David A. Prichard - Spectrum Brands Holdings, Inc. Andreas Rouvé - Spectrum Brands Holdings, Inc. Douglas L. Martin - Spectrum Brands Holdings, Inc..

Faiza Alwy - Deutsche Bank Securities, Inc. Olivia Tong - Bank of America Merrill Lynch Bob J. Labick - CJS Securities, Inc. Kevin Grundy - Jefferies LLC Jason M. Gere - KeyBanc Capital Markets, Inc. Ian Zaffino - Oppenheimer & Co., Inc. Joseph Nicholas Altobello - Raymond James & Associates, Inc. Jim A. Chartier - Monness, Crespi, Hardt & Co., Inc.

Shannon Coyne - BMO Capital Markets (United States).

Good morning. My name is Matthew, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal 2017 Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' prepared remarks, there will be a question-and-answer period.

As a reminder, ladies and gentlemen, this conference is being recorded today, Tuesday, May 2. Thank you. I would now like to introduce Mr. David Prichard, Vice President of Investor Relations for Spectrum Brands. Mr. Prichard, you may begin your conference..

Good morning, and welcome to Spectrum Brands Holdings fiscal 2017 second quarter earnings conference call and webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands, and I'll be your moderator for this morning's call.

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

Now, if we start with slide 2 of the presentation, you will see that our call will be led by Andreas Rouvé, our Chief Executive Officer; and Doug Martin, our Chief Financial Officer. Andreas and Doug will deliver opening remarks, and then conduct the Q&A session.

If we turn now to slides 3 and 4, our comments today include forward-looking statements including our outlook for fiscal 2017 and beyond. These statements are based upon management's current expectations, projections, and assumptions and are, by nature, uncertain. Actual results may differ materially.

Now due to that risk, Spectrum Brands encourages you to review the risk factors and the cautionary statements outlined in our press release dated today, May 2, 2017, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10-K. We assume no obligation to update any forward-looking statement.

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

With that, I am very pleased now to turn the call over to our Chief Executive Officer, Andreas Rouvé..

Thanks, Dave, and thank you, all, for joining us. Turning to slide 6. Overall, our second quarter performance was below our expectations with sales down 3.3% despite strong growth in Hardware & Home Improvement and Global Battery. The most important factor for the sales decline was the improved inventory management of major U.S.

retailers, which combined with the cold March, led to a delayed intake of our seasonal Home & Garden and Global Auto Care products as retailers are pulling inventory later than last year. About 70% of the full-year POS is recurring between April and September for these two categories.

We estimate the impact of this delay to be between $25 million and $30 million.

The sales decline of our Home & Garden product is also directly linked to the fact that we are comping an exceptional second quarter in 2016 as the Zika press coverage and warm March led to an unusual early pull of retailers in our Home & Garden division recorded last year, 25% growth in the second quarter compared to 2015.

If we compare our second quarter 2017 with the more normal year 2015, then our Home & Garden sales are up $8 million or 6.5%, well above category growth rate and we continue to expect a strong season given our POS trend. The second reason for the sales decline is the planned exit of non-strategic low-margin business of $11 million or 0.9%.

While this obviously reduces our sales, it actually has a direct benefit to our EBITDA. Finally, unfavorable currency was again a headwind and cost $10 million or 0.8% of the decline. However, it is important to note that the headwind is getting weaker and, in part of Latin America, we are already starting to enjoy some favorable impact.

If we exclude those three drivers, this means the impact of shipment delay, our planned exit, and currency, our core sales would have been up about 0.7%, which is still below our expectations.

The reason for this moderate growth rate is category weakness mainly in Home Appliances, but POS was also in some other categories soft especially at lower price point.

Our innovative and higher-priced products continue to perform well and, accordingly, we have a positive product mix which explains our strong margin improvement, for instance, in Personal Care and Home Appliances. At the same time, we are seeing strong growth in e-commerce, which is also linked to the success of our innovative products.

Turning to slide 7. If we take now a look at expenses, it seems as if there is not much year-over-year change. However, we have some opposing trends. On one side, we are increasing our investment into R&D as well as marketing to support the development and launch of innovative products in the out quarters.

In the second quarter, we have started, for example, a strong TV campaign and sampling program in Armor All to support their launch of our innovative Wash & Wax wipes, which are in stores now.

Beside those strategic investments, we were unfortunately hit in the quarter by close to $5 million in one-time operating expenses including a bad debt write-off linked to the bankruptcy of a U.S. retailer. These higher expenses were offset by our ongoing efficiency enhancement initiatives, and one-time share-based compensation last year.

Our adjusted EBITDA in the second quarter was down because of the delayed shipments in Home & Garden and Auto Care products. Our performance in the other categories was good. Hardware & Home Improvement EBITDA grew a strong 5.6%.

Also, Global Batteries & Appliances grew EBITDA due to the earlier mentioned favorable product mix despite strong currency headwinds especially from the weak British pound and about $3 million of one-time expenses. Pet increased its EBITDA as our margins improved significantly as we walked away from unprofitable nonstrategic business.

Also, our adjusted earnings per share were up as we were able to reduce our interest expenses significantly. The lower interest expenses are the results of our new debt arrangements and a good example of how we are strengthening the company long-term.

Another example of these continuous improvement initiatives is the significant year-over-year improvement in our free cash flow by $190 million. Turning to slide 8. Looking forward, we see a resumption of organic sales and adjusted EBITDA growth.

Despite the earlier explained delayed sales of Home & Garden and Auto Care, which will support our third and fourth quarters, we continue to make good progress with our "more, more, more" strategy. We are winning, for example, with batteries globally new accounts and better placements at existing key accounts.

Due to the strong growth, we are now in the process of expanding the capacity in our alkaline and hearing aid factories in Europe as demand exceeds our capacity even in the 24/7 mode, but also in all other categories we are making good progress. And let me share some examples from our Pet, Home & Garden division.

We are expanding into more categories, for instance, with Black Flag into the outdoor controls area; into more channels with an improved multi-channel strategy in Nature's Miracle; and into more countries in Latin America with insect repellents under the Rapid Repel brand.

All of these initiatives require startup expenses, and we are fully committed to pursue such organic growth initiative even in a quarter where it could be tempting to cut those investments to achieve a higher EBITDA result. However, we are driving for long-term growth and are, therefore, stepping up our R&D, selling and marketing investments.

At the same time, we are making good progress with our continued improvement initiatives, which are also an important pillar of Spectrum First.

Both the consolidation of our Auto Care manufacturing and distribution in Dayton, Ohio, and the consolidation of our Hardware & Home Improvement distribution center in Kansas are on track and will help us reduce expenses and inventory in the back half of 2017 and in 2018.

At the same time, we are continuing to streamline our management structures to make us not only more cost effective, but allow us also to take decisions faster. Finally, as announced last Friday, we are very excited to have PetMatrix join Spectrum Brands with its complementary portfolio of rawhide-free alternative pet treats.

This transition will be immediately accretive, and our teams are readying for rapid integration and continued growth. Let me turn it over now to Doug for the financial review and details on our performance by product category..

Thanks, Andreas, and good morning, everyone. Turning to slide 10, let's review Q2 results beginning with net sales. Second quarter reported net sales of $1.17 billion decreased 3.3% versus last year.

Excluding the negative impact of $9.7 million of foreign currency, organic sales declined 2.5% against strong organic growth of 4.9% last year, and also including the negative impact of planned unprofitable business exits of approximately $11 million or 0.9%.

Reported gross margin of 38.9% increased 60 basis points from 38.3% last year primarily due to improved mix and strong productivity, partially offset by the negative impact of foreign exchange; reported SG&A expense of $286.8 million, or 24.5% of sales compared to $285.1 million or 23.6% last year.

And reported operating margin of 12.3% was unchanged compared to last year. On a reported basis, Q2 diluted EPS of $1 decreased compared to $1.55 last year primarily due to a lower effective tax rate last year relating to the adoption of a new accounting standard for stock compensation.

Adjusted EPS of $1.19 improved 2.6% versus $1.16 last year primarily as a result of lower interest costs and share count, partially offset by the negative impacts of foreign exchange.

The Q2 reported tax rate of 36.1% increased from a 2.8% benefit last year primarily due to the absence of a valuation allowance and accounting standard's change benefit.

Turning to slide 11, our initiatives to improve working capital, not only absolute improvement year-over-year, but also systemic improvement throughout the year to reduce working capital seasonality and to continues to show good progress.

For the first half of fiscal 2017, we delivered positive adjusted free cash flow of $7 million, a $190 million improvement versus last year driven mostly by working capital. While you should expect full-year improvement, some of the first half gains would normally have occurred in Q3 and Q4, and those benefits have been pulled forward this year.

Second quarter reported interest expense of $50.6 million decreased $6.9 million from last year driven by the benefits of our 4% euro-denominated notes issued last September and re-pricing of our U.S. term loans in October.

Cash interest payments of $53 million were $5 million lower than last year largely related to major term debt reduction, the notary financing, and term loan re-pricing. Cash taxes of $9 million compared to $14 million last year, and depreciation and amortization and share-based compensation were $62 million compared to $66 million last year.

Cash payments for acquisition and integration, and restructuring and related charges were $4 million and $8 million, respectively, versus $12 million and $2 million, respectively, last year. Now, shifting to our operating unit results, beginning with slide 12 in Global Auto Care.

Q2 reported net sales of $119 million fell slightly against solid growth last year driven by unusually favorable early spring weather in February and March that pulled forward retailer orders, coupled with a more restrictive inventory policy this year at major U.S. retailers that delayed orders into Q3.

Appearance revenues were negatively impacted by the cooler weather conditions versus last year. A 6.6% decline in adjusted EBITDA to $45.4 million and margin decrease of 250 basis points to 38.2% was primarily due to lower volumes, input cost inflation in refrigerants and higher planned marketing expenses to support new product launches.

We continue to expect GAC to report adjusted EBITDA margins above 30%, even as the pace of innovation and international expansion accelerates. With GAC's seasonal strength in the spring and summer months, more than 70% of POS historically has occurred in our third and fourth fiscal quarters.

Our core Armor All, STP and A/C Pro brands are being supportive with robust innovation, educational initiatives and increased category awareness. Key launches are the Armor All Ultra Shine and Wash & Wax wipes, tire shine sponges, and flat-pack glass and cleaning wipes, which are rolling out now.

STP launches include High Mileage Transmission Stop Slip + Leak Repair and Ultra Plus 5-in-1 Fuel system cleaner and stabilizer. Turning to slide 13, hardware and home improvement continued its momentum from a record 2016 and a record Q1. HHI have reported record Q2 results, driven by growth across all of its core U.S.

businesses and residential security, builders' hardware, and plumbing. Q2 reported net sales of $313.7 million increased 4%, including the impact of planned exits from unprofitable businesses in Mexico of about 1.3%. Excluding favorable foreign exchange of $1.3 million, organic net sales grew 3.5% against a strong prior year.

The adjusted EBITDA increase of 5.6% to $56.6 million and a 20-basis-point improvement in reported margin to 18% was partially offset by one-time charges of $1.1 million for employee-related taxes from one of our acquisitions. HHI's strong performance in core U.S.

categories continued to be fueled by a robust new product roadmap, delivering steady innovation every quarter across all product lines. New product introduction this quarter include Kwikset Obsidian, a key-free smart lock; Baldwin Evolved, and the new Pfister product families.

HHI is growing in its core do-it-yourself homebuilder channels as well as distributor and showroom businesses. The home automation and electronics segment is HHI's fastest growing, driven by timely innovation to capture consumers' expanding appetite for connected home devices and standalone smart locks.

Adjusted for the planned business exits in Mexico, HHI is realizing international volume and margin expansion in Canada and Latin America. Now to Global Pet, which is slide 14. Q2 reported net sales of $191.8 million fell 8%, while organic revenues decreased 6.4%, excluding negative FX of $3.4 million.

We continue to see profits and margin expansion in fiscal 2017 ahead of revenue growth. That was the case in Q1 and Q2 reported adjusted EBITDA of $31.9 million increased 1.6% and 1.9%, excluding negative FX. Adjusted EBITDA margin grew 150 basis points to 16.6% from favorable mix, cost savings and lower expenses.

The sales decline was a result of category softness as well as significantly lower European dog and cat food sales, driven largely by the acceleration of the planned exit of a pet food costumer tolling agreement totaling $4.5 million in the quarter. The U.S.

companion animal sales were negatively impacted by the planned exits last year of low-margin private label rawhide and chicken jerky businesses. Overall, these planned exits adversely impacted sales by approximately 3.2%.

We continue to be encouraged by the positive impact that operational and process improvements made over the past 12 months to 15 months are having on pet's profitability and the continued transition to higher margin, branded companion animal products with increased market support and stepped-up efforts for geographic expansion in Latin America, Canada and Asia-Pacific.

Expansion on Nature's Miracle into broader distribution point is also underway in North America and Dingo has been successfully re-launched and repositioned. Moving to Home & Garden, which is slide 15. Home & Garden reported Q2 net sales of $131.9 million, which fell 14.9% and adjusted EBITDA of $35.6 million decreased 19.5%.

This compared to strong, historically high Q2 sales and EBITDA increases last year of 25% and 40% when favorable U.S. weather and the impact of the Zika virus led to significantly heavier-than-normal early season retailer orders.

Also impacting this year's Q2 results were continued robust retailer inventory management, cold and wet weather across much of the U.S. and a shift in promotional timing. It is important to note that Q2 sales and adjusted EBITDA grew a solid 6.5% and 13% versus fiscal 2015 two years ago, when weather patterns were more consistent with this year.

Looking at historical quarterly phasing, as much as 70% of Home & Garden POS occurs in our third and fourth fiscal quarters.

Given distribution and market share gains, more innovation, strong promotional commitments and an outstanding retail services team, Home & Garden is well positioned to benefit from good weather in the second half and the resulting solid consumer demand.

Innovation has been introduced for Spectracide and improved delivery, educational packaging and a new weed-stop formula. New aerosols and liquids are part of Home & Garden's unique Hot Shot bed bug integrated pest management launch, and as soccer activity heats up, Cutter's exclusive repellent sponsorship of U.S.

Soccer is helping to drive important off-shelf placement and strengthen brand awareness. Now to Personal Care, which is slide 16. Q2 reported net sales of $104.7 million fell 3.4%, while organic revenues decreased 1.6% excluding negative FX of $2 million. Lower U.S.

and European revenues were attributable to increased competitor promotions, category softness, and higher post-holiday inventory levels that reduced inventory replenishments. As a partial offset e-commerce sales grew at a strong double-digit rate.

Despite the overall sales shortfall, adjusted EBITDA increased double digits with margin improvement of 220 basis points, driven by favorable mix, lower operating costs and continues improvement savings.

Looking at the second half, Remington is targeting top-line growth with a mix of strong innovation, especially in shave and groom and in hair care and expanding distribution into new wide space areas along with continuing double growth in its fastest-growing channel of e-commerce.

In the second half of 2017, major new Remington product launches include the heritage shaver line, Nano series trimmers and an advanced straightening brush in the U.S., while in Europe, new introductions include the Keratin Radiance collection, Flex360 shaver and Air Plates, our latest, world's first innovative hair straightening with a unique suspended system providing one-pass styling every time.

Now let's turn to Small Appliances on slide 17. Q2 reported net sales of $123.6 million decreased 10.6% and excluding negative FX of $3.5 million organic revenues fell 8.1%. Lower revenues were in large part a result of category softness, a Brexit-related decline in demand in the UK, and in the U.S. from inventory reduction by a major retailer.

While adjusted EBITDA fell slightly, margins improved by 20 basis points, excluding negative FX of $1.6 million, organic adjusted EBITDA also increased. Small Appliances' objective is to broaden its portfolio and distribution points around the world, with steady innovation continuing to be its most powerful tool.

White space opportunities also remain a focus with a continuation of strong growth in ecommerce and brand expansion.

In Europe, for example, six new Black+Decker products are launching in the UK through Amazon, four George Foreman Grills launched across Continental Europe in March, and we plan to introduce 11 new Russell Hobbs products in July in the cooking category.

In the U.S., sales volumes are expected to be driven in the second half, primarily from innovation in the cooking and beverage categories. Finally, the Global Batteries which is slide 18. Global Batteries delivered a solid Q2, following a strong first quarter.

Q2 reported net sales of $185.2 million increased 3.9%, and excluding $2 million of negative FX, 5.1% organically. Organic adjusted EBITDA grew 3.5%, with volume growth in alkaline and hearing aide batteries in the U.S. and Europe, primarily driving the improvement.

Q2 EBITDA was adversely impacted by one-time operating expenses of $2.9 million associated with the retail bankruptcy and legal expenses. Global Batteries is pursuing growth in under-indexed channels and new geographies, such as hearing aide batteries in China, food and drug channels in North America. And through market share and distribution gains.

We are introducing refreshed Rayovac packaging in North America as part of our expanded go-to-market initiatives started last year, as we continue to pursue a number of white space opportunities in the region. In Europe, the winning combination continues to be a mix of new customers, distribution, market share gains and effective promotions.

Finally, Global Batteries is on track to deliver another year of strong, continuous and improvement savings, which help offset negative FX impacts and commodity pressure. Moving to the balance sheet on slide 19.

We ended Q2 in a strong liquidity position with more than $470 million available on our $700 million cash flow revolver, a cash balance of about $137 million, and debt outstanding of $3.84 billion. Given the announced acquisition of PetMatrix, we now expect modest deleveraging in fiscal 2017.

During the quarter, we increased the size of our cash flow revolver from $500 million to $700 million, extended maturities by two years to 2022, and lowered interest rate spreads and commitment fees. In early April, we also re-priced our $1 billion U.S. term loan facility, which will further lower interest expense.

As mentioned earlier, adjusted free cash flow for the first half of $7 million compared to a use of $183 million in the prior year, reflecting good progress across inventory, accounts receivable, and accounts payable to sustainably improved working capital management, and reduced some of the seasonal volatility of our working capital cycle.

Q2 capital expenditures were $23 million compared to $21 million in the prior year. And finally, during the quarter, we repurchased 44,550 shares of common stock for $5.5 million or $122 per share on average. Turning to slide 20, and a review of our 2017 guidance.

We expect reported net sales to grow above category rates for most categories, partially offset by the anticipated negative impacts from FX of approximately 100 basis points to 150 basis points. We expect to deliver adjusted free cash flow between $575 million and $590 million.

Full-year interest expense is expected to be between $200 million and $210 million, including approximately $15 million of non-cash items. Cash interest payments are expected to be between $175 million and $185 million.

Depreciation and amortization is expected to be between $245 million and $255 million, including approximately $55 million for amortization of stock-based compensation. Our 2017 effective tax rate is expected to be between 30% and 35%. And recall that for adjusted earnings, we use a 35% tax rate.

Cash taxes are expected to be approximately $50 million to $60 million. And we do not anticipate being a significant U.S. federal cash taxpayer for the next couple of years, as we continue to use net operating loss carry-forwards.

Cash payments for acquisition and integration and restructuring and related charges are expected to be between $30 million and $40 million. And capital expenditures are expected to be between $110 million and $120 million, including rollover spending from 2016.

These incremental investments will support footprint optimization, vertical integration improvements, technology and innovation, and are expected to enhance the company's margin structure and organic sales growth rate. Thank you. And now back to Dave for Q&A..

Thanks very much, Andreas and Doug. With that, operator, you may now begin the Q&A session, please..

Certainly Your first question comes from the line of Faiza Alwy with Deutsche Bank. Your line is open..

Yes. Thank you. Good morning..

Good morning..

So, Andreas, I wanted to just talk about your outlook on overall category growth. So, you mentioned category softness this quarter. Do you view that as just temporary or has your – I think before you had mentioned that you still expect sort of low-single digit category growth in the year? And then just a second question for Doug.

I noticed that you change the commentary around being a regular U.S. federal cash tax payer. It was previously next few years, and now it's next couple of years. So, has anything changed around that? Thanks..

Yeah. Thank you very much. I think if we look at the categories, again, let me start with the two most seasonal, which is Home & Garden and Auto Care. In Home & Garden, it is really a pure timing of retailers taking inventory in. It was last year that they deviated from the norm.

And in the meantime, if you look at our three biggest customers in the U.S., which are both in the mass channel and the home improvement channel, all three have significantly improved their inventory management.

If we look, for instance, at our inventory at the biggest retailer of the world, the inventory is down by more than 20% year-over-year, but at the same time, the in-stock is at a similar rate of about 98%.

That means we have simply to admit those retailers are doing a great job in managing their inventory better and pulling the orders and the goods just in time for the season. Also, if we look, for instance, at our POS in Home & Garden, we are actually now in April up 7% ex that biggest retailer of the world.

So, we are performing very well, and therefore we really believe that this is a pure timing. Growth is going to come in the third and fourth quarter as the retailers are pulling the inventory as they need it. And exactly the same applies to Auto Care. Now, if we look at the other categories, it's a little bit more of a mixed bag.

Home Appliances, which had the softest growth organically in the quarter, there we are seeing globally a slowdown of the category growth.

We believe based on the market data we have that in the first quarter the category was actually declining somewhere between 3% and 4%, and that is linked a little bit that we had last year a lot in the food processing area innovation, which is now missing, and therefore the whole category is down slightly.

However, at the same time, we have seen a trend of some retailers to move opening price point products more to private label, and therefore again, our strategy to focus more on innovative higher price point product is paid off very well.

Of course, that puts some pressure on the top line growth, but as you have seen in this quarter, we have seen a nice margin improvement and bottom line, we believe the trend is going to be positive. But, yet to admit openly, we will see in home appliances some softness in the top line.

And I can also say openly Black Friday is in the back half always a big event for retailers and here we have decided to walk away from unprofitable promotions, which only give a boost to top line but nothing to bottom line. So, we are focused about EBITDA growth.

Now, looking at the other categories, we see a very positive trend in batteries continuing. We see in Personal Care also a nice recovery, so therefore, that is nothing that was more kind of slowdown in the quarter because after Christmas and high inventory at the trade, but the category growth continue as well.

And then in Pet, it's a little bit of mix bag. We continue to perform good in our four companion and aquatics business, but we have some challenges in the dog and cat food category in Europe. So, a little bit of kind of mix bag, but overall we are very confident about the second half and our more, more, more strategy is really working very nicely.

I'm not sure, did I cover basically that question?.

Yeah. I think you did, Andreas. And the second question, Faiza, related to a couple of years versus few years. When we entered the year, we did have a few years left on our NOLs, and that's few is, three or so. We're now halfway through the year, and we're closing in on two or so. So, it was just an appropriate time during the year to change that.

As you'll recall, we were a little bit longer than that prior to the Global Auto Care acquisition, but virtually -most, anyway, of its profit is in the U.S., and that's a very profitable business in the U.S. So, we're using NOLs a little faster than we would have before that acquisition..

Operator?.

Certainly. And your next question comes from the line of Olivia Tong with Bank of America Merrill Lynch. Your line is open..

Great. Thank you. Good morning.

Just staying on the category growth, just if you could give us your expectations for what you think actually underlying category growth is right now? You, obviously, said your sales are down about a point for the first half on an organic basis, but seemed pretty bullish in terms of the flip back on a couple of the more seasonal categories.

And then in terms of the U.S., can you talk about the cadence of this quarter, specifically the March quarter, and then if you've seen anything different since quarter-end or are you seeing better replenishment, particularly in the non-seasonal businesses? Thanks..

Good. Let me just start with the second question on how April is doing. We see POS trending nicely. I mentioned it earlier. Home & Garden, Auto Care, we see a really nice pickup, partly linked to the weather. Yes, last week, the weather was bad again, but overall, for the month of April, POS is going in the right direction.

However, retailers are not – again the biggest retailer of the world, their quarter-end is end of April. So, we don't see a big spike now that they are suddenly reversing that trend of the previous quarter. They continue to pull in time.

And as you may know, they have implemented a scheme, which they call OTIF, on-time in-full, where they are working with all their suppliers and where they are actually implementing a kind of fine system, if their suppliers are not delivering on time. So therefore, they are simply improving their inventory management and now doing a great job.

So in-stocks continue, good, POS continues strong, but really the shipments continue to follow. This is also why we have mentioned, we are not seeing the entire impact of the second quarter revert in Q3.

It will be Q3 and Q4, because the fourth quarter is still a very important part of the top season, and therefore, the retailers last year were sitting on huge inventories in the fourth quarter, which they then drained down towards the end of the season. And this year, we expect a more normal kind of trend.

Now, help me again, the first part of the question was, what that again?.

Category growth rate..

Yeah, the category growth rate. Really, this is difficult to answer across the board. We believe it is, category-by-category different. Starting with the most positive is the hardware and home improvement. Here, we believe that the total market continues to grow over somewhere 4%-plus. And also, if you look at our growth in the last quarter in the U.S.

market or in North American market, we were up more than 5%. So that trend, we believe, is going to continue. If we look at batteries where we had also very strong quarter, yes, we are seeing a slight tick-up in the category growth, but still it's somewhere slightly in the 1% range or even slightly less than that.

So here, we are really gaining market share in different parts of the world, so therefore, we continue to grow that very nicely. In Home Appliances category, globally is down. We expect it to be down somewhere in the 3% to 4% range until some new innovation is going to hit the market.

We target to exceed that growth rate, what Doug mentioned earlier, by expanding into adjacencies. That means launching, for instance, more brands, which we have already in our portfolio, like for instance, Black+Decker. We have been working with Black+Decker only in the Americas in the past.

Now we are launching it as a second more competitive brand also in the UK. We have been using George Foreman in the past only in the UK and now we are rolling it out into Continental Europe so that we can go again after several price points, do a nice channel differentiation and so on.

So therefore, we see there's some kind of growth above category, but it is going to be a low growth rate. And Personal Care, modest growth, Pet, modest growth. So I think those will continue to grow, let me call it, in the GDP range..

Great. Thank you so much. And then in terms of just the exits that you guys have done. Obviously, conditions have become a bit more challenging particularly in the U.S.

Are you getting any additional – or are you putting any additional scrutiny on your businesses? And could we potentially see more product line exits as time progresses? And how much more is there on the existing exits that what you already announced? And how much more is flowing through from that? Thank you..

We have very different element and if we start, for instance, in Pet. There, we have exited private label business in the U.S. and this has now anniversaried. So, that effect is over. So, here we have comped now the impact that was more recent last April. So, that's done.

Whereas in the Europe, we are exiting a tolling agreement related to dog and cat food, and that would have typically gone into 2018, and there we are seeing now an acceleration of that tolling agreement or exit of that tolling agreement. And we expect to complete that by the end of this fiscal year. So that from next year on, it would be pure organic.

Now, looking at the other categories, if we look at HHI, there we have exited in Mexico, the FANAL business and there again, we are going to anniversary the impact in September. So, there's still another six months to go. So, overall, for this year, we expect the impact of those exits to be about $40 million..

Thanks so much..

Okay, operator....

Can we have the next question, please?.

Certainly. Your next question comes from the line of Bob Labick with CJS Securities. Your line is open..

Good morning..

Hi, Bob..

Hi, Bob..

Hi.

I wanted to just talk a little bit about retailer traffic and can you talk about which categories you are more impacted by declining traffic of retailers versus where you're kind of avoiding it? And then, more specifically, what are you doing strategically in those categories where retailer traffic has been a little bit weaker and tie it into your – obviously faster move to e-commerce – so, tie it into your e-commerce strategy as well if you could..

I think the retailer traffic if you talk generically, we had – and there are two stand-outs. So, first one is in the U.S.

and there really January and early part of February was very weak and this is probably linked to what have been communicated earlier the delayed in the tax refund, which especially has impacted lower kind of income groups and, accordingly also, that delayed a little bit that demand in the opening price point ranges where the higher price point product still continue to perform very well.

The second point is on the kind of more strategic shift. Here, we really see a channel shift occurring where it is that a brick and mortar is declining and e-commerce is growing rapidly. However, even in the brick and mortar, there are very different trends and if you look at the different retailers.

Our top customers, be it the leading home improvement centers or also the biggest retailer of the world, continues to perform very well. And therefore, we see actually they're having a very positive trend where some more of the traditional other retailers are challenged in their foot traffic.

What we are also seeing is that also those brick and mortar retailers are stepping up their initiative to drive their multichannel strategy, that means also pushing their e-commerce including order online, pickup in-store, which is performing very well. And overall, our growth is exceptionally strong. It is in the high-double digit range.

So, that is the kind of – but it's also kind of multichannel strategy where we see consumers looking online and then still buy in-store or ordering online and picking up store. So, it is really becoming increasingly a multichannel strategy..

Terrific. I appreciate that. I'll get back in queue. Thank you..

Thanks, Bob..

Okay.

Next question please, operator?.

Your next question comes from the line of Kevin Grundy with Jefferies. Your line is open..

Thanks. Good morning, guys..

Hi, Kevin..

Good morning, Kevin..

I just wanted to pick up on the top line a bit. So, it seems like, Andreas, it's based on sort of the category growth rate you are outlining. And to get to sort of like a 2% sort of growth rate for the year, it would imply that somewhere in the ballpark of like a 4% to 5% kind of organic sales growth rate.

And understanding that the comp is an easy one, particularly in 4Q, is that how you sort of see things trending given some of the benefit that you get from some of the sales that were sort of pushed into the third quarter?.

Yes. That is pretty accurate. So, I think that's a good assumption..

Okay. And I just wanted to come back to the U.S. piece because it's been sort of an ugly earnings season in HPC, particularly U.S. results.

But I just want to make sure I'm understanding you clearly, you don't really seem to see it that way in your business with the exception of, maybe, home appliances which was weak in calendar 4Q already, and I think there's been discussion, a lot of it about Walmart destocking there.

But it sounds like you don't really see it that way, Andreas, although some of the weakness here, you're going to pick up in fiscal 3Q. You seemed relatively comfortable with the dynamic with retailers, absent some of the destocking. And it sounds like things are a little bit better in April.

Just want to get your perspective to make sure I understand that clearly because there is a lot of sort of gloom and doom commentary out there..

I think, overall, the demand is there. I think, A, you mentioned it correctly, there is a delay in the intake. However, the second element, which we also have to take very serious and we are addressing it also is that there is a shift in the opening price point more to private label.

That means that in the category, an extreme, let me call it, margin pressure.

And that's why, again, we are investing so much focus on innovation because that's the only way to differentiate and therefore to avoid that pure price play which can, as I mentioned earlier, in a lot of cases, Black Friday promotions are at negative margin and that simply are games where we are walking away, where we believe that doesn't make any sense..

Okay. Thanks. One more, Doug.

On M&A, is it still safe to say that larger scale M&A is still off the table until we get greater clarity on what the HRG transactions will look like?.

I think those are two separate issues, Kevin, but I do think on the first question, larger scale M&A now that we have PetMatrix in front of us, and we're actively involved in planning for integration and closing that transaction, that will be our focus.

But any kind of M&A, whether it's bolt-ons or transformative, we can't really pick the timing on it. So, if something really attractive came up, I don't think that what's going on at the HRG level would impact our appetite or ability..

Okay. Very good. Thank you..

Operator, next question..

Your next question comes from the line of Jason Gere with KeyBanc. Your line is open..

Okay. Thanks. Good morning, guys. I guess one question with two parts. You talk about some of the investments that you're making this year. Certainly, that's in the changing retail environment to more e-commerce and even to kind of tackle the more, more, more strategy that you have.

So, I guess the first question is, are the investments really geared towards this year? Do you see that continuing next year? And then the second part is that where – you've done a really good job leaning on some of the productivity initiatives, some of the manufacturing changes out there, whether it's in Ohio or St. Louis.

Just wondering, what other type of projects do you see out there that can kind of drive more productivity savings to kind of, I guess, insulate the EBITDA as you make more of these investments in growing channels? Thanks..

Yeah. Let me first answer the question on the investments this year versus next year. It really is both, and let me take some examples the more, more, more, which I mentioned the example for Pet, Home & Garden going with Nature's Miracle in more channels, going with Rapid Repel into Latin America. This is impacting already this year.

And the Nature's Miracle will be – I would say, will probably have a six-month impact this year with the second six-month impact coming next year because that is going very rapidly, well accepted by those other channels. Rapid Repel into Latin America, that's more going to be a kind of step-by-step process.

We need to gain the local registrations, we have to gain market share, the listings in retail. That's going to be more kind of multiyear strategy where we adjust we have made the homework, the groundwork is prepared, and we are rolling it out.

Now, looking at some of the other divisions, and you may have seen on one of the charts where I was talking about those investments, that in our Auto Care division, we are, for instance, also working on developing adjacencies. Like for instance, in STP, expanding into lubricants and oil for small garden equipment.

And those are being developed this year, but in all fairness that impact is going to be earlier in 2018. So, a lot of those initiatives will really pay back next year. I think on the productivity, let me pass that on to Doug..

Sure. Thanks, Andreas. Jason, on the productivity elements, some of the things that you've heard us talked about very overtly have been the HHI and DC consolidation project and the Dayton DC and manufacturing consolidation.

And those are going well and those will contribute a little bit this year, but those will, from a working capital and cost savings perspective, fully flow into next year.

But we've also talked about our global transformation initiative across HHI, which is streamlining and chassis harmonization and automation across our manufacturing footprint there, and there's plenty of headroom, that's a multi-year project, it's a planned project.

We've added – or are in the process of adding battery capacity in both hearing aid and alkaline to serve demand that we see in those categories, especially in our European environment.

And then we've got other parking lot items, a nice robust list that we have out there that we haven't talked about publicly and it's – some are big items in there, meaningful items in there across the businesses, and some are just a normal productivity culture that this company has. We're always planning for productivity improvements..

Okay.

Next question?.

Your next question comes from the line of Ian Zaffino with Oppenheimer. Your line is open..

Hi. Great. I just wanted to touch on batteries. What was the price versus volume on that revenue increase? And I have a follow-up..

I think this is a tough question because if you look at batteries, we actually have those – big chunk is alkaline, second biggest category within batteries is hearing aid, but then you have also flashlight. You have rechargeable, power pack, specialty battery.

And our growth is really driven mainly by alkaline and hearing aid where – which we produce in-house. Accordingly, we have the highest margins. We see in flashlights a similar trend like at the opening price point in electric appliances that big retailers are moving increasingly to private label. And therefore, we are actually declining in flashlight.

Our growth is driven really by those in-house produced alkaline and hearing aid. And that is driving a favorable mix effect. But overall, let me be blunt, the market is still extremely competitive, and the competitive pressure remains strong..

Okay. And then just a follow-up on the hearing aids. I know the FDA was taking some steps maybe to improve what they said hearing aid accessibility.

I don't know what you're hearing there or what you're seeing there or if you can maybe give us a little commentary surrounding that, how that might affect you, whether or not it happens – just any color you could give would be great. Thanks..

So, as you may know, we are also member of the Hearing Industries Association, and I can tell you openly that of course if you make hearing aids more accessible, that it can increase the demand, and accordingly it may be beneficial for us, for instance, as a hearing aid manufacturer.

However, at the same time, we have to realize it is a medical device. And if you have patients trying to do a self diagnosis, then they may also be wrong, and therefore, they may also then pick an equipment where they are unhappy and they may not be satisfied with it, and also the safety and effectiveness of some of those products are wrong.

So, therefore, we as an association, are not necessarily supporting that even if at the surface it may look as if it may benefit the consumer. We see there are serious risks for the consumer, and therefore we believe that the role of the professional channel is so very important..

All right. Thank you very much..

Next question, please?.

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

Thanks. Hey, guys. Good morning. First question on Pet, if you look at the decline this quarter, it seemed to accelerate from last quarter.

I know you guys have talked about an acceleration or an improvement in organic sales in the second half, it sounds like this morning you're a bit less optimistic on that, maybe a little more clarity on what you're expecting for the Pet segment in the second half. And then my second question sort of goes back to Kevin's question on HRG.

To the extent that you can this morning talk about what your outlook is and timing is of a resolution until they've given that the FGL sale looks like it's hit a snag here. Thanks..

Yes. Let me just answer the question on Pet. I think there are a couple also of seasonal impact which impacted the second quarter, like for instance, in aquatics as part of our business is the outdoor pond. That means fish food for outdoor pond. And again, with the colder weather in both in Europe and also in the U.S.

in our fiscal second quarter, some of the retailers delayed the intake and also the consumer demand is slipping a little bit back. So, therefore, there's also some seasonality, we have not flagged it because it's not close to be in the same range as for Home & Garden.

Now, the second point which is really getting a little bit more competitive is in the dog and cat food category in Europe where we have struggled and where we are stepping up now our level of initiative driving more innovation, also going to invest more into marketing.

So therefore, that is the challenge where we still need to address and we don't see the turnaround happening in this year, that's more going to be a kind of 2018 impact..

So, on HRG, that's all happening above us. So, we really don't have any comment or any insight that you don't have into the situation..

Okay. Thank you, guys..

Next question please, operator?.

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

Good morning..

Hi, Jim..

Hi. In a slide that you mentioned, you now expect modest deleveraging this year given the PetMatrix acquisition.

Just give us some more color around that? Is that adjusted EBITDA margin down year-over-year? And if so, can you tell us what the sales and EBITDA contribution from PetMatrix should be this year?.

Yeah. I can tell you a little bit of that anyway. It's very straightforward. My reference was simply to the absolute dollars of deleveraging. It didn't have to do with multiples or anything like that. We're paying a headline cash number for PetMatrix of $255 million. And that business, the way it's structured, is a flow-through.

So, there are significant tax benefits that we inherit. We get full basis in these assets. So, the net present value of the purchase price then goes down to slightly below $200 million, and that's within the purchase multiple range that we target and execute against..

Okay.

So, there's nothing to do with leveraging of expenses?.

No..

Okay.

And then, in terms of the sales benefit from PetMatrix this year, is that incorporated into your expectation to grow above category rate this year?.

No. We haven't closed the transaction yet. The only thing we're signaling on this call is the impact on leverage for the year. I didn't want to reiterate a number that has a contemplated acquisition. Nothing else has been factored in at this point..

Okay. And then on batteries, yeah, very strong growth in the first half of this year.

Is that driven by strength in kind of the core channels and geographies or is it benefiting yet from your expansion into the under-indexed channels and new geographies?.

It is really both. We are seeing both in the countries where we are already strong and even at the retailers where we are already listed, we're gaining more shelf space. But second, we are also making nice progress in that country expansion into the channel expansion.

So the more, more, more strategy is also applying to batteries, and we are seeing nice growth. In this context, I should flag that of course, the more, more, more always has a certain lead time. And of course, batteries is the segment where we are doing it already longer, and therefore, the momentum is also stronger in that strategy..

Great. Thanks and best of luck..

Thanks, Jim..

Thank you. Okay.

Operator, we're near the top of the hour, so why don't we take one more question before closing down the call, please?.

Certainly. And your last question comes from the line of Shannon Coyne with BMO Capital Markets. Your line is open..

Hi, guys. Thanks for taking my question..

Hi, Shannon..

Hi. Sounds like you've begun to see the impact from Walmart pushing its private label strategy in the opening price point products and small appliances.

Do you expect that to get worst from here? And then what are the other categories you're most vulnerable to this? And so – and then what percentage of your business is in that opening price point range and where do you expect that to move to, given your investments and innovation, how long will that take?.

I think the private label strategy, if you take kind of step back and look at it from the long range, it is really partly also a kind of competition with other retailers. And as for instance, the dollar channel, as you know, the discount from Europe are coming to the U.S.

We believe that at the opening price point, the competition between retailers is going to get stronger, and accordingly that the retailers are going to utilize private labels to capture those price points so that they can compete against those discounted and dollar channels.

However, at the same time, the retailers are not only looking for a one-to-one price matching, they also are looking for their absolute margins.

And therefore, they are looking to have a kind of more complete assortment, where, yes, at OPP, they fight with their private labels, but as we go into the higher price points, they have a very strong need for innovation and for brands. And that's exactly the strategy which we are playing.

So, we will continue to see that positive mix effect going to higher price point product. Sorry, I didn't get your second question.

Or did I answer that?.

I think so, yeah. So, secondly – sorry. Can I have one more? I was looking at – your free cash flow was better than what I expected again this quarter despite missing on the EBITDA line.

Can you talk about your working capital expectations for the rest of the year? And so, maintaining your guidance, how much of that is continued improvement in working capital versus an improvement in EBITDA? That's it. Thanks..

Sure, Shannon. This is Doug. We have, as you know, been working on systemic improvements to – or systematic improvements to managing working capital for a couple of years now, and it's really beginning to flow through the balance sheet, and it began in the first quarter of this year.

There were significant improvement year-over-year there, and that improvement has been maintained and even expanded just a little bit in the second quarter. And you should really think about it as taking seasonality or some of the seasonality out of our working capital cycle.

So, what we've done in the first half is significantly better than last year, and we will hold that basic construct and performance throughout the year, but we obviously give back in quarters three and four some of what we had historically delivered in the back half in prior years.

So, there will be a little benefit on the whole year – some meaningful benefit on the whole year, but that's included in our $575 million to $590 million guidance..

Thanks..

All right. Thank you..

Okay. Thank you and with that, we have reached the top of the hour. So we will now conclude our conference call. I certainly want to thank both Andreas and Doug. And on behalf of all of us here at Spectrum Brands, we thank you for participating in our fiscal 2017 second quarter earnings call. Have a good day..

This concludes today's conference call. You may now disconnect..