Spectrum Brands Holdings Inc

NYSE:SPB

Earnings Call Transcript 2019-Q2

[Operator]

Good morning. My name is Jetenia and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands' Fiscal 2019 Second 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, Wednesday, May 8. Thank you.

I would now like to introduce Mr. David Prichard with Spectrum Brands. Mr. Prichard, you may begin your conference.

[David Prichard, Vice President of Investor Relations]

Thank you, operator, and welcome to Spectrum Brands Holdings Fiscal 2019 Second Quarter Earnings Conference Call and Webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands and your moderator for today's call.

Now to help you follow along with our comments, we have placed a slide presentation on the Event Calendar and presentation pages in the Investor Relations section of our website at Spectrumbrands.com. This document will remain there following our call.

So if we go to presentation and we start with slide 2, you'll see that our call will be led today by David Maura, our Chairman and Chief Executive Officer; and Doug Martin, our Chief Financial Officer. David and Doug will deliver opening remarks and then they conduct the Q&A session.

If we turn to Slide 3 and 4, you will note that 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 May 8, 2019, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10-Q and 10-K. We assume no obligation to update any forward-looking statement.

Also, please note that we will discuss certain non-GAAP financial measures in this call. Reconciliations on a GAAP basis for these measures are included in today's press release and 8-K filing, which are both available on our website in the Investor Relations section.

I will now turn the call over to our Chairman and CEO, David Maura.

[David Maura, Chairman and Chief Executive Officer]

Thank you, Dave and thanks everybody for joining us on the call today. In many ways this was a very good quarter for our company. In January, we generated just under $3 billion of cash proceeds from the sale of assets. We rapidly allocated a portion of these proceeds and paid down $2.40 billion of debt, while returning $250 million to our shareholders through share repurchases. And we will distribute approximately $86 million this year to shareholders in the form of dividends.

As a result of these actions, our gross leverage which peaked at nearly 6x in December of 2018 just a short while ago, has been reduced at the end of the second quarter to a net leverage of approximately 3.9x. We expect to finish the current fiscal year with net leverage of approximately 3.5x. These actions have resulted in a much stronger Spectrum Brands with a much stronger balance sheet. And they're paving the way for a material free cash flow growth in 2020 and positioning our company to end 2019 in the strongest liquidity position we've been in recent history.

Through these accomplishments, we are completing a period of significant transition and we are now entering a period of stability and renewed focus. Similar to our first quarter, these second quarter results were in line with internal expectations. We were pleased with both strong reported sales growth and more importantly we're very happy to deliver organic revenue growth 5%, with all four business units contributing. These results were led by strong growth in Home and Garden of 14%; HHI, our Hardware division grew at 4%, our Pet unit grew at 4% and our Home and Personal Care Appliance business grew 1% organically.

Adjusted EBITDA was flat with last year right on our first half plan. We do expect a solid second half with larger sales and larger EBITDA in the first half primarily due the seasonality of our home and garden business, and a typically stronger back half of the year for our hardware home improvement segment. Additionally, we expect improve sequential performance in our home and personal care appliance business as we lap a very difficult first-half comparison and we see benefits from a new leadership team that we've installed in that business during this recent quarter.

These changes include the appointment of a new President, David Albert. Dave is a strong and seasoned business leader with both general management experience in several businesses, and also regional experience. We also have appointed a new divisional CFO in the appliance unit with experience in both business unit and corporate financial strategy. We recently also completed the onboarding of a new VP of Marketing who was hired from a well-respected consumer product company outside of Spectrum Brands.

Additionally, new leadership has been appointed in our clients unit to streamline both our operations and supply chain functions. This new team has already hit the ground running. It is directing its efforts towards stabilizing the business, focusing on our core and planting the seeds for growth, which included stepped-up investments in this quarter in both new product development and increased marketing spend behind our home and personal care brands.

Across our company, we are launching important new products in all of our business lines. And we are setting up marketing spend behind our brands. We remain on target to achieve our original 2019 adjusted EBITDA goal of $560 million to $580 million. If I could have you turn to slide 7 now. I'd like to amplify my earlier comments about value creating and shareholder friendly actions that were completed in the second quarter. Our rapid and major debt reduction has eliminated all non-revolver senior debt in our corporate capital structure. We've improved the duration and tenure of our liabilities. We have reduced materially the cost of borrowing. And we are significantly lowered our pro forma annual cash interest expense.

We also ended the second quarter with a strong liquidity position of over $800 million. Regarding stock buybacks, subsequent to our first quarter call, we opportunistically repurchase 4.6 million shares or roughly 8.6% of our total share count. Going forward, we have up to an additional $750 million of capacity remaining on our three-year buyback plan. We could turn to slide 8. As we accelerate the transformation of Spectrum Brands in 2019, we are on our way to building the faster, smarter, stronger Spectrum Brands of the future.

We recently have embarked on a detailed global study to identify significant performance improvement and operating efficiency opportunities across our platform. Focus areas include the right resourcing of our commercial and our shared service structures, eliminating unneeded and duplicative work by improving and standardizing our processes. And we're seeking efficiency gains in manufacturing, distribution and our procurement functions.

We intend to deliver for our shareholders a fit for purpose organization for the new Spectrum Brands. And we are excited to provide more details on these activities and their expected results on our third quarter call. This work ties strongly to our Spectrum 2020 roadmap. It's a roadmap that I've discussed before in many settings and most recently at the CAGNY conference. Our Spectrum 2020 guiding principles are vision, where we are going; clarity, what we prioritize and focus, how we execute. This is our pathway to a consumer driven mindset. We will accept nothing but outstanding quality and service while increasing innovation and marketing investments behind our new products. These actions are driving a culture of greater accountability, much quicker decision-making with an experienced and energized leadership team refreshed with new talent focused on operational excellence as we position our company to be a low-cost provider delivering sustainable free cash flow.

With that let me turn the call over to Doug.

[Doug Martin]

Thanks, David and good morning everyone. Turning now to slide 10 and a review of Q2 results from continuing operations beginning with net sales; reported net sales increased 2.7% and organic net sales grew a solid 4.9% excluding unfavorable FX of $19.3 million. All four business units delivered organic growth based by a 14% improvement for home and garden. Reported gross profit was unchanged. Gross margin of 33.7% decreased 100 basis points primarily due to input cost inflation, an unfavorable product mix partially offset by pricing.

Reported SG&A expense of $235 million was unchanged from last year coming in at 25.9% of sales this year compared to 26.6% a year ago. Reported operating margin of 4.6% improved 100 basis points due to lower acquisition, integration and restructuring charges.

On a reported basis, a slightly higher diluted loss per share of a $1.06 versus a $1 last year was attributable to one-time interest charges related to the early extinguishment of debt and foreign exchange losses associated with multi-currency divestiture loans, partially offset by lower restructuring and acquisition and integration expenses and a larger income tax benefit. Adjusted earnings per share of $0.26 decreased 46.9% due to higher operating expense, driven by increased stock based compensation and a higher interest costs from assumed HRG debt.

Turning to Slide 11. Q2 reported interest expense from continuing operations of $94.2 million increased $26.5 million driven by one-time interest charges from early extinguishment of debt, primarily the assumed HRG debt. Cash taxes of $14.5 million were comparable to last year. Depreciation, amortization and share based compensation from continuing operations of $53.9 million increased from $27 million last year primarily due to increased share based compensation and the impact of home and personal care depreciation and amortization this year as a result of our moving the unit back into continuing operations.

Cash payments for acquisition and integration and restructuring and related charges for Q2 including discontinued operations were $14.6 million and $4.8 million respectively versus $12.6 million and $25.1 million respectively last year. The reduced cash spend was driven primarily by improved operating efficiencies in the HHI Kansas distribution center. Now the business unit results beginning with slide 12, and hardware and home improvement.

HHI's reported net sales growth was broad-based across this three product categories of residential security, plumbing and builder's hardware. Organic growth was 4.7% excluding unfavorable FX of $2.3 million. Strong load-in orders from new product introductions and effective promotions drove plumbing category growth, while increases primarily in the electronic lock segment fueled higher residential security sales. Adjusted EBITDA grew 15.8% or $52.7 million with 160 basis points of margin expansion to 15.9% from higher volumes, productivity improvements, and expense controls.

Looking ahead, HHI sees continued growth in its electronic deadbolt and smart lock product lines especially given relatively low and fast-growing US residential adoption rates. To maintain smart lock innovation leadership, HHI is increasing investment in cloud technology, mobile apps and access control. Highlighting a steady stream of innovation, new business in the back half of the year includes residential and commercial grade levers, Wi-Fi Halo Touchscreen smart locks, the Aura Bluetooth smart lock and an enhanced Baldwin Touchscreen.

HHI is also expanding consumer marketing awareness campaigns behind its unique patented Kwikset Smart Key security technology that allows consumers to re-key their door locks in seconds leaving lost or unreturned keys obsolete.

Now to Home and Personal Care or HPC which is slide 13. Our reported net sales fell 4.1%; organic sales grew 1% excluding unfavorable effects of $11.8 million. Lower personal care revenues partly offset by higher appliance revenues drove the reported sales decline. US personal care sales fell double digits from hair care distribution losses not yet lapped from last year in the mass and food/drug channels. Lower European sales were primarily from the UK Food and Drug and e-commerce channel softness.

Small appliances revenue improvement was attributed primarily to the US mass channel growth in garment care and coffeemakers with partial offsets in Europe from foreign exchange, UK consumer softness related to Brexit and reduce POS in the Latin America region. The decrease in adjusted EBITDA and margin was mainly attributable to lower gross margin from reduced personal care volumes, unfavorable mix, higher input related costs and increased marketing investments. HPC continues to expect second half comparisons to improve with Q4 EBITDA larger than Q3 consistent with historical seasonality.

This includes new product introductions and expanding distribution in the US, Europe and other regions in both HPC segments coupled with financial recovery initiatives and organizational streamlining, business simplification and rationalization with a heightened focus on the core. As we have said before in fiscal 2019, we are resetting HPC, rebalancing its cost structure and investing more behind its brands to prepare for growth in 2020.

Moving to Global Pet which is slide 14, building on solid Q1 top-line growth Q2 reported net sales increased 1.8%, and excluding unfavorable FX of $5.2 million, organic sales grew a strong 4.2%. Double-digit improvement in the US companion animal revenues, primarily dog chews and treats and pricing actions for raw materials and tariffs drove the increase partially offset by lower US aquatics and European dog and cat food sales. Adjusted EBITDA fell 8.1% to $32.8 million with a 160 basis point margin decline to 15.3% as a result of higher manufacturing and distribution costs.

Pet expects solid performance in its large US region to continue in the second half. Important new product launches are occurring across Pets' larger brands including Good 'n' Fun, DreamBone, SmartBones, FURminator, Nature's Miracle, Tetra and GloFish supported by higher investments in data-driven digital marketing aimed primarily at the rapidly growing e-commerce channel. Pet is also working to lower its global manufacturing and supply chain cost base and trim selective, unproductive SKUs to drive a higher long-term margin structure.

Turning to Home and Garden which is slide 15. The 14.1% net sales increase was attributable to double-digit growth in our outdoor category revenues - outdoor control category revenues. Distribution wins strong early season home center orders and generally more favorable weather this year than last drove category growth. Adjusted EBITDA increased 17% to $29.6 million and EBITDA margin expanded 50 basis points to 21.3% on the strength of improved manufacturing efficiencies from higher volumes and select pricing actions.

Home and Garden remains optimistic about sales and adjusted EBITDA increases in 2019 given growth expectations in its seasonally much larger second half from distribution expansion in home centers in outdoor insecticides, lawn and weed killer, and innovation success with Hot Shot Ant, Roach and Spider, all supported by higher advertising spend off-shelf promotion and other promotional programs. New feature space and end-cap placements in both mass and the DIY channels are also in place along with continuous improvement savings, improved manufacturing efficiencies and better mix.

Moving out of the balance sheet in slide 16, we completed Q2 in a solid liquidity position including $652 million available on our $800 million cash flow revolver, and a cash balance of $176 million. Debt outstanding was $2.4 billion, down 50% from $4.8 million at the end of fiscal 2018. 4.6 million Shares were repurchased in Q2 for $250 million or $54.22 per share and there's approximately $750 million remaining on our three-year repurchase authorization. Capital expenditures were $13.6 million versus $17.8 million last year.

Turning to slide 17 in our 2019 guidance. We continue to expect reported net sales growth from continuing operations in 2019 driven by innovation, increased marketing investments, pricing actions and market share gains. We now expect FX to have a negative impact on sales of approximately 130 basis points based on current rates. We re-affirm our adjusted EBITDA guidance from continuing operations to be between $560 million and $580 million. Consistent with seasonality in prior years, Q3 EBITDA is expected to be higher than Q4.

Depreciation and amortization is expected to be between $230 million and $240 million including stock-based compensation of approximately $57 million with roughly $17 million in each of Q3 and Q4. For adjusted EPS, the $29 million depreciation, amortization catch-up in Q1 when we put HPC back into continuing operations is excluded, and therefore, this range is $29 million at the midpoint.

Fiscal 2018 stock based compensation for reference was $12 million. We are increasing restructuring and restructuring related cash spending to be between $40 million and $50 million with the increased funding, the performance improvement and cost reduction opportunities David discussed earlier. Capital expenditures are expected to be between $70 million and $75 million. We have $1.3 billion of usable Federal NOLs remaining post the asset sales, and then finally as a reminder for adjusted EPS, we use a tax rate of 25% including state taxes. Thank you, and Dave, now back to you for questions.

[David Prichard, Vice President of Investor Relations]

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

[Operator]

[Operator Instructions]

You first question comes from the line of Olivia Tong with Bank of America.

[Olivia Tong, Bank of America Merrill Lynch]

Great, thanks. I want to actually start similarly to the way that I started last quarter, which is just about free cash flow; obviously we've got a lot of moving pieces here and I know that first half is usually used, but you are starting off of a lower base on a year-over-year basis, so can you just talk through the different puts and takes there to start? Thank you.

[David Maura, Chairman and Chief Executive Officer]

I will let Doug take that first one.

[Doug Martin]

Hi, good morning, Olivia. Yes, the free cash flow - we are not guiding on this year principally not because we don't want the clarity and transparency, but because at the time of the sale of the two businesses in January. One in early January; one in late January what would traditionally have run through working capital will now run through gain or loss on sales. So, it's a - it's a confusing story and at the end of the year we'll lay out all of the pieces - all of the pieces for you. I can tell you that we're on track against our internal expectations on free cash flow and have obviously captured all of those proceeds already and they're reflected in our net debt numbers and a little bit of cash we have on the balance sheet at this point.

So I gave you outside of that then the elements that you can use to - for your modeling and if I were - as I think about it, I like to model what I think the next year might look like based on information we have coming out of this year. So that's CapEx, that's depreciation as adjusted for the debt pay down that is a restructuring cash-- cash taxes, we still expect to be between $40 million and $50 million on an annual basis going forward. So, if that's - hopefully that's helpful, if not, please reach out to Dave or Kevin and they can continue to help.

[David Maura, Chairman and Chief Executive Officer]

The only thing also I would add, is we did pay off over 50% of the debt of the company; we do generally a lot of free cash in the back half of our year, so we're starting to collect the cash now, and so, our liquidity position will build as we finish out this year. And I think if you just look at the debt instruments we've retired thus far and we may do some more in the future. I think you can quickly come up with this $130 million, $150 million bucks of reduced interest expense going forward of which we'll start to see the benefit when we report the third quarter results, next time we talk to you.

[Olivia Tong, Bank of America Merrill Lynch]

Got it. Thanks, and then just on sales, clearly quite a bit better than we expected across the division pretty broad based, so - can you go over any timing shifts that we should be aware of? How you view your in-store inventory levels at this point? And then in terms of specific divisions, clearly appliances was better, can you talk about how sustainable this is? What changes you've made so far to the business to reinvigorate it? Thank you.

[David Maura, Chairman and Chief Executive Officer]

Yes, look I think across - hopefully you're getting a consistent story. I took this position just over a year ago and we obviously had an unfortunate quarter to report to you then. Since then we've tried to really get the company back to what I call vision & clarity focus and that means, we want to eliminate what I view is non-strategic spending, and we want to increase strategic spending, and so what I am trying to do is push - steer the ship toward higher levels of investment in new product development innovation and put more money into A&P and marketing and really start to drive the top-line.

Again, look, we don't want to over promise anything for 2019. 2019, as you remember, I build it as a year of returning the company to stability and planting the seeds for growth in 2020, but clearly we are planting those seeds, and you know, look I would tell you on the bottom line, we could be reporting much better numbers, but we are continuing to invest in earnings dilutive activity in the short run which is higher spend on R&D and marketing.

[Doug Martin]

Olivia, from a timing perspective, I would say that the Appliance business is - you saw some improvement, we are beginning to lap some of the negatives from last year and we've got a new management team in place and we'll have probably a better update in the - on the next call and the progress they're making, but they're they are highly focused on not just revenue, but profitable revenue. So, I wouldn't expect any surprises going forward coming out of there between now and then.

And then from Home & Garden perspective, I would say that this year is the weather's been generally better and POS particularly in the big box channels has been pretty strong so far. We still have 70% of the season in front of us. So a lot to go yet, but relative to last year and to your timing question, I would say for Home & Garden a little better seasonality.

[Operator]

Your next question comes from the line of Bob Labick with CJS securities.

[Bob Labick, CJS Securities]

Good morning. Congratulations on some nice growth. Yes, let's keep it up. So I wanted to kind of talk a little bit about that and then shift to online strategy as well, maybe merge the two, but can you talk about how you view each of the segments in terms of over a medium or longer-term organic growth potential, and then, one of the key drivers you are pushing - and you mentioned in the prepared remarks a focus on e-commerce particularly in PET, so maybe talk a little bit about the online strategy as you shift there for growth as well?

[David Maura, Chairman and Chief Executive Officer]

Yes, in the last 12 months we've made some key hires in the digital space, not just digital marketing, but we've got some key talent on board right now that really understands algorithms, that understands how to - again I think in the early days, we were very much focused on how do we fix our search, how do we get good content and I think we have done a pretty good job there. I don't think we've done a really good job of getting a return on digital spend, and so, right now we're in the midst of kind of optimizing that digital spend, but we are doing it with people that actually speak the language of the Amazons of the world and our other e-com partners and we're partnering with them, and quite frankly, we're getting better returns on the capital we allocate there.

So, I think, part of my new role is - we spent kind of ten years-- I was doing a lot of external capital allocation. Right now we want to get internal capital allocation to a much - to a much higher rate of return and we are doing that on the digital side.

Clearly on your first question, I mean Appliances continues to migrate online pretty rapidly. We are definitely seeing a meaningful increase in e-com and on our PET business as well. Home & Garden is small, but the growth rates are strong; HHI is - that's a smaller component. Any time you get liquid in a bottle like on our Home & Garden side, you've got heavy products like hardware and locks. You typically doing less online, but we continue to step up investment there, particularly on the digital lock side. We were one of the first to market with our Kevo products, and I see just a very low penetration rate there, with massive white space and I see very strong end market growth. And we see adoption rate low at the moment, but the growth rate is exponential.

And so I think, you've heard, Doug talk about it. I was recently in Lake Forest with our HHI team and I've just - we're revamping some of the merchandise, we've put out, we want to do not only a better job, explaining our smart key technology to our customer. But also trying to bring clarity at point-of-sale and increase the customers confidence at the point of purchase. Because, we think digital locks they're here to stay, they've got a great tailwind behind them and we want to continue to be the market leader there and quite frankly, we think that'll grow whether we're in expansionary times, recessionary times given the tailwind here in the adoption rate.

We really want to maintain our leadership position. So you'll see a lot more of that and you'll probably see a lot of news release in this summer and new products that were coming out with to further that activity.

[Bob Labick, CJS Securities]

Okay, great, thank you for the color. And then just one other quick one. You mentioned obviously, a whole new team or mostly new team at HPC Executive level. Could you talk about the priorities you've given to them? Is it - I don't want to put words in your mouth, what were the priorities and the charge that you've given to them going forward?

[David Maura, Chairman and Chief Executive Officer]

Listen to be blunt; I just think we got off track in that division. We tried to do too many things, to too many people with too many SKUs. Look, we are very, very good at procuring product. We are a low cost provider. We marry that with some innovation and we have great brands. And we've really just got to get back to our core. We've got to get the right product to the right customers at the right prices and that's what we've done for a decade. And I think we just kind of - we kind of lost focus. So it's restoring that focus.

Listen, there's some complexity in that business that we are going to drive out, there's more efficient ways to do the things and so, we're doing that. But listen, we are - there is no question on the profitability line this quarter, we probably could have doubled it for reporting purposes, but we would have been pulling back levers on marketing, on innovation. And that's kind of the new theme; I'm just not willing to sacrifice short-term numbers that would rob us of future growth.

My mission from 10 years ago was to create a sustainable free cash flow enterprise, and you just have to plant this - no better time to plant seeds for growth in the current moment, it's just those sometimes are expensive seeds. And so they have a mandate to continue to invest behind innovation, you've got to bring new products that answer consumers' needs and convenience. And you've also got to let people know about why those things help their - help them have better experiences in the kitchen or on a personal - on a beauty side, you've got to let them know that through smart advertising.

And so, those are different mandates that were not in the DNA of the prior team, it is in the DNA of this team, but they also have a dual mandate, which is to really streamlined supply chain, operating expenses, so that we can reinvest in more strategic activity. I would tell you that are kind of the main new vision, clarity and focus being brought to that business unit.

[Operator]

Your next question comes from the line of Faiza Alwy with Deutsche Bank.

[Faiza Alwy, Deutsche Bank]

Yes, hi, good morning. So my first question has to do with HHI. Can you talk about your outlook for that business now? I know when we last talked about it in February; there was some concern about housing and remodeling slowing. I think since then things have improved. So I just wanted your updated take on, how you're thinking about the market?

[David Maura, Chairman and Chief Executive Officer]

Yes, I think you're right. Look, we definitely saw a pre-rapid and deceleration in demand, I would tell you, I think it was November 2018 when I first partially noticed it and it was very sluggish through December and so that had me quite concerned is a real headwind. Clearly, I think the pivot by the Fed, lower rates from the market and the tenure trading it 2.5% and pushing lower now given the - given macro events is lowering mortgage rates. And the housing market has just become accustomed to very low rates. And so you're right, we do see a pickup in new home sales, which we think affects about 25% of our total top-line in the HHI division. But we remain the dominant player in the remodel space.

And again, I think right now it will be great, we see with the builders is, there is actually still a lot of pent-up demand. And you see the millennials wanting to get into housing. It's affordability and it's a supply issue. And so, quite frankly a lot of our builder partners are now looking to be - how do we create more product in that $200,000 to $500,000 zip code and that quite frankly would be extremely good for us, if we could see kind of the new home builds be in that range. Because they also tend to be the early adopters of our digital locks.

So look it's - again, I don't - we don't want to get over our skis, we have a tough comp in Q3 for the HHI unit. We're just billing - we're billing 2019, as we're getting back on our feet, we're stabilizing all our business units, we want to take the right long-term approach to investing now for better growth in 2020. But I'm feeling a lot better about the outlook for HHI as I talk to you today than I did 3 months ago.

[Faiza Alwy, Deutsche Bank]

Okay, great. And then just a follow up on like HHI EBITDA. So I know it accelerated relative to last year, but last year was a very easy comp from a margin perspective. And if I look at it on a 2-year basis, it's still decelerated. So could you talk about some of the puts and takes? Is it a mix issue, is that cost inflation, is that more investments? So just a little bit more color around the EBITDA, if I compare it to 2 years ago.

[David Maura, Chairman and Chief Executive Officer]

I'm going to pass this one to Doug, if that's okay.

[Doug Martin]

Primarily related to input cost inflation, little bit of - a little bit of tariffs, we've gotten some pricing across the board, across some of our categories there, but it's generally driven on the - on a cost side in the short run. And some of the initiatives that David talked about earlier in his prepared remarks include manufacturing and supply chain improvement opportunities and we see some in HHI.

[Operator]

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

[Jim Chartier, Monness, Crespi, Hardt & Co.]

Good morning. Thanks for taking my question. Hi guys. On the investment spend your first - can you give some more - a little bit of color on how much it was weighted to first half versus second half of this year? There was a more weighted to first half and should we see less impact on EBITDA margins in the back half?

[David Maura, Chairman and Chief Executive Officer]

It varies by division. So I can tell you, look with 70% of the lawn and garden season left, and we're off to a reasonable start, we're actually going to ramp up spending. So that would be a situation where we actually see marketing increase, but again it's increasing, it's supporting the appropriate amount of sales and profitability growth. Plus, we have distribution wins and we want to support those for our retailers, customers. I would say on the appliance side that was probably more weighted in the first half things like Manchester United are not inexpensive endeavors.

Doug, I don't know you want to add some more color?

[Doug Martin]

Now I think that's right. And I think the - later in the year appliances will ramp up a little bit as we headed into the holiday quarter, which is our first quarter next year, but some of that spend will be committed and happen ahead of time. And then on the HHI business they are relatively stable through the year, a little bit heavier in the back half, perhaps, again given their seasonality and pet is pretty steady state.

[Jim Chartier, Monness, Crespi, Hardt & Co.]

Great. And then you talked about the detailed study for improvement in efficiency opportunities. Do you plan to flow through most of that to the bottom line or you plan to continue to reinvest into your growth initiatives?

[David Maura, Chairman and Chief Executive Officer]

Yes. Look, I'm actually very excited about this. I want to wait and get some more tangible evidence in our hands, before we kind of talk to you more broadly about it and we intend to do that next quarter. I think you should think about it as, no stone is going to go unturned. We - if there is non-strategic spend or spend that is not value added or if there's redundancies or too much manual procedures and we can become more efficient. It's a pretty comprehensive study; I think a lot of it will come on the procurement side.

But again, I want to balance it, I think we will draw a lot of it to the bottom line. But I want to make sure we take a decent proportion of it and reinvest in the business. I want us to get much more in line with top performing CPG companies in terms of marketing spend, innovation and new product development. We - I'm bent on steering the ship towards a much healthier vitality, underlying all four businesses. We must make investments in 2019 to deliver growth that shareholders deserve in 2020 and beyond.

[Operator]

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

[Sam Reid, Wells Fargo Securities]

Hey guys, thanks for taking my question. Look, it's exciting to see all the innovation coming online across your platform and across all the segments. Could you give us a sense those to what proportion of your sales this year are coming from new products versus existing products and maybe how that compares to prior years?

[David Maura, Chairman and Chief Executive Officer]

It's never enough. Doug you want to hit it?

[Doug Martin]

Yes. I don't have specifics to provide to you, Sam, because they vary across the businesses. But our vitality rate in general is over a 3-year period is in generally in the high teens area and has been increasing in the last couple of years and will continue to increase a little bit this year.

[Sam Reid, Wells Fargo Securities]

Got you, now that's super helpful. And then if I could sneak one on HHI here. You guys mentioned in the prepared remarks, relatively low household penetration rates across that bolts and smart lock or electric deadbolts and smart lock products. Could you give us some numbers around there though and what penetration rates might be today versus where they could be over the next 3 to 5 years?

[Doug Martin]

Penetration in the US is sub 10 percent-ish on the smart lock category. Our overall -

[David Maura, Chairman and Chief Executive Officer]

Use between 5% and 10%, that's as narrow as we go.

[Doug Martin]

And then our overall electronics business which would include TouchPad and other non-smart, non-connected, so it's both connected and non-connected, it has also a little under 10% of around, around 10% of our total business.

[David Maura, Chairman and Chief Executive Officer]

Just listen you have a whole generation of customers that is used to just living on their phones. And now they're buying their first home, to be able to run that house on their phone, to access the house to lock the house, to let somebody deliver something, or to let a relative in or it's just the future and we want to be on front.

[Operator]

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

[Joe Altobello, Raymond James]

Thanks. Hi guys, good morning. So I did have a few questions around the investments you guys are making this year. You talked about that for the last couple of quarters, including this morning. And if I look at selling expense for example on R&D expense. Both are flat year-to-date, so it seems like all of that investment is going to other areas of marketing. Is that the case and if so, can you help us quantify how much of a step-up in marketing you're expecting in your EBITDA guide for this year?

[Doug Martin]

Joe, there are actually those couple of areas and that the piece that you don't see, which is reprioritization of gross to net spend. So we're focused on all of those revenue driving, spend activities. And I will tell you in the first or in the second quarter that we just came off. We did increase investment in Home & Personal Care and we did in the Home & Garden business and we are planning to - as planned, both of those are as planned. The other two businesses as planned to will, were about flat year-over-year and we'll see step-up in investment as we go throughout the year. But as it relates to those individual line items, they vary by business depending upon what we think is the best way to reach our consumer.

[David Maura, Chairman and Chief Executive Officer]

And you'll hear more of this theme, as we get into kind of Q3 and we talk to you about some additional shareholder enhancement vitality at initiatives that we're undertaking. Again, I think you could parallel at some of our earlier comments about getting a very detailed dashboard of non-productive spend and so there's a lot of dollars that are being recycled inside of these units. But to Doug's point, I mean we could have probably reported twice the profitability of the appliance unit this quarter, if we hadn't stock with our discipline to invest in innovation and marketing, in the phase of a challenge quarter profitability wise particularly in that unit. So we are sticking with a discipline.

[Joe Altobello, Raymond James]

Okay. So for the full year, is the step up $20 million to $30 million, would you call it this year?

[Doug Martin]

That's not an unreasonable. The high end of that, it is not an unreasonable area.

[Joe Altobello, Raymond James]

And that's recurring right? That doesn't come -

[Doug Martin]

Yes. That will go on forever - that would not only go on forever, but as David mentioned, as we get through these productivity and efficiency initiatives, some of those savings we'd like to reinvest in future growth. And obviously some of that investment will go in these areas.

[Joe Altobello, Raymond James]

Okay. And just one last one, if I could squeeze it in for David. I guess how are you thinking about uses of cash given that you paid down a ton of debt already, you bought back some stock in the second quarter. It sounds like you want to pay down more debt in the back half of this year. Could we see more stock re-purchases or you done for this year? And how you think about M&A as well? Thanks.

[David Maura, Chairman and Chief Executive Officer]

No. Listen, I appreciate that. I think the greatest single use of cash that has the greatest single return on it is buying back our share. However, I just lived through a 12-month period of time where, we went through tremendous disruption operationally and we transformed the company through divestitures and deleveraging. I am committed to delivering a stable Spectrum Brands this year that has vision, clarity, focus and ends 2019, it is as the smarter, stronger - faster, smarter, stronger Spectrum Brands in the future. We - I believe - I've talked about wanting to get to kind of just more consistency, just real rhythm and cadence in the underlying operations and we're making progress.

I mean if you just look at every metric from kind of three quarters ago, two quarters ago and this quarter we are absolutely moving in the right direction. We still have plenty of wood to chop, I don't want to get out over my skis, but I think we - look, I'll tell you, we are starting to look at tuck-ins again. So I don't see anything big on the horizon, but if we can do tuck-in acquisitions that are very, very accretive that fit with our existing business units, and are highly accretive and synergistic, we'll look at that. But it's going to have to be very, very compelling, because buying our own shares at these prices, like I said, is probably the single best use of capital allocation we can make.

[Operator]

Your next question comes from the line of Karru Martinson with Jefferies.

[Karru Martinson, Jefferies]

Good morning, guys. On yesterday's Energizer call, they talked about the VARTA dispositions of that they're being forced to make and the slightly lower proceeds coming from that, expected. Is there any liability for you all as part of that?

[David Maura, Chairman and Chief Executive Officer]

So we sold that - the entire battery division for $2 billion. We have reserves $200 million, should that we needed. And we will wait to see when they complete the sale. But no, we've booked and we've disclosed that $200 million possible true-up. And that's capped it - does a cap of $200 million. And so, hopefully, they do better, but we'll have to work - we'll have to wait to see how they progress that M&A discussion, and who is the buyer and at what price.

[Karru Martinson, Jefferies]

Okay. And with the material debt pay down here. How should we think about pro forma interest in on a go forward annualized basis?

[Doug Martin]

If you - we will be filing the Q at the end of the day today. You'll see the debt table in there, it's very straightforward now it's - so you'll be able to calculate it on an annualized basis.

[Karru Martinson, Jefferies]

Okay. And just lastly, there's been some talk for other seeing some gains in the Home & Garden space for roundup equivalents. I was wondering if there was any sort of a lift for you guys in lawn and garden space.

[David Maura, Chairman and Chief Executive Officer]

Look, we have expanded distribution there. It's never enough for me, I want more, I think our products have better efficacy, I think our products are better for a lot of things. I have been warned about the comments I can make it even litigation against Monsanto and glyph sate. But Spectracide is an amazing product, it's a great product. We want to tell more people about its benefits and the fact that we think that it's a superior product offering at a great value price point. We want to continue to get that message out there. So that's why we are stepping up our investment marketing.

[David Prichard, Vice President of Investor Relations]

Okay, operator. It looks like we have one more questioner, so let's take that and then I think we'll close down the call.

[Operator]

Your final question comes from the line of Carla Casella with JP Morgan.

[Carla Casella, JP Morgan]

Hi, I wondered if you could give us an update on any expected impact of tariffs, if they are - if changes are made.

[David Maura, Chairman and Chief Executive Officer]

Yes. We would prefer both sides reach a consensus. They think that'd be the best interest of the globe and ourselves. I think that depending on how things progress this weekend, you know, look, we went through this fire drill last fall; we were prepared to pass the increase on January 1, we know it got extended to March and here we are. Obviously, this week has injected a lot of volatility; I don't know any more than you know, but I think the biggest problem for us would be, if demand elasticity, I mean, yes, if it were from a mechanical standpoint we receive Chinese product and we would have to write a check to the United States Treasury, but, we are going to have to pass that on, and, so ultimately the consumer is going to pay for it, where we have to have go through the fund that we don't enjoy doing with our retailers.

But if we end up in a tariff situation we'll pass it on and we'll see where the final demand is. But I don't think we are alone in this, and then you know, thank god, the majority of our businesses are vertically integrated on this side of the globe.

[Carla Casella, JP Morgan]

Okay, great. And then you mentioned the Appliance, personal care appliance lost a little bit of share, when do we cycle that? Was that something that's just started this quarter?

[Doug Martin]

No, it began last year in the first half of last year, and so will continue to lap it as the year unfolds, but thinks - comps should begin getting better in the US.

[Carla Casella, JP Morgan]

Okay, and then just on the - now that you've completed the divestitures and brought your leverage down and you expect to get to 3.5x. Is that a good long term, go forward level? And were that and all of your kind of cost savings and business investment initiatives? Do you think it's - are you starting to look at maybe adding to the portfolio with another leg of the stool?

[David Maura, Chairman and Chief Executive Officer]

Yes, I think in my earlier remarks I said look I really want to see consistency in the rhythm and cadence of the underlying earnings of the company. We are looking at small tuck-ins but these are not anything that would move the needle. I think our stock price is very attractive relative to the value of what people want for private assets. So it's got a high hurdle to get in here, and I think we want to deliver what we promised this year. We want to deliver the - keep the balance sheet down, but, I think as we get into some greater detail, we can talk to you - we are excited to talk to you more about it next quarter.

If we can really start to drive the EBITDA line, going into 2020 et cetera then it's obviously free cash flow improves and we would generate a lot of free cash over the remaining life of that buyback program, and we'd like to take advantage of it. So it's just - we are looking at a lot of things and we'll continue to be opportunistic is the best I can -

[Carla Casella, JP Morgan]

And on leverage - on the leverage you think is the 3.5x go forward or would you be willing to take that up or does that need to come down more?

[David Maura, Chairman and Chief Executive Officer]

We like 3.5x given what happened last year and that's where I would to see us run on a long-term basis.

[David Prichard, Vice President of Investor Relations]

Okay. Operator, well thank to David and Doug. We have exhausted our questions and nearly reached the top of the hour. So, we'll go ahead and conclude our conference call. On behalf of Spectrum Brands, we want to thank all of you for participating this morning in our fiscal 2019 second quarter earnings call. Have a good day.

[Operator]

Thank you for participating in today's call. You may now disconnect.