Spectrum Brands Holdings, Inc. (SPB) Q1 2017 Earnings Report, Transcript and Summary

Good morning. My name is Lindsay and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal 2017 First Quarter Earnings Conference Call. [Operator Instructions] As a reminder ladies and gentlemen, this conference is being recorded today, Thursday, January 26. Thank you. I would now like to introduce Mr. David Prichard, Vice President of Investor Relations for Spectrum Brands. Mr. Pritchard, you may begin your conference.

Good morning, and welcome to Spectrum Brands Holdings fiscal 2017 first quarter earnings conference call and webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands and I will be your moderator for our call today. Now to help you follow our comments, we have placed a slide presentation on the event calendar page in the investor relations section of our Web site at www.spectrumbrands.com. This document will remain there following our call. So now if we start with Slide 2 of the presentation, you'll see that our call will be led again today by Andreas Rouve, our Chief Executive Officer; and Doug Martin, Chief Financial Officer. Andreas and Doug will deliver opening remarks and then they will conduct the Q&A session. Let's turn now to slides 3 and 4. Our comments today include forward-looking statements, including our outlook for fiscal 2017 and beyond. These statements 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 January 26, 2017, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10-K. 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 Web site in the investor relations section. With that, I am now very pleased to turn the call over to our Chief Executive Officer, Andreas Rouve.

Thanks, Dave, and thank you all for joining us. Turning to Slide 6. We delivered a very solid first quarter, with improvement in all of our key financial targets. Adjusted EBITDA, free cash flow and adjusted earnings per share were up despite further currency headwinds and a strong focus of all major U.S. retailers to reduce their inventory. We grew adjusted EBITDA as reported by $7 million or 3.4%. If we exclude the negative currency impact of $6.6 million, our organic adjusted EBITDA increased by 6.6% over the very strong first quarter of fiscal 2016. At the same time, we improved our free cash flow in the quarter by $247 million compared to the first quarter of last year and our adjusted EPS was up 20%. The earnings growth was impacted by increased spending in several strategic initiatives. Despite those higher expenses, we could increase our adjusted EBITDA margin by 70 basis points to 17.7% due to our clear focus to grow our core profitable category with the launch of more innovative products, as well as the expansion into more channels and more countries. The growth in our core categories is partly offset by our strategic decision to exit unprofitable business and deemphasize low margin promotions on Black Friday and during the holidays, as they only look great if you focus on market share but not if a company aims to grow EBITDA and free cash flow, as we do. In total, our net sales were down in the quarter as reported by 0.6%. But if we consider the impact of currency, the business exits and the two fewer days in the first quarter compared to last year, we delivered on a comparable days basis organic growth in our core business of about 3.5%, which was a key driver of our earnings improvement. We are pleased with the performance of all divisions and regions, even if we had to overcome one time headwinds in home and garden, and global auto care, which Doug will explain in more detail. Hardware and home improvement delivered record quarter one results, and also the performance of our global batteries and appliance division was excellent. On a regional basis, Europe, Latin America, Canada and Asia Pacific reported solid adjusted EBITDA growth despite the currency headwinds. The reorganization of our Asia Pacific region last year with new leadership and clear strategic focus is starting to show operating performance improvement. Turning to Slide 7. In line with our Spectrum First strategic roadmap, we're focusing not only on becoming the preferred partner to our customers and employees, but we are also working to continuously improve our processes to accelerate the sustainable growth of organic adjusted EBITDA and free cash flow. As such, our global auto care team is making good progress to complete the major simplification of its U.S. production, distribution and R&D footprint by consolidating in Dayton, Ohio. Production has started already on the first line and we expect to complete this project within this fiscal year. In addition, we have announced a few days ago a new initiative, which is the consolidation of hardware and home improvement's two distribution centers in the U.S. which are on each coast, into one single centrally located facility by the end of calendar year 2017. This will improve working capital and customer service by providing additional capacity for growth. At the same time, we're stepping up R&D and marketing investments and adding sales specialists to pursue white space opportunities in more categories, channels and countries. As part of our innovation process, we are also enhancing packaging and product differentiation to allow us and our retail partners to cover multiple price points, respond better to different consumer needs and avoid channel conflict. In parallel, we're launching several brand refreshes and 360 degree marketing programs to raise the awareness and appreciation of our brand. We expect accordingly for fiscal 2017, above category organic top line increases and solid bottom line growth, as well as free cash flow improvement. The second half of our fiscal year will again be larger than the first half due to the seasonality of our home and garden and global auto care business. We will be comping a strong second fiscal quarter as retailers had ordered last year exceptionally early related to [FICA] [ph] concerns and a favorable early spring weather. But we're on good track and even if Q1 is our smallest EBITDA quarter of the year, the solid resize provides an excellent start to achieving our eighth consecutive year of record financial performance in fiscal 2017. Let me turn it over now to Doug for the financial review and details on our performance by product category.

Thanks, Andreas and good morning, everyone. Now turning to Slide 9, let's review Q1 results beginning with net sales. First-quarter reported net sales of $1.21 billion decreased 0.6% versus last year. Excluding the negative impact of $18.8 million of foreign currency, organic sales grew 1% against strong organic growth of 6.3% last year and while also including the negative impact of unprofitable business exits of approximately $8 million and two fewer shipping days of approximately $20 million to $25 million. For clarity, we will get one of these days back in Q4 and the full year has one fewer day than fiscal 2016. Reported gross margin of 37.1% increased 90 basis points from 36.2% last year, primarily due to strong productivity and improved mix, partially offset by the negative impact of foreign exchange. Reported SG&A expense of $278.4 million or 23% of sales compared to $273.4 million last year or 22.4%. Reported operating margin of 12.5% increased 80 basis points compared to 11.7% last year, largely driven by expanding gross margin and lower acquisition and integration spending. On a reported basis, Q1 diluted earnings per share of $1.10 decreased compared to $1.24 last year, primarily due to an increase in our reported effective tax rate. Adjusted EPS of $1.21 increased 19.8% from $1.01 last year primarily as a result of volume, favorable mix, operating efficiencies and lower interest costs, partially offset by the negative impact of foreign exchange. The Q1 reported tax rate of 32.3% increased from 9% last year primarily due to the absence of a valuation allowance benefit in the prior year. Turning to Slide 10. As I have noted over the last several quarters and also mentioned by Andreas, the company continues to be focused on improving working capital. Not only absolute improvement year over year, but also systemic improvement throughout the year to reduce some of our working capital seasonality. And these initiatives are bearing fruit. In the first quarter, we delivered positive adjusted free cash flow of $6 million, a $247 million improvement over a year ago, mostly driven by working capital. Remember, this is both better working capital management and efforts to reduce intra-year volatility. So while you should expect full year improvement, some of the gains in Q1 would normally have occurred in Q3 and Q4. First quarter reported interest expense of $55.8 million decreased $2.6 million from $58.4 million last year, driven by the benefit of our 4% euro denominated notes issued last September and repricing of our U.S. term loans in October. Cash interest payments of $44 million were $18 million lower than last year, largely related to major term debt reduction, the note free financing and term loan repricing. Cash taxes of $10 million were unchanged from last year. Depreciation, amortization and share based compensation were $55 million compared to $57 million last year and cash payments for acquisition and integration and restructuring and related charges were $4 million and $3 million, respectively, this year versus $12 million and $6 million last year. Now on to our operating unit results, beginning on Slide 11 with global auto care. Q1 reported net sales of $69.5 million decreased 5.7%. Solid U.S. growth in refrigerants, primarily AC Pro, was more than offset by lower appearance and performance chemicals revenues, primarily due to the timing of shipments ahead of GAC's North American SAP go live last year, and U.S. retailer inventory adjustments. We also saw lower European region distributor revenues due to order shipment timing versus last year. Reported adjusted EBITDA of $19.8 million grew 3.1%, with margin improving 240 basis points to 28.5%. This year, GAC is supporting the core Armor All, STP, and AC Pro brands with new innovation, educational initiatives and increased category awareness. Extending Armor All and STP into adjacencies is a focus and one exciting example is the launch of our time saving Armor All Ultra Shine Wash and Wax wipes, which provide one step wash and waxing with no waiting or buffing and no need for a bucket or hose. International growth, most notably in Europe, is also a priority along with cross-selling and white space wins. Turning to Slide 12. Hardware and home improvement is continuing its momentum from a record 2016, with a record Q1 results, driven by growth in its core U.S. residential security business. Q1 reported net sales of $288.8 million increased 2.2%, including the impact of planned exits from unprofitable businesses in Mexico of about 1.5%. Adjusted EBITDA of $59.2 million improved 10.2%, with reported margin of 20.5%, up 150 basis points from last year. Organic adjusted EBITDA of $55.9 million grew 4.1%, excluding favorable FX of $3.3 million. A key driver of HHI momentum in its core U.S. categories is coming from a robust new product roadmap, with strong innovation every quarter across all product categories. At the Consumer Electronics Show in early January, HHI unveiled several new smart locks to strengthen its industry leadership in the fast growing residential electronic security category. This included Obsidian, a key free smart lock with a low-profile design, targeted at homeowners seeking modern decor looks. This latest smart lock from Kwikset will be available as a standalone deadbolt or as a home automation connected device. HHI seeks to sustain and further scale its strong do it yourself homebuilder channels, distributors and showroom businesses, pursue more growth in home automation and further establish its patented smart key technology as the industry standard. In continuous improvement, HHI has initiatives in progress to reduce costs, simplify supply chain and reduce SKUs and inventory levels. This global transformation program begun last year, will also add capacity and insourcing, harmonize lockset components and increase automation by the end of fiscal 2018 to strengthen HHI's position as the low cost industry producer. Now to global pet, which is Slide 13. Q1 reported net sales of $194.2 million fell 4.5%, while organic revenues decreased 3.1%, excluding negative FX of $2.8 million. Consistent with comments on our year-end call in November, pet expects to continue profit and margin expansion in fiscal 2017 ahead of revenue growth, which is expected to reoccur in the second half of the year. To that end, Q1 reported adjusted EBITDA of $30.7 million increased a strong 5.1% and 11% excluding negative FX of $1.7 million due to favorable product mix and favorable customer mix. Q1 reported adjusted EBITDA margin grew 140 basis points to 15.8%. Higher aquatics revenues, primarily from double-digit growth in Europe, were more than offset by lower North American companion animal and European pet food revenues. As expected, North American companion animal sales were negatively impacted by the planned exits of low-margin, private label rawhide and chicken jerky business last year and lower European pet food sales, in part from a planned exit of a customer tolling agreement. Together, these exits adversely impacted pet's top line by about 1.1% in Q1. As evidenced by the Q1 margin expansion, the operational and process improvements made over the past 12 to 15 months are taking hold. Pet continues to transition to higher margin, branded companion animal products with increased marketing support and stepped up efforts for geographic expansion in Latin America, Canada and Asia Pacific. In North America, the expansion of Nature's Miracle to broader distribution points is underway. Dingo has been re-launched and re-positioned and innovative campaigns are also underway for FURminator and ProSense. Moving to Slide 14, home and garden. In its smallest quarter of the year, home and garden reported record revenues, providing an encouraging start to 2017. Reported net sales increased 4.4% to $49.8 million, driven by double digit growth in the household controls category. The 19.7% decline in adjusted EBITDA to $5.7 million and 350 basis point decrease in reported margin to 11.4% was due to the absence of favorable manufacturing variances this year as a result of the improved manufacturing scheduling and the new aerosol line startup, which will both benefit later quarters. As well as investments in marketing expense to support innovation and new distribution. To add a little clarity to the impact of manufacturing to this quarter's results, recall that in the last couple of years, we began our seasonal pre-build for aerosols before the end of our fiscal year and into Q1. This has generated favorable manufacturing variances in the last couple of years that did not repeat this year as the new aerosol line was installed and ramp up of production began. This project nearly doubles filling capacity and will reduce inventory levels and production costs in 2017. The St. Louis plant also completed its first production run of global auto care aerosol products, specifically Armor All Tire Foam, in December and is increasing global auto care aerosol filling in this quarter, resulting in additional cost savings versus prior year, and the avoidance of using third party co-packers. To deliver continued strong results this year, home and garden plans for increased distribution and market share gains, more innovation and continued operational excellence. For example, the Black Flag brand is expanding beyond household controls into the outdoor control space with new insect products. A comprehensive plan supporting Black Flag outdoors is generating retailer excitement and driving consumer engagement. To support our Hot Shot bedbug pest management solutions, home and garden is employing a first of its kind integrated multi-product solution for consumers. And Cutters exclusive repellent sponsorship of U.S. soccer is helping to drive important off-shelf placement and improved brand awareness. Now to personal care, which is Slide 15. Reported net sales of $162.6 million fell 3.7%, while organic revenues decreased 1.5%, excluding negative FX of $3.7 million. Despite the sales shortfall, Q1 reported adjusted EBITDA was unchanged with margin improvement of 60 basis points. Organic adjusted EBITDA increased 8%. Constant currency growth in Europe and Asia Pacific was more than offset by lower North American revenues. The North America decline was largely attributable to fewer promotions and distribution adjustments at key retailers. Remington innovation will remain strong this year to drive organic growth, especially in shave and groom and in hair care, supported by a blend of traditional print and online media. In Europe, for example, Remington launched a new straight brush in unique PROLuxe range in women's hair care. The focus is on expanding distribution in the new white space areas as well as continuing strong double digit ecommerce growth. Now let's turn to small appliances on Slide 16. While reported net sales of $186.4 million decreased 1.8%, organic revenues grew 2.1% after excluding negative FX of $7.5 million. The improvement was attributable to strong growth in North America from distribution gains, incremental listings, effective promotions and strong ecommerce growth, along with modest growth on a currency neutral basis in Europe. As an example, our Wi-Fi enabled slow cooker was a very successful holiday product launch. Reported adjusted EBITDA grew slightly with a margin improvement of 40 basis points. Organic adjusted EBITDA grew more than 20%. Small appliances is working to further broaden its product portfolio and distribution points around the world, armed with strong innovation in fiscal 2017, especially in cooking and beverage. We expect to drive top line growth through distribution wins, white space opportunities and ecommerce, which continues to see the most significant channel growth for small appliances. In Q2, George Foreman Grills are launching into Continental Europe, following the success of the brand in the U.K. Cookware and bakeware innovation is also being introduced into Europe under the Russell Hobbs brand name. Finally, to global batteries which is Slide 17. Global batteries delivered an excellent first quarter. Reported net sales of $260.5 million increased 3.1%, and excluding $4.5 million of negative FX, 4.9% organically. Reported adjusted EBITDA grew 6.5% with margin expansion of 70 basis points, while organic adjusted EBITDA increased more than 10%. Solid growth on a currency neutral basis in Europe from new customers, organic increases and effective promotions, as well as in Latin America and Asia Pacific, drove the improvement. Alkaline battery growth in North America was strong. We expect a solid performance in North America, with increased and targeted marketing initiatives and on a constant currency basis in international markets as we move through fiscal 2017. Primarily in the alkaline and hearing aid categories, global batteries continues to pursue growth in under-indexed channels and new geographies, such as hearing aid batteries in China, and through market share and distribution gains. Our expanded Rayovac go to market strategy has been introduced broadly now in North America as we pursue key white space opportunities in the region. Moving to the balance sheet on Slide 18. We ended Q1 in a very strong liquidity position with more than $300 million available on our $500 million cash flow revolver, a cash balance of about $143 million and debt outstanding of $3.7 billion. We expect to continue to reduce leverage in fiscal 2017, similar to last year. We ended fiscal 2016 with total leverage of about 3.9 times. As mentioned earlier, adjusted free cash flow for the quarter of $6 million compared to a use of $241 million in the prior year, reflecting significant progress across inventory, accounts receivable and accounts payable to sustainably improve working capital management and to begin to reduce some of the seasonal volatility in our working capital cycle. Capital expenditures were $28 million compared to $17 million in the prior year. During the quarter, we repurchased over 802,000 shares of common stock for $97 million, or about $1.21 per share. Finally, the board this week also approved a new three year $500 million share repurchase program. Turning to slide 19 and a review of our 2017 guidance. We expect reported net sales to grow above category rates, partially offset by the anticipated negative FX impacts of approximately 100 to 150 basis points. We expect to deliver free cash flow of between $575 million and $590 million. We expect full year interest expense to be between $200 million and $210 million, including approximately $15 million of non-cash items. Cash interest payments are expected to be between $175 million and $185 million. Depreciation and amortization is expected to be between $245 million and $255 million for 2017, including approximately $60 million for amortization of stock based compensation. Our 2017 effective tax rate is expected to be between 30% to 35%, and recall that for adjusted earnings, we use a 35% tax rate. Cash taxes are expected to be approximately $50 million to $60 million and we do not anticipate being a regular U.S. federal taxpayer for the next few years as we continue to use net operating loss carryovers. Cash payments for acquisition and integration, and restructuring and related charges are expected to be between $30 million and $40 million. And finally, capital expenditures are expected to be between $110 million and $120 million, including the rollover spending from 2016. Thank you, and now back to Dave for Q&A.

Thanks very much, Andreas and Doug. With that, operator, you may now begin the Q&A session, please.

[Operator Instructions] Our first question comes from the line of Bill Schmitz with Deutsche Bank. Your line is now open.

A couple of things. Can you just talk about the trajectory in the U.S. It looks like it was down a little bit this year and I know there was inventory destocking. So from what you can tell, is the bulk of the destocking done and could there even be, maybe a snapback in some of that inventory level that at our retailers?

Yes, Bill, let me get that question. I think Doug mentioned we had in some divisions some one time effects likely. For instance in global auto care, where we had [backlash] [ph] for the SAP go-live on January 16 and as a consequence, a couple of retailers had pulled orders forward into the December. So those were the effects which were hitting the U.S. In addition we have in the pet division, walked away from unprofitable private label business and also this is in the U.S. But in addition to that, it is exactly what you mentioned, at really all major retailers and it is the biggest retailer in the world. The two biggest home improvement centers, the auto channel. All retailers are focusing on inventory reduction and they are heading towards their end of fiscal year and therefore they have accelerated their efforts now in the first quarter. So that is basically the key driver for the pretty flattish sales in North America.

Okay. And do you think there is going to be a snapback? Are we going to get back to normal ordering patterns or could there even be a catch up? I mean, are out of -stocks becoming a problem, any of that stuff?

No, actually not. And also all of those retailers have implemented better forecasting systems, better inventory management systems and we really see that service levels in stock at the retailers are at a very good level. Some of the inventory reduction in all fairness was a kind of correction of [indiscernible] inventory, especially in global auto care and home and garden, which are now in their low season. So in those two categories, we should see some snapback as we head into the next year's peak season but in the other categories, these appliances, be it in pet or in home and garden, that is truly going to be a kind of sustainable long term that simply retailers are more efficient.

Okay. Great. That's helpful. And I have to ask the question because investors are asking about it, but I know probably none of us really have a good answer yet. But how adaptable is the supply chain as it relates to border taxes? Because I mean my view is that I don't think you could find somebody to make a toaster oven in the U.S., unless I am wrong. So how do you think the whole thing plays out if there is some variation of a border tax?

First of all, I think it is a little bit premature to speculate about kind of possible changes, because there are so many unknowns and so many variations which are possible. So, therefore, I think it is really not extremely helpful to speculate right now. The good news is, and I would like to make that analogy to also currencies. Most of our competitors are pretty much in the same situation as we are. So, therefore, should we see significant charges to import cost, we believe it's going to be pretty much consistent in the industry and therefore probably will lead to chain reactions that means higher prices in the market. But then again, let's wait and see what really is going to happen.

Okay, great. And let me just sneak in one last quick one. Were you tempted at all to raise your free cash flow guidance? Because I don't know what your internal forecast was but we certainly weren't modeling positive free cash flow this quarter. So I guess the question is, is it really just sort of just smoothing out cash flow more throughout the year because of some the initiatives you are doing on the working capital front or do you just want to sort of have a fairly conservative stance because it's so early in the year?

Yes, Bill, this is Doug. I wasn't tempted to raise it at this point of the year. And these initiatives, we have had line of sight to these for a while now. We've been working on them for the better part of a year and each one is being addressed differently. So we've had really great improvement in inventory across the entire businesses and across the globe, about $88 million year-over-year. We've implemented new and now are pretty much fully up and running on new terms with most of our supply chain, and that was about $96 million year-over-year. But we have been getting some of those benefits as we have gone along. And then on the AR side, we have also made some improvements. So these are improvements that are really great for the company because we are now getting this cash earlier in the year, we can reduce debt earlier in the year. But at the endpoint of our year, the natural seasonality of our working capital cycle still falls out in the September timeframe. So you should expect improvement from us and we have some in that cash flow guidance, year-over-year improvement. But right now we're pulling this benefit forward.

Our next question comes from the line of Joe Altobello with Raymond James. Your line is now open.

Just a couple questions. I guess first on global batteries and small appliances. Global batteries up on a very tough compare, small appliances up for the first time, I guess, in about a year now. So it sounds like most of that was coming from distribution gains and things that you guys are doing internally, but was curious if you're seeing any improvement in overall category trends in either of those two categories?

If we look at the two different categories, I think in batteries, it is really what you mentioned. It's more about focus. We start seeing the benefits of our more, more, more strategy, where we are going after more price points, more channels, more countries. And that growth is really starting to pay off. But even within batteries, it is fair to look at different trends in the sub categories. Like for instance, Doug mentioned earlier, we are growing very nicely in our two core categories, which is alkaline and hearing aids. Whereas in the lower margin, heavy duty batteries, there we continue to see declines as consumers shift towards higher price point, higher quality alkaline batteries. So there are also certain shifts within the category which are supporting our growth strategy . Now in small appliances, we really had last year a tough year and the category in the quarter was overall flat. However, this year, Doug mentioned it also earlier, we have launched some really innovative products like this Wi-Fi slow cooker, which has been a very big success. So therefore, again, our long-term strategy to focus on real innovative products which will help us gain a shelf space, but also attract consumers and also partly justify higher price points, is starting to pay off.

Okay, that's helpful. And just one question on global auto care. I was wondering if you guys could quantify how much was pulled forward in the year ago first quarter? I'm just trying to figure out how to think about that for the second quarter of this year.

Sure, Joe. It was about $3 million.

About $3 million. Okay, great, thank you, guys.

You bet.

I think the other -- sorry, let me just jump in. I think the other point is, also in Europe we had a weak quarter in global auto care. And Doug mentioned it was linked to distributor sales. And part of that was driven by our sales because we are getting tougher on credit management and therefore simply holding orders off distributors if they have over dues. So part of that is also going to come back as those distributors get in line with our payment practice.

And the next question comes from the line of Bob Labick with CJS Securities. Your line is open.

I was hoping you could discuss and elaborate on your ecommerce strategy. Specifically, what brands and areas are a focus and can most benefit, how big the opportunity is and how you can also help enhance your retail partners ecommerce sites as you focus on your strategy as well?

I think if we look at ecommerce, we have to accept it is an integral distribution channel, more or less, for every retailer. It is not only the Amazons of the world, all the big home improvement centers, all the big retailers, are equally focusing on that channel. Now the relevance of this channel is very different category by category. And the highest e commerce penetration is in the higher priced appliance business. That means in personal care with Remington brand, in small appliances with Russell Hobbs, Black & Decker, George Foreman, simply because the price point, features are more important, and that allows the consumer to better research. So we're fully going after this channel in all of our divisions because even in batteries, even in home and garden with insect repellents and so on, the channel is getting more important and we are growing very nicely. We had a significant growth in the quarter in ecommerce. Now, the point obviously is that ecommerce is kind of a challenging because you have to avoid channel conflict. You have to avoid that you have a strong price competition between the different channels and this is why we are pushing forward very significant product and packaging differentiation to avoid that we are seeing a price erosion because those channels compete with each other.

Okay, terrific. Thank you for that. And then just one other quick one, and this may be difficult to answer directly but I know we are certainly getting tons of questions as well. In terms of your majority shareholder HRG, any thoughts on the potential timing of any outcomes and the best outcomes for the minority owners of Spectrum Brands?

This is really a tough question because, again, it is mainly driven by HRG. So, therefore, that question really probably would be better suited for a call with the HRG management, which I think is in a few days. But again, we believe there are plenty of opportunities and we again believe it is going to be long term favorable for Spectrum Brands.

And our next question comes from the line of Steph Wissink with Piper Jaffray. Your line is now open.

This is actually Lauren Wolff on for Steph. Just looking at gross margin, gross margin growth was pretty significant this quarter. Would you be able to discuss the drivers for expansion in a bit further detail? And do you believe that this current pace is sustainable on a year-over-year basis? And then I guess secondarily to that, has the pricing strategy shifted at all? And my follow up question is just specific to the global auto care segment. Do you feel that, that business in particular is maybe more seasonal than you had initially anticipated and does that impact your Q1 results more than expected? Thanks.

Sure, Lauren, this is Doug. Thank you. On gross margin, it's really a pretty good story across the businesses and across the regions for us. And part of it is productivity and as you know, we have got a pretty healthy engrained culture of continuously driving improvement across not only cost of goods sold, but really throughout the entire P&L and that is showing up in our results, and specifically in gross margin. We also have taken some actions to exit low margin or negative margin categories and that benefit is flowing through and we have had good customer mix. We don't have a lot of pricing. We do get pricing in Latin America, we've had a little bit of pricing in Europe. But by and large, these are mix and productivity gains across the businesses. And a couple big ones we've mentioned. As you know, global auto care is benefiting from a lot of the consolidation work that we began over a year ago. So, overall, I think you should expect continued gross margin expansion from us. We have talked about a 30 to 50 basis point range over time and some of it will be choppy. This is obviously a really nice quarter for us because some of those productivity initiatives are hitting. In terms of the global auto care, no, we're not surprised by the seasonality of the business. This is consistent with the way we planned the businesses this year and the two things that we have already talked about. One of them was putting global auto care on SAP last year and asking retailers if they wanted to take some safety stock in ahead of time and many of our big ones did. And, fortunately, that go-live went without a hitch. So we will expect that to normalize this year. And then as Andreas mentioned, for some distributors in part of our European region, we have tightened up on our credit policies a little bit. And I expect those sales, in fact most of those sales have already gone out in the month of January.

Our next question comes from the line of Jason Gere with KeyBanc Capital Markets. Your line is now open.

I guess the first question is really thinking about category growth. So you're talking about this year growing faster than category growth and obviously from November to now, maybe there was a little bit of inventory de-stocking that's out there. So, I guess I'm just trying to get comfortable with your talk around the pace of innovation, distribution gains, but also growing faster than category. The way that we are looking at organic sales this year, 2% to 3%, is that still the right way that we should be thinking about fiscal '17?

Yes, we would be extremely disappointed if we would not hit those numbers. And again, I think we're going to see some nice pick up. Doug mentioned it earlier, for instance, in pet. We have been suffering in pet from our decisions now that we are exiting private label in some of the lower margin categories. But that's going to anniversary now in the second quarter and we have already won a lot of new listings at major retailers where we are going to see those shipments going out in the year, third quarter. So we should see a nice continued trend in top line and we believe that we will be able to grow significantly faster than the category.

Okay, great. And then the last question I guess is just on, you're talking about some of the increased spending on initiatives. Can you talk about what you have seen so far in terms of the payback? And then how that's effected your decision to maybe accelerate some of the additional projects that obviously don't make the first cut but have to get pushed off a little bit in terms of timing?

I think we're seeing a very nice, and if we talk about favorable mix, it means that we are successful with launching innovations and that this is substituting exited or lower margin old business. So we're seeing the nice payback already from launching more innovation and we will actually step up the speed of bringing new products to the market. Now, the second element where we are also stepping up our investment is into marketing. Like for instance, we have spent the first time since quite a couple of years in the Rayovac brand in the first quarter. So we are stepping up our marketing spend to drive brand awareness and appreciation and I think that is going to pay back significantly. Because, again, retailers are interested to have strong brands which resonate with the consumers and that is going to pay back. Doug mentioned in his example we are doing, for instance, in pet, quite significant re-launches, where we are stepping up our activities, be it in Nature's Miracle, be it in Dingo, in FURminator. And that really applies across the board in all different categories.

Our next question comes from the line of Olivia Tong with Bank of America Merrill Lynch. Your line is now open.

On global auto care, you have got obviously some pretty amazing margin progression there and you've talked about some of the incremental changes you're making. So how high do you think that margins can go in that particular division?

Hi, Olivia, this is Doug. Margins in that business are so good right now and attractive for us, that we should not have a desire to take that much higher. We would rather take that excess earnings and reinvest it in growth. We're investing in growth in Europe in a meaningful way, we're exploring our opportunities in Latin America in a meaningful way as well, and we have a good solid business in the APAC region. So that low 30s% overall EBITDA margin that we have there, we want to use that to accelerate growth across that business.

Got it. And then just on margins overall. Obviously the gross margin expansion continues to be very strong, but SG&A also continued to grow quite a bit on top of a big increase last year. So can you parse out some of the bigger drivers of the increase in SG&A this quarter and what you think in terms of progression for the year?

If you look at SG&A, I think overall, we were actually reported flat. However, that is a separate trend. While we are reducing our integration and restructuring expenses, we are able to step up R&D, marketing and selling expenses. And, yes, we believe we can or we should continue to step those up because we believe these are investments in gaining more market share by expanding into more channels, more categories and more countries. Now we believe the expenses at margin of sales actually should continue to improve. We were just impacted this quarter by the two fewer days, also by those exits. But that should, again, reverse going forward and, therefore, we see the expense ratio improving long term despite higher investment into those expenses.

All right, thanks. And then, it's obviously still early in terms of legislation proposed by the new administration. But how, if at all, does that affect your thinking on M&A? Not necessarily more or less, but categories that you might be interested, mix of non-durables versus faster moving consumer goods and things like that?

Olivia, I think on the M&A front it's right now, less about the legislative environment and more about the availability of assets at an affordable price that fit our portfolio. And if the right assets come along at the right prices, I think we would continue to be very interested because we are investors over a very long period of time. So short term legislative impacts won't have a big influence on our decisions.

Our next question comes from the line of Joe Lackey with Wells Fargo Securities. Your line is now open.

First, in batteries, can you kind of walk through some of the white space opportunities, particularly in new channels, grocery and drug? And I guess we saw some good progress this quarter. I'm just trying to gauge kind of what inning we are in as far as the progress you are making there? Thanks.

If we talk about white space, we really have to look at it not only in the U.S. by retail channel, and it is one of our biggest opportunities and you actually mentioned the two biggest channels which are white space for Rayovac already. Right now, we serve only about 50% of the channels which are selling batteries in the U.S.. So therefore, you see that it's a major white space opportunity. But in all fairness, you're investing into the additional sales resources, gaining the trust of the retailers, gaining the tests, gaining those listings, will take time. So this is not something which is going to happen overnight. But we are making good progress and seeing really nice replies already in the U.S. with alkaline and partly also with hearing aids. Now the second element which is equally important is that we have to look also globally that there is still a lot of white space. Doug mentioned with hearing aids, where we are global market leader with hearing aid batteries. But there are many regions in the world, like for instance Asia, which we have simply neglected in the past and what we are doing right now is that we are adding also resources in those regions to go after those channels.

Thanks. And then, Doug, on free cash flow. So I guess lots of good progress on your working capital efforts. But just wanted to get some specifics on how you are specifically reducing seasonality. Is this just a factor of producing closer to when you ship to retailers? Kind of what is going into that smoothing of the seasonality? And then also trying to gauge when the timing and the positive benefits from the aerosols line start up will begin to benefit margins and free cash flow? Thanks.

Sure, you bet. On the first one, it's really a leveling of the peak. So ordinarily this is our peak investment in working capital. And we did. We did invest in working capital in this quarter, still close to a couple of hundred million dollars. But the top of the hill in terms of where we invest in working capital is being lowered a little bit and part of it is our ability to produce closer to distribution. As we invest, as you know, in this aerosol capacity, it requires much less of a seasonal pre-build in that particular business. Consolidating our global auto care business into one location is going to continue to help us with better managing inventories going forward and we've already seen a nice impact in that business. We've taken aggressive negotiating positions with our supply chain to get better terms and later-transfer of ownership of the goods to us by improvement on terms that way and then on the other side, on our payment terms. So it is really just trying to lower the peak of our working capital build during the year. And I'm sorry, I lost track of -- the aerosol. Yes. The aerosol benefits, they will begin -- they are fully in production now, in January. And our peak seasonal season as you know is late in Q2 but really in Q3 in that business, and you will see that bleed through then.

Our next question comes from the line of Kevin Grundy with Jefferies. Your line is now open.

I wanted to come back to capital deployment and your decision to buy back stock in the quarter, because it's something you guys have not done a lot of historically. And I guess couple that with the increase to the authorization, which is now up to $500 million. So maybe you could touch a little bit on that, understanding that you said it seems like valuations may be a bit stretched. So a couple of things. Talk about the decision to deploy cash to buy back stock in the quarter, again, which is a bit out of step with what you guys have generally done. The expanded program of $500 million, what is your appetite to go after that aggressively? How quickly could you possibly work through that authorization? And then maybe touch on a little bit with the pipeline? And lastly, just the dynamic with HRG, and that came up earlier in the call as your largest shareholder. Does that encumber you at all in any way with respect to M&A, whether that is smaller or probably more appropriately, larger M&A?

Okay, Kevin, let me take those, starting with the buyback. We have been saying for the last several years that we intend to use the share repurchase program to offset equity compensation, and we expect that to be about $60 million this year. It was about the same last year. And so we have done a little more than that in this first quarter. So we have already offset our equity compensation dilution. We also feel that the stock is very attractively priced, where we've been buying back. So we think it's a very good capital allocation choice for us. We did about the same thing last year. We front loaded our share repurchase program to offset equity compensation dilution for 2016 in the first quarter as well, because we felt similarly that the share price was undervalued. So I think this is fairly consistent. We are about halfway through the original $300 million program, so we just felt it was a prudent time to refresh that program and upsize it a little bit. Again, if we think our stock is undervalued and it is a good capital allocation choice and we're not going out and borrowing money to do it, it is a good place to potentially put our money to work. The M&A pipeline, we have a great funnel. We know what we would like to buy over time. We can't predict when assets will come to market. The Chairman of our board, David Maura, is very involved in this. And again, if we find the right opportunities at the right price, we will move forward and we don't believe that anything that is happening with HRG would impact our ability to continue to do M&A.

Okay. All right. That is helpful color. And then I wanted to come back to some of the channel dynamics in the U.S. It seems to be sort of a recurring issue, specifically in home appliances and batteries, where we will get the U.S. Nielsen data, it doesn't look great, specifically in batteries and home appliances. And then you guys will generally report a number which is better, even just for the U.S. So can you talk a little bit about some of the dynamics that are going on in batteries and home appliances? Why your trends seemingly are quite a bit worse than Wal-Mart, Target, to a lesser degree grocery channel, than what you are seeing in non-tracked and online?

Yes, Kevin, I mentioned earlier during my prepared remarks, there are some companies which are focusing their management incentive on market share. So there is a certain tendency of certain of our competitors to focus on those big retailers. And in all fairness, that is where typically the competition is toughest and the prices are lowest, and where we partly decide to walk away from business if it's too low margin. And then on the opposite, our more, more, more strategy is exactly aiming at gaining more footprint, which is partly not covered by Nielsen because it may not be the largest retailers. And that strategy has worked very well in Europe over the last eight years and it's starting to pay off now also here in North America. So we will continue to pursue that strategy.

And if I may follow up, Andreas, on that. Just real quick, just to make sure I'm clear. Some of the market share that's being picked up in those channels by some of your competitors, is it your estimation that, that is not profitable business or just lower margin business?

It is at very aggressive pricing, let's put it that way.

And our next question comes from the line of Ian Zaffino with Oppenheimer. Your line is now open.

Following up on the buyback, how quickly are we going to be looking at doing this? I guess stock is off. Does that mean you are going to be doing it very quickly or should we expect it really to take three years?

I think you should look at it as, first and foremost, offsetting the equity compensation dilution. So maybe half of it we will do that over the next three years. And then we can' predict if the stock we think is undervalued and we don't have other good capital allocation choices, you could see us continue to do something like we did in the first quarter. But at the moment, we are pretty quiet.

Okay. And then as you look at kind of businesses that you have exited, the unprofitable ones. Is there anything else that you're looking at, maybe looking to exit, or any other type of portfolio re-jiggering that you would have on the horizon?

Not really. I would say the vast majority of the initiatives we have started. I mentioned earlier, for instance in pets the exiting of the private label that is going to anniversary pretty soon. The exit of our HHI business, the [funnel] [ph] business in Mexico. That was just started in the first quarter, so that should continue until the fourth quarter. But, overall, pretty much all initiatives have been started and we continue to measure our profitability by category, by channel, and also look at our long term competitive advantages and focus on that. But right now, we feel very confident that we have done our homework.

Our next question comes from the line of Karru Martinson with Jefferies. Your line is now open.

You guys talked about light commercial expansion for HHI. I was wondering how those initiatives were going? What's been the sell-in on that side of the equation?

Actually, it has been going very well. After the acquisition of [indiscernible] we had a slight setback, linked a little bit to the decline in oil prices and related things. But now we're seeing a very nice momentum because, again, our more, more, more strategy is starting to bade back where we are taking their product portfolio, taking them into more countries. Like for instance, into Canada, into Latin America, but also taking them into the channels where we are strong. So this is paying off quite nicely and we're seeing a very nice momentum in this category.

Okay. And just lastly. When you guys look at building brand awareness, Rayovac in particular, had always been one kind of more in-store advertising. So when you put that emphasis on building the brand, should we be expecting Super Bowl ads from you guys or is this more of your [ncaps] [ph] and so forth?

No. It is really -- and that's a strong belief that in batteries, batteries are impulse purchases. So therefore for certain categories to focus on POS on in-store activities is 100% right and therefore is long term the right move. But then we offer also in our portfolio a very different product, like even our new electronic locks. Some of the latest Pfister products which we are launching which have features which are much easier to call out if you put some advertising funds behind it. So those marketing investments will really be very different category by category. And then of course, again, it will be linked to where we can reach the consumer the most effectively. And in all fairness, I think the age of those big TV advertising is coming to an end as there is a strong shift of advertising dollars into more the digital channel where you can target much better. Like for instance, we had a very nice success last year where in the Internet you can really do a campaign depending on the weather forecast of the next couple of days where you can target the right region with the right product offering, be it in home and garden, be it in auto care with AC Pro. So therefore, the Internet really offers us plenty of opportunities to reach our target consumer better.

Okay, Operator, I think -- Kevin, can you have one quick question? We've really reached the top of the hour. But I think Kevin is still queued up, right?

We have a question from the line of Kevin Ziets with Citi. Your line is now open.

Dave, thanks for squeezing me in. I'll just ask on a follow up on the border tax issue. I'm curious how you think your products and maybe your brands in particular, respond in an inflationary environment? And then as a follow up to that, your outlook for commodities in general and how that figures into your margin expectations and your working capital expectations?

Let me start with your second part on commodities. We do see an uptick in our key commodities and that is going to affect -- but then again it is going to affect the entire market, that means all competitors. Sooner or later it probably will lead to certain inflationary pressures in the category. We have, similar to currencies, we have a very systematic hedging program where we have rolling hedges which is going to soften the impact in the near term, and again, which allows us to respond appropriately in the markets. Now coming back to your point on border tax. Yes, if there will be a cost increase, again it is going to impact all competitors, but also what we are seeing partly, especially in some of the other markets, are mainly these low margin OPP, where the players are really working on ultra thin margins. In some of those cases, the deals won't work any longer. So as long as you have high featured products, where you can explain to the consumer why they are paying a certain price for it, we believe we will be able to price up in that environment. So therefore we are not overly concerned in all fairness.

Okay. Well, thank you very much, Andreas and Doug. And with that we have gone past the top of the hour, so we will conclude our conference call this morning. On behalf of Spectrum Brands, all of us here want to thank you for participating in our fiscal 2017 first quarter earnings call. Have a good day. Thanks, again.

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