Spectrum Brands Holdings, Inc. (SPB) Earnings Call Transcript & Summary

So next up this afternoon, I'm pleased to welcome Spectrum Brands CFO, Jeremy Smeltser. Over the past year, Spectrum has been busy at work simplifying its portfolio, obviously, with more news on that front yesterday and deleveraging the balance sheet while reinvesting productivity savings to accelerate longer-term growth, and that's all while managing COVID-19-related supply chain disruptions. I'm going to pass it over to Jeremy to go through some prepared remarks, and then we'll move on to a Q&A that I'll be hosting. Thanks.

Thanks, Lauren. Thanks for having us again, and good afternoon, everyone. Also wanted to mention we have Kevin Kim here who runs Investor Relations for Spectrum Brands. Given the timing and significant nature of the transaction we announced yesterday, I will focus my prepared remarks on that topic. Before I get into that, our comments today include forward-looking statements, which are based upon our current expectations, projections and assumptions and are, by nature, uncertain. Actual results may differ materially. And due to that risk, we encourage you to review the risk factors and cautionary statements outlined here on Slide 2. Also, please make a note of our reference to certain non-GAAP financial measures here on Slide 3. Okay. So turning to Slide 4. Here are some key details of the transaction we announced yesterday. I know many of you were on the call we did yesterday, but also many probably we didn't have a chance to because we didn't have a lot of lead time. So this deal, we believe, delivers significant value to our shareholders. We've gotten a great reaction from shareholders and new investors over the last couple of days. We announced definitive agreement to sell HHI for $4.3 billion in cash, allow Spectrum to strategically shift to a more focused consumer staples company with the concentration in Global Pet Care and Home & Garden, which will now make up 75% of our adjusted EBITDA. The net proceeds of $3.5 billion creates significant opportunity to unlock value for our shareholders. If you recall, we acquired the HHI business for less than 8x trailing EBITDA in December of 2012 for $1.4 billion in cash. During our ownership, our brand and product investments have helped nearly double adjusted EBITDA. With approximately $1 billion in net cash post closing and a gross cash position of approximately $2 billion post our initial delevering, our use of proceeds will be focused on maximizing the impact of each dollar of capital generated from the transaction. We plan to significantly reduce gross debt, resulting in a delevered company, with a near-term target gross debt leverage ratio of approximately 2.5x. This will obviously significantly improve our balance sheet and risk profile. Post that delevering, we will still have about $2 billion to invest in the company, M&A and opportunistic share repurchases and not exceed our net leverage target range of 2 to 2.5x EBITDA going forward. As you may recall, our Board approved a fresh $1 billion share repurchase authorization in May of this year. In addition, we also remain committed to our quarterly dividend of $0.42 per share. While we're proud of the success from HHI, as we looked at our Spectrum Brands business and strategy for the future, it became clear that HHI's business differs from our other businesses in a few important ways. Some of the key differences include HHI sales are closely tied to the industrial sector and the housing market for new home construction. Their products are more durable than our other product offerings, meaning the purchase is less often compared to our other business units. And our customers include more industrial and commercial segments than the rest of our company. Because of these unique features, we believe ASSA ABLOY is better positioned to move HHI forward in the coming years as they grow across key market verticals and geographies while investing in innovative home solutions. Next on Slide 5, here are the key points of why we're so excited about this transaction. We've unlocked significant shareholder value and demonstrated the value embedded in our portfolio. We intend to move to a more conservative leverage range while still having significant capital to deploy. We're now more focused leading consumer staples company in attractive growing categories with a concentration in consumables and a concentration in Global Pet Care and Home & Garden. We also continue to believe in the attractive attributes of our HPC business, and we will continue to look for strategic and organic ways to enhance value. Our strategy as a home essentials company does not change. At Spectrum Brands, we continue to focus on what we do best, delivering innovation and high-quality products in profitable and fast-moving consumer goods categories. We remain committed to using our operating model, our global enabling functions and customer-focused business units to deliver organic growth by driving organizational efficiencies, delivering best-in-class services, building our brands and providing new home-based solutions. Let's turn now to Slide 6. We remain committed to our strategy of striving to use consumer insights to fuel innovation, grow our trusted brands and excite consumers by providing new solutions for the home. The largest profit contribution is now from Global Pet Care, our most consistently performing business unit over the last few years. Home & Garden becomes our second largest profit contributor at 29%, followed by HPC at 25% of contribution on an EBITDA basis. The total company on a pro forma basis generated nearly $3 billion of net sales and adjusted EBITDA of $386 million on an LTM basis as of our fiscal third quarter. Additionally, our net leverage improved from 3.6x to $1 billion net cash position pro forma as of year-end. Now let's take a look at Slide 7. The new Spectrum Brands is a company with leading market share, attractive growth opportunities and consistent operational execution. Looking back at the last 3 years, each of our 3 remaining business units have delivered significant financial improvements with solid top and bottom line growth. Starting with the top line. We've seen strong growth with net sales CAGRs ranging from 8.5% to nearly 14%. We also delivered strong operating leverage across each business unit with adjusted EBITDA CAGRs ranging from 9% to 25%. GPC, as I said, will become our largest profit contributing business, generating 46% of EBITDA on a pro forma basis. And over the last 3 years, this business unit has a top -- has grown top line at a 14% CAGR and adjusted EBITDA at a 25% CAGR. Turning to the next page on Slide 8, we will continue to focus on increasing investments to grow our leading brands as we've done over the past 3 years in doubling our A&P investments alone. Our top 15 brands now represent nearly 90% of pro forma 2020 net sales. Our brand reinvestments overall across advertisement, promotional spending, commercial operations, R&D and IT will continue to focus on driving sustainable organic growth, and we are very pleased with the returns we've seen these past couple of years. And finally, on Slide 9, now this shows that we're reducing our net leverage target range from our prior range of 3 to 4x to a new, more conservative range of 2 to 2.5x. Given the massive amount of liquidity coming from the HHI sale, we will still have more than sufficient funds to deploy across our 3 main pillars of capital deployment strategy. We will continue to focus on investing internally for organic growth, which is our highest ROI, returning capital to our shareholders via dividends and opportunistic share repurchases and disciplined M&A as we pursue complementary strategic acquisitions that are synergistic and help drive additional value creation. That concludes our prepared remarks for today, and we're happy to take any questions on any topics.

Great. Jeremy, Kevin. So I'm going to jump into some questions that we prepared. So first thing, Jeremy, was just since you presented at our conference 12 months ago, can you just give us sort of an update on Spectrum's progress to being more of an operating company?

Sure, Lauren. Yes. Thank you. We've been really busy executing on that over the past year and our shareholder commitments, obviously. Over the last 12 months, we've continued to execute against our global productivity improvement program, as you heard last year. That's really the playbook for running the company, and that's the playbook for transitioning to an operating company. Included in that is a savings target to fund these new capabilities that we have been building. And during this past fiscal year, on our Q2 call, we were able to raise our ultimate target savings from $150 million annualized to $200 million, which is expected to take us into and through fiscal '22. Consistent with the start of the program, continue to focus on commercial improvements, leveraging our supply chain scale, driving direct and indirect sourcing initiatives, and adding automation and global shared services. In reality, I think we've stood up each of those investments, so we've really completed that shift. But I do believe we're in the early stages of gaining benefits from that. We really have done it in phases. I would say commercial operations, we started standing up 18 months ago, and it is running extraordinarily well and has a great pull from our business units and our enabling functions, frankly. And then most recently, we've announced internally that we are putting our global supply chain in each of the business units under a center-led group. And that transition is happening as we speak now. And having put that team in place already who've been working with the business unit supply chain teams, it has gone very well, particularly during the pandemic and the global supply chain challenges that we've experienced here recently.

Okay. That's great. And sticking with this conversation on supply chain, I mean, across the board, companies at the conference have been focusing on challenges of labor, transportation, raw materials. So can you talk about the impact of these factors to your financials and the degree to which you've got visibility into impact from Hurricane Ida at this point, though? For most people, we've heard too soon to know.

Yes. I'll start last and then move backwards. Ida, fortunately, for us, wasn't much of an impact -- of a negative impact. And obviously, we feel for those folks who've had that. It's certainly the challenge across a large part of the country. And then as it relates to global supply chain challenges, yes, I mean, it's just been a fascinating 3 years, right, between tariffs, which hit us for $135 million over a 2-year period, ramped up and then the pandemic and now here we are with these supply chain challenges. Combine that with demand for our products have really exceeded supply over the last year or so as demand has been stronger than I think anybody probably would have expected during the pandemic for our categories. We mentioned again on the Q3 call, we've had to factor in about $120 million to $130 million of input cost inflation as compared to F '20 and that most of that headwind, the vast majority is really only hitting the P&L in Q3 and Q4. So if you think about annualizing that inflation, that means the first half of our fiscal '22 will have significant headwinds year-over-year. And the primary drivers for us are higher ocean freight rates, followed a little closely by raw materials, overall, resins, metals, things like that, that go both in our products and as well as our packaging. By business unit, HHI and HPC have been the biggest drivers of these inflationary pressures, to be frank. We think we're performing pretty well against our peer set. That's what we hear from our retail customers as it relates to being able to keep shelves filled. But certainly, our fulfillment is not where we want it to be. Global container shortages continue to be a big challenge, and that global container shortages certainly are continuing to keep spot rates at extraordinarily elevated levels for container shipping.

Okay. So as an offset, I mean, can we talk a little bit about the GPIP savings?

Yes. I mean that's an offset for us just like it has been for tariffs and just like it's actually funded our ability to invest in these additional capabilities, adding resources, et cetera. Fortunately, so far, we've still been able to grow EBITDA, even though we've had these headwinds through the GPIP savings as well as now a very concentrated effort to get price to offset some of the inflationary things that we're experiencing. But GPIP overall, that savings target, first, I'll say, a big chunk of it -- about 1/4 of it, it was in our HHI business, most of which we've experienced already, which is great. It's been part of improving EBITDA in that business year-over-year here in F '21. But 2/3 of the savings overall really came from external sources. So sourcing both indirect and direct, changing suppliers, being able to reroute country of origin away from China to avoid certain tariffs has certainly been part of that strategy. It's gone really well. I'm really proud of the organization, their ability to embrace the change that we brought to the organization because compared to 3 years ago at Spectrum Brands, there probably isn't a single thing that we do the way we used to do it.

Okay. Great. And in that vein, I mean, on your most recent call, [ you're talking about ] things that are different at Spectrum Brands. You also outlined significant brand investments.

Yes.

So could you discuss kind of the primary buckets here?

Yes. I mean this is the thing that has such huge benefits for us. It's not just about growing net sales and consumer awareness. It's about the retail partnerships that it strengthened, and then it's about the impact it has culturally on our employees. It's just -- it's a wonderful thing to see how they've embraced the extra spend that we're giving them on their brands, how it's helping them win in the marketplace. And you can see that if you follow the company in external places, social media LinkedIn, et cetera. During that call, what we outlined is -- was that in the quarter, we had $19 million of incremental innovation, marketing and advertising spend, versus the third quarter just a year ago. So that was a really big number, our biggest year-over-year increase by quarter that we've experienced. And for the year, we expect that to be about $45 million. The strategy to step up these reinvestments into the business to drive stronger net sales growth are consistent with the plan laid out, out of the GPIP program a few years ago. And the ultimate goal for us beyond all the benefits that I mentioned earlier is really to target 1 to 2 points of net organic sales growth above our average category growth across the products. That's really kind of our long-term operating algorithm, if you will. That's what we're targeting.

Okay. So I mean how would you say then you balance that between driving margin expansion and that reinvesting to get at the future growth?

Yes. I mean I think if you go -- if you look back at the slide, I think it was Slide 8, maybe 7 in the deck, and we'll have -- that deck is on our website. With the 3-year CAGRs, I think we're actually really pleased with the margin improvement that we've seen in -- particularly in Global Pet Care and Home & Garden. I think inflation started to hit HPC pretty hard in Q3, and it impacted margins quite a bit. But the first half margins were really strong. I think our focus is really more about continuing to reinvest in the businesses and drive that net sales growth than it is about improving the margins from where they are now. Global Pet Care is in the high teens. Home & Garden is in the low 20s. And HPC, which, as you know, is structurally very different with different barriers to entry and sourced products. So it's a high single-digit EBITDA business. But again, we think the better thing to do is to continue to ramp up investments as we keep seeing the returns on those. I think our advertising spend, just as an example, is still, even after we've doubled it in 2 years, still at about 1.7%, 1.8% of net sales in total. We'd like to see that move up to probably more of the 2.5% range or so over the coming couple of years as long as we continue to see the returns and grow the brands. Some categories may be more like 4% or 5%. There are going to be many categories where most of our investment is actually digital versus traditional advertising. And the dollar spend is less, so the percentage is less, but the impact is, we think, right.

Okay. Thinking about growth, we've all read or experienced the rise in pet adoption since the start of the pandemic. So as you think about the market opportunity in Global Pet Care, is that different than what you thought it might have been if I asked you this question 2 years ago?

Yes. Absolutely is. I think of it a little bit the way I think about how you hear expert commentary on e-commerce growth where people say that during the pandemic, we kind of fast forwarded 4 to 5 years of e-comm expansion. I feel that way a little bit with our Global Pet Care business. We grew organically in the mid-20s for a year straight basically. 2/3 of our business is consumables. So we think that's really sticky. The only areas we've seen a step-down in demand as people started to kind of reopen, return to travel, return to office, unfortunately, some of that's being paused, but the only place we saw that kind of downturn was really in hard goods like fish tanks and perhaps a little bit our FURminator brand. But given that 2/3 is consumable, primarily companion animal, chews and treats, Nature's Miracle, fish food, filters, cleaning products, all that's really doing is moderating our growth rates back down to category growth rates, which, for this business, we feel like it's probably 5%, 6%. Some industry studies have it a little bit higher than that. That feels right to us. And we're not going to see, we don't think, an actual decline. So it's a whole new base of customers out there and/or expanded pet ownership within a customer base that we now have to grow on. So it's a really nice step function change for the business.

Okay. Great. And just final question, I'm going to sneeze -- squeeze in is this...

That's why we're working from home, Lauren. That's why.

Right. Your most recent M&A activity and just how that fits in with capital allocation priorities, I thought, was a good place to wrap up.

Yes. Sure. I mean I obviously described the sale throughout my prepared remarks, so I won't comment on that. But on the buy side, our last 3 deals that I've talked about have been done in the time that I've been here a couple of years, 2 have been in Global Pet Care. So one was a small high-end fish food business called Omega Sea or Omega One, which is adjacent and complementary to our Tetra fish food brand. And albeit small, it's gone extraordinarily well. We've been able to grow the brand well. We have been able to integrate the manufacturing into our existing footprint. So we've gotten the cost synergies. Really pleased with it. The other one was, again, a very good example of the things we would look for at Armitage, which is essentially a U.K.-based, mostly dog and cat, chew and treat, a little bit of toys business. Excellent retail presence in U.K. grocery, which is where a lot of pet chews and treats, et cetera, are sold in the U.K. where we haven't had as good a presence. So we're excited to bring our products from the U.S. and other parts of Europe into the U.K. and also bring the Armitage brands into our existing channels. So that's again exactly what we want to do, exactly what you have to do to get a strong return on invested capital when you're paying double-digit multiples for businesses these days. You've got to have cost synergies, and you got to have revenue synergies because you need to grow 7%, 8% organically to grow into that return. And then finally, the most recent, which is a little bit different, and we've had to explain a little bit more to investors, is Rejuvenate in Home & Garden. So it's really a new category within our Home & Garden business in household cleaning and restorative products. So the primary Rejuvenate product a lot of folks have seen has been an interior cleaning mop that kind of competes with the 2 big players that are out there in the space that are significantly larger. And Rejuvenate has been able to get into one of our larger big-box retailers but is really not seen across most of our channels. And we think with the rest of our distribution and relationships across multiple channels in our Home & Garden business that we can get a lot of revenue, accelerate their ability to expand distribution as well as we have a lot of strong capabilities in R&D, supply chain and manufacturing around liquids in a bottle. That's what we do already. So we think that will be additive to the new product lineup in Rejuvenate. So really excited about that. And I think it's a good thing for our equity investors as well in particular because the quarterly seasonality in our Home & Garden business has been something that's difficult for people to wrap their heads around at times, and Rejuvenate will be a much more steady revenue base to add into the business.

Yes. Okay. Perfect. We are out of time. But Kevin, Jeremy, thank you so much. It was great to see you, guys, and hopefully, next year in person.

You as well. We said that last year, and we're really going to try to make it happen this year.

I know. Got to come up with a new line.

Take care. Thank you.

All right. Thanks. Bye.

Thank you.