Energizer Holdings Inc

NYSE:ENR

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Sharon, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Energizer's Second Quarter Fiscal 2018 Conference Call. As a reminder, this call is being recorded.

I would now like to turn the conference over to Ms. Jackie Burwitz, Vice President, Investor Relations. Madam, you may begin your conference.

[Jacqueline E. Burwitz, Energizer Holdings, Inc.]

Good morning and thank you for joining us. During the call, we will discuss our results for the second quarter of fiscal 2018 and our outlook for the remainder of the year, and update you on our acquisition of Spectrum Brands battery and lighting product business.

With me this morning are Alan Hoskins, Chief Executive Officer; Tim Gorman, Chief Financial Officer; and Mark LaVigne, Chief Operating Officer. This call is being recorded and will be available for replay via our website, energizerholdings.com.

During the call, we may make statements about our expectations for future plans and financial and operating performance. Any such statements are forward-looking statements which reflect our current views with respect to future events. We also refer to non-GAAP financial measures. A reconciliation of non-GAAP financial measures to comparable GAAP measures is shown in the press release issued earlier today which is available in the Investor Relations section of our website, energizerholdings.com.

During our prepared remarks, we will refer to the acquisition of Spectrum's global battery and portable lighting products business as the Spectrum acquisition or the acquisition of the Spectrum business. Information concerning our category and market share discussed on this call relates to markets where we compete and are based on estimates using Energizer's internal data, data from industry analysis, and adjustments that we believe to be reasonable.

Investors should review the risk factors in our Form 10-K, 10-Q and other SEC filings for a description of the key factors affecting our business. These risks may cause actual results to differ materially from our forward-looking statements. We do not undertake to update these forward-looking statements.

With that, I'd like to turn the call over to Alan.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Thanks, Jackie, and good morning, everyone. In the quarter, Energizer continued to execute well and we made progress toward closing our acquisition of the Spectrum business. Planning is underway between both teams for a smooth integration.

As announced in our earnings release this morning, our team delivered solid results in the second quarter, continuing our momentum from the start of the year. Adjusted earnings per share of $0.45 reflects the benefits of our portfolio optimization pricing actions around the globe, offset by ongoing investments in our continuous improvement initiatives, for which the benefits will start to materialize in the back half fiscal 2018.

Organic revenue was up 1.8% as the carryover benefits of portfolio optimization and favorable pricing were partially offset by the divestiture of ASI. Excluding the impact of the ASI divestiture, revenue grew by 2.7% on a like-for-like basis. Gross margins, excluding unusuals, declined 180 basis points versus the prior year. This was due to unfavorable year-over-year overhead absorption associated with the inventory build in preparation for our launch of innovation in late fiscal 2017, unfavorable product mix driven by portfolio optimization, and higher commodity costs.

A&P spending was up versus prior years. We returned to more normalized seasonal investment level. SG&A, excluding unusual items, was down $3.5 million versus the prior year, reflecting in part the continued benefit of our ongoing cost control efforts. And adjusted free cash flow in the quarter was $17 million, a decrease of almost $30 million versus the prior year, primarily due to investments in working capital in the current quarter and lapping the $19 million gain on the sale of real estate in the prior year.

However, on a year-to-date basis, adjusted free cash flow was $15 million above the prior year, primarily due to improvements in working capital during the first half of the year. These results were achieved by continuing to focus on executing against our three strategic priorities: leading with innovation, operating with excellence, and driving productivity gains.

First, we continue to lead with innovation. In the last nine months, we have implemented our portfolio optimization to simplify the category and make the world's longest lasting AA batteries, Energizer Ultimate Lithium, more visible and accessible to consumers. In addition, we launched our best-performing Energizer MAX batteries during the fourth quarter of fiscal 2017 and took pricing in several markets to offset our investment in innovation, so that we can continue to invest in products that meet consumer's power needs for their high-drain devices.

Our innovation pipeline remains strong across our businesses as we continue to invest behind both product performance and improve shopper experiences. We also continue to remain focused on operating with excellence. Even as our team is heavily engaged in the acquisition and integration planning of the acquisition of Spectrum, they are still focused on ensuring that the base business is delivering results and meeting our goals for fiscal 2018. The current quarter's results demonstrate the effectiveness of their focus.

And, finally, the team continues to drive productivity through our continuous improvement initiatives, as we streamline our international organization and optimize our manufacturing footprint. Our latest project, moving production from our Chinese alkaline battery manufacturing to Singapore, has driven cost savings as we continue to see the benefits of efficiency and scale at this facility. These projects will result in improved margin and lower SG&A in the back half of the year.

Now turning to global trends for the 13 weeks ended February 2018. Value and volume were up 3.9% and 2.6%, respectively. I'd like to note that the global data includes December, one month of the critical holiday selling season. The improved category value performance was driven by innovation and pricing actions in several markets and increased category volumes were driven by holiday promotions, particularly in Europe.

As we indicated in last quarter's prepared remarks, Energizer's market share moderated in the quarter. Going forward, we expect improvements in our market share of track channels as we have now anniversaried the shelf space changes. Global value share of 34.6% declined 120 basis points in the latest 13-week data and the U.S. share of 35.3% was down 150 basis points. These share changes were offset by strong performance in several untracked channels, including home center and e-commerce.

Looking more specifically at online sales, the U.S. e-commerce battery category grew 28% with Energizer's share growing 4 points to 21.8% versus the same period a year ago. We continue to be the branded share leader in this fast-growing channel. Overall, the team continues to do a great job focusing on core category fundamentals and operating with excellence through superior execution both in-store and online.

Now turning to capital allocation. Consistent with what we have previously communicated, we will continue to take a balanced approach across our three pillars of capital allocation by reinvesting in the business, returning capital to shareholders by paying a meaningful dividend, and opportunistically repurchasing shares and strategic M&A.

First, we remain committed to investing in and strengthening our base business through innovation and productivity improvements. I've talked about a number of those initiatives today and we have a great pipeline of investments that we will continue to pursue supported by strong advertising copy, investment in shopper activation, and as continuing improvement in our business operations.

We also continued to reward shareholders with meaningful capital returns. In the quarter, we returned $17 million to shareholders through a dividend of $0.29 per share. Through the first half of fiscal 2018, we've returned $85 million to shareholders through both $35 million of dividends and $50 million of share repurchases that occurred in the first quarter. Regarding share repurchases and acquisitions, in the near-term, we will be focused on integrating and deleveraging from the recently announced acquisition.

Now, I'd like to provide an update on our $2 billion acquisition of the Spectrum business, including the VARTA and Rayovac brands. As we've discussed before, this transformational combination will expand Energizer's presence in a number of international markets and broaden our manufacturing capabilities. In addition, Energizer's customers and consumers will benefit from accelerated innovation and a wider range of products. This combination also provides Energizer the opportunity to drive cost efficiencies and enhance our ability to compete in the category.

Since announcing the acquisition of Spectrum on January 16, our team and our outside advisors, along with the team from Spectrum, have been working on obtaining the necessary regulatory clearances around the world in order to complete the transaction. In the U.S., Federal Trade Commission allowed the expiration of the waiting period for the Hart-Scott-Rodino Act. We are pleased to have achieved this milestone, a significant step towards the completion of the transaction.

We have also received clearance from Colombia and New Zealand and continue to work towards achieving approval in a number of other jurisdictions, including Germany, Australia, Russia, the UK and Spain. We are in the process of making all required filings and have had a number of productive meetings with government agencies around the world to enhance their understanding of the benefits that this combination will enable us to bring to both customers and consumers.

Since announcing the acquisition, integration teams from Energizer and Spectrum have been working together in order to prepare for a smooth closing and orderly transition of the business. Our current estimate for accretion remains unchanged with modest accretion to adjusted earnings per share in the first full year of ownership, excluding one-time transaction and integration costs. We expect to further achieve favorable accretive impacts all in our realization of targeted synergies of $80 million to $100 million.

We expect run rate synergies to be achieved in our third full year of ownership. In addition, the top line and free cash flow growth from this acquisition will further enhance our ability to drive long-term shareholder value. We expect the transaction to close in the second half of calendar year 2018. And over the next several months, we will go to market to raise permanent financing.

Looking forward to the remainder of fiscal 2018, we are maintaining our full year organic sales growth outlook of up low-single digits and adjusted earnings per share outlook of $3.30 to $3.40. Tim will review the full outlook in just a moment. Overall, we continue to execute on our strategic initiatives and stay focused on delivering results in our core business, while making great progress on closing and integration of the acquisition of the Spectrum battery and portable lighting business.

Now, I'll turn the call over to Tim for a review of the financial results and our financial outlook for fiscal 2018. Tim?

[Timothy W. Gorman, Energizer Holdings, Inc.]

Thanks, Alan, and good morning, everyone. I'll discuss the financial results for the second quarter, including providing detail on net sales and gross margins in the second quarter. I'll also walk through the details of our income statement and other metrics. Finally, I'll provide an update to our outlook for fiscal year 2018.

Before I get into the numbers, I wanted to call attention to a change made to our segments. Our earnings release now discloses two segments: Americas and International. This change was brought about by international organizational changes made during the quarter as part of our continuous improvement initiatives.

For the quarter, adjusted earnings per share was $0.45 versus $0.50 in the prior year second quarter. The current year quarter benefited from a strong top-line performance, improved overhead, the benefit of a lower tax rate, and favorable tailwinds from currency. Total net sales for the quarter increased $15.4 million or 4.3% to $374 million.

Excluding favorable currency of approximately $9 million, organic revenue was up 1.8%. The increase in organic sales was attributable to the following components: 1.3% from investments in our portfolio optimization made in the back half of fiscal 2017, and 1.2% from favorable pricing action across several markets. These amounts were partially offset by the May 2017 divestiture of the ASI business that was part of our auto care acquisition.

Looking at revenues by segment, in the Americas, organic net revenues were up 2.9%, due primarily to favorable net impact from our portfolio optimization, with our lithium sales and volume up approximately 65% and 119%, respectively, and favorable pricing in a number of markets. These amounts were offset by retailer merchandising changes and the sale of the non-core promotional sales business. International organic net revenues were essentially flat as new distribution was partially offset by unfavorable customer mix.

Before turning to the rest of the P&L, I also wanted to mention that based on historical trends we exited the second quarter with normal retail inventory levels. As you recall on last quarter's call, I mentioned the inventory levels were slightly elevated at the end of the first quarter and we expected modest retailer de-loads during the second quarter from the elevated levels which did occur.

Gross margin was 45% in the second quarter, down 180 basis points from the prior year. The lower rate was impacted by less favorable overhead absorption versus the prior year, and the impact of commodity cost increases and unfavorable product mix, driven by changes related to our portfolio optimization.

A&P as a percent of net sales was 5.6%, an increase of 100 basis points compared to the prior year second quarter. As we discussed on last quarter's call, this increase was expected as our full year spend will be more balanced throughout the current fiscal year versus fiscal 2017 spending that was more weighted towards the back half of the year.

SG&A spending, excluding the acquisition and integration cost, was $87.7 million or 23.4% as a percent of sales in the current quarter, down 200 basis points compared to the prior year second quarter. On an absolute dollar basis, SG&A decreased $3.5 million due to lapping increased legal reserves in the prior year quarter and strong cost controls.

We incurred acquisition and integration costs during the quarter of $16.5 million, which primarily included legal, consulting, and advisory fees to assist with obtaining regulatory approval around the globe and the plan for the closing and integration of the Spectrum Brands' battery and portable lighting products business. On a year-to-date basis, we've incurred total cost of $22.2 million. We also incurred debt commitment fees of $2.9 million that are included in interest expense in the current quarter.

Our ex-unusual effective tax rate for the second quarter was 25.8% compared to 27.5% in the prior year quarter. The decrease in the rate is driven by U.S. tax reform legislation enacted earlier this year and takes into account the new statutory U.S. rate that is now effective for fiscal year 2018. I would like to point out that the reported rate of 56.2% includes $5.5 million in withholding taxes related to the anticipated international cash movement to fund the Spectrum acquisition.

Looking at our balance sheet, we ended the quarter with $490 million in cash with substantially all of it held offshore. Our debt level at the end of this quarter was approximately $1.1 billion, essentially unchanged from last quarter. And we maintained our debt to EBITDA at roughly 3 times on a trailing-12-month basis. We generated adjusted free cash flow of $17 million in the current quarter compared to $47 million in the prior year second quarter with the decrease primarily due to lapping $90 million in prior year real estate sales and investments in working capital.

Our adjusted free cash flow in the first half of the fiscal year was $153 million compared to $138 million in the first half of fiscal 2017, an increase of $15 million or about 11%. The increase in adjusted free cash flow was primarily due to working capital improvements. In the quarter, we paid a dividend of $17 million.

As always, we will continue to take a balanced approach to capital allocation by investing in our business to support long-term growth, returning capital to our shareholders through a meaningful dividend and opportunistic share repurchases, and, finally, pursuing M&A opportunities that are the right fit for Energizer. As Alan mentioned earlier, regarding future share repurchases and acquisitions, in the near-term, we will be focused on integrating and deleveraging from the acquisition of Spectrum Brands' global battery and portable lighting products business.

Now, turning to our outlook for fiscal 2018. As Alan mentioned earlier, we are maintaining our adjusted earnings per share outlook of $3.30 to $3.40. Net sales on a reported basis are expected to be up low-single digits. Organic net sales are expected to be up low-single digits, including lapping the impact of hurricane activity of approximately $26 million and lapping distribution gains in fiscal 2017.

The organic net sales growth is primarily driven by increased pricing actions around the globe and favorable impact of the portfolio optimization. Favorable movements in currency are expected to benefit net sales by 1% to 1.5% based on current rates. Our gross margin rate is now expected to be flat to up 25 basis points versus fiscal 2017. The change in our outlook reflects the impact of rising commodity and transportation costs. With respect to key commodity costs, we are now essentially fully locked on our expected requirements for fiscal 2018.

A&P spending is expected to be in the range of 6% to 7% of net sales, consistent with our long-term outlook. Again, I want to remind you that timing of our A&P spending during fiscal year 2018 will be different than the timing that occurred in fiscal 2017 where the spend was more weighted to the back half. We expect A&P will be more balanced across the fiscal year, resulting in higher spend of about $4 million to $6 million during the next quarter, offset by lower spending in the fourth quarter.

SG&A as a percent of net sales is expected to be flat on a year over year basis, excluding the acquisition and integration costs. However, the timing of SG&A cost will not be evenly spread throughout the year. As I mentioned on previous calls, we will continue to make investments during fiscal 2018 to simplify and streamline our organization and business processes and to continue to ramp-up investments in our e-commerce capabilities.

In the first half of fiscal 2018, approximately $10 million was included in SG&A. The costs in the second quarter were lower than expected due to timing of projects and reduced cost estimates. We expect additional costs of $2 million to $3 million per quarter to be reflected in each of the next two quarters. Our continuous improvement initiative remains on track. We expect the cost mentioned, a portion of which is recurring, will be offset by savings with the majority expected during the second half of the year.

Pre-tax income is now expected to be favorably impacted by the movements of foreign currencies of between $10 million to $15 million net of hedge impacts based upon current rates. This is a slight improvement in expectations versus our prior outlook. Our ex-unusual income tax rate is expected to be in the range of 23% to 25% taking into account the impact related to the new U.S. tax legislation passed in December and our current expected country mix of earnings.

Our expectations for capital spending remain unchanged in the range of $30 million to $35 million and we continue to expect depreciation and amortization to be in the range of $40 million to $50 million. We continue to expect adjusted free cash flow to be in the range of $240 million to $250 million. In addition to the impact of the U.S. tax legislation, the range includes a benefit associated with improved working capital and our gross margin expectations.

As a reminder, fiscal year 2017 adjusted free cash flow included significant asset sale benefits which will not be repeated in fiscal 2018. To reiterate the confidence in delivering our fiscal year 2018 results, the following are the key headlines from our outlook: low-single digit organic sales growth. adjusted earnings per share of $3.30 to $3.40 and adjusted free cash flow of $240 million to $250 million.

Recently, we have received several inquiries regarding the impacts of commodity and freight costs as well as tariffs. As many of you know, we lock in a portion of our commodity cost 12 to 18 months out. For fiscal 2018, we are essentially fully locked on our requirements for the full fiscal year, and for fiscal 2019, we are approximately 25% locked.

The commodities, which are mostly impactful to Energizer, include zinc, steel, and lithium, and to a lesser extent silver and copper. Zinc is approximately 5% of total COGS; steel is slightly under 10% and lithium is below 5%. The basket of commodity exposure has created a headwind for fiscal 2018, which is reflected in our revised gross margin outlook. Looking at freight, the impact to fiscal 2018 is minimal with freight representing about 5% of our total COGS. Our outlook includes approximately 10 basis points of increased cost over planned levels.

Now turning to tariffs, we continue to monitor potential impacts to our business from tariffs. As you know, the tariff situation remains highly fluid and changes frequently. At this point in time, we expect the impact to fiscal 2018 to be minimal with an impact of less than $2 million. For fiscal 2019 and beyond, we currently estimate the annual impact could be as high as $10 million, and we will take appropriate actions to mitigate this risk and any further risks that arise in the future, including considerations of pricing actions if necessary and sourcing changes. Our ongoing continuous improvement initiatives enable us to manage and partially absorb the volatility risk associated with commodities, transportation costs and potential tariffs.

Turning to the acquisition. As Alan mentioned, we continue to work on obtaining regulatory approval in several markets and on developing our plans for integrating the business. We are also working on obtaining permanent financing to consist of a new revolver and a mix of term loan and new senior notes. We also expect to maintain our existing senior notes that mature in 2025. As part of the financing process, we will refinance our existing credit facility, including the existing revolver and term loan.

We also currently expect to use between $250 million and $300 million of cash held in our international markets to fund the acquisition and we will seek financing in Europe in addition to the U.S. given the expanded European presence. As we stated when we announced the deal in January, we expect our pro forma leverage ratio to be approximately 5 times at closing. In the near term, we will focus on integration and deleveraging after the acquisition.

At this time, we continue to expect to generate significant value through identified annual run rate cost synergies of $80 million to $100 million, driven by network optimization, SG&A reductions and procurement efficiencies. We expect to incur one-time cost of approximately 1 to 1.25 times savings to achieve these synergies and fully realize the benefits within our first three years of ownership. We will update you on financing and synergy targets along with the cost to achieve synergies after closing, which is now anticipated to occur in the second half of calendar 2018.

Now, I would like to turn the call back to Alan for closing remarks.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Thanks, Tim. With strong execution of results for the first half of fiscal 2018, we continue to build a strong foundation for continued success. As we continue to work towards the closing and integration of Spectrum's battery and portable lighting product business, we are confident that the Rayovac and VARTA brands will complement the Energizer and Eveready brands to build an even stronger foundation going forward. We're excited about the opportunities ahead of us and we remain focused on delivering value for our shareholders.

Operator, we can now open it up for Q&A.

[Operator]

Thank you, sir. The first question is from Mr. Bill Chappell of SunTrust. Please go ahead, sir.

[William B. Chappell, SunTrust Robinson Humphrey, Inc.]

Thanks. Good morning.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Good morning, Bill.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Good morning, Bill.

[William B. Chappell, SunTrust Robinson Humphrey, Inc.]

Just circling back to the Spectrum deal – and I understand there's still a lot of moving parts, but to close in the second half kind of gives a nice wide six-month window. Any more kind of clarity there. I guess in particular questions we've had is on Germany or any other country that you might be getting pushed back or second notices or anything that might delay that. And then also, is the company prepared if it's as early as July, which would technically be in the second half, to close and start executing on it from there?

[Mark Stephen LaVigne, Energizer Holdings, Inc.]

Bill, this is Mark. I'll cover that. We are in active discussions with all of the regulators and the markets that we mentioned. We've gotten clearance, as you know, in three of them, but then we continue to have discussions in the UK, Germany, Australia and others. I don't want to speculate in terms of the tone or tenor of those discussions because they tend to just ask questions and we continue to run the process with them. We expect to close in the second half of the year. It's a wide range because these discussions with regulators are uncertain in terms of when it's going to be closed out and when the time periods are going to run.

For your questions in term of readiness, we're working very diligently with our Spectrum counterparts on integration. We just had a discussion with them last week, where we had a large working group meeting. We're going to be prepared to close in the second half whenever that arises. So, as soon as we have clearance and are able to close, we're going to be ready to do so. And that's our goal. So, I wouldn't worry that if we get clearance we won't be ready because the teams are working hard to make sure that that's not the case.

[William B. Chappell, SunTrust Robinson Humphrey, Inc.]

Okay. And then, back to the U.S. market in the lithium strategy. I think we're coming up on lapping that first real expansion. Can you give us just an update on how that's gone in terms of the market share versus what you expected? And then, kind of as we move into year two of that, should we expect a further expansion? Would you cut it back? How do I look at that going forward?

[Mark Stephen LaVigne, Energizer Holdings, Inc.]

So, Bill, it's Mark again. On the repositioning of the Ultimate Lithium product and to remind everyone, what we did is expand the accessibility and availability of that product in our U.S. retailers. It was very well-received by both customers and consumers. Overall, net sales were up 64% in Q2, 58% year-to-date of Ultimate Lithium. We've achieved the two value share of the category, so it's been very successful.

When you look at the latest 13 weeks in consumption, value is up 64% and volume is up 134% because – and as a result it has really been well-received. We would expect our teams to continue to leverage that success with our customers. We are not going to stop there and pull back. We're going to push for more and more as the quarters continue. So, I would not expect it to pull back from there.

[Operator]

The next question is from Olivia Tong of Bank of America. Please go ahead, madam.

[Christopher M. Carey, Bank of America Merrill Lynch]

Hi, everyone. This is Chris Carey on for Olivia. Thanks for taking our question.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Hi, Chris.

[Christopher M. Carey, Bank of America Merrill Lynch]

So – how are you? So, just on the productivity initiatives that you guys have and you mentioned moving the production facility to Singapore and the sort of cost savings that you expect there. Like how many of those do you have waiting in the wings, so to speak, if you need to offset some of these cost headwinds that you foresee on the horizon? Like how deep is that potential of projects that are there that you can pull on if you need to?

[Timothy W. Gorman, Energizer Holdings, Inc.]

Yeah. As we've mentioned, historically, the project transformers was a major restructuring. As we move forward, we have identified a number of initiatives and a pipeline of continuous improvement both in our integrated supply chain, as well as our corporate overhead. Specifically, on the integrated supply chain, we have the move from Singapore, but there are a number of initiatives that are baked into our pipeline. And we'll balance those initiatives against our integration activities with Spectrum as we look at the sequencing of events. But we're confident in our ability to offset the volatility that we have going forward.

[Christopher M. Carey, Bank of America Merrill Lynch]

Okay. Thanks. And then, just I think you mentioned that category value was up nearly 4%, correct me if I'm wrong, with volumes up a little bit less than that. And it just strikes me that growth in the industry has been consistently better than this maybe secular headwind thesis. And I just wonder if you could comment, on the latest, your views on sort of the longer-term trends for category value and volume.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Yeah. Hi, Chris, Alan. It's a great question. So you're spot on. Value in the most current quarter was up just around 3.9% and that was really driven by growth in the premium price and specialty segments which is consistent with what we've seen in previous periods. The value also reflects the pricing action that was taken in several markets around the globe. So, that would be the bigger headline on the current quarter.

As you look ahead, our outlook for the category – we've been pretty consistent around flat to down low-single digits. Certainly over the past several reporting periods, you've seen volume flat to slightly up. We will continue to monitor a number of trends that might provide potential upside to our outlook. And we'll continue to look at that and if warranted may make adjustments to our overall outlook. At this time, we're currently holding it.

To give a little bit more color for you on why we believe there may be potential to the outlook. So, first, you're seeing a stabilization in the device universe. So, both the number of devices owned and consumption are steady and you're also seeing the conversion to battery onboard nearing maturity. Second, the Internet of Things continues to create a whole new class of devices specifically in the smart home, smart health connected device population. Many of those take smaller, more powerful batteries like AA, AAA and specialty. If you take smart home just as an example, over 50% of those connected devices require household batteries.

The third thing is really just the continued miniaturization of devices. So, when you look at what's happening there in both developed and developing markets, AAA and specialty are growing as a result of powering those types of devices which means you're going to see an increase both in share of devices and share of consumption going forward.

And then, finally, demographic shifts and I've alluded to this in prior calls. We know that with an aging population, greater adoption rate of hearing aid usage, more binaural usage which means you have a hearing aid in both ears, bodes well for growth of the hearing aid sub-segment within the overall category. So, if you factor those four things in around the device universe and the correlation directly to what we're seeing in volume, there is potential upside to that outlook.

[Operator]

The next question is from Faiza Alwy of Deutsche Bank. Please go ahead.

[Faiza Alwy, Deutsche Bank Securities, Inc.]

Yes. Hi. Good morning.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Good morning.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Good morning.

[Faiza Alwy, Deutsche Bank Securities, Inc.]

Hi. So, I just want to talk a little bit about what you're seeing in terms of the pricing environment. So, I think you had three points of positive impact from pricing last quarter. And so it's lowered a little bit this quarter. So, I just wanted to see if there was any change. And then as you see just the rise in commodities and transportation cost, what is your outlook on just the ability to take any incremental pricing sort of later in the year?

[Alan R. Hoskins, Energizer Holdings, Inc.]

Yeah. Hi. It's Alan, and I'll ask Tim to also provide part of the answer for you. So, when we look at the pricing, over the last periods, we benefited from pricing action in over 17 markets around the globe, particularly the U.S. And that's been behind the introduction of new product innovation. It's helped us offset commodity inflation and it reflects the changes that we're currently seeing in currency rates. As a result of the pricing actions, we've been able to see overall improvement in category value, particularly in the U.S.

As you look at the impact of pricing, there's really a couple of headlines around that. So first, you're seeing average unit prices to consumers actually increase as a result of the pricing in markets. That is a good thing. We've seen that hold consistent over the past several reporting periods. And from a promotional standpoint, the promotion environment, if you look at the most current quarter in the U.S., continues to remain stable. So, the percent of sales coming from promotion is relatively flat. We are seeing an increase in full price displays which is actually a good thing for the category, and the percent of batteries that are sold with some level of price decrease is actually declining.

So, if you take the combination of everyday shelf pricing improving and going up and a stable promotional environment, we're very comfortable overall with where pricing is. In terms of future pricing – and then I'll hand it over to Tim to talk a little bit more about commodities – when you think about future pricing, any decisions we take on pricing, we certainly do independently. And we take a number of variables into consideration, everything from macroeconomic conditions, product inputs, category dynamics, what we're seeing around new technology and innovative products that we bring to market, certainly changes in currency rates.

Anyway, we look at all of our markets for both pricing and promotion and we use that information to take any decisions on pricing that are in the best interest of Energizer. We will continue to do that based on what we're seeing around commodity inflation, what we're seeing around transportation costs. And then certainly as we bring new innovation to market, we'll also evaluate pricing of that as well. So overall, we feel we're in a relatively good place. And I'll let Tim maybe speak a little bit more to some of the commodity inflation that we're seeing.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Yes. With respect to both commodities, as well as fuel and transportation, and now the evolution of potential tariff impacts, we look at all those. And first on the commodities, as I mentioned in my prepared remarks, we do look to lock in forward commitments in the 12 to 18-month range. For the current year, we're fully locked and 25% locked for next year. Obviously, these have been headwinds in the current year. They are expected to be headwinds in fiscal 2019. So, we look at the continuous improvement initiatives that we have and the one that we called out this year is moving our manufacturing from China to Singapore, which had two benefits: one, it mitigated potential impacts from tariffs and, two, we just have better utilization at the Singapore facilities. So, those benefits will occur in the future.

And so, we look at those continuous improvement initiatives to offset the volatility that we have in those cost categories moving forward. And as Alan pointed out, additionally, those would be factors that likewise come into play in our decision factors of potential pricing actions in the future. In particular, I'd indicate with tariffs, that would be a consideration of potential future pricing actions as well. And then likewise, we'll look at potential sourcing changes as the tariffs become finalized and we have a clear view of what those will be in the future. But again, our focus is really on driving productivity to reduce our operating costs to offset the volatility that comes from those factors.

[Faiza Alwy, Deutsche Bank Securities, Inc.]

Great. Thank you. And then, just one other thing on the Spectrum transaction. So, first of all, congratulations on getting approved in the U.S.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Thank you.

[Faiza Alwy, Deutsche Bank Securities, Inc.]

Can you talk about what you – like was there a specific model that you'd maybe propose to the FTC? Sort of how are you envisioning running these two brands along with private labels sort of in the U.S.?

[Alan R. Hoskins, Energizer Holdings, Inc.]

So, I think what we presented in the U.S. was just why we believe that this transaction is beneficial to both our customers and our consumers. And as they analyzed it and they dug into the details themselves and asked clarifying questions, they ultimately arrived at that decision. I don't want to speak for the regulators in terms of why they ultimately cleared the transaction.

In terms of modeling of what we're going to do with these businesses going forward, we'll leave that to subsequent discussions when we actually own the business and can provide our strategic outlook for it. But we are excited to have the manufacturing capacity that Spectrum has. We're excited about the Rayovac and VARTA brands and what we can do with them.

[Operator]

The next question is from Mr. Kevin Grundy of Jefferies. Please go ahead, sir.

[Kevin Grundy, Jefferies LLC]

Thanks. Good morning, guys.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Good morning, Kevin.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Good morning, Kevin.

[Kevin Grundy, Jefferies LLC]

Two questions, the first one more detail-oriented. Tim, can you help us – so your guidance implies some material improvement in gross margins in the back half of the year. Can you help us with some of the key drivers there? So, commodities and freight higher than you had expected before. You should get some benefit from pricing. It sounds like productivity will be a bigger contributor than it was, at least in the quarter, if not in the first half of the year. You're looking to drive favorable mix, and then there's going to be some FX in there. But I just want to make sure I'm thinking about this appropriately in terms of the magnitude of the improvement that's implied in your guidance and how you get there, given the larger headwind from commodity and freight. And then, I have a follow-up.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Sure. So, Kevin, as the year kind of unfolds, as you'll recall, last year, we began implementing the portfolio changes. And so, we made investments beginning in the latter half of the year. So, as we look at moving forward in Q3 and Q4, we'll be lapping those investments that were made in the back half of the year. The one, obviously, headwind that we have is lapping the hurricane activity. But that will be a significant benefit as we have the benefits of lapping that investment and the portfolio optimization.

We're also getting the benefits of pricing actions that were taken. As you recall, the majority of the U.S. occurred beginning in the fourth quarter of last year and really lapping over into Q1 of fiscal year 2018. So, that'll be a tailwind for us as well. And then likewise, we have identified the benefits of currency that are a tailwind for us in fiscal year 2018.

[Kevin Grundy, Jefferies LLC]

Okay. Is there anything you can quantify for us, Tim? Commodities and freight are going to be X-basis-point headwind offset by pricing of X basis points. So, you don't carry particularly that level of detail on the call.

[Timothy W. Gorman, Energizer Holdings, Inc.]

Yeah. We don't really get into that level of detail.

[Kevin Grundy, Jefferies LLC]

Okay.

[Operator]

This concludes the question-and-answer portion of the call. I would now like to turn the conference back over to Mr. Alan Hoskins for any closing remarks.

[Alan R. Hoskins, Energizer Holdings, Inc.]

Thank you, operator, and thank you for everyone joining us on the call today and for your continued interest in Energizer.

[Operator]

Ladies and gentlemen, thank you for joining. You may now disconnect your telephones.