Spectrum Brands Holdings Inc (SPB) 2023 Q1 法說會逐字稿

Good day, and thank you for standing by. Welcome to the First Quarter 2023 Spectrum Brands Holdings Earnings Conference Call.

(Operator Instructions)

Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today, Faisal Qadir. Please go ahead.

Thank you. Welcome to Spectrum Brands Holdings Q1 2023 Earnings Conference Call and Webcast. I'm Faisal Qadir, Vice President of Strategic Finance and Enterprise Reporting, and I will moderate today's call.

To help you follow our comments, we have placed a slide presentation on the Event Calendar page in the Investor Relations section of our website at www.spectrumbrands.com. This document will remain there following our call.

Starting with Slide 2 of the presentation. Our call will be led by David Maura, our Chairman and Chief Executive Officer; and Jeremy Smeltser, Chief Financial Officer. After opening remarks, we will conduct the Q&A.

Turning to Slides 3 and 4. Our comments today include forward-looking statements, which 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, 2023, our most recent SEC filings and Spectrum Brands Holdings' most recent annual report on Form 10-K and quarterly reports on Form 10-Q.

We assume no obligation to update our forward-looking statements. Also, please note that we will discuss certain non-GAAP financial measures in this call. Reconciliations on a GAAP basis for these measures are included in today's press release and 8-K filing, which are both available on our website in the Investor Relations section.

Now I'll turn the call over to David Maura. David?

Thanks, Russell. Good morning, everybody. Welcome to our first quarter earnings update, and I thank everybody for joining us today. Today, I'm going to kick the call off with an update on our -- the operating environment and the company's strategic initiatives. Then I'm going to give an update on our current financial performance. Jeremy is then going to provide more financial and operational details, including discussion of the specific business unit results.

If I could get everyone to turn to Slide 6. Our financial results for the quarter demonstrate a renewed focus on profitability, financial discipline and cost management. We are pleased that our first quarter EBITDA exceeded expectations despite continued heavy inventory levels at retail weighing on the volumes of products sold during the quarter. This was particularly evident in our HPC business, where several of our competitors got excessively aggressive and sold products at material losses in the marketplace, causing overall sales to be less than expected in the quarter.

This will require us to be even more aggressive in the marketplace around our appliance business in the second quarter and beyond. Therefore, while our second quarter will be slightly better than our first quarter results, we still expect to liquidate large amounts of high-cost inventory at aggressive prices, which will continue to pressure our margins in the second quarter.

Based on current sales trends and our current inventory reduction plans, we believe our margin structure will materially improve starting in the month of March. We are excited to be only 1 month away from a profitability inflection point, and we expect our profitability to materially improve in our third fiscal quarter.

As we anticipated and discussed with you during our last earnings call, our operations continue to be challenged by the difficult macroeconomic environment. We expect a challenging consumer demand environment and our customer inventory actions to continue.

And as such, we have put in place strong countermeasures to offset these pressures including further price increases and a strategic focus on fixed cost reductions to prepare the business for a more difficult environment. Our focus on simplifying our business model and reducing costs is starting to pay off as we operate as a leaner organization with renewed financial discipline.

In addition, our focus on cash generation also yielded positive results as we reduced our inventory by another $65 million during our fiscal first quarter, including HHI. This means that we have now reduced our inventory position by $170 million during the last 6 months since we have shifted our operating priorities to maximizing cash over earnings and reducing our overall inventory levels.

We will maintain this focus on reducing working capital and strengthening our balance sheet throughout fiscal '23 as we prepare for uncertainty in demand in the near term given the higher interest rate environment.

And lastly, we remain dedicated to our strategic transformation to become a pure-play Global Pet Care and Home & Garden company. To that end, we are committed to closing the HHI sale and expect to win the DOJ lawsuit. As previously communicated, we expect to close this transaction no later than June 2023, which will allow us to substantially reduce our debt and to return capital to our shareholders. We are confident that equity investors will look to allocate capital to a faster-growing, higher-margin, pure-play Global Pet Care and Home & Garden company, resulting in a significant rerating in the valuation of our publicly traded shares.

Now if I could have you turn to Slide 7 for our financial performance. As I mentioned earlier, our operating environment remained challenging, both due to our customers' actions as well as the consumer demand dynamics. Our retail partners remain focused on inventory reductions as their own inventory levels remained higher than prior year. The consumer demand environment as remaining challenged compared to strong COVID-related demand growth a year ago, especially for hard good categories where demand is continuing to normalize to pre-pandemic levels.

These market dynamics, combined with the disappointing holiday sales for our HPC appliance business, obviously put pressure on our top line and resulted in lower sales. Our total sales declined 5.8%, while organic sales, excluding the impact of FX and acquisitions, declined 9.5%.

While this volume decrease was the main contributor of the EBITDA decline in the quarter, EBITDA was also pressured by unfavorable FX year-over-year as well as the impact of selling down the high-cost inventory accumulated during last year.

As a reminder, we started this fiscal year with approximately $55 million of excess capitalized variances on our opening balance sheet that we expect to roll through the income statement in the first half of fiscal '23. Approximately $25 million of those capitalized variances have impacted earnings in the first quarter. We expect the remaining balance to roll through the income statement predominantly in the second quarter.

Moving on to Slide 8 and our high-level '23 earnings framework. Generally speaking, inventory retail continues to appear to be higher than the period a year ago in many categories, but particularly in hard goods. This is especially true for our HPC business where our retail partners are expected to continue their focus on lowering their inventory.

We now expect that replenishment orders in our HPC business will continue to remain below POS throughout the second quarter, and we will see further reduction in inventory through the supply chain in that business. We will also continue to focus on inventory reduction in the second quarter by driving sales through discounting and promoting our products in our HPC business unit, which will further pressure the margin in that business during this quarter.

Based on this additional revenue pressure, we now expect the top line for the year to be flattish to fiscal '22. As a result, we have made further fixed cost reductions and have executed additional reductions in headcount across the organization, but with a greater focus on our HPC business.

We expect to maintain our framework for adjusted EBITDA as a result and grow EBITDA in low double digits. As I mentioned, we had approximately $55 million of excess capitalized variances in inventory on our opening balance sheet that will roll through this -- through our income statement in the first half of fiscal '23.

Based on current input costs, this negative impact to our earnings will be mostly behind us as we enter the second half of fiscal '23. We are committed to strengthening our balance sheet and generating cash to pay down our debt. We will utilize cash flow from operations, cash from inventory reduction, and the proceeds from the HHI transaction, to pay down debt and reduce our leverage.

As I mentioned earlier, we are confident that we will receive $4.3 billion in cash upon the completion of the HHI sale. However, in the unlikely event that the HHI transaction does not close, we expect to have cash flow in excess of $500 million this fiscal year, which includes the HHI break fee. In either scenario, we expect to be able to decrease our net leverage to approximately 5x or less by the end of fiscal '23.

Before I turn the call over to Jeremy, I would like to thank our teams who are working tirelessly in the face of the current market headwinds while making some very difficult short-term decisions to prepare our businesses for long-term success.

You'll now hear more from Jeremy on the financials, and on additional business unit performance. Over to you, Jeremy.

Thanks, David. Let's turn to Slide 10 for a review of Q1 results from continuing operations. Starting with net sales, which decreased 5.8%. Excluding the impact of $39.6 million of unfavorable foreign exchange and acquisition sales of $67.8 million, organic net sales decreased 9.5% from reduced customer replenishment orders and the maintained focus on inventory reduction and from lower consumer demand for hard goods and consumer durables categories compared to last year.

Gross profit decreased $17.4 million and gross margin of 28.3% declined 70 basis points from a year ago from the reduction in sales and from sales of higher cost inventory accumulated during the prior year. Operating expenses of $222.1 million increased 8.6% at 31.1% of net sales.

The dollar decrease driven by the beneficial impact of fixed cost reduction efforts initiated last year and reduced spend on restructuring, optimization and strategic transaction costs. Operating loss of $20.2 million was an improvement from a year ago due to the reduction in operating expenses, offset by a decline in gross profits.

The increase in GAAP net loss and decrease in diluted earnings per share were primarily driven by the increase in interest expense offsetting the decrease in the operating loss. Adjusted EBITDA was $39.8 million, declining due to the decrease in volume and unfavorable foreign exchange impact, offset by favorable price and fixed cost reductions. Adjusted diluted EPS declined to a loss of $0.32 per share, driven by the lower adjusted EBITDA.

Turning to Slide 11. Q1 interest expense from continuing operations of $33.4 million increased $11.6 million due to a higher interest rate on our variable rate debt and increased borrowing levels. Cash taxes during the quarter of $6.1 million were $600,000 lower than last year. Depreciation and amortization from continuing operations of $22.6 million was $2.9 million lower than last year. Separately, share and incentive-based compensation decreased $2.3 million.

Capital expenditures were $10 million in Q1 versus $14.1 million last year. Cash payments towards strategic transactions, restructuring related projects and other unusual nonrecurring adjustments were $30.2 million versus $35.8 million last year.

Moving to the balance sheet. The company had a quarter-end cash balance of $228 million and $253 million available on its $1.1 billion cash flow revolver.

Total debt outstanding was approximately $3.3 billion, consisting of $2 billion of senior unsecured notes, $1.2 billion of term loans and revolver draws and $91 million of finance leases and other obligations. Pro forma net leverage was 6.2x compared to 5.4x at the end of the previous quarter as the trailing 12-month EBITDA declined sequentially.

Now let's get another review of each business unit to provide details on the underlying performance drivers of our operational results.

I'll start with Home & Personal Care, which is on Slide 12. Reported net sales decreased 4%, excluding the unfavorable foreign exchange impact of $25.7 million and the impact of the TriStar acquisition, organic net sales decreased 15%.

The organic net sales decrease was driven by category decline from lower consumer demand, particularly in kitchen appliances and retailer inventory reductions. Sales were also lower in personal care appliances garment care remains strong and posted growth as post-pandemic recovery continues, and we continue to win market share.

Sales in the U.S. remained challenged during the quarter as retailers continue to work down inventory. Sales were further adversely impacted by disappointing holiday performance in both personal care and kitchen appliance categories. Competitors were more aggressive with their pricing, which led to loss [to call it] a placement and POS.

The EMEA region sales also declined, primarily driven by FX and the impact of the Russia-Ukraine war on consumer spending. Net of FX, the garment care category registered growth while kitchen appliances and hair care categories declined due to higher COVID sales last year. Adjusted EBITDA decreased to $13.2 million. Lower adjusted EBITDA margin was driven by lower volume, impact of unfavorable foreign exchange rates and higher cost of sales as we continue to sell our high-cost inventory from last year.

Our continued focus on cost reduction measures, including the fixed cost restructuring we undertook during the second half of last year, offset some of the EBITDA pressure. Looking forward to the second quarter, we continue to expect softer consumer demand, particularly in the kitchen appliance category and expect retailers to continue their focus on inventory reduction.

This will drive further sales pressure in the second quarter as retailers are not yet consistently ordering to POS trends. As such, we have also maintained our focus on inventory reduction and have further slowed down and in some cases, stopped incoming orders.

This has already resulted in a substantial decrease in the inventory levels in our HPC business. We are monitoring customer inventory levels closely to understand ordering patterns and will ramp promotional activities as needed over the coming quarters to drive higher volume.

Commercially, our focus will be to drive fewer bigger, better consumer-relevant innovations that enhance our current position to simplify the operating model of the business. As a result of this business model evolution, we have taken the unfortunate but necessary action to eliminate additional salary positions to rightsize the cost structure and to prepare for a more challenging commercial environment. The Tristar business integration is on track and is expected to be substantially completed during the quarter.

Let's move to Global Pet Care, which is Slide 13. Reported net sales decreased 8.2%. Excluding unfavorable foreign currency impact of $13.9 million, organic sales decreased 3.6%. Net sales decline was driven by customer focus on inventory management, leading to lower replenishment orders. This was partially offset by new price increases in EMEA and the impact of pricing actions taken in the Americas last year.

Despite retailer inventory reductions, global sales in companion animal versus last year adjusted for FX. The sales decline was directly attributable to the overall aquatics category softness [across all regions].

Our European sales were adversely impacted by unfavorable foreign exchange rates as the dollar strengthened against the British pound and the euro compared to last year. Adjusted for FX, sales increased in EMEA due to growth in the companion animal category, including our dog and cat food business, despite the decline in aquatics as we continue to compare to strong prior year aquatic environment sales.

Sales in the Americas region declined across categories and replenishment orders were below POS due to retailer focused inventory reduction across most channels. Additionally, we continue to reshape our North American portfolio by exiting less profitable nonstrategic SKUs and categories such as litter and litter accessories and private label which has adversely impacted sales. However, this will benefit us in the long run as we continue to move our sales mix towards higher profit, more strategic categories and product lines.

On the POS side, our largest category of Chews continues to experience strong double-digit growth, and we gained additional market share in the category. However, our second largest category, aquatics, experienced POS declines compared to strong prior year sales, fueled by new hobbyists that entered the category during the pandemic. Despite the overall decline, POS in our aquatic consumables category, which is the largest segment in our Aquatics business, grew nearly double digits, and we gained market share there as well.

This is a good sign as it signals that those who have entered and stayed in the category choosing our brands and products for their aquatic nutrition and care needs. On the pricing side, we were successful in executing additional price increases in EMEA that we referenced during our last quarter call.

These increases are offsetting cost pressure from unfavorable FX and energy inflation that we continue to experience in our international business. We experienced inflation in line with our expectations, and are encouraged by the fact that costs have either stabilized or, in some cases, are starting to retreat.

On the innovation side, while we are the clear market leader in the Chews category, we're a small player in the instant gratification dog and cat treats categories. A great opportunity in this space to leverage our R&D capabilities, strength of our brands and our strong customer relationships. That is why we are excited about the launch of new dog and cat treat items in our second and third fiscal quarter. We've secured commitments from many of our top customers with some products being available for purchase in the next few weeks.

Adjusted EBITDA for GPC declined to $37.2 million. The decline of $1.5 million was primarily driven by lower volume, the unfavorable impact of FX and the impact of capitalized variances as we continue to sell our high-cost inventory last year. Our continued focus on cost reduction measures, including the fixed cost restructuring we undertook last year, and incremental pricing actions in the EMEA region are helping to offset most of the FX and volume pressure.

We expect to see the first quarter's trend to continue in our second fiscal quarter. We remain cautious about performance of certain categories within the pet specialty channels, such as aquatic environments and hard goods within companion animal, as the rates of new entrants settle to pre-pandemic levels.

Despite these short-term pressures, we remain encouraged by the category fundamentals, especially given the profile of our business, which has become more aligned to consumable products for your pet, which represents over 80% of our total sales.

The GPC team remains focused on the execution of our long-term strategy, which is centered around inspiring more trust through the delivery of unique and innovative products in order to drive demand for our portfolio of leading brands. The business is a historically recession-resistant business, tremendous upside potential. So I'll remain bullish about the continued growth of this business.

Finally, we'll look at Home & Garden, which is Slide 14. Net sales decreased 5.2% in the first quarter, driven by lower early inventory investments from retailers across pest control categories, partially offset by positive prior year price increases.

Cleaning products registered growth versus last year, increased distribution and the benefit of prior year price increases. This quarter is predominantly focused on preparation and staging for the highly seasonal Home & Garden business starts to ramp up later this quarter.

We are preparing for a normal season this year based on our discussions with retailers after an abnormally difficult weather season last year. The timing of order ramp-ups still remains slower than historical trends.

That said, retailers continue to remain positive on the season despite slower early inventory uptake. While the first quarter represents a very small portion of the annual consumer activity in this category, consumer demand has been gradually improving across all categories.

We are experiencing constant POS growth surpassing last year's demand in the last 4 weeks. Although our season has not really started yet, early signs for the year are positive, the precipitation in southern regions of the United States boding well for the drought-impacted markets.

Retailers have not made significant inventory investments yet, but we're collaborating with our key customers and remain confident that sales will pick up as the season starts and normal seasonal POS materializes in our second and third quarter.

Continue to make progress, getting strong innovation into the market in advance of this year's season. All our key initiatives have either made it to market already or are well on track to be delivered.

In our Spectracide brand, we now have available the new One Shot premium weed and grass killer, product designed for a highly demanding consumer that is willing to pay a premium for superior results. Traditionally, Spectracide is focused on consumers looking for strong results at a great value. The One Shot platform allows consumers to find also a superior performance option with the brand they trust.

In our Hot Shot brand, we partnered with top fragrance makers to deliver an exciting evolution for ant, roach and spider killer aerosols. The new products continue to be extremely effective, and now also offer a superior experience as our new fragrances effectively mask that unmistakable bug spray smell, leaving only a crisp linen scent, an innovation that received high scores in all of our consumer testing.

Adjusted EBITDA for our Home & Garden business improved by $4.9 million. EBITDA increase was driven by prior year price increases and better operational performance during the quarter. We are also seeing the benefits of fixed cost restructuring and operational cost reductions initiated during the second half of last year.

We experienced higher product costs from raw materials, labor and freight in line with our expectations. We continue to assess further price increases for fiscal '23 to ensure we maintain our margins going forward. All in all, despite the slower start to the year, we remain confident in our strategy will continue to drive innovative consumer solutions.

We are carefully monitoring POS and watching for the increase as the season draws near and that will determine the timing of the ramp-up of retailer orders. We have made strong progress driving agility and speed into the organization to be prepared to ramp up production and meet the increased retailer demand when it occurs.

As we look forward to the balance of fiscal '23, we are pleased with our new distribution gains, and we remain bullish on the cleaning and pest control categories based on our retail customers' focus on these consumable high-velocity purchase products.

The fundamentals of our Home & Garden business remain robust as our innovative products, driven by consumer insights, and our strong brands continue to excite our customers and end consumers alike.

Let's turn now to Slide 15 and detailed expectations for the rest of fiscal '23. We now expect fiscal '23 net sales to be flat to last year with foreign exchange expected to have a negative impact based upon current rates. We continue to expect adjusted EBITDA to grow low double digits despite some inflation headwinds, which are offset by the annualization of current pricing actions and planned further price increases as well as additional productivity gains, and the benefits of our cost reduction actions.

From a phasing perspective, we expect the second quarter to be challenging year-over-year as retailers continue to reduce their inventory levels, especially for the HPC business. First half profitability is also negatively impacted as we sell-through our legacy higher-cost inventory.

Turning now to Slide 16. Depreciation and amortization is expected to be between $110 and $120 million, including stock-based compensation of approximately $15 million to $20 million. Full year interest expense is expected to be between $130 million and $140 million, including approximately $5 million of noncash items.

Cash payments towards restructuring optimization and strategic transaction costs are now expected to be between $60 million and $65 million. Capital expenditures are expected to be between $60 million and $70 million. Cash taxes are expected to be between $30 million and $40 million. For adjusted EPS, we use a tax rate of 25%, including state taxes.

To end my section, I want to echo David and thank all of our global employees for their strong efforts during these challenging times and for staying committed to our long-term strategic initiatives. David?

Thank you, Jeremy. Again, thanks, everybody, for joining us on the call today. At this point, I'd like to take a couple of minutes and just recap kind of our key takeaways. You can find those on Slide 18.

First, as I said earlier, our Q1 financial results demonstrate our renewed focus on profitability, financial discipline and cost management. Our operating environment remains challenging. We are resolved to navigate these headwinds profitably and with financial discipline strong.

We expect some of these headwinds to continue in the second quarter, which puts further pressure on our revenues. We have proactively taken additional actions to ensure that we maintain our profitability in fiscal '23. As referenced earlier, we are targeting flat net sales but low double-digit EBITDA growth for the year. We expect to reduce our leverage by generating free cash flow through improved operating performance and working capital management.

Secondly, we will maintain our focus on operating a leaner business focused on fundamentals, free cash generation and debt reduction built around 4 key pillars.

First, we are streamlining our organizational structure and reenergizing our employee base; second, we are increasing operational efficiencies and limiting risk; third, we are protecting and deleveraging our balance sheet and strengthening liquidity; and fourth, but not least, we are transforming this company into a pure-play Global Pet Care, Home & Garden business with faster growth and higher margins pro forma.

Last, certainly not least, we expect to win the DOJ lawsuit and to close the HHI transaction by no later than June 2023, and collect $4.3 billion of cash. I want to close by reiterating that despite the short-term challenges, I remain quite optimistic about the future of our company. I believe we are well positioned to execute on our operational goals and generate cash flow in fiscal '23.

I want you to know the future of Spectrum Brands remains bright as we continue to make living better at home.

I'll now turn the call back over to Faisal for questions.

Thank you, David. Operator, we can go to the question queue now.

(Operator Instructions)

Our first question comes from Bob Labick with CJS Securities.

A couple of questions. I wanted to start with -- you touched on this a little bit, but -- can you talk about the current inflationary environment and inflationary impact you're seeing beyond the elevated costs on the balance sheet?

So kind of go-forward environment -- yes, where it is, how does it compare to, I guess, pre-COVID, pre -- when transportation took off and raw materials took off, and where are we now? And where is that trending?

I'll give you the broad brush and then Jeremy can fill them on some more specifics. I would say, look, clearly, you have permanent and inflated labor costs, like across the board, right? That's from the factory floors all the way through middle management.

Freight rates, which continue to really burden the EBITDA in Q1 and will hurt us in Q2 as well, they're through the -- they've dropped tremendously. And so that's why we believe -- as I sit here today, we're kind of 30 days away from seeing that inflection point actually flow through the P&L, right, because that new inventory at these lower freight costs are starting to hit the balance sheet. And as we turn our inventories a little quicker, we think we'll see that margin uptick.

So -- and then look, I think certain commodities have come off. There's clearly more capacity in the factories around the world because of the slowdown of growth, particularly in the durable goods side.

But it's only, I guess, the last couple of quarters where we feel like we've got enough price to kind of offset the inflation. We do see some deflation now in certain materials, but freight has been kind of the big one, but we have yet to benefit from that in the P&L, and we're hoping that starts in the month of March. And then you'll really see it kind of show up hopefully in the third quarter. Jeremy?

Yes, I agree with all of that. And I would say, I think to your last part of your question, Bob, was around -- as compared to pre-pandemic, really across the board, everything is still materially higher than it was pre-pandemic.

I mean I would tell you that our P&L, even at current freight rates, is probably burdened by $80 million to $100 million of incremental freight as compared to pre-pandemic. All materials are higher. And to David's point, labor, I would view it, permanently higher than if you go back 3 years.

Got it. Okay. Super. Appreciate that. And then I know it's obviously easy to get fixated and caught up on both the macro, which we're kind of just discussing in the DOJ timing. So I wanted to step back to -- and ask -- you talked about this a little bit.

Could we dig a little more into the company-specific variables that you're focused on this year to grow revenue and margin? You talked a little about SKU rationalization, but just kind of refocus us on the revenue margin in your control variables this year, please?

I mean, look, the 2 big levers that we've been executing on since we pivoted the strategy starting kind of summer of last year into the fall to run the business to maximize cash was to kind of break the back of the ever-ballooning balance sheet, which was -- elongated supply chains to try to keep our retail partners happy. We've made a really concerted effort to bring that down. And you can see, normally, we consume capital in the first quarter and you see another $60-plus million of inventory coming out of the system. We pulled $170 million, I believe, of inventory out of our business in the last 6 months, and we're going to continue to drive that down to create cash for ourselves.

And so that's the -- we've got the working cap going in the right position, finally, and that's something that's within our control. The other big thing that we've done is, quite frankly, as the tide has gone out from the COVID demand, we've got to materially lower our cost structure. And so it's been very painful for our company but we've taken quite a bit of fixed costs out of our operating model, and we continue to be very, very disciplined around expense management.

We're trying to get through the second quarter and then pivot the profitability of the business. We really got to get the P&L going in the right direction, get EBITDA growing again year-over-year. And we believe we will do that by the third quarter, obviously.

But we want to reinvest some of this money into some promotional activity, into some discounting, and really try to drive that top line sensibly. And recently, I've been meeting with some people. We're doing quite a bit of work in some of the divisions on DTC channels, digital channels, really trying to get better yields on our investments and make them truly correlated to transactions, if that makes sense? Jeremy, you want to...

I think that covers it. Yes.

Our next question comes from Peter Grom with UBS.

So I guess, I wanted to ask this -- so I guess, I just want to ask specifically about the phasing of the year from an EBITDA perspective. Can you maybe just provide a finer point on what you mean by 2Q will be challenged year-over-year? Is that kind of as a percentage of sales? Is that more just in pure dollar terms? Just any color on that would be pretty helpful.

And then I just -- I guess, just in that context, the ramp implied in the back half of the year is just pretty substantial. So just -- can you just talk about the confidence in that ramp and kind of the underlying assumptions embedded in that?

Yes, I'll start Peter and David can follow on with any comments. So what we're expecting is that we'll see Q2 be down year-over-year. I think we do expect to see it improve sequentially -- but the reality of this year is a tale of 2 halves with this $55 million of capital variances that we started the year, 90-plus percent of that, I think, is flushed by the end of Q2. So you kind of got a $50 million benefit in the second half as compared to the first half, which, by the way, is something that, all other things being equal, would be a first half '24 benefit year-over-year as well.

So that's a good thing, but it's painful to get through here in the first couple of quarters of this year. So we're very confident in that. That's math, it's in the system. We see those capitalized variances, we know as they flow out. I mean, our assumptions really are for a pretty consistent environment with what we're experiencing in the first quarter for the rest of the year with the exception of Home & Garden, right, which we have to account for and predict some level of seasonality there, which is always challenging.

And we've got to partner really closely with our retail channels to make sure we understand how they're thinking about really each month to stage for the season. So there'll be some variability there. But that's kind of transparently how we're thinking about the year.

We don't have an expectation that we see a strong improvement in consumer demand this fiscal year. I think current expectations for a soft landing are great, but I think we need to be prepared for even a further level of decline in the macroeconomic environment.

Great. And then maybe just like a follow-up on that, a bigger picture question around the earnings power of the company. David, I think it was back in the summer, you kind of threw out a number around $400 million in adjusted EBITDA before the company normalized.

And I know we're really still in a very tough environment. But I guess, has anything changed over the last 6 months or so where you feel differently about the earnings power of the company? And then I guess if not, and we take into consideration the back half ramps and Jeremy's comments around some of the benefits flowing into '24, I mean how quickly can the company get back that degree of earnings power?

Yes. Thank you to that. Look, I think the only delta at the current time is the appliance unit. That business has materially underperformed in the latest quarter -- in the current quarter because it's durable product, everybody stocked their kitchen with cooking equipment during COVID, but a lot of the competition entered the space.

We acquired one of them to bolster our own platform. But there's just a lot of inventory and a lot of competition that is flushing product at very large losses. And so if you dig around, I think you'll see there will probably be some bankruptcies of some of these players over the next quarter or 2 would, be my expectation, given what's going on in that space.

And so look, do I think $400 million is the earnings power of [RemainCo]? Yes. What does that entail? It entails Pet getting back to $200 million in EBITDA, and that requires Pet run-rating $50 million in EBITDA a quarter. Once we get through these capitalized variances, we believe that's very achievable for Pet.

Secondly, it requires Home & Garden to be at least $100 million plus in EBITDA. We believe that's achievable this year, and we believe that we can grow materially above that, given our exposure to cleaning and our plans for rejuvenate, et cetera.

So there's [$300] of it. And then, listen, appliances will not do $100 million in EBITDA this year, but it does have that earnings power potential, but you won't see that probably until fiscal '24. So that's how we'd lay it out. I would say, look, the $400 million of earnings power is intact.

The big divot to you seeing, this year is going to be appliances. But Pet and Home & Garden is the future of where we're trying to take the businesses. And once we close HHI, we're going to look to solve for the appliance unit.

Our next question comes from Ian Zaffino with Oppenheimer.

All right. Glad to hear the confidence in the deal closing with HHI. How are you guys actually thinking about the cash proceeds? And I guess what I mean by that is we're sitting here -- you mentioned deleveraging, probably some buybacks, but you do own -- you're basically going to be receiving more cash than your market cap. So how do you handle that cash receipt? And maybe how do you think about potentially returning that to shareholders? And then I have a follow-up.

Yes. Look, we're going to go to trial in April. We're going to win the case. We're going to close the deal in June. We are going to -- I would say if the money gets wired to me on a Monday, what do I do on Tuesday? Tuesday, I probably pay off all my bank debt, at a minimum.

I despise our leverage position. I'm working every day with the teams to drive inventory, drive working capital out of the system, run the business for cash flows. And so that's a big focus. But again, we've said for some time and -- look, there's a lot of distortion here. I think what people -- to Peter's earlier question, you've got the slack in the system between -- POS can be very strong.

For example, POS in January is very strong for our Home & Garden business, but we're not yet seeing the factory shipments we want to see, right? And that's just retailers continuing to wait, continuing to burn off a little bit of inventory they had last year. And so that causes a lot of distortion to reported numbers until we can get into an equilibrium situation. We're clearly going to get into equilibrium on Pet, Home & Garden much faster than appliances.

And so that's why you're going to see such a big rebound in the back half of the year as we burn through these capitalized variances, and we see profitability restored Q3, Q4. But -- look, we believe our stock is materially undervalued. I know that hasn't meant a whole lot in the last 9 months.

The company, last year, did trade over $100 a share. And we, quite frankly, think we're worth that. And so it would be silly for us to kind of sit on an extra couple of billion dollars. We'll probably call some of our notes.

But quite frankly, while our leverage is too high, the liability side of this company is actually an asset in today's capital markets environment because we have bonds at 4% and less. That's a pretty attractive rate to finance yourself when the 2-year note is above 4.5%. So -- we need to keep our capital structure in place, pay off the banks, buy back some stock and then look to see what bonds we take out. That's how I'd answer the question to that.

Okay. Perfect. And then also on the change in the revenue guidance, can you maybe bucket that for us? How much is FX? How much is incremental headwinds that you're seeing? And then when we get on to the EBITDA line, how much of that FX is naturally hedged, you're not really seeing an impact of that?

I'll let Jeremy answer your real question, I'll just tell you straight up, the real reason that revenue is coming down is the appliance business, beginning and end of story. But -- Jeremy, you guys -- you want to take the FX piece?

Sure. Yes. I agree with David. It's the appliance business, what we experienced in Q1 and really what we think now, based on that experience, what the rest of the year will look like. And then on the FX front, one, as compared to where we started the year, we've seen a benefit with the dollar weakening a bit. I think we probably pegged at the start of the year, parity with the euro, we're sitting around [1 0 7], [1 0 8] today, I believe, or yesterday. So that's a bit of a benefit. In general, we try to hedge 60% to 70% or so in our European businesses against FX.

We fight both translation and transaction. Obviously, you're not really hedging translation. So you still have some level of exposure as you go through the year. But the trend right now is a little bit positive, and we reflected that in our updated forecast.

Our next question comes from Chris Carey with Wells Fargo.

So just a clarification then another question. But Jeremy, I just wanted to clarify a prior question around EBITDA phasing -- I'm looking at the Q2 consensus EBITDA of $80 million after roughly $40 million this quarter and commentary on headwinds persisting into Q2, margins don't inflect until March. Should we be thinking about an EBITDA number roughly at that level? And I apologize if you had said this and I missed it, but I just want to get that straight, just to make sure we're thinking about that correctly.

Yes. I didn't mention a specific number for the quarter, and we don't give quarterly guidance. But I understand the question, certainly. Yes, I mean, consensus is sitting for Q2 above our last year performance. And clearly, I said that -- I expect we're going to be down year-over-year, but we'll up sequentially. I think we could talk through that business by business as we connect with [Faisal and I] today. But it's -- the reality is, I think that we're going to see a decline in HPC and most likely, given our comments around the H&G timing of loading inventory at retail, we're going to see a decline there as well.

So the first and second quarter are impacted by a lot of factors that are frustrating, but they're real. We also know when they will we get relief from them. And so I agree with David's comments that come March and certainly the third and fourth quarter, we expect much better margins. But as I said earlier, just I think take solace in the fact that we are not expecting a positive sequential change in consumer demand in our forecast.

We're expecting this to be a slugged out year across the board with the exception of I think, a better weather season for Home & Garden.

Okay. Great. That's very helpful. Just -- David, you were just asked this and maybe I'll just back it from a little bit different lens. But the macro backdrop has obviously evolved a lot since the HHI deal was initially announced. And clearly, at the time, they were maybe nebulous and/or direct plans for debt paydown and stock buybacks and perpetual M&A.

And so obviously, you still have some time to make the decisions should the deal come through as you expect. But does the backdrop change your thought process around, okay, well, we need to pay down more debt than maybe we wanted? We need to put more money into buybacks as opposed to doing M&A? Like, why would we do M&A in a volatile backdrop? Just conceptually, how does the macro impact how you're thinking about deploying capital should -- and as you expect, the deal go through?

I appreciate the question. But the whole reason that we agreed to sell HHI to ASSA was we really believed we had been the best steward of the asset we could have been and taken it as far as we thought we could take it given that we are a diversified business. We have 4 different businesses now. We had 6 a few years back, and we have a levered balance sheet.

And so the simple fact of the matter is ASSA is in a great position to bring innovation, R&D, launch new products, give consumers choice and, quite frankly, bring more competition to the market. So the original deal is constructed, I think, is fantastic for the American consumer. Clearly, I wish the DOJ would see it that way.

But any and all questions that you could possibly raise about any sort of competitive erosion is absolutely [nuder] by ASSA's sale of their assets to Fortune. And so that is why I am highly confident in winning a trial, and I look forward to that.

In terms of your commentary around the environment changing and how do you allocate capital from here. Look, I remain one of the largest individual shareholders of the company. I absolutely dislike a mild or our current leverage. And so I -- as I said earlier, I would -- if the money gets wired on a Monday, Tuesday, we're going to pay off all of our bank debt, that's for sure.

Again, this deal, I can't believe it's taken almost 2 years now. But the reason we did this deal was we wanted to have basically a debt-free balance sheet, and we wanted to have tons of liquidity in case the market fell apart, multiples contracted. We would then be in the catbird seat to do accretive tuck-in M&A.

And unfortunately, we've run into this snag with the DOJ. And conditions have deteriorated, but we still don't have the cash. And so -- yes, I think paying down debt is the #1 priority given current leverage. I think buying back shares is a lot less risky than buying some other business. And then we still need to solve for the appliance unit.

And so you may see us buying, I don't know, $0.5 billion of stock, $1 billion of stock, we'll see where it is when we get there. But we'll probably keep some extra cash sloshing around also because we're committed to creating a global Pet Care and Home & Garden business. And that's going to require us to merge, spin, solve for the separation of our HPC assets. So that's our thinking. It's long winded, but hopefully it helps you out.

Our next question comes from William Reuter with Bank of America.

Following up on the last question. Previously, you had a pro forma gross leverage target that was explicitly 2.5x after the deal. Is that no longer kind of in place? Are we now kind of going to rethink everything?

Yes. So that -- what I would say there is, that was a point in time when we were trying to get the market an indication of the volume of debt reduction that we would expect. So directionally, I think that's still in the right place, though, mechanically, with our EBITDA declining this year as compared to where it was when we made that kind of pinpoint time announcement. That would imply something different.

So I would not expect -- one of the things that we talked about originally, Bill, is that we have the debt -- the bank debt that David talked about, and we have 2 callable bonds. And our longer-dated paper totals about $1.1 billion in total. That level of debt is probably a reasonable place for us to end the mechanism and which notes and pieces and notes, et cetera, yes, but that's still TBD. Once we get closer to closing, we'll figure that out along with our advisers.

2.5 is a really great ratio. The amount of debt paid down might be greater than initially anticipated.

And then just 1 follow-up. Jeremy, earlier, you mentioned that your freight costs have gone up by $80 million versus pre-pandemic levels, and you guys also talked about how those freight costs are now kind of on a cash basis, at pre-pandemic levels. Would we expect to see $80 million of rate come out of your P&L costs over the next year or 18 months, whatever it is, until they go through?

No. So when we talk about cap variances as explicitly as we have, that really -- that includes freight inflation. So it's not incremental to that $55 million that we talked about in the first half of this year.

And my comments earlier were to say that even current market rates are heavier or higher than pre-pandemic levels. And I don't see that taking a further step down unless the global economy also takes a further step down and then that kind of adds to there adds more challenges to the plate.

So I would not expect an incremental $80 million to $100 million of benefit next year as compared to the $55 million of cap variance I was talking about earlier.

Our next question comes from Carla Casella with JPMorgan.

Most of my questions have been answered, but one clarification. You talked a lot about inventory at retail and retailers destocking. Did you say, I may have missed it, which categories are heaviest at retail and inventory and -- or even on your own books that might take longer to work through?

Yes. We're trying to point you to durable goods. So where we've got toaster ovens and coffee makers, it's still heavy. And we got undercut in the holiday season by some competitors doing things even beyond our wildest estimations. Fish tanks, those types of things. But again, the bulk of the business where we play, we're 80% consumable in Pet. Home & Garden had a very rough year last year with weather. Again, we're pretty optimistic on Pet, Home & Garden going forward here.

Yes. I would say in Home & Garden, as retailers have been slower to order, we have seen their inventory coming down. It's still a little bit higher than it was a year ago, but I don't think materially enough to impact the season as it comes.

Okay. Scott had talked about stronger December. And I'm wondering, is that just the different vision of business or you think they're discounting? Is that on where you've seen more of that promotional...

Yes. I mean, I think of this, it's business mix. They sell a lot of seed, growing media. We're not in that business. We need the weeds to grow, and then we can kill them. And so we're typically -- March to June is kind of our hotspot.

That's super helpful. Okay. And then one on this recent acquisition where Post bought to pet food brands from Smucker. I'm wondering how you're thinking about M&A. Did you look at that deal? Or are there certain categories or things you would stay away from as you're getting this big chunk of cash in soon, hopefully?

We're not looking at any transactions except for closing HHI, delevering the balance sheet and trying to deliver on our promises for fiscal '23. That's the reality of our situation.

And I'm showing no other questions at this time. I'd like to turn the call back to Faisal Qadir for closing remarks.

Thank you. With that, we've reached the top of the hour, so we will conclude our conference call. Thank you, David and Jeremy. And on behalf of Spectrum Brands, thank you all for your participation today.

Thanks, everybody. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.