Spectrum Brands - Earnings Call - Q3 2018
July 26, 2018
Transcript
Speaker 0
Good morning. My name is Mariama, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal twenty eighteen Third Quarter Earnings Conference Call. As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, July 26. Thank you.
I would now like to introduce Mr. David Pritchard, Vice President of Investor Relations for Spectrum Brands. Mr. Pritchard, you may begin your conference.
Speaker 1
Thank you, operator, and welcome to Spectrum Brands Holdings fiscal twenty eighteen third quarter earnings conference call and webcast. I'm Dave Pritchard, Vice President of Investor Relations for Spectrum Brands, and I'll be moderating this morning's call. Now to help you follow our comments, we have placed a slide presentation on the event calendar page in the IR section of our website at www.spectrumbrands.com. This document will remain there following our call. So if we start with Slide two of the presentation, you'll see that our call will be led by David Mora, Chairman and CEO and Doug Martin, CFO.
David and Doug will deliver opening remarks and then they'll conduct the Q and A session. If we turn now to Slides three and four, our comments today do include forward looking statements, including our outlook for fiscal twenty eighteen 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 July 2638, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10 ks.
We assume no obligation to update any forward looking statement. Also, 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 eight ks filing, which are both available on our website in the Investor Relations section. With that, I will now turn the call over to our Chairman and CEO, David Maura.
Speaker 2
Thanks, David, and thanks, everybody, for joining us today. I'd like to start actually by welcoming the new shareholders from HRG Group to Spectrum Brands. That transaction, which is now complete, enables them to participate directly in the significant upside opportunities that I believe our company has. When I last spoke to everyone three months ago, I took on a new role here, and I told you that the second quarter results would in no way define our company. However, I did mention that it would refine us, and that that we we are we are starting the process of refinery.
We're being refined. While we have much more progress to make, the third quarter results demonstrate that the leadership changes will focus on restoring the ownership and accountability culture of our company. They're already beginning to read through into significantly more positive results. I'm also pleased to report to you that we are delivering on the positive momentum and the growth that we promised you we would have in the back half of this fiscal year. I would be completely remiss not to thank all my team members and to extend my sincerest gratitude to every one of our employees worldwide who have responded with determination and extreme resiliency to put our company back on a positive trajectory as we move through this transformational year that I believe will ultimately result in a much less leveraged, much more focused company with four streamlined operating core units with much greater growth potential and a much higher margin structure.
Our third quarter results from continuing operations rebounded strongly from Q2. We did deliver increased sales and adjusted EBITDA versus the prior year. And we achieved significant encouraging progress against the operating efficiencies that we've been experiencing in the greenfield facilities for both our hardware and home improvement assets in Edgerton, Kansas, and our global Auto Care assets in Dayton, Ohio. Highlighted by double digit growth are HHI and Auto Care businesses, and strong top line in our Home and Garden, we reported our highest quarterly organic sales growth rate of 7.3% in many, many years this quarter. This quarter is also our largest quarter.
The market demand for our products and brands is solid. New product introductions were launched across our portfolio, and e commerce growth was exceedingly strong. Perhaps most importantly, customer order backlogs were markedly reduced in the Edgerton, Kansas and Dayton, Ohio facilities, which confirms that our new approach to culture and our new efficiency measures are taking hold and are working. Our adjusted EBITDA of $2.00 $6,000,000 did grow about 4%, even as we continue to be significantly impacted by increased commodity input and freight costs, unfavorable product mix, higher operating costs, to name a few, even as we improve the efficiency in the Kansas and Ohio facilities. However, I remain confident that the long term strategic merits of these consolidations will result in improved operating efficiencies and lower inventories going forward.
As such, today we reiterate our fiscal twenty eighteen adjusted EBITDA guidance from our continuing ops of 600,000,000 to $617,000,000 and our adjusted free cash flow of about $485,000,000 to $5.00 $5,000,000 We're now anniversarying the Rawhide recall we experienced in our Pet unit last year. And I continue to be bullish on the outlook for this business. To be honest, I thought it would turn over a year ago, but we did have this rawhide reset. And this quarter's Pet segments were negatively impacted by some short term start issues in late April and May as the consolidation of our European Aquatics and Pet Food distribution centers in The Netherlands had some issues. But these ramp up issues are now largely behind us, and we expect to shift the small temporary customer order backlog that was built as we return to efficient operation in the fourth quarter.
In The U. S, the Pet business delivered encouraging results in the third quarter, and PetMatrix and the GloFish acquisitions are leading the way. And now that the Rawhide recall from last year is essentially behind us, I'm looking forward to reporting improved results in Pet as we move forward here. If I turn to Slide seven, if I can get you to turn to Slide seven, I want to highlight some of the aspects of our strong progress in Q3 and the ability we've had to correct some of these operating efficiencies in Kansas and Dayton. First, in Kansas, our order backlog was reduced by about $20,000,000 this quarter, which essentially got rid of the backlog that was created in the month of March.
The facility achieved this is remarkable. The facility achieved its highest network shipments in the history of our company. And we did it with a single DC model, versus the the actual we had a three DC model before and moved to two. So it proves actually that this one DC facility is going to work, it just wasn't underwritten properly at the outset. The DC management team has been strengthened.
Process improvement teams are in place, and they continue to drive down our cycle times. We have broad improvements helped to expand our shipping capacity. And looking forward, I'm confident that a strengthened leadership team, better trained and more experienced workforce, along with newly installed automating picking equipment to improve our product selection speed and accuracy, will enable Kansas City sorry, our Kansas DC to continue to work down the order backlog to an optimal level by the end of this calendar year. We're going to continue to drive improvement in our customer service levels as we move forward, which is the most important part of this. In summary, HHI sales growth of 14.7% in the third quarter was remarkable.
As I sit here today reporting these numbers to you, I couldn't be more pleased, given the logistic bottlenecks that we found in the month of March. So a real round of applause for the HHI team and all our employees there. Thank you very much. It's been a lot of hard work, and I thank you. In Dayton, we saw improved and impressive results in the third quarter under the new leadership in that facility.
That team did make a number of short term and tactical fixes in the third quarter, and the clear focus is on servicing the customer. I I can't emphasize enough the cultural shift there. There's a there's a there's an absolute maniacal focus on serving the customer. That team shifted its entire $9,000,000 March backlog, ending the third quarter with a modest and normal backlog and meaningful improvement, which is exceedingly important to me. Our on time shipment rates are now acceptable, and I'm very pleased with that.
Dayton employees rose to the challenge. They did an excellent job of what we call shipping the season, given the solid market demand for our products during this peak demand period in the Global Auto Care's seasonal calendar. And as the seasonal demand naturally winds down as we get into the fall, we're going to make more significant improvements. And we've already scheduled them for the Dayton facility, especially in the manufacturing production areas. Under the new leadership team there, we believe Dayton will be operating at a much more efficient and lower cost per unit basis by the start of next year's spring season.
And I really have to extend my sincerest gratitude and thanks to Randy Lewis, to Steve Keller, and Rob DeRitter. All three of these guys exemplify the new culture here at Spectrum Brands, ownership, accountability, and bringing their teams together to do whatever it takes to take care of our customers. And the entire GAC team, they really pulled out all the stops to make this turnaround possible, and I'm forever grateful for that. We have much more work to do here, however, but we're off to a great start in turning around the business, and I'm extremely excited about the future prospects for our Auto Care unit. If I could ask you to turn to slide eight, please, at this time.
The tax free merger with HRG Group was completed on July 13. The transaction was overwhelmingly approved by shareholders of both companies, and this does result in a much more widely distributed shareholder base. It meaningfully increases the trading liquidity in the company's stock. And it now has provided us a truly independent governance structure at the Board of Directors, while additionally bringing us significant tax attributes. Regarding the pending asset sales, we are on track to close the sale of our battery and lighting business to Energizer for $2,000,000,000 That's a cash transaction, and we expect it to close at the end of this calendar year.
We remain in active discussions to divest, and we're continuing to market the personal care and small appliance units. And we intend to use significant net proceeds from these divestitures to mainly reduce debt, repurchase shares, and increase our investment in organic growth initiatives. And we'll also be looking at bolt on acquisitions as we move into the fall for the four remaining businesses. In closing, although we have much to be excited about as we look ahead, I continue to believe that a year from now, Spectrum will be in its best position ever during the ten years that I've been with this company. We will significantly strengthen our balance sheet from our fiscal twenty eighteen free cash flow and from the proceeds from the asset sales in the second half of this year.
And now with the resolution of the HRG Group ownership structure, we're well on our way to building a smarter, stronger, much more focused spectrum brands for the future. I'm I'm happy to come back to you during q and a, but let me turn it over to Doug now, and he can give you much more details on the quarter. Thanks, Doug.
Speaker 3
Thanks, David, and good morning, everyone. I plan to take you, this morning to our Spectrum Brands operating results as normal. But I wanna start by commenting on the form of the merger with the HRG Group and the impact on the presentation of our financials. The legal form of the merger resulted in the historic HRG legal entity being being the surviving company, while Spectrum Brands name, operations, board, and management team continue on to run the business. As a result of this, however, our q three year to date comparable period results in include both Spectrum and HRG activity rather than solely Spectrum Brands.
So the queues are are gonna look a little unfamiliar to you when they're, when they're filed, and that's really the difference. So for at least the remainder of the fiscal year, I will be speaking primarily to Spectrum Brands' only performance from an adjusted EBITDA and adjusted free cash flow perspective. Reported numbers will include both Spectrum and HRG. Additional details relating to the HRG activities apart from Spectrum Brands can be found in our 10 Q. And in addition, a complete listing of separate historical financial information and filings for both Spectrum Brands and HRG Group can be found on our Investor Relations website.
Now turning to Slide 10, let's review Q3 results from continuing operations beginning with net sales. Third quarter reported net sales of $945,500,000 increased 9.6% versus last year. Excluding the favorable impact of foreign currency of $4,900,000 and acquisition sales of $4,500,000 Organic net sales grew 7.3%. HHI and GAC delivered double digit growth driven by solid market demand and tailwinds from reduced backlogs. Home and Garden also reported solid growth as favorable weather finally broke in the latter part of the quarter.
Reported gross margin of 37.5% increased 40 basis points from 37.1% last year, primarily due to lower year over year supply chain restructuring costs. Reported SG and A expense of $198,600,000 or 21% of sales compared to $197,200,000 or 22.9% of sales last year, primarily due to spending discipline and leverage from strong sales growth. Reported operating margin of 13.4% increased 170 basis points versus 11.7% in the prior year, largely driven by higher gross profit. On a reported basis, Q3 diluted EPS from continuing operations was 11.51 which increased compared to a loss of $0.51 last year, primarily due to the release of HRG valuation allowances. Spectrum adjusted diluted EPS from continuing operations of $1.76 increased 23.9% versus $1.42 last year, primarily due to higher sales volumes and changes in The US corporate tax rate.
We are using a 24 and a half percent blended annual rate for fiscal two thousand eighteen versus 35% last year due to changes in The US tax laws. Turning to slide 11. Spectrum reported interest expense from continuing operations in the third quarter of $43,600,000 increased $3,800,000 from last year. Spectrum cash interest payments of $60,300,000 were $18,700,000 higher than last year driven by the timing of payments on our euro denominated notes as well as higher debt and LIBOR rates. Spectrum cash taxes of $7,900,000 decreased compared to $9,700,000 in 2017.
Spectrum depreciation, amortization, and share based compensation from continuing operations of $37,100,000 was equivalent to last year. And Spectrum cash payments for acquisition and integration and restructuring and related charges were $23,100,000 and $27,500,000 respectively, versus $3,000,000 and $12,700,000 respectively last year. Restructuring charge increases were primarily the result of operating inefficiencies in the HHI Kansas and GAC Ohio consolidation projects, higher acquisition costs related to our battery and appliance divestiture processes. Now onto our business unit results from continuing operations beginning with Slide 12 on Global Auto Care. GAC reported record quarterly net sales in Q3 of $175,200,000 an increase of 12.5% from the prior year, driven by solid growth in refrigerants and performance chemicals, along with a tailwind from reducing its customer order backlog.
Reported adjusted EBITDA of $50,100,000 was slightly below $50,700,000 last year, while margins declined three ninety basis points driven by operating inefficiencies, inflationary pressures, especially in refrigerants, increased distribution costs, and higher Project Alpha marketing investments. GAC is benefiting this year from its Armorall Ultra Shine Wash and Wax Wipes, which were successfully launched last year, and strong market acceptance of a new line of Armor All automotive air fresheners. Turning now to Slide 13. Hardware and Home Improvement reported record quarterly net sales in Q3 of $372,400,000 an increase of 14.7% from last year due to continued strong demand in residential security and plumbing and a tailwind in shipments through a significant reduction of our customer order backlog in the Kansas DC. Excluding favorable FX of $1,300,000 organic sales grew 14.3%.
Record quarterly reported adjusted EBITDA of $73,900,000 increased a strong 18.8% with a margin increase of 60 basis points. Excluding favorable FX of $1,800,000 organic adjusted EBITDA grew 15.9%. Profitability in the quarter, however, continued to be pressured by higher commodity costs for zinc, copper and steel as well as increased freight costs. New product introductions across the security, plumbing and builders' hardware lines continued at a steady pace in Q3 with more innovation scheduled for Q4. Now to Global Pet, which is Slide 14.
Q3 reported net sales of $194,700,000 grew 2.5%, driven by $14,500,000 of acquisition sales from PetMatrix and GloFish, which are performing really well. Approximately $6,000,000 of orders in house were unable to be shipped at the end of the quarter due to the consolidation of European distribution centers that began in April and is now largely back to normal operating rhythm. Also partially offsetting this increase was a decline in European dog and cat food sales, largely from the planned exit of a pet food customer tolling agreement of $5,200,000 while U. S. Companion animal sales were adversely impacted by an estimated $6,000,000 from lost business as a result of the Rawhide safety recall initiated in June 2017, which has now been fully annualized.
Excluding the impact of unfavorable foreign exchange of $2,900,000 and acquisition sales of $14,500,000 organic net sales decreased 6.7% in the quarter. Reported adjusted EBITDA fell 3.3% to 34,900,000 with a 110 basis point reported margin decline driven primarily by unfavorable product mix and lower volumes. Excluding unfavorable foreign exchange of $600,000 and acquisition EBITDA of $5,600,000 organic adjusted EBITDA declined 17.2%. Peck continues to introduce innovation across its food, grooming, health aids, and rawhide chew categories, along with further expansion of Nature's Miracle into non pet channels, which is another one of our Project Alpha initiatives this year. We continue to expect the full year impact of the exit of the European pet food customer tolling agreement to be approximately $24,000,000 Moving to Home and Garden, which is Slide 15.
Home and Garden reported net sales of $203,200,000 which were a 5.6% improvement from last year driven by strong sales growth in both the outdoor and household categories. Adjusted EBITDA of $57,000,000 decreased 4.2% and reported margin of 28.1% fell two eighty basis points. The declines were the result of unfavorable product mix and input cost inflation primarily in oil, corrugate and steel. Given the distribution of market share gains and an outstanding retail services team, Home and Garden expects to deliver another solid quarter in Q4 as it did in 2017. Trends to date in July are encouraging.
Now Home and Garden also provided important support during Q3 to the Global Auto Care business by producing certain Armor All lines in our St. Louis facility. Now moving to the balance sheet on slide 16. We ended the third quarter with ample liquidity, in fact very strong liquidity of over $1,000,000,000 including $234,000,000 available on our $800,000,000 cash flow revolver and a cash balance of $815,000,000 with debt outstanding of $5,400,000,000 Our peak working capital borrowing season is behind us, and we expect to pay down the revolver through fiscal year end. Q3 capital expenditures, including discontinued operations were $27,800,000 and essentially similar to $26,800,000 in the prior year.
Turning to Slide 17 and our 2018 guidance. We expect reported net sales from continuing operations to grow above category rates for most categories, including the anticipated modest positive impacts from FX. We continue to expect spectrum adjusted free cash flow to be between $485,000,000 and $5.00 $5,000,000 and the following estimated ranges include discontinued operations. Full year spectrum interest expense is expected to be between $215,000,000 and $225,000,000 including approximately $10,000,000 of non cash items. Spectrum cash interest payments are expected to be between 200,000,000 and $210,000,000 Spectrum depreciation and amortization is now expected to be between $215,000,000 and $225,000,000 for 2018, including approximately $20,000,000 for amortization of stock based compensation.
For adjusted earnings, we now use a blended rate of 24.5% versus 35% for taxes, and Spectrum cash taxes are now expected to be between approximately 40 and $50,000,000 without the impact of any dispositions. We do not anticipate being a significant US federal cash taxpayer during fiscal two thousand eighteen. Spectrum cash payments for acquisition and integration and restructuring and related charges are now expected to be between 105 and $115,000,000, and CapEx should be between 100,000,000 and $110,000,000 Thank you. And now back to Dave for Q and A.
Speaker 1
Thanks, David and Doug. Operator, with that, you may now begin the Q and A session, please.
Speaker 0
Thank you. Your first question comes from the line of Faiza Alwy with Deutsche Bank. Your line is open.
Speaker 4
Great. Thank you. Good morning. David, I wanted to ask two questions. One is just around HHI.
So it sounds like a lot of the excess backlog has been cleared. So just given the volatility in sales, perhaps you could give us a sense of what the underlying trends in HHI are like. So what are you seeing? There's been some concern around just housing generally. So I'd love to hear your thoughts on just end market demand for that segment.
And maybe if you could talk a little bit of I I know you've gained some distribution at Lowe's and other retailers for private label. So just more more color around that. And then I have a second question, but I'll come back to that once we get through this. Thank you.
Speaker 2
That sounded like four or at least three. No. Listen. You know, I would say and and Doug can correct me if I'm getting wrong. But, you know, we only I mean, I'm pleased we got the backlog down by $20,000,000, but the underlying organic growth there was double digit.
Our end markets are exceedingly strong. Our incoming orders are strong, there's a tremendous amount of innovation there. You know, we've got a smart key cobalt toolbox that we launched, and that's just it it uses our smart key technology, but we're partnering with other toolbox, just other applications, with this smart key technology, and and people love it. POS is good. And look, I think, you know, we just went from a position where, you know, some previous decisions were made to to to bring stuff in, and I don't think we used a prudent enough timeline, and I don't think proper underwriting of of the logistics network was done.
And and we went from a standstill in the month of March with three fifty trailers blocking not only inbound but outbound. We don't have any aged trailers in that parking lot today. Listen, that's a yeoman's effort. I would say our on time in full from QuickSet and Pfister, our biggest lines of business, are satisfactory. And again, again, I'm not if my team's listening, I think you did a great job, but for me, I wanna go to the next level.
I think we need to, you know, we still have issues, real issues with builders' hardware. We some elongated metal, very unique pieces, SKU intensive stuff that was brought in from our Carolina DC, and and we're we're not where we need to be there. And, you know, but we just put in some new automation, and I'll be back down there in that facility in a couple weeks to make sure that's working. Doug's gonna come with me on that trip. But, look, you know, you you can do the math.
If you just back out the 20,000,000 of backlog, the rest of that was organic, and that's a double digit number. So, listen, it's a fantastic result for HHI. I can tell you the numbers I see in this quarter remain at that level of double digit organic growth. Now look, do I do I think that's the long term growth rate of the company? No.
I I think it's kind of a a mid single digit grower, and we're probably in let's be honest, we're probably in the seventh, eighth inning of the housing recovery. But we still don't see housing starts or we still don't see the recovery anywhere near where the peak was prior to the financial meltdown in 'eight. And so there's still room to go, and millennials are are buying their first homes and and and supply of existing homes is still really, really tight. You know, just because you had that the the new home sales number this week, that's just that's for a very short period of time. That's like watching five minutes of a movie and concluding
It's not. You got to continue to watch it. So we we see fantastic demand. I'm thrilled that we are on time in full with our major customers because now it's time to go talk price. We're in the business of making money, and we see tremendous inflation, and we need to go price for that because it's it's now it's now time to restore the gross margin of this business.
And if my sales guys don't do it, I'll go do it for them. What's the next question?
Speaker 4
Great. So my next question was around the sale of the personal care and small appliances business. So I noticed that you lowered the EBITDA from discontinued operations. I'm assuming most of that is essentially this business. No.
And I no.
Speaker 2
Okay. No. That's a wrong assumption, but go ahead.
Speaker 4
Okay. Okay. Okay. So I'd love to hear more about that. Maybe if you could break out what the EBITDA for this particular business is, sort of what the holdup is.
I know there are questions around, you know, tariffs. Previously, you talked about carve out financials. I believe you're, you know, sort of making progress on that front. And so just more color around how you're thinking about the sale. Is there a scenario where you might decide to not sell this business?
Speaker 2
Yeah. Listen, until something's sold, it's not sold, and so you own it. If we don't find the right buyer at the right price, we'll put it back in the balance sheet. I mean, that's that's that's what happened. That's what m and a is.
If I give you an update, the update is we got audited financials done on the business last week. We have numerous buyers that are still interested in it and quite frankly wanna pursue it. You know, it's a good business. It generates a tremendous amount of free cash flow. But when you put assets held for sale and the battery deal moved faster than we thought, and then we needed to get, carved out financials audited, which we didn't have in the first round.
It basically delayed it. And yes, there's been some underlying deterioration in the business because of inflation costs and difficulty getting the margin structure right. Honestly, the tariffs, we're not Whirlpool. I see very, very little impact to our appliance business from all the tariffs being banded around in DC. And frankly, recent results actually point to not only stabilization, but we might have a pretty good fourth quarter in our appliance unit.
Look, I'm still bullish on selling the asset. We, You guys know my history. I'm basically an M and A guy. Multiples are exceedingly stretched away from spectrum. I think our multiple is reasonable.
I think the rest of the world is excessive. Any PE firm can go get seven times stable levered financing out there. Interest rates are still exceedingly low. Private equity's got records amount of capital to put to work. Strategics need to find ways to grow.
There are worldwide players in appliances that don't like their US ops, and they really need to have a bigger, more efficient supply chain, critical mass, go to market strategy, and we have phenomenal brands and dominant market share positions. Look, I I just don't wanna comment any more on this than we have. Let's get to a definitive deal, and we'll we'll tell you about it.
Speaker 4
Great. Thank you so much.
Speaker 1
Yes, operator, next
Speaker 0
question comes from Joe Altobello with Raymond James. Your line is open.
Speaker 5
Hey, guys. Good morning. So throughout your presentation, David, you mentioned higher commodity costs and higher logistics costs a number of times in pretty much all of your businesses. I'm curious if you could quantify how much of a headwind do you think you're going to see this year and maybe next year? And what's the potential to price against that next year?
Speaker 2
Yes. I'm kind of getting away from the guidance game. Look, it's a pressure, but we have been taking prices in some of our divisions. They have been sticking, some more easily than others. Obviously, where you have a where you have the number one position, where your brand equity is significantly powerful, you know, the the retailer is more likely to take it.
You know, when I see the results coming out of some of, you know, much larger multinationals, clearly they're having to go into those retail buyers and demand price increases. And so look, our situation has been one where I just needed to get us healthy from a supply chain standpoint. We've got to be able to service, get the customer service levels up to where we're on time, we're in full, and then we're going to go ask for price. And those conversations we're having now, and and and we're going to go get them. So, you know, we are going to restore our margins.
We're not shy. We're in the business to make money. The more profitable we are as a company, that means more money we can invest in innovation, R and D, new product development, which helps our retail partners grow, and quite frankly, makes us a better counterparty to do business with. So, we're take we're gonna take a pretty aggressive stance. And if my customers are listening, we're coming to ask for price increases.
Speaker 5
Okay. That's very helpful. Then I guess secondly, on the Pet business, if you back out the backlog, the tolling exit and the recall, it looks like Pet sales were actually up this quarter. You mentioned earlier that you expected that business to turn last year, and it hasn't. So looking forward, it seems like that's been sort of the problem child here.
Would you expect that business to be up in terms of sales and EBITDA next year?
Speaker 2
You know what? You're calling me out, and you deserve to call me out. I really did think it would turn a year ago. And I would tell you, I'd have been right other than that pet recall we had with the FDA. It was voluntary.
It was on our we did it ourselves. It was wildly expensive. It really hurt us with our customers. I personally have visited, with the owners of some of these specialty pet retailers recently. We are putting new programs in front of them.
I was recently believe it or not, I've been living between Dayton and Edgerton, but I made it down to our Ecuador facility. I was just there with them in Ambuto. And we've got a fantastic new plant there that comes from the old Salix acquisition. And we're making amazing product. I'm telling you, we are it's human grade.
We're not only treating it with enzymes and all the right cleaning chemicals to make it the healthiest product on the market for your dog, but we've got irradiation in there. I mean, we are producing the highest quality, best looking. We've relaunched Dingo. We're relaunching Digestese. We're going back after the private label we lost.
So look, it's a long winded way to say yes. I remain bullish. I think that, we are absolutely going to experience growth going forward. And let's talk next quarter and see if I'm right.
Speaker 5
Okay. Will do. Thanks a lot.
Speaker 6
Thanks, Joe.
Speaker 0
Your next question comes from Bob Labick with CJS Securities. Your line is open.
Speaker 7
Want to take a step and talk a little bit about the Home and Garden. You said obviously that facility helped out on Global Auto and things like that. Can you talk about the margins in Home and Garden? Did that impact it? Or was that mix raw material?
Just a little more color around those margins and the potential recovery there.
Speaker 2
Yeah. No. Listen, I really appreciate the question. And and and let me tell you, the the reason I really appreciate is because I believe everything begins and ends with culture. And and nobody's asked me yet, but I'm gonna go ahead and tell you.
My biggest surprise, since taking, the new expanded role, I call myself chief encouragement officer, by the way, not chief executive officer. But, you know, we this company got way more siloed and too bureaucratic. And in fact, I saw way too many regional, almost matrix like reporting structures, Bob. And I'm tearing all those down. And, to be brutally blunt and transparent, which is one of the things I'm preaching is the new culture here of unvarnished truth.
As we get back to kinda clear lines of ownership, accountability, simplifying our reporting structures, I can't stress how important that change has been. And it's most evident, if if you really peel the onion back to the question you just asked. In the old world, given the capacity restraints in Dayton, one, those people wouldn't have raised their hand to say they had a problem. And, you know, we we are really encouraging people. We have we have a we have a new, challenge, and it's called speak up.
And, you know, I wanna know at 6AM where the problems are. And because the faster I know where a problem is, the faster I can bring a solution to it. And we are we are solutions oriented mentality company now. We are not a bunch of whiners and complainers. But what happened here in this quarter, and the only reason we were able to do this, and that's why I gave specific thanks, you know, to Randy, to Steve, Rob DeRitter.
Listen. We would have not been able to service our customers. We would have not been able to produce the results we did this quarter if we didn't, produce not only listen, we launched a new line of Armor All Trigger Sprays in Blacksburg, Virginia. I mean, that's amazing. That's that's my pet division.
That's where we make nature's miracle. And those guys said, hey. We're one team now, and we're gonna contribute to making sure we keep Global Auto Care's customers in stock. And we ran that line, and and it delivered fantastically. And Randy opened another line for me in our Chapin plant here.
I'm I'm actually sitting in Saint Louis today, with that team. And, that's what made all the difference. And it's this it's this one team mentality. It's breaking down silos, and it's everybody contributing to win. And look, on the margin side, look, the entire division only had a 16% EBITDA margin just last quarter.
I mean, we had a 30% margin just in The US and 28%, I think, international dragged it down a little bit. But, you know, Home and Garden and this is why I'm so excited. And and listen. Don't get me wrong. We have a lot of work to do.
I don't wanna oversell this. I mean, I'm I'm glad we had the quarter we did, but we, you know, we have a lot more to do to become a smarter, stronger, more focused company. And and, but, you know, I'm exceedingly pleased that, Home and Garden has basically best practices globally, and has been doing this a really, really long time. And so I'm equally excited to get into the fall and take some of those best practices from Home and Garden and then apply them to Auto Care under the new stewardship, the new leadership team with the new culture. It's gonna be exciting.
So that's really all I wanna say about it. I don't wanna overcommit. I don't want people to get overly excited. But, I'm very bullish on what we can do. The the industrial logic between, you know, between the assets in Home and Garden and where what we have in Dayton for Auto Care, they're one and the same.
And and and Randy and his team are just they won't quit until we get that thing just beautiful. And I'm I'm I'm I'm you know, we gotta get there, but it's gonna take me twelve months.
Speaker 3
Bob, just quick follow-up. This is Doug. The the margin, margin difference year over year in Home and Garden specifically is related to a little bit of heavier private mix that we've private label mix that we've talked about. We also, because the season started a little late, didn't sell in as much of our concentrate business, which is also a bit of a a margin drag. But over time, the items that David just talked about are going to help us from a productivity and efficiency perspective across the entire liquids and aerosol network.
Speaker 7
Okay. Great. That's great color. And particularly the ability to shift among your similar facilities is a great asset to take advantage of going forward. So without pinning you to a specific number, it sounds like with a very strong recovery in the problems from last quarter.
Looking out a year or so, do you believe margins can be back to historic levels or higher across your segments? Or how are you thinking about it medium to long term and not trying you know, peg you down on raw materials this quarter or transportation that quarter?
Speaker 2
Well, you know I like you, but you are trying to peg me down. I'm not gonna answer your question, but I'm gonna give you two paint look. I wanna get Spectrum back in the business of under promising, over delivering. I wanna get Spectrum back in the business of let's do it and then talk about it. And so in that vein, I'm not gonna give you specifics.
Look. There's a lot more there's a lot more operating efficiencies to get. And, you know, give us we need six to twelve months to go get it, and we'll make those additional changes in the fall. The learning curve, the Dayton, can go up now, given the just incredible legacy of the Home and Garden native knowledge and their industrial intelligence is exciting to me. Look, it also depends on how much price we can take, right?
So let me go do that and let's talk about it in the future. That's all I'm going to say.
Speaker 7
Sounds good. Thanks so much.
Speaker 0
Your next question comes from Ian Zaffino with Oppenheimer. Your line is open.
Speaker 6
So question would be, as you look to shut down the GAC fill plant, does guidance Woah. Assume
Speaker 2
Woah. Woah. Woah. Woah. We're not shutting down We're not shutting down any plants.
We're making them
Speaker 5
better. Okay.
Speaker 6
So as you fix it and make it better, what is what might be the inventory build? Maybe talk about how you might address some potential issues that might arise just because I think you've done a very good job on everything so far, but the company has in the past had some issues. Is there something where we should be looking at there as far as an inventory build or efficiency ramps? Or any color like that you could give us on how we should be thinking about that would be helpful.
Speaker 2
No, no, Listen, let me let's just go through the history real quick. There were five different facilities. They were put into one in our auto care unit in in Dayton, Ohio. What happened there was, one, you know, it's revisionist, and I don't wanna be a Monday morning quarterback, and I don't care about the past. I care about the future.
And I wanna create a great future for Auto Care. So look. The the problem with Dayton was you tried to do your production there. You tried to do your retail ready packaging there. You tried to do your distribution there, and you assumed you could do those old volumes plus more volumes, plus more SKUs, and take what's called change outs.
And so if you're running an old line that you brought in from Garland, Texas, and you're running a bunch of 24 ounce bottles through it, but then another customer wants an 18 ounce or 12 ounce bottles. There's downtimes on the lines. Okay? I personally and it's it's not gonna be me. I I believe in empower look.
I believe in in in in, you know, inspiring, empowering, encouraging. Now the other part of that is I believe in accountability big time too, and and the team knows that. But at the end of the day, GAC and Dayton are going to be optimized. And so there'll be additional lines brought in there, added to, that will increase the efficiency of that. And long term, we probably won't need to use some of these Home and Garden and Pet assets to supplement.
But Randy Lewis and his team are going make those decisions, and I'll approve them. But there's a lot of optimization to go on there, Ian. And that facility is going to prove to be good. I just think we may have to rethink, do we really wanna do distribution all out of there? You know, would it be better to look at a three p l?
Retail ready packaging, we never did it, and we did a poor job of it. You know, maybe we use a a a third party, a co packer. It is just you know, we need to we we we're just re underwriting that. And, actually, I have a whole team of consultants that's been ripping through these plans with me personally. I've learned way too much about standard cost accounting recently.
But, you know, I'm reunderwriting these facilities, and they're gonna be world class. I'm I'm getting off you know, what what I just wanted to rebaseline what your view of that was because the way you asked the question, I I just thought I needed to kinda put a new framework around it.
Speaker 3
Ian, from an specifically from an inventory perspective, we will probably build a little bit in our in our q one this year as we as we, reorient the facility. But that as you know, this is a pretty seasonal business. So next year end, we'll be in great shape again on an inventory basis.
Speaker 5
Okay, great. And Doug, while
Speaker 6
I have you, can you just give us an update on the NOL balance and the share count pro form a for HRG, so currently?
Speaker 3
Yeah. Sure. So the NOLs that we expected to get from HRG, got. And the capital losses that we expected to get, we got. So those are about a billion 2 and a billion and and 400,000,000.
As you know, we entered the year with a couple years worth of NOLs to to use at the Spectrum, branch level as well. So, you know, no no real change in what we said before. And about 55,000,000 is the is the outstanding share count. And you're gonna see something really funny in the 10 q. The 10 q is gonna show $33,000,000 33,000,000 shares outstanding because, again, the way the legal form of the transaction occurred.
And then in the fourth quarter, you'll see that number move up to, to what will be the normal run rate again for us.
Speaker 6
Alright. Great. Thank you very much.
Speaker 7
Thank you.
Speaker 0
Your next question comes from Jim Chartier with Monness Crespi Hardt. Your line is open.
Speaker 8
I have two questions for you. First, on the Home and Garden business. Scott came out recently and said that they expect a 2% to 3% headwind from retailers reducing inventory levels in that business. Are you seeing the same pressure there?
Speaker 2
We're going to grow our Home and Garden business And going forward and next
Speaker 8
then on Project Alpha, just curious what your thoughts are on the early returns from that initiative. And if could go into some detail, that would be great. And then is there an opportunity to maybe expand that going forward?
Speaker 2
Yes. I'll let Doug hit the specifics. But I'll tell you, Project Alpha originated with me three years ago. It is no longer gonna be a suggestion or a tiny little side project. It's gonna become the way of life.
So there is gonna be absolute resourcing, investing, and driving innovation, new product development, and news and excitement across our portfolio We are going to be faster, smarter, stronger, and we're going to be a lot more relevant to our consumers as we move forward. We are content providers. We're going to make great content, provide it at a great value, and drive this business. And Project Alpha will not be part of fiscal nineteen.
It will be part of the culture of '19.
Speaker 3
Just specifically, Jim, on the, on the continuing ops businesses, we've take we took the opportunity with the most of the almost all the Alpha spent this year to invest in the future. So we did very little of pure advertising this year. Instead, we've we've invested, for example, in the new line of Nature's Miracle Cleaning, which takes us out of PET and into broader applications in the home. And we're very excited about that. That works underway.
We're getting near, the beginnings of launch there, but we we really invest in formulations, packaging, distribution opportunities, sizes, all that all that kind of thing. And that's true, in our in our locks business as well. We're we're investing in next generation electronics and smart home. And that's so those are those are two really good examples of where we're investing in the future with those alpha funds.
Speaker 8
Great. Thanks and best of luck. Thank you.
Speaker 0
Your next question comes from Olivia Tong with Bank of America. Your line is open.
Speaker 3
Morning, Olivia.
Speaker 9
Hey. Good morning. Can you hear me?
Speaker 2
Yep. Yes.
Speaker 9
Perfect. So I just wanna ask you now that you closed the HRG deal, what your expectation is for go forward net interest expense? And then in terms of in terms of the priority of cash use, where does your new debt fall in?
Speaker 2
Yeah. Let me let me hit that. I think a lot of people were expecting us to call the bonds right away. And they sit up at a super holdco level, so they're not part of our bank and bond operating agreements at Spectrum Brands level. They are high cost interest, however, and they do have a call feature that steps down early next year.
You guys all know me. I'm more of a capital allocator, and and now I'm becoming an operator. But, you know, at the end of the day, I wanna put up a couple of really solid quarters. I I I like to see some, real rhythm and cadence to the business first. And so, you know, my view is, you know, I wanna get a few quarters under our belt where we make some deposits back at the at the at the trust bank, and we start to earn your confidence and trust back in us as as people to do what we say.
But then, also, I just have a view of the world where and I'm not a macro guy, but but I do believe that besides us, and I'm I'm being honest, I I think a lot of valuations out there are overstretched. And so my view of the world is when the world doesn't price liquidity high, I wanna make sure I do price it appropriately. And so you see today, have a billion dollars of liquidity. I wanna build a fortress like balance sheet. And I'm not saying that because I have a crystal ball, and I think the world's gonna fall apart in '19.
But I am saying that I wanna materially delever this company, and I've I've been pretty blunt about that. And we might go sub three times levered, and we might run it there for a while. We may buy back a dis a you know, some shares. But, you know, I wanna keep the liquidity position of this company extremely high over the next six months, call it. You know?
So I I look. I I I I'm putting a premium on liquidity where the market isn't. And, you know, I want to, you know, make sure we have a decent operating track record, and then we'll go and we'll we'll look at those HRG bonds. And we'll look to optimize the cap structure in its entirety, quite frankly. But I want to, I wanna get there first.
I wanna earn our way into it.
Speaker 9
Got it. I guess, just to follow-up. I mean, I guess, you know, looking at the free cash flow for next year, you know, you're looking for about, let's call it, 500,000,000 this year. But, obviously, you're you plan to eventually lose the contribution from the discontinued ops. Of course, that's offset by the proceeds.
But kinda curious your view in terms of how the free cash flow, outlook how how that looks next year.
Speaker 2
Yeah. Look. We again, I'm gonna get away from from guidance. It it's probably gonna irritate you a little bit. But, you know, I I notice a short termism with all this quarterly guy.
I know you guys love it, but I don't love it. I I believe in maximizing sustainable free cash. I believe that you have to make investments today to be strong three to five years from now. And, quite frankly, I think that's gonna create a tremendous amount of shareholders for everybody that takes a longer than a ninety day view of our company. And and and so look, I I think free cash flow is gonna grow materially from here.
But, you know, it it, you know, it doesn't grow in a straight line. And there may be some times where I need to invest more capital to get more efficiencies, to build out certain businesses, to to get the innovation and the vitality that I want in in in new product development side so that we can create the amount of news and excitement that creates increased velocity of our SKUs on the shelves of our customers. And that's where we're going. So I know that's not the answer you want, but that's the kind of shareholder base I want to attract.
Speaker 9
Got it. Thanks.
Speaker 0
Your next question comes from Sam Reid with Wells Fargo. Your line is open.
Speaker 10
Thanks guys for taking my question. Quick question here on the Pet segment. It sounds like you guys are well on your way in terms of expanding some of your volumes into the non Pet channels. I guess I'm just curious though if you could comment on the response you're getting to that from say the Pet specialty retailers themselves. And is that in any way impacting your shelf space that you're being allocated at those retailers?
Speaker 2
You know, that's a great question. And you know what? That was wildly negative three years ago. I mean, we absolutely got our heads handed to us. And we've we've taken some of our brands like Nature's Miracle, and we've gone to the mass channels.
And we've it's growing like it's growing like wildfire. In fact, I'm here in St. Louis. I just reviewed a new line in Nature's Miracle. We're about to launch, and I can't wait for it to hit the shelves.
So we have a lot of new stuff coming. It's going to be broadly distributed. But I'll tell you this, I have also been recently personally meeting with the pet specialty retailers and their ownership. And we have phenomenal programs to go back into them with. And I think we're going to grow again, because I think their customers are desperate for them to put the specialty back in Pet Specialty.
I think over the last three years, they commoditized their offering, their footprint, their store traffic dropped as a result. You simply can't source everything from Asia and not have differentiated product. I mean, the humanization of pets is real. Our consumers want the best for their dogs, cats, etcetera. And they want premium product.
And we have the best brands, the best content, and we're going back on the shelf. And yes, we're going to do some exclusive stuff back with the pet specialty retailers, but we think we can bring category management. We think we can build a lot of news and excitement with some in store displays with some Glowfish. And again, I'm talking about the future now. They're not there today.
But what you're talking about, that pain between Mass and Pet happened to us three years ago, was a big part of why we've had the struggles over the last two years with that channel. We are rebuilding relationships with that channel, and we're bringing win win solutions to that channel. And I hope I can talk to you in the coming quarters about how that's back on a growth trajectory. But we're not there yet.
Speaker 10
Got you. No, thanks so much. That's super helpful. And maybe just pivoting really quickly over to Global Auto Care here. So I know we've talked a little bit on some of the progress you've made, but I also know obviously there's still some work left.
I'm just kind of curious beyond efficiency in the supply and what are the other levers that you can pull here to really kind of get margins back up to the levels that we might have seen, say, last year, for example? Thanks.
Speaker 2
Look, I think Armor All can expand outside the garage, Okay? I think we need to change the mindset of STP. Yes, we like Richard Petty. I personally am, in friends with Bubba Wallace. You know, he's a great guy.
You know, need to get STP into more categories. STP could be a general purpose lubricant. It could go into two cycle engines. Armorall might expand to to deck cleaners. We we have got to to break the mold of of a of a mindset that's been around since Clorox owned it and and and previous.
And and so recent they call them town halls. I call them real talk, sitting down with our marketing, our our innovation, our design teams. I said, look. I wanna completely rethink. Nobody knows what STP stands for anymore.
You meet a kid today, they think it's stone tumble pilots. They don't know it's scientifically treated petroleum. So maybe we need to rebrand it. Maybe we need to have a new slogan. And breaking out of these old mindsets, making what's old new again, bringing new life, new products, expanding into new categories, that's the future of that business.
That's going to drive sales and drive margins.
Speaker 1
For one more question before we close down the call, please.
Speaker 0
Your last question comes from the line of William Reuter with Bank of America. Your line is open.
Speaker 11
The desire for liquidity. You have almost a billion dollars of cash, and then you're gonna have 2,000,000,000 of gross proceeds coming in, from the sale of the battery business. I wasn't sure whether that commentary was meant to imply that you were planning on keeping a cash balance that's extremely high, or whether you still expected to use the majority of this for debt reduction.
Speaker 2
Yeah. I think look. I think, you know, to Doug's comment, and, again, this is on the margin, but I want to make sure GAC is the highest performing auto care operation on the planet, and that's not an exaggeration, come March. We're just not going to we're we're moving forward. So, you know, that means I wanna build some inventory because I don't want a single customer service issue.
I don't wanna hear about it. Right? So we're gonna make sure we supply everybody in on time, in full, you know, at at a 99% confidence level. I mean, it's just gonna be that's where it's gonna be. Okay?
So the benchmark is raised, and I have zero tolerance for anything less. So that'll require some capital, but that's small. That's, you know, maybe $1,020,000,000 bucks. Your question is a much bigger scale question. Clearly, I'm not gonna sit on $3,000,000,000 of cash with no yield, and I've got my debt structure out there.
We're gonna delever. But I wanna get into I wanna put some of these quarters behind us. I wanna re earn the trust of our investor base. I want to get the balance sheet very, very liquid. And and when my debt holders see that, I think it's gonna allow me to refinance at a very attractive rate.
I think it's gonna let me call some bonds, cheaper than I can get them today. And I think it'll be very prudent for our company as we get into, calendar nineteen. But we will we will we will pay down a lot of debt. We will not sit on $3,000,000,000 of liquidity.
Speaker 11
Okay. And then just one follow-up for me. It seems like you think that M and A valuation multiples are essentially too high in the market. And in the near term, at least, it seems like you're going to be on the sidelines. As you think about the mix of businesses that you have today, do you see a, I guess, a wish list of other businesses out there that if they were at the right multiples, would fit in well with the portfolio?
Speaker 2
So look, I agree, that I I I agree with your first part of your statement or question. I have two main focuses, and and I'm a simple person, drive operational improvement throughout our businesses. That is my number one goal right now, and that's where all my efforts going to massively delever our balance sheet with asset sale proceeds and free cash flow. And then look, we'll look at tuck ins, but I don't think you're gonna see me do anything aggressive. I I view my own stock price as a better place to put my capital than somebody else's business at 14 times EBITDA.
I'd also say real quick, you know, a lot of the Bloomberg data, Reuters data is wrong. Some people value us. It's you know, it they've got the wrong numbers in there because of the HRG merger, and we're screening it like 17x EBITDA, when in reality we're trading at 8x and 9x. And so this is a stock pickers market. And if you're out there, you need to do your old fashioned homework and figure out what the company's worth.
Speaker 11
That's very helpful. Thanks for the commentary.
Speaker 1
Okay. Thank you. And with that, we have, exceeded the top of the hour, so we will conclude our conference call now. I want to thank both, David and Doug. And on behalf of all of us here at Spectrum Brands, we want to thank you for participating in our fiscal twenty eighteen third quarter earnings call.
Have a good day. Thanks again.
Speaker 0
This concludes today's conference call. You may now disconnect.