Spectrum Brands Holdings (NYSE:SPB)
Q1 2011 Earnings Call
February 10, 2011 9:00 am ET
David Prichard - Vice President of Investor Relations and Corporate Communications
John Heil - President of Global Pet Supplies
Anthony Genito - Chief Financial Officer, Chief Accounting Officer and Executive Vice President
David Lumley - Chief Executive Officer and Director
Terry Polistina - President Small Appliances Division and Director
Torin Eastburn - CJS Securities, Inc.
William Chappell - SunTrust Robinson Humphrey, Inc.
Hamed Khorsand - Beating Wall Street, Inc.
Karru Martinson - Deutsche Bank
Reza Vahabzadeh - Lehman Brothers
Mary Ross Gilbert
Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands First Quarter Fiscal 2011 Earnings Conference Call. [Operator Instructions] I would now like to introduce Mr. David Prichard, Vice President of Investor Relations. Mr. Prichard, you may now begin your conference.
Thank you, Michelle, and good morning, and welcome to Spectrum Brands fiscal 2011 first quarter earnings conference call and audio webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands and your moderator for today's call.
With me this morning to lead the call are Dave Lumley, our Chief Executive Officer; and Tony Genito, our Chief Financial Officer. Also with us today for the Q&A session are Terry Polistina, President, Global Appliances; and John Heil, our President of Global Pet Supplies.
Now our comments today include forward-looking statements including our outlook for fiscal 2011 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 February 10, 2011, and our most recent SEC filing and Spectrum Brands Holdings' most recent 10-K. We assume no obligation to update any forward-looking statement.
Additionally, please note that we will discuss certain non-GAAP financial measures during our remarks, including adjusted diluted earnings per share, adjusted EBITDA, free cash flow and net sales excluding foreign exchange translation. Spectrum Brands' management uses these metrics because it believes they first provide a means of analyzing the company's current and future performance and identifying trends; and second, provide further insight into our operating performance because they eliminate certain items that are not comparable either from one period to the next or from one company to another. Additionally, adjusted EBITDA can also be a useful measure of a company's ability to service its debt and is one of the measures used for determining the company's debt covenant compliance.
Also, management believes that free cash flow is useful to both management and investors in their analysis of the company's ability to service and repay its debt and to meet its working capital requirements. Free cash flow should not be considered in isolation or as a substitute for pretax income or loss, net income or loss, cash provided by or used in operating activities or other statement of operations or cash flow statement data prepared in accordance with GAAP or as a measure of profitability or liquidity.
In addition, the calculation of free cash flow does not reflect cash used to service debt and therefore does not reflect funds available for investment or discretionary uses. While Spectrum Brands' management believes that these non-GAAP financial measures are useful supplemental information, such adjusted results are not intended to replace the company's GAAP financial results and should be read in conjunction with those GAAP results.
I want to caution the audience that although net income is the GAAP measure from which adjusted EBITDA is derived, projected adjusted EBITDA results discussed during this call may differ significantly from net income results due to factors not included in the calculation of adjusted EBITDA.
Now in our press release dated February 10, 2011, which has been furnished on a Form 8-K filed with the SEC, we have provided the reconciliations for the following non-GAAP information in the tables indicated: first, in Table 3, a complete reconciliation of diluted loss per share on a GAAP basis to adjusted diluted earnings per share; second, in Table 4, a reconciliation of GAAP net income or loss to adjusted EBITDA for the three months ended January 2, 2011, versus the three months ended January 3, 2010, and the three months ended December 28, 2009; and third, in Table 6, a reconciliation of GAAP net income to adjusted EBITDA on a consolidated prospective basis for the 12 months ended September 30, 2011; and four, in Table 7, a reconciliation of net cash provided from operating activities to free cash flow for the 12 months ended September 30, 2011.
A copy of the 8-K is available on our website at www.spectrumbrands.com under the Investor Relations section. We will provide reconciliations of net sales, excluding foreign exchange, during this call.
Effective October 1, 2010, the company's chief operating decision maker decided to manage the businesses in three vertically integrated product-focused reporting segments: first, Global Batteries and Appliances, which consists of the company's worldwide battery, shaving and grooming, personal care, small electrical appliances in the kitchen and home product categories, and portable lighting business; second, Global Pet Supplies, which consists of the company's worldwide pet supplies business; and third, the Home and Garden business, which consists of the company's lawn and garden, and insect control businesses.
This current reporting segment structure reflects the combination of the former Global Batteries and Personal Care segment with substantially all of the former Small Appliances segment, which consists of the Russell Hobbs businesses acquired on June 16, 2010, to form Global Batteries and Appliances.
In addition, certain pest control and pet products in the former Small Appliances segment have been reclassified into the Home and Garden business and Global Pet Supplies segments, respectively. These reclassifications have been made for all periods presented.
Now let me take a moment to review our GAAP results. For the first quarter of fiscal 2011, the company reported a GAAP net loss of $19.8 million or $0.39 per diluted loss per share, compared with the net loss of $60.2 million or $2.01 per diluted loss per share. In addition, the company reported a GAAP net loss of $112.6 million for the first quarter of fiscal 2009.
Now by segment. For the first quarter of fiscal 2011, the Global Batteries and Appliances segment reported net income of $79.4 million versus $47.0 million a year earlier. The Global Pet Supplies business segment reported net income of $13.4 million in fiscal 2011's first quarter versus net income of $300,000 in fiscal 2010.
And finally, the Home and Garden business segment reported a net loss of $7.5 million in the first quarter of fiscal 2011 versus a net loss of $18.7 million in fiscal 2010.
During the course of our comments today, unless we say otherwise, current year results relate to the fiscal first quarter of 2011 while any references to prior year results are for the first quarter of fiscal 2010.
Also unless we state otherwise, all results provided today for the quarter are provided on a pro forma basis, assuming that Russell Hobbs' results of operations have been included in Spectrum's portfolio since the beginning of the respective period discussed.
With that, I am pleased now to turn the call over to our Chief Executive Officer, Dave Lumley.
Thanks, Dave, and thanks to all of you for joining us on the call this morning. I'm pleased to report Spectrum Brands is off to a solid start for fiscal 2011, building upon the momentum we created as we closed out fiscal 2010. The message I want to leave you with today is one about excitement about our future. We are on track. We're ahead of schedule in, one, the strategic development growth of our businesses; two, our financial results; three, the strengthening and deleveraging of our balance sheet; four, our across-the-board operating cost reductions; and five, our synergies and synergy estimates from those actions.
Earlier today, we reported record quarterly net sales in adjusted EBITDA for the first quarter of fiscal 2011 as we reconfirmed our full year guidance, which was given during the fiscal 2010 year-end call in early December. The takeaway from this is we are continuing to see very real success from our Spectrum Value Model [ph] (28:44). This model, which is at the heart of our operating approach, focuses squarely on enhancing retailer margins, introducing superior valued new products and product line extensions and rigorously reducing costs across our company, all of this to create the most efficient operating structure we can. This Value Model permeates all of our businesses.
Adjusted EBITDA for the first quarter of fiscal 2011 was a strong $123 million, that's nearly a 5% increase versus the $117 million last year and was led by improvements in our Global Batteries and Appliances and Home and Garden business segments. When adjusted for the negative impact of foreign currency, the quarter-over-quarter growth was an impressive 12.5%.
Importantly, we also made two voluntary prepayments of $50 million and $20 million in the quarter to reduce our original $750 million senior secured term loan, down to $680 million. This began a continuous and aggressive debt paid out program to reach our target leverage of 3x or less over the next two years. As we have said, we anticipate a cumulative debt reduction on our term loan of at least $200 million during fiscal 2011. This would reduce the principal amount to a minimum of $550 million versus the original $750 million.
Let's talk about our first quarter performance, which Tony will review in even more detail, but it was solid. We reported a 2.4% net sales growth after including the Russell Hobbs businesses for the first quarter 2010, and a 4% growth when adjusted for the negative impact of foreign currency. Leading the net sales growth were our Global Battery and Personal Care categories, which posted increases of 3% and 10% in the first quarter.
In particular, Remington sales reached an all-time high quarterly level, as the business saw a significant market share gain in key categories based on new product introductions and distribution gains. In fact, Remington was the fastest growing hair care brand and the number one hair straightener brand in food, drug and mass retail outlets in both dollars and units in the United States market for the fourth fiscal quarter of 2010, this according to Nielsen. Remington was also the number two hair appliance brand in food, drug, mass market retail outlets, showing the fastest growth in certain categories in both dollars and units in the U.S. market for the same fourth quarter of 2010.
Our Worldwide Battery business continues to grow with its product performance strategy of last as long for less. In North America, we have reached a record level of alkaline share with our value proposition. In Europe and elsewhere, we remain a significant player in all key markets with a solid number two position. In Latin America, we remain the number one battery player with the best overall alkaline and zinc carbon performance.
Finally, we also are the number one worldwide market share leader in hearing aid batteries.
We are still dedicated to develop new programs for batteries to ensure we continue to win a point of sale with value performance. In addition, we are committed to our global new product development approach with continuous cost improvement to drive ongoing cost reductions and offset rising commodity cost inflations.
In summary, we will continue to aggressively support our battery business as an integral part of our strategy.
We also enjoyed a good North American holiday season for our battery and personal care products, highlighted by excellent in-store placements and promotion. In the process, we maintained or grew our market share with our pledge of providing the same performance at a lower price or providing better performance for the same price. This is coupled with our ever present focus on winning a point of sale. This is also a result of a collaboration with our key customers and key placements wins achieved many months ago for the 2010 holiday period. Again, we believe our Spectrum Value Model with its focus on point of sale, consumer value and retailer margins was the key success we had during the Christmas season.
We're also very pleased at the pace of the integration of Russell Hobbs, and continue to be confident of achieving and more likely exceeding the $25 million to $30 million level of cost synergies we have projected over the next several years. Additional opportunities are also present to capture revenue and new product development synergies as we begin leveraging each company's regional strengths in complementary categories. We're also excited about our opportunities to improve Russell Hobbs’ supply chain and cost activities. To that end, we are starting to see some initial progress already in Eastern Europe, using our battery and personal care platforms we have established there. Such revenue and supply chain opportunities are not included in the $25 million to $30 million of forecasted business for Russell Hobbs.
Now in addition to Russell Hobbs, we have significant integrations also occurring at this time in our Global Pet business where we continue to forecast annualized cost savings of $7 million to $11 million over the next several years as the business consolidates plants, systems and distribution centers. So combining the projected Russell Hobbs synergies of $25 million to $30 million with the pet cost savings of $7 million to $11 million, we are forecasting total synergies from these restructurings and consolidations of $32 million to $40 million and likely more over the next two years.
We've also completed the relocation of our corporate headquarters from Atlanta, Georgia. to Madison, Wisconsin, and the consolidation of distribution centers, offices and our headquarters for our Home and Garden business from Atlanta to St. Louis.
In short, Spectrum Brands now has a streamlined organization, one that is totally aligned along global business units and connected to a global shared services platform.
In addition to organic growth in our business segments and a focus on driving more volume to our plants to improve capacity utilization, we will continue to look for small accretive [indiscernible] (35:30) acquisitions for Pet and Home and Garden divisions in the months ahead. Our Birdola wild bird seed acquisition for Pet in December for $12.5 million is an excellent example of what I'm talking about.
As we move Spectrum Brands into a promising new era, we have a clear roadmap and a multiyear strategy in place, along with a tested management team with demonstrated accomplishments and experience in their industries. Our Spectrum Brands vision is clear: To be the leader in retailer metrics with superior value consumer products for everyday use.
I want to stress Spectrum Brands has compelling opportunities for continued market share growth around the world along with corresponding increases in EBITDA. We have the means now to generate strong free cash flow. This free cash flow is built on a diversified revenue stream, attractive margins, hop [ph] (36:32) one, two or three global market positions, all with trusted, extendable and enduring brand names and in categories with room for distribution growth.
I'll close with one final point about fiscal 2011. Our guidance for this year is not built upon expectations for a meaningful consumer spending rebound or economic recovery. We are also well aware of rising costs, especially coming from Asia and of the suppliers there. But a key strength of our company is that most of our products are nondiscretionary, replacement products providing value, quality performance to consumers in everyday living. This, along with our Spectrum Value Model, to us is a winning proposition.
Let me turn over now to Tony for a detailed financial review.
Thanks, Dave, and good morning, everyone. I'm pleased to say that we've continued our momentum from fiscal 2010 by completing a solid fiscal 2011 first quarter. This positions our company well for further operating and financial progress in the rest of this fiscal year.
The company reported consolidated GAAP net sales of $861 million for the first quarter of fiscal 2011, up 45.5% from $592 million in the year-ago quarter. The addition of Russell Hobbs businesses as of June 16, 2010, and solid sales growth in both Global Batteries and Remington, which we refer to as Personal Care, drove the net sales increase. These results were negatively impacted by $14 million of foreign exchange. When we included the fiscal 2010 first quarter results of Russell Hobbs, net sales for 2011 first quarter of $861 million increased 2.4% versus $841 million last year. Excluding the negative foreign exchange impact, net sales increased 4.1% in the first quarter of fiscal 2011 versus last year's first quarter.
The company's gross profit for the first quarter improved to $299 million, an increase of 62.2% from $185 million for the same period last year. Total operating expenses for the first quarter were $230 million, up from $166 million for the comparable quarter last year. The increase of about $65 million was driven by: one, $49 million related to the addition of Russell Hobbs businesses; and two, $14 million primarily related to acquisition and integration-related charges incurred in connection with the Russell Hobbs transaction.
Corporate expenses for the quarter were $11 million, down slightly from $12 million for the same period last year. As a percentage of consolidated net sales, corporate expense for the first quarter was 1.3% versus 2% for the 2010 first quarter. This reduction in expense was driven by synergy savings from the move of our world headquarters from Atlanta to Madison.
For the first quarter of fiscal 2011, the company recorded a GAAP net loss of $20 million or $0.39 per diluted loss per share versus a net loss of $60 million or $2.01 per diluted loss per share in 2010. After adjusting both years for certain items, management beliefs are not indicative of the company's ongoing normalized operations. The company generated adjusted diluted earnings per share of $0.47, a non-GAAP number, for the first quarter of 2011 compared with adjusted diluted earnings per share of $0.42 in fiscal 2010's first quarter. These adjustments, which aggregated to $0.86 and $2.43 per diluted share in the first quarters of 2011 and 2010, respectively, are spelled out in detail in Table 3 of the earnings release. So in the interest of time, I won’t go through that here.
2011's first quarter consolidated adjusted EBITDA was $123 million. This was a healthy 4.5% increase versus the very strong consolidated adjusted EBITDA for the first quarter of fiscal 2010 of $117 million, which includes the results of Russell Hobbs as if combined with Spectrum Brands as of the beginning of last year's first quarter. Foreign exchange had a $9 million negative impact on adjusted EBITDA in the first quarter of 2011. Excluding the negative foreign exchange impact, adjusted EBITDA grew 12.5% in the first quarter of 2011 versus the first quarter of 2010. So we are off to a good start toward achieving our target of adjusted EBITDA of $455 million to $465 million in fiscal 2011.
We are very pleased with these results and we believe they reflect the momentum of our businesses, especially considering that our adjusted EBITDA in the first quarter of fiscal 2009, which again after adjusted for the results of Russell Hobbs, was $74 million. I know you can do the math, but that translates into an increase of 65.8% in our adjusted EBITDA from the first quarter of fiscal 2009 to our fiscal 2011 first quarter.
Now let's review our first quarter segment results.
Led by solid top line growth in the Worldwide Battery and Personal Care Product categories, the Global Batteries and Appliances segment reported fiscal 2011 first quarter net sales of $697 million versus $429 million in the first quarter last year. First quarter 2011 segment sales were negatively impacted by $12 million of foreign exchange. Including the Russell Hobbs businesses as if combined with Spectrum in last year's first quarter, the segment's 2011 first quarter net sales of $697 million increased 3.7% versus $672 million a year earlier.
First quarter Global Batteries sales were $274 million, paced by a strong North American performance, compared with $266 million a year earlier or a 3% increase. Foreign exchange negatively impacted these results by $9 million. Despite continued competitive pressures in North America, battery sales grew 15.2% or $126 million with market share continuing to grow. European battery sales for the quarter, which were negatively impacted by $7 million of foreign exchange and where the company continued its voluntary exit of low margin, private-label sales, were $97 million compared with $104 million during the same period last year. Because of our continuing focus on profitable growth, despite a smaller top line in the region as a whole compared with a year ago, Europe's branded battery business saw an improvement in sales and profits. Finally, in Latin America, battery sales were $48 million for the first quarter, a decline of 3.6% versus $50 million in the comparable period last year. Foreign exchange negatively impacted Latin American battery sales by $3 million.
Reflecting growth across all geographic regions, net sales for the Global Personal Care product category, or the Remington branded products, rose a strong 10.3% to $180 million in the first quarter of fiscal 2011, a record quarterly level versus the $163 million for the same period last year. The net sales growth was attributed to a combination of new product introductions, line extensions and expanded in-store promotions. Foreign exchange negatively impacted these results by $4 million.
The small electrical appliances products unit of the Global Batteries and Appliances segment, consisting predominantly of the Russell Hobbs businesses, [indiscernible] (00:44:54) connected sales in the first quarter of fiscal 2011 of $243 million, unchanged from the previous year's quarter after including the Russell Hobbs businesses with Spectrum in that quarter. Continuing softness in North America was partially offset by higher international sales, primarily in Europe. Foreign exchange positively impacted this product category's net sales by $1 million. With segment net income of $79 million, the Global Batteries and Appliances segment reported adjusted EBITDA of $111 million for the first quarter of fiscal 2011, an increase of 4.1% versus adjusted EBITDA of $106 million in the year-earlier quarter when segment net income was $47 million. Excluding a negative foreign exchange impact of $8 million, adjusted EBITDA for this segment improved 11.9% over the first quarter of fiscal 2010.
Turning now to Global Pet Supplies. This business segment reported net sales of $137 million for the first quarter of fiscal 2011, which was flat with the comparable year-ago period. The reclassification of certain pet products since the Global Pet Supplies segment from the former Small Appliances segment accounted for a net sales increase of $4 million in the fiscal 2011 first quarter. However, this was offset by a continuing softness in the North American aquatics category due to macroeconomic factors. Foreign exchange negatively impacted these results by $2 million.
Net income for the segment was $13 million for the first quarter of fiscal 2011 versus $300,000 in the prior year's quarter. As a result of product mix and modest remaining expenses from the companion animal recall that we discussed in the fourth quarter of fiscal 2010, adjusted EBITDA of $22 million for this segment in the first quarter declined from $24 million in the same period last year.
As we continue to consolidate some of our operations and facilities within this business segment, we anticipate capturing an additional $7 million to $11 million in cost savings between now and the end of fiscal 2012. We expect to see a meaningful part of these savings start to appear in the second half of fiscal 2011.
The Home and Garden business segment reported net sales of $28 million for the first quarter of fiscal 2011, an increase of 4.6% from $26 million for the same period last year. This was primarily the result of the reclassification of certain pest control products into the Home and Garden business segment from our former Small Appliances segment. Let me remind you that the first quarter of the fiscal year is generally a period of internal inventory building in advance of Home and Garden's major selling season, which is typically in the spring and summer months.
In fact, first quarter net sales [indiscernible] (00:47:48) are typically less than 9% of full year net sales. Home and Garden recorded a first quarter net loss of $8 million which is, nonetheless, a significant improvement compared with a net loss of $19 million in 2010's first quarter. As a result of operational excellence initiatives including strong cost controls, Home and Garden improved its adjusted EBITDA by 12.8% to a loss of $3 million in the first quarter of fiscal 2011 from a $4 million loss in the same period last year.
Let me review a few more items in our first quarter financial statements.
Interest expense for the first quarter of 2011 was $53 million compared with $50 million for the same period last year. This variance was primarily due to the increased debt that was acquired in connection with the merger with Russell Hobbs as well as an increased principal balance on our 12% pick notes. Cash interest for the fiscal 2011 first quarter was approximately $54 million, compared with approximately $24 million for the same period last year. Cash payments for fiscal 2011 were higher primarily due to timing as a result of the change in our capital structure.
Tax expense for the fiscal 2011 quarter was $35 million compared to $22 million we paid last year. Cash taxes for the 2011 first quarter were approximately $12 million compared with $7 million for the same period last year. Cash taxes are higher for fiscal 2011 due to higher profits in some of our foreign entities, the inclusion of Russell Hobbs in 2011 versus the same period in 2010, as well as various timing differences in payments year-over-year. As I've said before, based upon the level of NOLs we expect to be able to utilize, we do not anticipate being a U.S. federal taxpayer for at least the next five years. We will, however, continue to perform [ph] (00:49:48) in a very small amount of state cash taxes. Cash taxes are expected to be approximately $45 million to $50 million in fiscal 2011.
Let's turn to a review of our solid liquidity position. We finished the first quarter of fiscal 2011 with approximately $44 million drawn on our $300 million ABL working capital facility, consistent with normal business seasonality and with a cash balance of about $83 million. At the end of the quarter, total gross debt was $1,756,000,000 which consisted of a senior secured term loan of $680 million, senior secured notes of $750 million, subordinated notes of $245 million, the working capital facility draw of $41 million and other debt, primarily foreign, of $37 million. In addition, we had approximately $36 million of letters of credit outstanding.
Regarding our cash flow projections, as we've previously stated, given the strong cash flow potential of our businesses, we expect to generate between $155 million and $165 million of free cash flow for fiscal 2011 and more than $200 million for fiscal 2012 and beyond. We still expect capital expenditures to approximate $40 million in fiscal 2011 of which more than 2/3 represents investments and new product development cost reduction projects.
As Dave mentioned, given our very solid adjusted EBITDA in 2010 and our strong liquidity position, we are pleased to have made voluntary prepayments, which totaled $70 million during the first quarter to reduce our $750 million senior secured term loan to $680 million. This is the start [indiscernible 00:51:44) of our primary corporate financial objectives, using our strong free cash flow to aggressively pay down debt and thereby reaching our target leverage of 3x or less in the next two years. As part of that plan, we are targeting a cumulative debt reduction of at least $200 million in fiscal 2011. Let me point out that the difference between our $200 million cumulative debt reduction target in fiscal 2011 and our estimated free cash flow of $155 million to $165 million is due to a reduction in our cash balance.
As most of you know, on February 1, we completed the refinancing of our existing $680 million senior secured term loan at a lower interest rate, which we believe reflected improved credit market conditions and the company's strong performance and favorable outlook. This new facility issued at par and due June 2016 reduces our interest rate spreads by 250 basis points and our LIBOR floor by 50 basis points for a total 300 basis points savings. At today's interest rates and assuming a $680 million term loan balance, this pricing would reduce the company's annual cash interest expense by more than $20 million. In connection with the refinancing, the company expects to record a pretax charge of approximately $43 million, of which nearly $36 million is non-cash in the second quarter of fiscal 2011 ending April 3, 2011. This charge primarily represents the write-off of deferred financing fees and original issued discount associated with the financing back in June.
In summary, our first quarter performance confirms our expectation with continuing operating and financial momentum in fiscal 2011. To reiterate, we expect to see top line growth of 3% to 4% in fiscal 2011, as well as expecting increase in adjusted EBITDA this year of $455 million to $465 million. And we continue to project that free cash flow will reach $155 million to $165 million in fiscal 2011 and at least $200 million in fiscal 2012 and beyond.
This will allow us to set the date for additional voluntary debt prepayments, even after we continue to expand our businesses with new product developments, line extensions and increased in-store placements while we create a low-cost and efficient operating structure.
Finally, we’ve targeted an additional $1 billion of enterprise value over the next several years, specifically by the end of fiscal 2013, if not sooner. We see this resulting from a combination of continuing growth in adjusted EBITDA and aggressive debt reduction. We believe the combination of the two should enable us to reach the target of $1 billion of enterprise value. Our management team is focused on delivering greater shareholder value and growth in the quarters and years ahead.
Let me now turn it back to Dave for a few closing remarks before the Q&A.
Thanks, Tom. We're excited about Spectrum Brands' outlook for value creation, both in the short term and over the long term. Our company continues to be well positioned for strong financial results as a global, superior value proposition leader. As our earnings release said, and as Tony described, we expect another year of improved sales in fiscal 2011 and significant increases in adjusted EBITDA, free cash flow and along with more than $200 million of debt reduction. This will lead to an even stronger balance sheet and significantly reduce leverage over the next several years.
More importantly, we will persist on what we believe is a winning strategy for our businesses: providing superior margins for our customers and offering consumers products with the same performance at a better price or better performance at the same price as leading brands. We will move forward, continue to invest in all of our businesses, reduce our cost structure, launch new products and product extensions, expand geographically, but more importantly, grow EBITDA and pay down debt, grow EBITDA and pay down debt; and we'll do this by generating strong free cash flow for our shareholders.
Thank you all for tuning in. We're now ready for your questions.
Operator, if you could now begin the question-and-answer session please?
[Operator Instructions] Your first question comes from the line of Bill Chappell from SunTrust.
William Chappell - SunTrust Robinson Humphrey, Inc.
I just wanted to first dive into the outlook and maybe what you're seeing on the battery side in terms of the price rollback -- the price increases that everybody's taking this quarter. When do you expect that to kind of benefit your bottom line? And then second question on commodities in general. I don't know if you really quantified what you see as the commodity basket increasing year-over-year and how hedged you are, I know certainly on zinc and on some other things you are, but on some of the other items kind of where you stand?
This is Dave Lumley. I'll answer batteries. I'll make a comment on commodities and then have Tony talk about the hedges that we have on materials as well as financial hedges. I think that the outlook for batteries, especially in the second half this year, is much better than it’s been over the last 18 months. There is pricing in the market by the leading companies on some of the battery types, 9 volts, Cs and Ds. The change in strategy of more batteries by all the 3D battery companies and changing that to a [indiscernible] (00:57:54) more normal and balanced approach. But I think, we know it will take probably the first half of this calendar year for all that field inventory to sell through, and that field inventory is being heavily discounted to sell through. But by the second half of the year, I think that this will be a much stronger picture for everybody in those terms. I think the other thing that I want to continue to stress to all of you is that the battery business from a cell usage, meaning the total cells that were consumed last year, were flat to the year before. They weren't down. Batteries tend to be consumed by usage as long as there's more people and devices, the battery business is okay. All that happened last year is that a lot of people gave 20% more batteries away, so that took down units, pack sizes and it took down dollar sales. I think you are going to see more return to rationality as we go forward. So I think it's cautiously optimistic outlook.
Now in terms of commodities, we’re three business segments, four, five different types of business, all of them have a different story. I think in batteries, there's zinc and other chemicals, materials costs are up, no doubt about it, and that affects all the battery companies. None of the pricing that you see out there should deal with a lot of it. I think less batteries will deal with a lot of it and the pack, so I think the battery business will be okay. We'll have to wait and see.
Our other businesses, Home and Garden and Pet are pretty well balanced. They don't buy as much from Asian suppliers. When you think about our Appliance business, and that is going to have an impact. It's going to have an impact on our Russell Hobbs, our Black and Decker and is going to have an impact on every single other appliance and personal care maker because they all come out of the same place. So pricing is probably going to come into that market next year as we move along -- and more consolidations, so everyone's preparing for that. Now regarding -- we spent a lot of time on hedges in material, and financial, and, Tony, you may want to talk about that.
Sure. From a hedging standpoint, I’m not going to get into the specifics. It's probably good to bring the picture too, here. I think most people know this but I'll reiterate it again, and that is there's no one single commodity that quite often keeps me up at night. For instance, zinc, we constantly focus on zinc. But zinc represents about 1.5% of our consolidated cost of sales. And as Dave said, there's other chemicals out there that prices fluctuate, and we see periods where they're going up and they're coming down, and they do have a loose negative correlation to currency, which also impacts us since we're a global company. But for everybody's sake on the phone, we do have a very disciplined hedging program. We do hedge zinc which is a component in the manufacture of batteries. It's a very disciplined program, as I said. We have a rolling six-quarter average that we put in a certain layer every quarter, so it becomes almost $1 averaging. And right now, we are currently hedged over 70% of our projected purchases for 2011 and about 50% for 2012. So we look to layer in a fixed amount as I said. And then if we see an opportunity -- again, this is not to play the market. This is really just to take a variable off the table. If we see an opportunity where the prices seem to dipping, we might put a discretionary additional hedge on top of the fixed amount that we have for our policy.
With respect to currencies, about 70% again of our currencies have been hedged for 2011 and about 25% for 2012. I think it's also important to note that we feel pretty good about '11 because -- just a little tidbit, the Appliance business, which is part of the Global Batteries and Appliances segment, the Appliance business which is obviously the former Russell Hobbs and the Remington business, about 40-plus percent of the EBITDA of that business is behind us through the first quarter. So that's basically "in the bag." So that's a good thing. And again we continue to hedge currencies in a very disciplined process that we've instituted, and we feel pretty good about that. The business is a complex business. There's a lot of moving parts, a global business like I said. It's typically -- we've got commodity impacts, we've got foreign exchange impacts, and there's a loose correlation between those two as I said, and usually they are inverse to one another. So with all the moving parts, we feel that we can manage through the white waters ahead, and like Dave said, what's impacting us is impacting every other company out there as well.
William Chappell - SunTrust Robinson Humphrey, Inc.
I assume you're unchanged top line guidance basically is not assuming any price increases taken this year, though it sounds that's likely. And then also on the battery side, would you expect the March quarter to be pretty, for lack of better words, ugly as you see discounting pushing up, plus is there some kind of hangover instead of selling one pack of 12, last year you're selling one pack of 15, so the pantries are fuller than normal?
To the first point, pricing in some markets is going up. We are gaining pricing on some global markets and some segments everywhere, and some are more difficult. As I originally said, Bill, all you have to do is open the Sunday circular, and you could see the discounting. And I think that it's flushing through, and everyone's motivated to do that. And I think like I said the first half of this calendar year, this thing will flush through in the second half should be returned to normalcy. That's what it looks like.
Your next question comes from the line of Reza Vahabzadeh from Barclays Capital.
Reza Vahabzadeh - Lehman Brothers
You talked about the North American business, the batteries gaining share in sales. If you can just talk about what is driving that, is it shelf space, new customers or expanding shelf space at the existing customers? And then on the other hand, pet sales were lower year-over-year as were Russell Hobbs in the North America, can just you talk about those three segments sales trends?
This is Dave Lumley. I'll address batteries, and then we're fortunate to have our presidents of those two divisions, Pat and Russ Hobbs [ph] (01:05:22), and they can give you a brief answer [indiscernible] (01:05:25). Our battery sales increases are for the most part across the board sales and distribution gains within our existing customers. We're in mass market. We're at home centers. We still have a lot of attention on the industrial channel and the hearing aid battery channel with audiologists. We're a little different there than others. We made a concentrated effort to grow all those and we've also been able to open up some new business that we haven't gotten before in the food and drug channel, and some other mass merchants, and this isn't just United States. We've just had some major recent wins that we can't disclose yet but we will soon, in Europe and Latin America in the Battery business. So it's a concentrated effort on our part to continue to move our value proposition to the retailer in the Battery business. So it's pretty much even across the board. Now remember, our share in the United States is much less than the two leaders. So for us, every point of gain is much more dramatic, whereas in Latin America, we're the leader. We’ve gained a couple of points of share, but that's on a basis of a high share, same in Europe. But if you add all that together in this environment, it's pretty good. And I think it goes back to the fact that our batteries lasts as long as the premium priced batteries, but you get a better value and get a few more batteries or you get a better price. Maybe John Heil, you'd like to talk about Pet for a moment?
Let me break it down into a few different parts. First, as I mentioned on the last call, we lost some distribution on our companion animal business. The first quarter is the third quarter that we have of that loss, and the next quarter will be the last quarter, then we will have anniversaried. So I'm still dealing with that which is having a negative impact on my companion animal business. Without that particular loss of distribution, our companion animal business is actually up versus a year ago and doing very nicely, and we feel good about the rest of the year. In Europe and rest of the world, our volume is up modestly. Europe is doing quite well on the companion animal. Aquatics is flat. Rest of the world, other than Europe, pretty much the same. Our North American Aquatics business is dealing with a soft category, and we are finding customer by customer differences. Some customers are up, and some are off. But overall, net-net, the industry on aquatics continues to be down versus a year ago, and that's a large part of our portfolio.
Terry, you want to talk about Appliances in North America and overall sales?
Yes. First of all, Dave mentioned in the opening remarks how well the Personal Care business did, and I think that's a direct reflection of the Spectrum Brands' globalization of that category. And we're going to copy with pride [ph] (01:08:47) the same thing in the home side of the business. But around the globe, we did very, very well, and Personal Care, very strong internationally, and Home, the one soft spot would have been in the United States. And as John said, we had a little bit of lost distribution prior to the merger that we've recently got back. So we're feeling very good about growing in the future. But that probably is our one weak spot around the globe was North America, in particular the U.S. Home business.
Reza Vahabzadeh - Lehman Brothers
Besides zinc, Tony you mentioned that the small ingredient cost for you -- but besides zinc, what are the other larger or commodity costs that you spent time thinking about?
That's a great question, Reza. There really isn't a lot. There's other chemicals for instance, there's EMD which is manganese ore, that's about the same percentage of zinc on a consolidated basis for batteries. But after that, of course, there's steel, there's gas prices, oil prices and packaging materials and of course, fuel costs, transportation costs, and so. But there's not one of those items that represent something that’s a deal breaker. Maybe the best way to analogize it is, if you think about our former fertilizer growing media business, we had three commodities that went into the bags. It was diammonium phosphate or DAP, potash and urea. And basically [indiscernible] (01:10:30) commodities, so I lost a lot of sleep back when we the FDM [ph] (01:10:34) business because every day you’d want to know what the price of urea was. Unfortunately, it was tripling or quadrupling in that year, the last year we had that business. But there's no commodity that we have that really moves the deal, for example “Boy, we’ve got to watch that,” and “That's going to [indiscernible] (01:10:54) take away the or shape the way business is going to go.” Obviously, there's commodities that go into all of our products, and they have impacts, but I'll say that they're slight impacts as opposed to something -- a mammoth move like the commodity prices of urea, DAP or potash.
This is Dave Lumley. I think that's an important point for the products that Spectrum Brands sells. There is no overriding giant one commodity. Like you said, in fertilizer, you could think of the plastics industry, there are certain companies that give 40%, 50%, 60% of their cost of goods is [indiscernible] (01:11:30). And that's a real problem. So I think the bigger issue for all companies today is the rising inflation in China, and how that is rolling into an overall cost increase for all companies that source from that Asian country, whether it's the duties, the inflation, the labor, the freight, the commodity, and even that country's inward turn towards taking care of their own market growth. So that is something that I think that companies who do a good job will do a good job over the next couple of years, and those who don't are in for quite a surprise.
Your next question comes from the line of Torin Eastburn from CJS Securities.
Torin Eastburn - CJS Securities, Inc.
First question is on Personal Care in the shavers, that industry has been strong. Your performance within the industry has been strong. What's your outlook both for the industry going forward? And what are the things you think you can do to continue …?
This is Dave Lumley, and then I'll have Terry jump in. Terry just inherited the Shaver business. Are you talking about men's electric shavers? Or are you talking about shaving, in general?
Torin Eastburn - CJS Securities, Inc.
Well, mostly, the whole Personal Care segment.
Well, we have a joke around here. We don't know too many women or men who leave their house without cutting, shaving their hair and shaving. So we feel pretty good about that, and that goes back to what we talked about nondiscretionary products for everyday use. I think what you're seeing is that the price increases in wedge shape for the handle and blade are so pronounced over the last three to five years. You go back and see what it cost five years ago and what it costs today, it's hard to imagine that you can buy our best-selling rotary shaver for $39, and the payback is about two or three months versus wedge shape, which is really kind of hilarious if you think about it. So I think what you're getting at is men who are more attuned to personal grooming, not only on shaver, but all these grooming devices that we sell, beards or 2-day growth, or trimming body hair and all those types of things and the wet good that goes with it and the accessories. And on the women's side, same thing, the cost of going to a salon -- instead of going every week, it could be every other week as they can get devices, whether it's a straightener, a curling iron, a dryer and some of the accessories that go with it, the wet goods that go with it, so a little bit more of do-it-your-own, a little bit of price shock from what I would call the wedge shape blade business. Even though they're doing well in pockets, but not overall. You think about where most people shop and the large mass merchants' price points are important and total outlie of how much money you're going to spend is important. We live in a world today where some people only buy the gas they need for the next couple of days; they don’t put $100 of cash in their car. So the same thing is true here. I think it's just better products that perform better. One of the reasons we're selling more shavers is we came out with a new product that flexes and pivots and it works better, same with the grooming thing; and on the women's side, faster products that straighten their hair, dry their hair faster and do things they just do [indiscernible] (01:15:13). So product innovation, better price points, more do-it-yourself, a little more attention to it, while the big mass merchants are spending more attention on especially the women's side of beauty as they see that opportunity and the wet goods. So it's kind of a fusion of all those things. And Terry, you want to add anything to that?
I think you captured it. The product pipeline that we have is coming out -- certainly on the Personal Care side of business doesn't keep me up at night as far as where we're going to grow in my segment. So I feel good about the growth that's going to come out of PC.
Torin Eastburn - CJS Securities, Inc.
In the Home and Garden business, I would imagine you're getting close to receiving orders for the selling season, if not starting to get them already, what is the outlook as early as it is for Home and Garden?
You know last year, there was an unusual early launch to Home and Garden. There was great weather. There was tremendous enthusiasm. Everyone's shipped a lot early. Everyone sold a lot early. Everyone extrapolated that we're going to sell twice as much. It was a very good year, but it all kind of balanced back out. This year, I think, the industry has to overcomp that in the early launch, but nevertheless, there continues to be strength at big mass merchants, in particular home centers in North America, of people taking care of their lawns and spending more times in their backyard. So you're right. All the orders and decisions were made long ago. You have to build that all winter, which is partially why you lose money in the first quarter because you don't ship anything [indiscernible (01:17:11). But with very strong orders, very strong distribution gains, I anticipate a very, very robust Home and Garden season again. And I believe that our Home and Garden division now that it's singularly focused on selling herbicides and pesticides in a bottle or can for the most part. We have a joke that we kill things, and when you kill things that people don't like, you make a lot of money. And we're confident that everyone's going to do that, the retailer and the companies. And I think we are going to have a very, very, very good Home and Garden season. That's what I think. I can't guarantee that. We don't know if it rains for four weeks straight, then that will be another problem. We just have to wait until the mosquitoes come out later.
Your next question comes from the line of Hamed Khorsand from BWS Financial.
Hamed Khorsand - Beating Wall Street, Inc.
On a quarterly basis, do you think Q1 sales will be the peak for the year?
I think if you were to look at a historical trend of our sales -- now obviously, if we adjust for that Russell Hobbs and you make that churn, you'd see that our first fiscal quarter does represent typically the single largest quarter, but we do have a strong third quarter as well because of the Home and Garden season. There's a lot of sales that straddle between the month of March and April, May, June as well. But typically, I would say that our first fiscal quarter would be at the height of sales dollars.
Hamed Khorsand - Beating Wall Street, Inc.
What are you doing to gain traction at big retailers whom only carry the top two battery brands and the store brand name?
We work very hard to show them what the opportunities they would have if they carry our brand. I don't mean to be funny in that. I think that the Battery business is one that for some retailers is very important, and some it's not so important. And what I mean is that some of them are more focused on different segments in their store. In our case, we believe we have a compelling proposition now for them, and that is that you can have a product that lasts as long as the two leaders. It has a better value, lower inventory costs to bring in. And we present it and we go in and we do research and we show it just like any other company would, and I think that we are slowly converting them as they go along. Batteries are something that usually are very profitable for a retailer, but they have to decide if they want to be in the business. Meaning, they had to give it enough space, batteries are 60%, 70% impulse. So they have to decide to give that space, but that sometimes there's more of that issue than it is how many brands they carry. And then of course, you have some retailers who are very -- they come in and out of private label in this category. And that is something that I think is a big opportunity for the branded companies as we move forward, especially a company like Rayovac. Because the private label business [indiscernible] (01:20:59) source directly, anything from China right now is extremely risky. And the costs, the delivery, performance, returns, there's a lot going on there that could appear to be a cost-saving move, but by the time those batteries are delivered in three to five months between currency and input cost and freight cost and fixed price, and of course any returns or problems you have with those batteries because China is yet to build a battery that I think performs as well as the batteries provided by the top three that are made in the United States and Europe from a performance standpoint. I think it's a combination of all those things, and every retailer is different. I would say that we're making headway in almost everyone we're in. Some you know have long-term contracts, and those things come in if you have to wait till those expire, and a lot of that is happening right now in the coming year. So I think you're going to continue to see a very competitive landscape in the batteries but one of opportunity for a performance brand.
Your next question comes from the line of Mary Gilbert from Imperial Capital.
Mary Ross Gilbert
Kind of following up on some of the things that you brought up. It sounded like in Home and Garden you're seeing expanded distribution and I just wondered by segment, what is the status of shelf space in terms of expansion opportunities and also with regard to Russell Hobbs and integration into emerging markets?
Well, think of Home and Garden though in three segments. You have the controls which are mostly outside. You have household which is mostly pests inside your house, and then you have repellents, right? And if you think about it, I think our Home and Garden division, which its legacy name is United Industries, with its Cutter brand, [indiscernible] brand, (01:23:21) and Spectracide brand, it really competes against two major competitors with some -- and they each possess one really, really well-known brand name and they have large shares, and so I think our distribution gains and opportunities there are still good. Whenever you have people well who have over 30, 40 share in category, there should be opportunity in that category. So I think all three of our categories have really good room for growth, and that's not only against the competitor but more importantly in channels. There's the home center channel. There's the mass merchant channel. There's food and drug channel, right? And we have room for growth in all those. So I would say that's bullish, and we could talk more about that offline. Russell Hobbs, I'll let Terry talk about Personal, and then I'll come back in.
I would say because of the merger, we became from a middle-of-the-pack guy to a very, very near the top of worldwide market share in small domestic appliances. And so that helps us become more relevant. The Spectrum infrastructure that we gained is allowing us to have very, very good distribution opportunities, Dave alluded to it at the very beginning. But we've started to ship into eight countries in Eastern Europe which probably would have taken me 10 years to get to on a stand-alone basis. And we have other examples of that around the globe with personal care coming into some of those locations that we had strength. So I think there's actually very good distribution expansion opportunities for the Appliance business over the next few years.
Mary, this is Dave Lumley. What Terry is referring to is we made, despite our financial challenges of the last few years, we made a significant bet in investment to build our Eastern European business through our battery platform. We brought Remington in there. And now we can bring appliances right in there, and it's a really good significant part of sales and a good infrastructure we have in place. I'm talking whether it's Russia, Poland, Bulgaria, Romania, Czech Republic, it doesn't matter, Turkey. We went in, and we got distributed. We did all that work. So that's when we say we have opportunities to go [indiscernible] (01:25:51), we've already done that with two business segments that's why we're very confident, and Terry's so bullish on that.
As we've said, Mary, the $25 million to $30 million of synergy savings, which we've announced and we feel really, really good about those, that does not include any opportunities coming from revenue enhancements that Terry and Dave just described.
Mary Ross Gilbert
So this is incremental? This isn't built into your total guidance for the year, the EBITDA guidance, that doesn't incorporate the entrance into some of these emerging markets. Is that correct?
Mary Ross Gilbert
Also following up on that, you reiterated your free cash flow guidance. You've obtained interest savings, and then you've also talked about additional savings because we're really looking at $32 million to $40 million now over the next two years? Are those being offset because there was no increase in...
Let me answer that one, Mary. Let's take the first one. With respect to the interest savings, yes, we will have, on an ongoing basis, if we held the debt at $680 million which, of course, we want to make payments on that debt -- but interest rates and the debt at $680 million, we're going to save over $20 million a year. However, this year, there's obviously a cost to do that. We had a [indiscernible] (01:27:22) of 1%, which is the $6.8 million or close to $7 million, that's the recall I mentioned about a $43 million charge that we'll take in the second quarter of which $36 million was non-cash. That's the write-off of the deferred [indiscernible] (01:27:37) and the OID that is related to the original issuance of the debt. However, we do have that $7 million cash payment. But my point is, is that considering the time of the year we did the repricing and the out-of-pocket cost, it's basically going to be a push. It’s actually about $1 million to $2 million negative cash-wise this year, but we're still holding our guidance because we can make that up. We're a large company. And as I constantly say, we have a lot of moving parts that we can offset that. So that's the answer on the interest side of things. You had mentioned about the synergies. What we mentioned is that in prepared remarks where the $25 million to $30 million related to the Russell Hobbs transaction and we talked about the pet savings, what we did is -- we're saying is we've always had those in our projections back from the get-go. So that was not a new -- we just added those two numbers together to give you an order of magnitude of the kinds of savings that we're going after. But they were always inside -- they weren't really new numbers is my point.
Karru Martinson - Deutsche Bank
How should we look at changes in working capital this year? Is that going to be an increase, given inflation?
Even though the business will be increasing, we've talked about a 3% or 4% increase on the top line. I think the best assumption to use is that working capital will remain relatively flat because we still have some savings in there.
Your last question comes from the line of Karru Martinson from Deutsche Bank.
Karru Martinson - Deutsche Bank
Did you guys actually give what the market share for battery is in North America?
No, we didn't. Actually, we've drawn the line in that -- had we released what the new market share is for batteries in North America, I don't think we've publicly released that, but I don't know if we want to. It's Nielsen data so.
It'll be published next week. They'll be able to see it if they subscribe to Nielsen. I would just say that we're in the high teens.
Karru Martinson - Deutsche Bank
When we look at the inventory at retail, are we still in that six to eight weeks of inventory? Or do you feel that has built up here through the holiday season?
I think it's different for each battery company. I can speak to ours. Ours is in line with the retailers.
Karru Martinson - Deutsche Bank
In terms of the softness in the home category versus small appliances in North America, is there any kind of change afoot to address that? Or is this more of a broader industry issue that you guys just have to kind of wade through?
I think what we're doing to address it as a company is bringing out more performance for the same, as Dave said, as far as the Spectrum Value Model. We actually see some nice improvement in the back half of the year in our products and placement. So just speaking from our side of the equation, I think it's looking much better in the back half of the year for us.
Everyone, thank you very much. I just wanted to say again on behalf of Dave Lumley and Tony Genito, Terry Polistina and John Heil, again thanks to all of you for joining us on today's Spectrum Brands First Quarter 2011 Earnings Conference Call. And we will talk to you again next quarter, and have a good day. Thank you.
This concludes today's conference call. You may now disconnect.
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