Spectrum Brands Holdings, Inc. (SPB) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is Laura, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal 2013 Second Quarter Earnings Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Tuesday, April 30, 2013. Thank you. I would now like to introduce Mr. David Prichard, Vice President of Investor Relations. Mr. Prichard, you may begin your conference.

Good afternoon, and welcome to Spectrum Brands Holdings Fiscal 2013 Second Quarter and First Half Earnings Conference Call and Webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands and moderator for today's call. Now to help you follow along with our comments this afternoon, as some of you may have seen already, we have placed a slide presentation -- and it's on the Event Calendar page in the Investor Relations section of our website, which is www.spectrumbrands.com. This document will remain there following our call, so you can access it in the days to come as well. So if we start with Slide 2 of this presentation I just referenced, our call today will be led, again, by Dave Lumley, our Chief Executive Officer; and Tony Genito, our Chief Financial Officer, who will both provide opening comments and then conduct the Q&A session. If we now turn to Slides 3 and 4, our comments today include forward-looking statements. They include our outlook for fiscal 2013 and beyond. These statements are based upon management's current expectations, projections and assumptions and are, by nature, uncertain. Now actual results may differ materially, so due to that risk, Spectrum Brands encourages you to review the risk factors and cautionary statements outlined in our press release dated April 30, 2013 and our most recent SEC filings and Spectrum Brands' most recent 10-K. We assume no obligation to update any forward-looking statement. Also, please note that we're going to discuss certain non-GAAP financial measures in this call. Now reconciliations of these on a GAAP basis for these measures, they're included in this afternoon's press release and 8-K filing, which are also both available on our website in the Investor Relations section. For the second quarter of fiscal 2013, the company reported a net loss of $41.2 million or $0.79 diluted loss per share on average shares and common stock equivalents outstanding of 52.1 million. This compared to a net loss of $28.7 million or $0.56 diluted loss per share in the year-ago quarter based upon average shares and common stock equivalents outstanding of 51.5 million. By segment for the second quarter of fiscal 2013, the Global Batteries & Appliances segment reported net income as adjusted of $34.6 million versus $35.6 million a year ago. The Global Pet Supplies segment reported net income as adjusted of $16.4 million versus net income as adjusted of $14.8 million in fiscal 2012. The Home and Garden business segment reported net income as adjusted of $20.6 million versus net income of $21.2 million as adjusted last year. And finally, the Hardware & Home Improvement segment reported net income as adjusted of $600,000 in the second quarter of fiscal 2013. With that as background, I am now very pleased to turn the call over to our Chief Executive Officer, Dave Lumley.

Thanks, Dave, and thank you, all, for joining us this afternoon. Turning to Slide 6. We reported good results for Spectrum Brands, including the legacy business, in the second quarter, which seasonally is our smallest quarter of the year, and HHI, our new hardware group, added an improved performance in its first full quarter as part of our company. Our markets remain challenged by a difficult macroeconomic environment, highlighted by sluggish retail activity, tightening retail inventory management and frankly, a stunned consumer. These consumers are juggling higher taxes, generally stagnant wages and higher everyday expenses. Still, we believe our Spectrum Value Model and our largely nondiscretionary, non-premium price replacement products serves us well, providing consistent value to our retail partners and consumers worldwide. With a solid first half behind us, we remain on track to deliver another year of record growth and improved results from our legacy business, along with the added growth from HHI. On Slide 7. Our second quarter net sales showed an increase of 1%, including HHI at both quarterly periods. HHI and Global Pet reported revenue growth. Our legacy business sales were solid, impacted by the planned $10 million continuing exit of low-margin promotional business in North American Small Appliances; this is similar to past quarters. We also had an expected shortfall in Home and Garden revenues given the difficult comparison with last year due to the very early and warm 2012 spring. Our net loss in the second quarter was driven by an inventory revaluation related to HHI and one-time acquisition and integration and restructuring costs. Lower adjusted EPS of $0.44 in the second quarter versus $0.47 last year was due to an increase in noncash stock compensation expense, driven by employee stock-based award programs. Still, adjusted EBITDA results were solid. Including HHI in both…

Thanks, Dave, and good afternoon, everyone. Turning to Slide 16. Let me first comment on our gross profit and margin in the second quarter. Our gross profit and gross profit margin of $323 million and 32.7%, which includes HHI, compared to $260 million and 34.8% a year ago for legacy Spectrum Brands only. The gross margin decrease was driven by increased cost of goods sold of $26 million from the sale of inventory, which was revalued in connection with the HHI acquisition, and that impacted the margin by nearly 300 basis points. This inventory revaluation offset solid gross profit margin improvement of more than 450 basis points from the previously announced exit of low-margin product sales in the North American Small Appliances business of nearly $10 million. Excluding HHI and the inventory revaluation, I'm very pleased to note that the gross profit margin in the second quarter of fiscal 2013 for legacy Spectrum Brands as adjusted for restructuring and related charges was 35.7% versus 35.1% last year. Second quarter SG&A expenses, excluding HHI, were essentially flat with last year's second quarter, similar to what we saw in the first quarter. Interest expense in the second quarter was $60 million compared to $69 million last year. The decrease was related to nonrecurring costs incurred with the replacement of our 12% PIK notes last year of $27 million in savings primarily related to the refinancing of those notes. This was offset by increased interest expense of $21 million from the additional debt financing for the HHI acquisition. Now to our effective tax rate, which was an unusual 249% in the second quarter versus 142% a year ago. Our book income tax rate is impacted by our high level of profits in foreign jurisdictions. This means we provide for foreign income taxes even…

Thanks very much, Dave and Tony. Operator, you may now begin the Q&A session, please.

[Operator Instructions] Your first question comes from the line of Bill Schmitz from Deutsche Bank Securities.

Can I ask you about -- the last quarter, I think you talked about some interesting news on the distribution side in Batteries. So is there anything you can share with us on that front? And then maybe, there is some rumblings that there is a little bit of dislocation at Walmart in the battery quad, and so can you just talk about what's going on there as well? And then I have a follow-up, too.

We don't discuss individual retailers, it's a -- the deal we have with them. I can tell you by segment. We've had very good success in what I would call the Home Center segment and the 2-step segment. I would tell you that we have not lost any distribution anywhere right now of that -- of your comment.

Okay, that's really helpful. So you have the same sort of shelf space now at the major retailers as you had last year, with maybe some gains in some of the home centers, is that directionally right?

As of today, yes.

Okay. And then did you -- have you ever thought about bringing the production for some of the Small Appliances back to the U.S. because it seems like the wage inflation and the cost inflation and the freight inflation has been so high, I mean, is there an opportunity for you guys to onshore some of that stuff?

We are looking into that. I think it's more of a North American opportunity, not necessarily U.S., and even the Caribbean, not only in Appliances but things -- some of our other products. We've actually moved products in the Home and Garden division into the Caribbean islands. We've moved products into Mexico, and we are aggressively pursuing it. It will take time because the infrastructure for the parts, especially our Appliances, are all in Asia. But I can see certain products of that happening. So everyone's working on it. It will take a while, though.

Okay. Great. And then just lastly, what are you most surprised about with HHI? That business is doing extremely well, so where is the incremental growth coming from, and what did you kind of find out that you didn't know during the due diligence process?

That's a great question, Bill. Basically, Dave and I -- this is Tony speaking. Dave and I had gone out to the HHI facilities -- I guess it was the end of February. I had a deep-dive management meeting with the entire HHI team, which I went through each of the functions. And of course, you do your due diligence process, and it's -- you do what you do. But this was a deep-dive with the management team, and I think the big opportunity that I walked away with, and I don't want to speak for Dave, but I think he felt the same way, is that we see quite a bit of opportunity where this business is very well-run with respect to cost improvement, but we see further opportunities with that, as well as the opportunity for further benefits in the mass area. I mean, clearly, approximately 50% of the business is with the big-box home centers and not a very strong presence in the mass area. So we see that as an opportunity, especially considering the fact that we just closed on the acquisition of Tong Lung on April 8, which is a supplier of not only a private label, but branded locksets, and gives us a vertical integration, so to speak, that allows us to really enhance that and accelerate that opportunity. So it was really another check box, where not only did we see, as we've talked about doing the acquisition itself, the opportunity for geographic expansion, but also channel expansion, I think. And also, the opportunity that as well-run as the business is, we believe that there's further opportunities from a cost savings perspective within that business itself.

Your next question comes from the line of Dan Oppenheim. Daniel Oppenheim - Crédit Suisse AG, Research Division: I was wondering if you can talk about sort of the batteries in North America. I'm talking about based on a price competition. What's your sense -- any reason to think that we'll see less of a competitive response there in -- on the pricing side? How are you looking at that at this point?

I think that the pricing in batteries will stay very competitive for a little longer, but I don't think it's sustainable at some of the things that have been going on. I think it will level out. Daniel Oppenheim - Crédit Suisse AG, Research Division: Okay. And then in terms of just Remington in terms of the shelf space. Wondering -- you talked about sort of onetime -- how are you thinking about that in terms of just some underlying issues and making sure lots of your -- continue to gain shelf space, you think you'll take on more as you have new products coming out here?

Yes, I think -- this is really just a bump in a road for Remington. If you look at it, its growth pattern, especially the last few years, have been fantastic. This was a decision by a major retailer to try something new, and credit them for trying that. But we think that the strength of Remington and Shaving and Grooming has returned, and we have a very good opportunity, and that we also see an increased sales online for these type of products. And we have obviously, the new consumable products that -- our haircare accessories and some of the other products we have in that area, i-LIGHT, that are really bolstering that group. So we're very bullish on Remington. This is not uncommon. This happens from time to time in this category. And I think we'll be right back on the track here right this quarter. And by next quarter, I think we're right to where we were. So we're bullish on that.

Your next question comes from the line of Lee Giordano from Imperial Capital.

My question's on HHI. The 11% growth seems pretty impressive. When you look ahead, I guess, what should we think about for a normalized growth rate for HHI? I think you said there was a timing issue in there that might have boosted it. And then secondly, how much of that growth is coming from the improvements in the housing market?

We would love it, Dave, if we grow double digits every quarter. I think a more realistic thing is probably the mid to high single digits. That's more normal. They did have some timing there in the quarter, where some stuff shipped a little early that wouldn't normally. So I think you'll see steady growth there. Housing is, as we've told you, 25%, 30% of their sales, and it tends to lag 7, 8, 9 months, right? Because they still have to build the -- I'm talking about new construction -- the locksets for it. So they tend to have to build a house and get it all ready then with the lockset, right? So even though they're doing better than that, I don't think you're going to see a big, big impact from that for a while yet. You are seeing -- we are seeing better than we thought sales with our new SmartKey technology, which lets people rekey things, right? We are seeing even some better results from their plumbing business. Really, if you looked at their sales there, they are pretty high, too. And that's driven by this universal trim system they have where you don't have to knock the wall out to change things in the shower. So again, double GDP, something like that. And we're just learning, so we'll see. But we're optimistic. But things take a little time here. They still have a lot of integration to do. We want to manage this thing prudently and get everything set right. So I think it's good, and I think it'll continue to get better.

Great. And then secondly, just on product costs. Can you talk about product cost trends? Are they still accelerating in China? I think you said they might have slowed a little bit. And then what's your ability to pass those costs on to retailers? Are you getting any pricing power?

First of all, they've moderated, and they're slowing quite a bit. The amount of increases they have hit people with for the last 2 years hurt them, too. Those factories are in trouble. Their markets are slowing. Even with the demand they had within China is slowing. So I think we're going to see a moderation on that, actually could create an opportunity for our Appliance division next year. More importantly, our ability to hit our -- that Appliance business is integrated like we have, they are catching up, and they are starting to cover price increases with really good global new product development cost increase. So I think we are going to catch that. I don't think we'll be negative anymore as well. So that's good. I would say to get pricing on, in most of our businesses, we can cover most of it with cost improvement and select pricing actions. The only place you really have struggle doing that is small kitchen appliances because there's just so much capacity and so many brands and the ability of people wanting to give it away continues to be around, which is why we took the big action on literally the #1 brand in North America, Black & Decker, and the #1 grill brand, George Foreman, and just said, "Look, we're going to charge what it's worth." So there was some pain there in those $50 million in sales, but you've seen the increase in the EBITDA and the reduction in working capital. So if somebody else wants to lose all that money, well, let them do that.

Yes, we're very excited, Lee, with respect to the Appliance business because, as we've said back when we acquired the business that, it takes about 2.5 to 3 years to be able to hit on all cylinders with respect to the cost improvement side of things. And as you recall, the business had done a -- prior to the -- our acquisition, had done a very good job of tending the herd with respect to eliminating SKUs and eliminating brands that were not profitable. However, we really began the -- in earnest, the cost improvement processes really in, say, end of 2011, and we're starting to see the dividends of those pay off. And we were very excited. Keep in mind that North American appliances was always sort of the sore spot with respect appliances, and we're doing very good in Europe and Latin America. But we saw a 300-plus basis point improvement in gross margin in the first quarter, and it was a 400-plus basis point improvement in North America this quarter. And this is really driven by the superb work on the cost improvement initiatives that we're now getting those dividends that we invested in earlier.

[Operator Instructions] Your next question comes from the line of Hamed Khorsand from BWS Financial.

Just want to ask you, any market share gains for the wet shave and the female personal care lines?

In the haircare accessories, we have significant gains at the top 2 retailers in the United States, I mean, really, really significant gains. We went from 0; we're in the teens already in market share in -- overall in North America and to new markets. We got a very early big win in the U.K. as well at their super retailer, too. So we're very happy about that. In wet shave, remember, we're still in the development and testing of that, so that, we won't really have a lot this year. In i-LIGHT, of course, we've built a substantial business, and that's growing in every market we're in, okay? So that's doing very well. And then we have all these new products coming behind us. So that's the exciting future for us, and I think we've just scratched the surface.

Yes, and may I just tag on to what Dave said. In Dave's prepared remarks, you heard that we received the approval of i-LIGHT in Brazil, so -- which is a large market. So we're very excited about that as well.

On the i-LIGHT product line, are you going about that at the same kind of strategy with your personal care like Remington line, or you're taking a strategy of more of like a Small Appliance kind of distribution base?

No. In fact, we're doing what I would call the new model. We are developing a lot of -- dedicating a lot of resources and spending to e-commerce first in all the markets, and then some, DIRECTV, and then we'll go to specialty, and then finally to mass. This product lends itself more under that pyramid. So we're literally -- it's a multi-channel approach. And then we have replacement bowls, which we can sell in all those channels and online. So we're using all the channels, which makes it an exciting product as you can customize to channels and price differently with different add-ons. Plus, it kind of brings along the Remington product line. You still have to shave first before you use it, whether it's wet shave or dry shave. You still -- you could still use other products in conjunction with it, and then we can add value-added, whether it's our new hair accessories line or it's our dryers, straighteners and whatever. So exciting, exciting futures.

Last question. Tony, on the R&D line, what kind of volatility should we expect from your spending going forward?

Yes, there really shouldn't be too much volatility in that line in any way, shape or form. I think if you look at the P&L that -- if you go to the earnings release, you can see that R&D was up a little bit this quarter versus last quarter. That was the investments that we're making that Dave alluded to in the consumables side of the, primarily, the Remington business and in the e-commerce business. So I think once those investments are made, which we talked about those in last quarter's call, then we'll see more of a I'll say, "normal return to the R&D line."

Your next question comes from the line of Karru Martinson of Deutsche Bank.

So we, guys, out started talking about the stunned consumer, juggling higher taxes, stagnant wages and higher everyday expenses. And unfortunately, I don't think anyone will see any of that changing. So I'm kind of wondering what gives you the confidence in your guidance here as you look forward into the second half of the year.

It's Dave Lumley. Because we've had major distribution wins that are all going to go into place in the second half and shift, number one, so we're going to be in a lot more points of distribution than we are now. We have some newer products that actually have better features and benefits that will cost the same or less at the same time. Three, what's going on with the consumer now is completely opposite of what's going on at stock market. Because they don't evidently own any of the stock that everyone else is making their money on. I mean, this is something I heard directly from one of our top retailers who said -- so they're seeing the consumer trade down and want more and buy things on promotion. That's our model. So that's why we feel so good about it. So this isn't a hope that this happens. If you're in place, priced right and you have more of it while this is going on, you should sell a lot more, and that's why we feel confident about this.

Okay, makes sense. When we look at the exit of the low-margin small appliance product lines, $10 million for the quarter. What should we think of that as an annualized number, and I'm sorry if I missed that if you gave that?

Yes, it will total out -- we're just about down $50 million. So as we look forward to '14, we can get some of that back, right, on an annualized basis and at acceptable margins for promotions, rather than what this was at. So that's an, actually, opportunity in '14.

Okay. I mean, is that business right now going to private label, is it going to competitors or is that just kind of avoid...

Two things happened. They did go with some other lesser brands, and Black & Decker and George Foreman didn't work too well. They just didn't do it because they didn't make money either for retailers. So we just -- there's no sense in selling a George Foreman Grill for $9.95. I mean, as a joke, I'm going to the Yankee Stadium tonight, I think that's how much a beer costs. So I mean, that's probably not a good promotional approach.

A beer at Yankee Stadium will cost you more. Just lastly, on Latin America at the battery market. We've had a lot of kind of irrational pricing. We're looking for second half growth. I mean, is that pricing environment, in particular in Brazil, is that stable, or are we seeing kind of a return to the norm there?

I would say that we're halfway back to normality. There's still some irrational things going on tied to something that has nothing to do with batteries. There's a World Cup and Olympics coming there. And there is all kinds of activity for those companies to have their products do well in the marketplace. So I think as that passes, we'll see more rationality into it. Remember down there, there's a fourth battery company that we compete with in Panasonic, and they just happen to be involved with one of those, and then the other -- one of the other big battery companies owned by a very large firm is the sponsor of the other one. So I do think that you'll see that to get better. There's other things going on down in Brazil. There's a movement of one type of battery, which we call heavy duty or zinc carbon to more alkaline sales, as that country and that consumer has more money to spend. So that's going on, too, and that's more expensive. So indirectly, you sell less of them. I know they cost more, but they buy less of them, but they do last longer. So there's a lot going on there, but as battery markets go, Latin America is a fraction of the size of total sales as America or Western Europe.

Okay, operator, it looks like we have exhausted all the questions that are in the queue, and with that, I want to thank Dave Lumley and Tony Genito once again for handling the call today. And with that, we have reached the conclusion of the call. On behalf of Spectrum Brands, all of us here want to thank each of you for participating in our fiscal 2013 second quarter earnings call this afternoon. You have a good rest of the day, and we'll talk to all of you next quarter. Thank you again.

This concludes today's conference call. You may now disconnect.