Spectrum Brands Holdings, Inc. (SPB) Q4 2018 Earnings Report, Transcript and Summary

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal 2018 Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' prepared remarks, there will be a question-and-answer period. [Operator Instructions]. As a reminder, ladies and gentlemen, this conference is being recorded today, Monday, November 19. Thank you. I would now like to introduce Mr. David Prichard, Vice President of Investor Relations for Spectrum Brands. Mr. Prichard, you may begin your conference.

Thank you, operator, and welcome to Spectrum Brands Holdings' Fiscal 2018 Fourth Quarter Earnings Conference Call and Webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands, and I'll 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 spectrumbrands.com. This document will remain there following our call. Now if we start with Slide 2 of this presentation, you'll see that our call will be led by David Maura, Chairman and Chief Executive Officer; and Doug Martin, our Chief Financial Officer. David and Doug will deliver opening remarks and then conduct the Q&A session. Our General Counsel, Ehsan Zargar, is also in attendance on the call and he will participate in the Q&A session. If we turn now to slides 3 and 4, our comments today include forward-looking statements, including our outlook for fiscal 2019 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 November 19, 2018, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10-K. We assume no obligation to update any forward-looking statements. 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. I will now turn the call over to our Chairman and CEO, David Maura.

Thank you, Dave, and thanks everybody for joining us today. Over the past six months, my new team and I have worked tirelessly to evaluate each and every business unit and its long and short-term value prospects. We’ve also reviewed and assessed each unit’s senior management team, business strategy and the available opportunities and challenges. I believe that with the operational changes, the strategic transactions that we’re pursuing, we will be able to stabilize our operating results in fiscal '19 and prepare this company for sustainable growth in fiscal 2020. Upon the completion of our planned divestitures, we expect to apply the $2.9 billion plus gross proceeds towards significant debt reduction, which will meaningfully delever our balance sheet. As we ended fiscal '18, our total leverage stood at 5.8x while our net leverage net of cash stood at 5.2x. Once we close these transactions, we will delever the balance sheet to approximately 3.5x, which will narrow our operating focus to the Hardware & Home Improvement business, Home & Garden, Pet and our global Appliance business. This will allow us to restore our EBITDA growth at a faster pace given the narrower focus of our business units. With a much stronger balance sheet and the maintenance of a very strong liquidity position, which stood at 1.3 billion at the end of 2018, we will have both the time and the resources to reinvest strategically behind our four remaining businesses and to focus on products and markets which have the greatest growth potential. As Doug will explain in greater detail during this call, the issues that impacted our fourth quarter versus our expectations were largely one-time in nature and in many cases were choices we made to accelerate our investment in the future success of this company. For example, in our Global Auto Care division, we wrote off and liquidated excess and obsolete inventory to clean up the balance sheet of that division and we also established reserves for a multiyear duty catch-up accrual. These actions prepared the Auto Care business for the sale to Energizer in a very healthy state. In our Home & Garden business, we established an accrual for a legal claim, we took lower vendor rebates and, similar to the Auto Care unit, we wrote off excess and obsolete inventory in this business. Home & Garden was also impacted by unfavorable weather which curtailed this year’s selling season at our retailers. After our recent review for fiscal 2019, I’m excited to see how the Home & Garden business performs over the next 12 months. In our Pet unit, we experienced numerous one-time issues and we made meaningful and significant investments associated with trade spend to support the relaunch of our rawhide business and our new FURminator product lines. We did also here liquidate some excess and obsolete inventory in the quarter to end '18 with a cleaner balance sheet in this business. In fiscal '19 for our Pet business, we expect meaningful sales growth in the United States with meaningful new product launches and distribution gains. While we still have much work to do in our Europe operations, we expect solid performance for our Pet business this year. The acquisitions of both the GloFish operations and PetMatrix, which is our SmartBone and DreamBone companion animal business continues to outperform our initial underwriting assumptions. HHI effectively matched its year ago earnings and is expected to have another solid year in fiscal '19. Despite the noise in our fourth quarter performance, we made meaningful fundamental changes to our four remaining businesses, and we expect much steadier performance during the course of fiscal '19. Additionally, we are making significant investments behind selling, marketing, advertising and R&D, all of which we expect will result in sustainable sales and cash flow growth in the future. If I can have you turn to Slide 7 now, at this point we have identified the major headwinds facing each of our business units. And upon closing the pending transactions, our remaining businesses each have significant competitive strengths going forward. In our Home & Garden business, for example, we have the number 1 and number 2 brands in a business with strong margins, good innovation, great retailer relationships with world-class manufacturing operations. In our HHI unit, we have the number 1 and number 2 brands in residential security and builders’ hardware, with solid growth and margins. HHI is a vertically integrated business with balanced customer and channel exposure. In our Pet Care operations in the United States, we have a business with recovering sales growth, strong margins and excellent brands. In fiscal 2019 we are launching a strong pipeline of new, innovative products with enhanced distribution, meaningful in-store support and we expect to gain more market share here as we go forward. In our Appliance business, we have fantastic brands and a great free cash flow conversion business. With a renewed focus on innovation and marketing, and reinvesting behind this business, we believe we can both stabilize and grow our small appliance and personal care businesses again. During fiscal '19 we will be making material investments in all four of our core businesses. We will materially invest behind selling, marketing, advertising and R&D. This level of investment is included in the $560 million to $580 million EBITDA guidance from continuing operations in 2019. We firmly expect to increase both the vitality and the strength of our product offerings and return the company to a meaningful growth trajectory by 2020. If I could have you turn to Slide 8 please. In my new role over the last six months, I have seen the power and the importance of promoting a culture that fosters inclusivity and the free flow of information and ideas. Hand-in-hand with my goal to change the culture and the focus of the company, it has been a top priority of mine to upgrade the talent of the organization and eliminate duplication. For example, Randy Lewis has been promoted to Chief Operating Officer of the company. Randy is the company’s strongest operator with the deep knowledge of all our businesses and the culture. He has appointed new leaders in several of our major business lines already. We have also introduced many new incentive structures to promote an improved, longer-term and company-wide ownership mentality on the part of all of our employees. Before I turn it over to Doug for details on the fourth quarter and our business unit and this year’s outlook, I also want to say that we have recently amended our shareholder agreement with Jefferies Financial Group. This new amendment will allow them to own up to 19.9% of the company’s common stock, up from 14.9% currently. We have a constructive and supportive relationship with Jefferies and we value their input and their confidence in us and the business going forward. Separately, I want to mention that many in the executive management team have been in a material blackout period for multiple years, and has been granted to sell the company up to $20 million worth of stock. Our selling of these shares in no way relates to the prospects for the company but rather relates solely to personal circumstances and liquidity needs of the management team. Once we close on the previously announced transactions and delever the balance sheet, we will have the opportunity to consider substantial share repurchases. With that, I will turn it over to Doug.

Thanks, David, and good morning, everyone. I plan to take you through our Spectrum Brands operating results as normal this morning, but as I did for the first time in Q3 I’d like to remind you about the form of the merger with HRG on July 13 and the impact on the presentation of our financials. Following the completion of the merger, HRG emerged as the surviving entity and was renamed Spectrum Brands, with a combined shareholder group of the two former companies. The surviving company will continue to operate as a global consumer products company similar to legacy Spectrum Brands. The Spectrum Brands name, operations, Board and management continue to run the business. As a result of this, our Q4 year-to-date and comparable period results include both Spectrum and HRG activity rather than solely Spectrum Brands. For Q4 and fiscal 2018, I will be speaking primarily to Spectrum Brands only performance from an adjusted EBITDA and adjusted free cash flow perspective. Reported numbers will include both Spectrum and HRG. You can find additional details related to this in our 10-K. In addition, complete separate company historical financial information and filings for both businesses can be found in the Investor Relations section on our Web site. Now turning to Slide 10 and a review of Q4 results from continuing operations, beginning with net sales. Fourth quarter reported net sales of $787.8 million were unchanged with prior year, and excluding unfavorable FX of $3.1 million, organic net sales grew 0.4%. Reported gross margin of 36.8% decreased 250 basis points from 39.3% last year primarily due to operating inefficiencies at the HHI Kansas and GAC Dayton facilities, higher input costs and unfavorable mix. Reported SG&A expense of $225.5 million, or 28.6% of sales, compared to $210.1 million, or 26% of sales, last year primarily due to higher shipping costs, increased marketing investments, and transaction costs associated with the HRG merger. Reported negative operating margin of negative 10% compared to a margin of 5.8% in the prior year predominantly driven by the write-off from the impairment of goodwill in the GAC business of approximately $92.5 million. On a reported basis, Q4 diluted loss per share from continuing operations of $3.00 decreased compared to a loss per share of $1.01 last year primarily due to the write-off from our impairment of goodwill, HRG merger transactions costs, lower gross profit and higher distribution costs. Spectrum adjusted diluted EPS from continuing operations of $0.79 decreased 7.1% versus $0.85 last year primarily due to lower gross profit and higher distribution costs. For adjusted tax, we used a 24.5% blended rate for fiscal 2018 versus 35% in prior years due to changes in the U.S. corporate tax rate. In fiscal 2019, we’ll use an annual rate of 25% which now includes estimated state taxes. Turning to Slide 11. Reported interest expense from continuing operations in fiscal 2018 of $163 million increased $2.1 million from last year. Spectrum cash interest expense payments of $208.4 million were $25.3 million higher than last year driven by the timing of payments on our Euro-denominated notes as well as higher debt and rates. Spectrum cash taxes of $49.6 million increased compared to $37.5 million in 2017 primarily due to non-repeating refunds received last year and the timing of other worldwide tax payments. Spectrum depreciation, amortization and share-based compensation from continuing operations of $141.1 million decreased from $179.3 million last year due to significantly lower share-based compensation. Spectrum cash payments for acquisition and integration and restructuring and related charges for 2018, including discontinued operations, were $79.4 million and $98.5 million, respectively, versus $22.3 million and $44.3 million in the prior year. Restructuring charge increases were primarily the result of operating inefficiencies in the HHI Kansas and Global Auto Care Dayton consolidation projects. Higher acquisition costs related to our battery and appliance divestiture processes and HRG merger costs. Now to our business unit results from continuing operations beginning on Slide 12 on Global Auto Care. Q4 reported net sales of $103.1 million increased 0.5% versus the prior year, driven by growth in performance chemicals and refrigerants. Excluding unfavorable FX of $0.6 million, organic net sales grew 1.1%. Reported adjusted EBITDA of $14.6 million decreased 55.1% with a reported margin decline of 1,750 basis points driven by Dayton operating inefficiencies, higher input costs, increased distribution, E&O liquidation mix, a multiyear duty catch-up accrual, and higher marketing investments as we continue to support the Global Auto Care brands. We have made significant progress fixing the Dayton facility, improving the quality of inventory on hand, and preparing for a successful 2019. We announced on November 14 that Spectrum Brands had entered into a definitive agreement to sell the Global Auto Care business to Energizer Holdings in a transaction valued at $1.25 billion. This transaction is subject to customary closing conditions, including regulatory approvals, and is expected to close in the second fiscal quarter of 2019. The transaction value is comprised of $938 million of cash and $313 million of Energizer Holdings equity. Turning to Slide 13. Hardware & Home Improvement reported Q4 net sales of $360.9 million, an increase of 3.4% from last year due to continued strong demand in residential security, plumbing and builders’ hardware in the U.S., along with a modest tailwind from the reduction of our customer order backlog at the Kansas DC, which returned to normal historical levels by the end of Q4. Excluding unfavorable FX of $1.6 million, organic net sales grew 3.9%. Reported adjusted EBITDA of 75.2 million fell 1.6% with a margin decrease of 110 basis points due to higher input costs primarily for zinc, copper and steel, as well as increased freight costs. New product introductions continued at a steady pace in Q4. The current focus at the Kansas facility is further improvement in labor efficiency and HHI is planning for top and bottom-line growth in fiscal 2019 highlighted by continued, underlying market growth, a steady stream of new product launches, especially in the fast-growing electronic security category and e-commerce, and pricing actions. Now to Global Pet, which is Slide 14. Q4 reported net sales of $212.1 million fell 2.3% primarily as a result of lower U.S. aquatics revenues largely driven from our prior-year business exit at a major retailer and in Europe from temporary customer order backlogs from the consolidation of our European DCs which also negatively impacted branded dog and cat food sales. Also contributing to the decline was a decrease in European pet food sales largely from the now completed planned exit of a customer tolling agreement of $4 million which negatively affected segment sales by approximately 1.8%. Largely offsetting the decline was a strong increase in U.S. companion animal sales, predominately dog chews and treats. Excluding unfavorable FX of $0.9 million, organic net sales decreased 1.9%. Reported adjusted EBITDA fell 27.3% to $32 million with a 520 basis point reported margin decline driven primarily by lower volumes, volume-related unfavorable manufacturing variances, DC operating inefficiencies and unfavorable mix. Excluding unfavorable FX of $0.5 million, organic adjusted EBITDA of $32.5 million fell 26.1%. In fiscal 2019, Pet expects solid performance in its largest region, the U.S., as it works to improve the profitability of its European operations. Moving to Home & Garden, which is Slide 15. Home & Garden Q4 reported net sales of $111.7 million decreased 6.2% driven by lower-than-expected volume due to retailers’ early exiting of the category and the lack of repellent and insecticide demand relating to the timing of hurricanes in the prior year, unfavorable promotional timing against a strong 2017, related unfavorable manufacturing variances as production volumes were reduced, lower vendor rebates, and a reserve for a legal issue, partially offset by solid growth in household category sales. Adjusted EBITDA of $19.8 million decreased 38.5% and reported margin of 17.7% fell 930 basis points. The declines were the result of lower volumes, unfavorable product mix and continued input cost inflation. Home & Garden expects to deliver sales and EBITDA growth in 2019 from new business, improved mix and strong continuous improvement savings. Moving to the balance sheet on Slide 16. We ended fiscal 2018 in a very strong liquidity position including $777 million available on our $800 million cash flow revolver and a cash balance of $553 million. Debt outstanding was $4.8 billion. Total leverage was approximately 5.8x at the end of fiscal 2018, slightly lower than 6.1x at the end of 2017, primarily as a result of the redemption of $864 million of HRG 7.875% senior notes in January 2018 prior to the merger with Spectrum Brands. Capital expenditures, including discontinued operations, for Spectrum were $103 million compared to $115 million in the prior year. Turning to Slide 17 and our 2019 guidance. We expect meaningful reported net sales growth from continuing operations in 2019 driven by innovation, increased marketing investments, pricing actions, which include tariff-related increases, as well as market share gains. The FX impact on sales is expected to be modestly negative based on current rates. We expect adjusted EBITDA from continuing operations to be in the $560 million to $580 million range as we stabilize operations and increase revenue-generating investments, also including the anticipated impact of tariffs and input cost increases, partially offset by pricing actions. Given the uncertain timing and use of proceeds, particularly as it relates to interest expense, we are not providing adjusted free cash flow guidance for fiscal 2019 at this time. For adjusted earnings, we now use a tax rate of 25%, including state taxes, versus a blended rate of 24.5% in fiscal 2018. Thank you. Now back to Dave for questions.

Thank you, David and Doug. Operator, with that, you may now begin the Q&A session please.

Thank you. [Operator Instructions]. Your first question comes from the line of Faiza Alwy with Deutsche Bank. Please go ahead.

Yes. Hi. Good morning.

Good morning.

So I guess my first question is just on the quarter. Maybe if you could give us just your view on what changed from three months ago or when you last reported? Because it seems like a lot of the factors that you’ve talked about today we knew about. So may be if you can talk in a little bit more detail around what surprised you the most this quarter?

Look, I think – I’ll go first and then I’ll turn it over to Doug. When I stepped into this role in April, the first – our attention really focused around customer service, getting the backlog out, getting some consultants around both the Dayton and the Edgerton facilities and stabilizing that. And we had a phenomenal June quarter. We had – some of the businesses grew double-digit rates in revenue, margin structures restored. And when we spoke to you in July, we actually had a pretty good July under our belt. I think in my opening remarks I talked about that there’s a number of one-time things here and there’s also a lot of intentional cleanup. The Home & Garden that’s really weather-related and a reserve and so I don’t view that as sort of impact to the earnings power of that going forward. And in fact I’m very bullish on Home & Garden for '19 just having completed our review and budgeting process for that unit. On the Auto Care side, that’s almost half of the miss and that’s effectively cleaning up the balance sheet and one-time reserves. And frankly that Dayton facility is 75% of the way back to where it should be. The fill rates are back at 99%. And I think we’re handing off a very clean business to our partners at Energizer. When I look at Pet, yes, we had probably more challenges than we originally anticipated in the DC in Europe. We’ve put a new leader in there, Eric Beukeboom, and I think we’re going to be able to run that much more efficiently in '19 than we did in '18. And HHI effectively met its EBITDA. I think what we wanted to do is be very transparent with you that based on internal guidance, it was about 6 million lower. So that was – I think I covered it all.

Yes, pretty much covered it all. I’d say some of the – when you think of it in bigger categories, greater than 50% of it were unforeseen or cleanup items that Dave had mentioned. The E&O sales across several of the business units were an affirmative action on our behalf to sell inventory and simplify – begin simplifying the business. The duty issue that we mentioned was a multiyear duty issue in the Global Auto Care business that was discovered in August as we were reviewing potential implications from new tariffs and so was a cleanup that actually preceded our ownership for the business. And the claim issue is also one that was appropriate for us to accrue for in a quarter based on other settlement activity from another manufacturer with a very similar claim. So it’s those types of things that were actually not visible to us at the time of last guidance. And then something less than half related to the volume, and David mentioned those indicators; the weather, the category dynamics, those types of things.

The only thing I did fail to mention to you is we maintained a pretty robust investment behind the businesses to make sure we entered '19 on a strong foot. So that requires a lot of discipline when you’re facing these types of situations to make sure you continue to invest behind the business despite the short-term impact. And that’s a reasonable piece of it as well.

Okay. And then if I could just follow up on your guidance. I know you’ve talked about meaningful sales growth. Maybe if you could tell us – sort of quantify what that might mean? And then you mentioned the word rebase, so I’m curious how much of that is the real sort of voluntary rebase of the business? So maybe if you could size out for us how much of it is incremental investments that you’re making and how much of the rebase is – because you have to invest in the business or you have to see the impact from tariffs and you’re not getting pricing or just business trends, or sort of how much of it is voluntary versus how much of it is you’re just experiencing it?

Look, I appreciate the question and I’ll do my best to give you clarity. I believe what we call the AOP internally basically are budgets for '19, we’re probably the most ground up business-by-business and collective, collaborative budget we’ve done from the operators telling me over the last three to five years. So I have tremendous confidence in the underwriting of it. I don’t want to give you specifics on the amount of the incremental investment which is netted against that, but it is material. I think you guys know – I had the fortune of presiding as the Chairman over 10 years and building a great company through acquisition. I think the CPG industry has changed where you can no longer just buy businesses, buy brands. You’ve got to materially invest behind them. You’ve got to have innovation. You’ve got to bring news and excitement to the marketplace and you have to tell people through digital advertising and authentic communication tools as to why your products either have better efficacy or perform better. And that’s a new strategy for Spectrum, right. We used to historically just list stuff and a point of sale was the only thing we pushed. And basically what I’m trying to do is create more of a pull model where customers are demanding our products and pulling them through the retailers and that requires a greater level of vitality. So that’s really the main cultural strategic investment change and that is in the AOP of the – I’m sorry, in the guidance of the $560 million to $580 million EBITDA and it is material.

Okay. Just one last thing if I could just add. What was the EBITDA for the Appliance business that you’re now reconsolidating?

Doug, you want to take that.

Yes, the EBITDA for the Appliance business was about $119 million in fiscal 2018.

Okay. Operator, can we go to the next question please?

Thank you.

Certainly. Your next question comes from the line of Bob Labick with CJS Securities. Please go ahead.

Thank you. Good morning.

Good morning, Bob.

I want to talk about where you stand with your customers and customer relationships and given many of the operational issues and things discussed, how are those relationships and have you started regaining pricing and where do you stand on our ability to price going forward?

Yes. Listen, thanks for the question. Look, a lot of the costs of 2018 were maintaining those customer relationships. And I think even through the ups and downs, if you can see, we continue to grow in HHI and Global Auto Care on the top line which had the most disruption to those units. I think our retailer relationships are very good. And again, we need – as I said last call, we need to start putting – showing things and then talking about them. But based on some of these collaborative investments that we’re actually doing co-marketing now with some of the retailers, that’s why I have such bullish outlook on Home & Garden next year is we’re able to partner with some of our major home centers and put ad dollars behind it, and actually we’re gaining traction. So I think the retailer relationships are quite good. Even in the Appliance business this year we’ve launched some new products, got some new listings in the home centers and the POS is fantastic to be honest with you. So customer relationships are very good. We maintained those almost at all cost and it was an expensive proposition, but the book is intact.

Okay.

And you asked on pricing. Yes, listen, we had a material degradation to margins as you see during the course of '18. There’s always a lag effect here. We have been taking pricing. Pricing has been sticking for most of the businesses. Again, in my opening remarks, we have number 1, number 2 positions in most of our businesses on a continuing operations basis. We do have pricing power. Obviously, you always want to take more price than the retailer would give you. But we’ve been successful in passing that. We’ve been successful in passing some of the tariffs. But, look, we would be remiss not to say we hope not all these tariff increases go through, because on an absolute dollar basis if we had to price them all, we’re simply just trying to pass that on. We’re not getting any sort of margin there. So it’s just dollar for dollar which is why we’re indicating margins could be dilutive in '19 but nowhere near the extent you experienced in '18 because we are pricing and we expect to stabilize the margin structure in 2019 because of that. Is that helpful?

Yes. That was very helpful. I appreciate that. And then maybe taking a step back, obviously there’s been a lot of change even over the last few days for us from the outside and reshuffling the deck. Can you talk to us about the long-term vision of the company? Are these the right assets that fit together as complementary businesses? And what’s the three to five-year plan and maybe even the three to five-year growth rates for these businesses?

Yes, look, I think at the end of the day we had very good indications of interest for our Appliance unit going into last fall and then when we announced that we were holding it for sale, I think one of the things that gets lost on us and the street is that when you put a business out for sale, it creates a lot of instability in the employee base. It’s very disruptive. And typically a retailer is going to wait to see or the buyers at the retailers are going to wait to see where the assets end up and who’s hands they end up in. And that quite frankly caused a lot of degradation to earnings. Just recently we made investments behind appliances and just by putting it back on the books, I can tell you at major centers we now – POS is tracking plus 7%. That’s in the personal care division. We’re regaining listings. We just launched – George Foreman came out with a new copper grill and it’s 60% more productive than the SKU it replaced. So we know that with small investments you get this tremendous stimulus. And so by putting appliances back on the books, by reinvesting behind it, we’re pretty confident we can regain listings, start to grow and it’s a tremendous free cash flow converter. We had indications of interest for it at that 1.6 billion level. Unfortunately, the instability of putting it up for sale and then some cost pressure caused the operating results of that business to deteriorate during the course of the year. And we don’t want to be a price taker on any asset. And I think if you look at the divestitures we’ve done, we’ve been able to sell assets at double-digit multiples while our conglomerate trades at a meaningful discount to that. And so I appreciate that there’s been a lot of noise this year but we think there’s tremendous value in our company. And I think narrowing the focus to four business units from six and then applying meaningful investment behind those is going to allow us to restore operating momentum not just to the top line but also get EBITDA growing again, which is critical. And so as I stepped in here in April, given the operating volatility, my number 1 priority and the Board agreed with me was let’s materially delever this balance sheet. And so while we were on a good trajectory with Global Auto Care, we had a fantastic June quarter. That business is honestly really cleaned up. We’re at 99% fill rates out of Global Auto Care. We had an unsolicited offer from Energizer. It makes sense for them. They have the industrial logic of an auto business and a battery business today. They’re buying similar assets from us, right, auto and batteries. There’s synergistic actions they can take there and frankly that gives them greater scale, greater diversity and they can invest behind those businesses and grow them. So I think – look, we have a very bullish outlook frankly for all four of our businesses over the next three to five years, but I think narrowed focus of the portfolio given limited resources that we can really now invest behind, the stability of defining our four core businesses, getting our employees to settle down and then closing these transactions and applying the proceeds to debt reduction is going to meaningfully help the company in 2019.

Super. Thanks very much.

Thank you. Can we go to the next question please, so everybody that’s queued up can get a chance for their questions.

Certainly. Next we have Nik Modi with RBC Capital Markets. Please go ahead.

Thanks. Good morning, everyone. Just a couple of quick questions from my side. Just maybe going back to the last question, Dave, if you can just address what the category growth rate now of the new entity is as we think out the next couple of years? And then I just wanted to understand kind of what inning we’re in as it relates to leadership changes because there’s obviously a lot of change going on right now within the company? Just want to see kind of where you are in that process? Thank you very much.

Yes. Listen, I deliberately took – I never liked kind of the category growth description in the past. Look, we’re going to meaningfully grow the top line. We have distribution gains. We have a lot of new products. We have a lot of innovation. The pipelines are pretty good. Customer relationships are good. And obviously we’re taking pricing and we’re pricing for commodity and we’re pricing for tariffs. So you’re going to see pretty good top line. The focus is really reinvesting and doing new investment programs that are meaningful. Again, I’m not giving numbers but they’re very large numbers and they’re meant to revitalize this company. And so – what was the second part of your question? I’m trying to remember.

Leadership changes --

Leadership changes in terms of the inning, listen, there’s probably been underneath Randy eight different appointments across the company. You can never say never. Listen, I do believe we’ve kind of bottomed it out. I do believe we’ve identified all the headwinds. But there are a lot of moving pieces. And so might I add some additional expertise in e-com, might I add some additional marketing people. We’re making major investments behind selling, marketing, R&D. And so we’re open for business and we’re going to be hiring there. But you want an inning, seventh inning.

Great. Thanks. Very helpful.

Okay. Next question, operator.

Thank you. From the line of Ian Zaffino with Oppenheimer, please go ahead.

Hi. Great. Just sort of one more question about the portfolio. What is sort of the criteria that you’re assigning I guess each business in the portfolio to decide whether you’re going to keep it or not keep it? And I guess the reason why I’m asking that is because they’re just kind of very disparate business right now. You have some low margin businesses. You have some high margin businesses. You have some inflation in some areas but you don’t in other areas. So just kind of give a sense of how you think about the portfolio and kind of what you want the company to be once this transformation is done?

Look, we are investing to provide innovative and exciting products that allow us to margin up, get the mix back in the right direction and provide sustainable growth. You probably heard from me over a decade that my focus was always about maximizing sustainable free cash flow. And that’s still going to be the mission going forward. In terms of disparate businesses, we’re selling two and so we’re narrowing the focus. I think we have a less disparate portfolio. Listen, we have a very strong company. We have great brands. We have great products. We have great market share positions. And the company’s got a very bright future. It’s got a lot of noise because in 2018, look the company got off track operationally. It took on too many internal consolidation projects at the same time that didn’t go the right way. And we introduced too much uncertainty with all the transactions. It was just July this year that we got the HRG deal done. Batteries and appliances and now Auto Care, that’s just a lot of moving pieces. And so I think we all underestimate as we complete this strategic transformation and we settle things down over the next several months, we can stabilize the company, we can invest behind the operating businesses. We’ll have a materially stronger balance sheet with a phenomenal liquidity position. And inherently that’s just going to lead to much better performance. You get the right people in the right seats and you invest behind the businesses, good things happen.

Okay. And then just a follow up on capital allocation, free cash flow, how you think about this buybacks, dividends? You have the dividend. Is that going to grow or --?

Listen, I think I said it on the last call about I want to see several quarters operational stability before we get aggressive with the $1 billion stock buyback. We clearly are sitting on a ton of liquidity. I think it’s about 1.3 billion today. We’re going to be – it’s about 3 billion of gross proceeds coming across the trend somewhere in the next couple of months. And on the free cash flow side, depending on what tranches of debt we pay down, you can materially boost the free cash flow if you just look out three to six months and assume we pay down a couple of billion dollars of tranches worth of debt. And so, look, we are going to be buying back stock this quarter but it’s going to be modest. And as the proceeds come in and as I get greater confidence and visibility in getting the rhythm and cadence of our operating performance consistent, we’ll look to get more aggressive with it. But it’s clearly a way to reverse dilution from selling earnings to shrink the float.

Okay. And the dividend?

Dividend is fine. We’re going to leave it unchanged. And it’s solid.

Thanks very much.

Next question, operator.

Your next question comes from the line of Olivia Tong with Bank of America. Please go ahead.

Great. Thanks. Good morning. First question just trying to better understand how you envision the next two to three years; so fiscal '19, the game plan obviously is to invest heavily to grow the top line, so “meaningful sales growth” but what sounds like flat to down on EBITDA. And then for fiscal '20 you grow organic sales from that point with EBITDA growth. First, just want to make sure that I’m understanding that correctly.

Absolutely correct. You got it.

Perfect. Okay. And then just given how much is going on, some of it is category specific, some of it is Spectrum specific, can you just give us a better overview in terms of your perspective on what you think your categories are growing at right now in the go-forward businesses?

They vary, Olivia. As you know, we’re across the businesses. The HHI business alone has three different categories and that’s currently in the 3% to 4% kind of growth range. The companion animal part of our Pet business is growing in that probably 2% to 3% range. It’s a really healthy growth rate in our U.S. markets where we’re largest. Our aquatics business as you know is kind of a flat to down category. Some years it grows little, some years it’s down a little bit. The Appliance business categories have been challenged over the last couple of years but we’re seeing some recent improvement in that, as David mentioned, not only for us but in the category. And the Home & Garden business is a relatively low single-digit growing category.

Perfect. And then just specifically on Auto Care, you mentioned in your prepared remarks that you believe you’re setting up a strong business for Energizer but obviously the margins have maybe some pretty big degradation. So in your view, how long does that business need to turn in order to get – do you feel like it’s on solid footing now starting at the 14 mark and can move from there, or does there still need to be a fair bit to get that business on solid footing?

No. Listen, those are phenomenal brands. I love that asset. If deleveraging wasn’t the number 1 priority, we wouldn’t have sold it. And we took back equity because we actually believe not only in the synergies that Energizer can realize through it, but they have a strong marketing machine and they’re going to invest behind the core Armor All business. And again, it’s a dominant market share business. It’s got very strong brand equity. The 5 to 1 consolidation caused us a lot of headaches but it’s 75% or more completed and fixed and the fill rates are back at 99%. That’s ahead of our internal plan at this point in time. So, look, I think with the right stewardship which I expect from Energizer and investing behind the business, it’s probably a two year – listen, that business not long ago did 150 million in EBITDA in our hands. We bought the business. It was 138 million in EBITDA. We grew it to 150 million and change. And I think it was 146 million in EBITDA last year. It’s a very good franchise. And I think they can do a lot with it and we’re hoping to participate in the upside.

Great. Thank you.

Your next question comes from the line of Jim Chartier with Monness, Crespi, Hardt. Please go ahead.

Hi. Thanks for taking my questions. I just want to talk about HHI. Doug, can you just give us an estimate of what you think the operational issues at HHI cost that business in terms of EBITDA margin in FY '18? And then where operationally HHI stands today? And then just in general terms there’s a lot of concern about kind of the housing market and the impact on homebuilder related stock. What’s the leverage of HHI to kind of new home starts or housing turnover? Thanks.

Okay. Those three things, I think, make sure I get them all. So operationally today the business – the business has performed operationally well consistently since we purchased it outside of the recent DC challenges that we’ve had over the last year and a half or so. So outside of the DC, the business continues to perform well. Operationally, it’s got a highly vertically integrated supply chain and that’s all working quite well. The DC itself is back to shipping our expectations from a service level perspective and that meets our customers’ expectations as well. We do have a little more labor in the facilities still than we want to get to and the team continues to work at that and we’re seeing consistent improvements there. So today operating – the business is operating fine. On the margin structure, it’s a little hard to bifurcate what is distribution related versus mix related versus actual DC. So I won’t spend a lot of time on that. I will say distribution costs are up overall. You see that across our business and others and you can get a sense for that piece versus the DC. And then we’ve had a little bit of inflation. So not a lot of the margin degradation was associated with the DC challenges. In fact, some of that went through our restructuring bucket. From a category perspective, new housing starts, build, that kind of thing, we have direct exposure of 25% to 30% or so to new housing starts. But we tend to do well even when new housing starts slow down a little bit, because as long as housing turnover remains healthy, we have a big business in repair and remodel especially in the large home centers. So we’re fairly well diversified there.

Let me add to that. Listen, HHI despite all the DC issues in fiscal '18, we grew the top line $100 million and it grew 8% versus prior year. We do have a dominant market share. We do have leading brands and we’ve got very strong relationships. So I think, look, we’ve got the backlog down. That got us very excited with the June quarter. I agree with Doug. We’ve got consultants on the ground. They’re working with our team because we still want to get labor efficiency and increase workforce stabilization at Edgerton. But we’ve driven down the hourly headcount by about 21% while also clearing pent-up demand. So I think the business is on very good footing. Our electronics business continues to be just a highlight. We’ve got a lot of new products coming literally every quarter and we’ve got double-digit growth continuing there. We’re converting homebuilders to Kwikset in the U.S., Weiser locks in Canada with our SmartKey technology which is proprietary to us. It makes it very easy for builders to have a turnover of the key to new homebuyers with peace of mind, so no one has copies of the keys. We continue to pound away and invest behind that SmartKey technology. And as Doug mentioned, 75% of our sales are basically replacement cycle sales. And even in the new home should we have new home sales decline, which we clearly see some headwinds there where we got to be honest about it. But when you start a project, it takes 9, 12 months to finish a house. So we feel pretty good about the outlook for '19, despite headwinds. I clearly wish interest rates aren’t rising. That would be a good thing for us. But we feel very good about the prospects for HHI.

Great. Thank you.

Your next question comes from the line of Joe Altobello with Raymond James. Please go ahead.

Thanks. Hi, guys. Good morning.

Good morning, Joe.

First question, I just want to talk about the divestiture tax leakage here. It would seem like it would be pretty low given the NOLs you guys have that you use to offset that because – the reason I’m asking that question is your leverage ratio you gave this morning of 3.5x, I calculate you got even closer to 2x. So I’m curious what I’m missing in terms of that calculation. Thanks.

Well, we might want to leave some room to buy back shares. But I’ll let Doug take the tax leakage piece.

Yes. On the tax piece, Joe, between the two, but I’ll just group tax and transaction costs, you’re probably on both batteries and the Global Auto Care business around $150 million.

Okay, so it’s very small. Second, and correct me if I’m wrong, David. You mentioned earlier that you are open to selling – or some senior executives are open to selling stock back to the company up to $20 million. Is that correct? And what’s the thought process behind that? Thanks.

Yes. Listen, we’ve got a lot of execs around [indiscernible] in stock. Performance has not been good over the last couple of years. And so people have not been paid bonuses. And we just want to make liquidity available to employees at the end of the year. And we probably won’t even use all of it. But it’s just available to employees.

Okay. Does that include you?

It does. My old HRG stock converted into Spectrum shares and I have certain financial commitments I’ve made to family and year-end charity obligations. And so, yes.

Okay. Thank you, guys.

Thanks, Joe.

Your next question comes from the line of Sam Reid with Wells Fargo. Please go ahead.

Hi, guys. Thanks so much for taking my question here. A few things on the Appliance business actually. Would you be able to give us a sense as to where your retail mix stands as it relates to brick and mortar versus online? And then I know you guys in the past have talked a little bit about deemphasizing Black Friday for this segment. At this point in time, do you guys think you’re more or less right-sized heading into Black Friday this week or do you see opportunities to further reduce your exposure here? Thanks.

On the online exposure one, I can grab that. So across personal care and small appliances, we range closer – it’s somewhere in the 15% to 20% range depending on the category. We’re growing very healthy and continue to grow healthy in that channel.

In terms of Black Friday, I’ll just tell you, look, some of the home centers have picked up our appliances for the first time and we’re seeing extremely good POS. We have some specialty channels that are new distribution for us as we try to diversify our mix in bricks and mortar. And POS is literally up 100%. So we just – we also had some pretty favorable developments. I talked earlier about the new George Foreman copper grill. But there’s also a Black & Decker Helix hand mixer which is out there and it’s getting extremely good coverage because Oprah picked it as one of her favorite things. I don’t want to get into – we used to sell about 40 of those a day. We’re selling 1,000 a day and we’re just trying to meet demand. So we actually have a very good Black Friday set up. And even in the department stores across the nation, we have very, very good placement, very strong placement for Black Friday and we have TV support on. So there’s real investment going on behind appliances. And well, let’s see where we go.

Awesome. Thanks, guys. And then if I could just sneak one more in here just on retailer inventories. Broadly speaking kind of where would you say inventories are at retail today across your business? And are there any pockets where you think there might be some more rationalization in 2019? Thanks so much.

Well, we think there’s a never-ending path from a retailer’s perspective to make their inventory positions as efficient as possible. But we think most of that is behind us. We did see a little bit of it in the quarter, but much less so than we had in the previous 18 months. So I’d say we’re at a relatively stable position.

Got you. Thanks.

Your next question comes from the line of Carla Casella with JPMorgan. Please go ahead.

Hi. Thank you for giving additional color on the EBITDA of the appliances. But can you give us a sense for what revenue was for the year and then how we should think about gross margin profile going forward given that you got rid of auto but are adding back appliances in?

Sure. I can give you – well, we’ve given you the EBITDA and the net sales was about $1.1 billion on that business. So you can do the quick math on the margin across there. And the Global Auto Care one is out there as well.

Is that on the gross margin, I’m just wondering do --?

Sorry, not on the gross margin. That’s not something that we generally talk about across our businesses. I will tell you the Appliance business is a little bit lower than the Global Auto Care businesses, but healthy relative to the total portfolio.

Okay, great. And then have you said which debt you would target to pay down? I’m assuming you would take out the most expensive bond, the one that’s callable currently. But any more color there?

Look, I don’t want to commit to anything. Let’s get the proceeds in. But I would tell you that yes, we have a large amount, 890 million I believe of HRG seven and three-quarter notes that we inherited with the collapse of the structure. I don’t like that piece of paper. Also for financial flexibility going forward, I would like to look at the term loan and see if we can get rid of senior secured bank debt. But I’m not committing to anything at this time. When we get the proceeds in, we’ll look at it. But hopefully, we’re just months away from a materially multi-billion-dollar debt pay down and I’m excited to get to that point.

We are too. Can I just ask one more on Sears? Any specifics on impact from the Sears bankruptcy and if there’s a greater impact, does the company end up liquidating versus continuing as a growing concern?

No. We have a very modest write-off in the first fiscal quarter related to Sears and Kmart, less than $0.5 million. We changed terms early in the year for virtually all of our businesses there.

Great. Thank you.

Okay. Operator, we’re near the top of the hour. I think we have one more question. Why don’t we take that? And that will exhaust all questions. And we’ll close down the call.

Certainly. Your final question comes from the line of William Reuter with Bank of America. Please go ahead.

Hi. I just have one question a little bit related to the operations. In the second quarter, you had had some challenges in Kansas and Dayton. And then it sounded like a lot of those had been improved into the third quarter. I guess maybe you can talk a little bit about what happened between the third and fourth quarter that reverted some of the challenges?

I think we hit that. The DCs continued to improve. But we had weather hurt us on Home & Garden side. Pet, we had issues in the DC in Europe. On the GAC piece, which is now sold, that was 18 million of the delta and that’s really related mostly to just inventory cleanup to get that balance sheet healthy for E&R and also reserves. And we took reserves across the rest of the portfolio as well. Look, in general, I’m going to run this company much more conservatively from both a P&L and a balance sheet standpoint and that’s the reality.

Okay. And then just one follow up. It sounds like the tariffs are going to impact you. However, you have pushed through a lot of price increases to offset these, however, not fully offset them it sounds like. In the event that the tariffs are repealed, have you had conversations about what would happen to pricing? Meaning would you be pushing through less price increases or a smaller amount than you’ve been talking to at this point?

That’s a good assumption. I hope you’re right. Your lips to God’s ears on them getting repealed. But look, we want to get through it first. And we have priced for tariffs. What we’re trying to communicate is, look, if the waters remain choppy on tariffs, we’ll be passing them through. But we’re only passing them through dollar for dollar. And obviously that continues to constrain margin.

Makes sense. Okay. Thank you.

Thank you. With that, we have reached the top of the hour. So we will conclude our conference call. I certainly want to thank both David and Doug. And on behalf of all of us here at Spectrum Brands, thank you for participating in our fiscal 2018 fourth quarter and full year earnings call. Have a good day.

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