I think you'll see some of the changes that have occurred at retail and distribution in certain customers. Again this is a very strong focus for this organization. You'll notice when Brian and I speak to the investor community we don't talk about promotion and we don't talk about taking share we talk about effective category fundamentals. We believe that the base that is what's going to strengthen not only our business but allow us to contribute value to the category. In North America, that will continue to be our focus.

If I could just quick follow-up on HandStands integration. Maybe Brian could you just clarify of the $30 million to $35 million of what portion of that integration and acquisition cost you expect to be cash versus non-cash and then it sounds like the integration your planning is fairly comprehensive. So more than just corporate platform integration but actually supply chain integration, salesforce integration etcetera. I just want to validate that read and by extension is this the level of integration that we should expect from you going forward on M&A? Because I think to some extent people are trying to assess whether to what extent you really are going to be an integrated operating company going forward versus more of a platform company where the portfolio model is a bit more loosely knit. Thanks.

It's quite a few questions there which we appreciate. Let me just answer the one around each deal being different. We're going to look at every deal on its own merit and how we structure and integrate that into the company and potential synergies that will be assessed deal to deal. It really depends on what part of the household segments we choose to pursue and what kind of talent we can acquire, the types of categories in businesses that we acquire. Again we're going to look for highly comparable businesses that are good fits with us both from a business and financial standpoint, but I'm not sure I want to commit that everything's going to be the same for every deal. I think we’re going to assess them on their own merit. And then Brian if you wanted to comment on the others?

Of the total of $30 million to $35 million of acquisition and integration cost, $8 million to $9 million is non-cash that's the inventory accounting step up charge the remainder would be cash. As far as the extent of our integration efforts. HandStands has and we acquired a very talented team. Very impressive within the commercial teams, their product development team, their pipeline of innovation. We will take advantage of being able to integrate some of the back office services and then also leverage our global supply chain network and so it's really going to be a hybrid approach as to how we integrate. More fully folded in with the back office but really looking to supplement the talented team that they already have within commercial and also product development with the teams we already have around the globe.

Our next question will come from William Reuter from Bank of America Merrill Lynch. Please go ahead.

Most of mine have been answered just had a quick follow-up on the question about M&A earlier. You mentioned total leverage of 3.2 times I think the question was asked about kind of what you guys would take it up to and I'm not sure if I heard an answer to that. So do you guys have perspective and has that changed at all?

Our perspective hasn't changed. And it's really hard to speculate. We will evaluate every deal on its own, though a lot depends on the cash flow characteristics, how we would be able to integrate, how quickly we would be able to realize the synergies and pay down the debt. I think the take away is that currently we were at around three times that’s a good level where we can capitalize upon opportunities but how high we would go, it's really deal dependent.

Okay. And then just lastly with 90% of your cash located overseas. Do you guys have a sense for how much of cash you guys need to keep on the balance sheet?

With part of the HandStands acquisition, we were able to utilize a fair amount of international cash for the acquisition. It was actually delevering event, so we’re going to go from about 3.2 times to around 3 times leverage levels. We've upsized our revolver and we will draw around $50 million of that $350 million dollar revolver and we have plenty of firepower and access to liquidity.

Ladies and gentlemen this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Alan Hoskins for any closing remarks.

Thanks, Operator. So just to close again we appreciate everyone taking the time to join the call today and your interest in Energizer. We're very pleased with the strong quarter and the strong start to the year. The fundamentals of the business are strong and we're very pleased with our ability to continue to deliver value to our shareholders, both near term and long term. So thank you everyone for your time.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.