Spectrum Brands Holdings Inc (SPB) 2006 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Spectrum Brands third quarter earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. Ms. O'Donnell, you may begin your conference.

Thank you. Good morning everyone. Welcome to Spectrum Brands' third quarter earnings call. Dave Jones, our Chairman and CEO, will host the call today; along with Kent Hussey, President and Chief Operating Officer; and Randy Steward, our Chief Financial Officer. Please note that our comments this morning include forward-looking statements. These statements are based on the management team's best current assumptions and projections and as such contain an element of uncertainty. Actual results may differ materially. Risks and uncertainties which could cause actual results to differ include changes in the competitive markets in which we operate, changes in the economy in general, and our ability to successfully achieve the synergies and other cost savings that we've projected.

For more detail on these and various other risk factors and cautionary statements we refer you to our most recently filed Form 10-K and 10-Q. We assume no obligation to update any forward-looking statements that we make today. We'll also be making reference to various non-GAAP numbers during our remarks. These non-GAAP numbers provide information regarding results of operations before restructuring and certain other costs. We provide a reconciliation of these non-GAAP numbers to GAAP financial results in table three of our press release and on our website at www.spectrumbrands.com. This non-GAAP information is prepared based on numerous assumptions as described in the reconciliation and is offered as a supplement to our GAAP results to assist you in analyzing the long-term trends in our business. At this point I will turn our call over to Dave Jones.

Thanks, Nancy. Good morning, everyone. Thanks for joining us on our call today. Spectrum Brands' third quarter results, which we released this morning, reflect the impact of a number of challenges to our business, some of which we believe are behind us, and some that we're still working to address. So as I walk through the results from this quarter, I'll share with you where we are and what we're doing to create value in each of our business units.

Starting with the big picture, Q3 revenue was $698 million, a decline of 1% versus last year's results, or a decline of approximately 5% adjusted for acquisitions and divestitures. We generated earnings per share of $0.05, or $0.22 excluding restructuring and other charges that we believe are one-time in nature and not indicative of the Company's ongoing operations. Our North American segment generated sales of $394 million, down 5% year-over-year. North American alkaline battery sales were down 10% year-over-year. In line with our internal projections.

As most of you are aware, we've been struggling for several quarters with the lingering effects of recent underperformance issues including some market share loss and distribution losses at several accounts. However, our Q3 battery results represent a modest sequential improvement over second quarter results so we believe we're starting to head in the right direction with this business. We are optimistic that this trend will continue going forward for a number of reasons. We're rolling out impactful new consumer promotions, one of which, the Rayovac power challenge, we formally launched just last week with a full-page ad in U.S.A. Today and freestanding inserts in selected local newspapers. You'll be seeing more over the next few months. We have launched a new web page, batterytruth.com, that supports our new marketing message. So far the power challenge has been very well received by the trade. We've made progress with distribution gains at a half a dozen key retailers, including some permanent gains and some in and out promotions. It's too early to measure the impact of the power challenge on sales, but at this early stage, we're feeling very optimistic. Finally, we do not expect further retail inventory adjustments.

So there are some positive things happening for us, and we're feeling optimistic that you will soon see us return to year-over-year growth from North American batteries. Remington shaving and grooming products had a disappointing third quarter in North America with sales down significantly versus 2005 results. Our women's shavers did very well an d gained market share, as did our personal care products. However, the dry shaving category as a whole did not perform well at Father's Day. We attribute that in large part to an overall pull-back in category support by by key retailers compared with 2005 promotional support levels. As a result, Remington men's shaving and grooming sales fell short of our expectations.

Looking forward, we're very excited about the introduction of our new men's shaving platform which will be on retail shelves beginning in September. We have a lineup of new and attractive shaving and grooming and personal care products for the fall and a new exciting advertising campaign featuring a highly recognized celebrity spokesperson, all of this planned for a fall unveiling and all aimed at driving sales growth in retail placement in the all-important holiday season. We are optimistic that these efforts will create significant interest and support by retailers as well as consumers, and that we can return this category to improved growth trends in the near term.

Moving on to lawn and garden, the lawn and garden season at retail has been solid. Consumer purchases of Spectrum Brands products grew 5% overall versus 2005. However, retail inventory reductions had a negative impact on our business during the third quarter, particularly in the area of controls. As a result, our Q3 revenue grew at a slower 3% rate versus the 5% take-away at retail. We believe that our results are in line with overall industry trends, and that our brands are growing at point of sale, so we do remain bullish on the long-term prospects for this business.

Now turning to Europe and the rest of the world. Overall sales from this business unit were down 15% for the quarter. We continue to face very challenging conditions in our battery business in western Europe resulting in a decline in battery sales of 23% versus last year as the overall industry continues to shift to private label and to mass merchants away from traditional channels such as specialty stores and photo shops, where VARTA has a very strong presence. Additionally, we continue to de-emphasize marginally profitable private label business across the region. We are taking a number of actions to help mitigate this difficult battery environment. We have talked in the past two earnings calls about our aggressive plans to right-size our organizational structure in the region. For a total estimated annual savings of over $30 million when completed later this year. These initiatives are progressing on schedule, and will go a long way toward improving future operating margins from current levels.

We have also recently announced price increase across our VARTA battery product portfolio. Discussions with customers on these pricing initiatives are ongoing. The first increases will be implemented in Q1 of '07 with more scheduled for later this year. In addition to these actions, we recently retained the McKenzie group to help us with a comprehensive analysis of the broad market trends and outlook for the battery category in Europe. We're taking a fresh look at everything including our market positions and strategies, our branding, our distribution channels, our allocation of resources, all with an eye towards focusing our business on the growth opportunities within the category.

McKenzie is nearing completion of their study. They have come up with a number of insightful ideas and recommendations that we expect will be helpful to our business going forward. We realize how critical it is to stabilize this business and regain our momentum. The management team and all of our employees throughout Europe are focused and motivated to do just that. We still have a good bit of work to do, though, and I believe it will take another few quarters before you will begin to see tangible improvement reflected in our financial results.

In more positive news, our European Remington business had a terrific quarter, generating sales growth of 19%. The U.K. business has finally anniversaried the wet to straight success from the prior year and we generated in-country sales growth in the U.K. in Q3 for the first time in 18 months. We are making significant progress with the introduction of the Remington brand throughout the continent, and we consider that success to be a compelling validation of our strategy to leverage our European presence across new product categories.

Latin America continues to be a strong performer for us with sales in Q3 up 10%. Battery sales grew modestly for the quarter, about 1 percentage point. Our initial Remington rollout has been a big success in the region with the majority of sales to date coming from the women's personal care category. We plan to further leverage this initial success this fall with a big launch of the new men's shaving platform. Our traction with Remington to date is encouraging to us to introduce additional new product categories in Latin America, and we're currently in the planning stages of a number of new initiatives.

Turning to pet, our Global Pet segment generated sales growth of 1% this quarter. Sales growth was negatively impacted as a result of an unprofitable product line that was discontinued earlier this year. Excluding that impact sales growth would have been 2%. Aquatics was flat year-over-year in large part due to the softness in the Japanese marketplace. Companion pet grew 3%, or again if you exclude the discontinued product line, 6%. While a bit slower than the double-digit growth rate we've seen in companion pet for several quarters now, Q3 was also impacted by the timing of several shipments out to our customers. July sales were back to the year-over-year double-digit growth trend, so we do believe Q3 results represented a temporary moderation of this category. Category trends at point of sale remain about the same, overall strong and in line with historic trend. Kent, I'll now turn it over to you, at this point, then I'll come back and wrap up.

Thanks, Dave, and good morning, everyone. Our gross profit margin for the quarter was 38%, or 38.4% after adjusting for $2.7 million in restructuring charges, that's down about 200 basis points compared with last year's adjusted 40.3%. Higher raw materials, particularly zinc, and some inefficiencies in manufacturing due to the sales shortfall are the primary reasons for the decline. Operating income this quarter was $49 million, or $62 million excluding restructuring and other costs versus last year's $91 million adjusted on the same basis. Operating margin was 8.8% of sales, 400 basis points less than last year. Higher distribution costs of approximately $10 million accounted for much of the increase in operating expenses in the quarter.

On a segment basis, North American profitability was 61.7 million, or 15.7% of sales, compared with 17.5% last year. The decline again is primarily due to lower sales volume in the battery category and higher input and distribution costs. Increased fuel costs hit our North American segment results particularly hard during the fiscal third quarter because of the relatively high volume in our home and garden business. Distribution costs for fertilizer and growing media as a percentage of sales is approximately double that for our packaged goods.

In Europe, segment profit declined to $4.3 million from $18 million last year, as a result of lower battery sales volume, negative product mix changes, and higher raw material costs. As we've discussed before, we're in the midst of a major restructuring of our entire European organization, targeting over $30 million in annual cost savings when fully implemented. Latin America segment profits of 4.2 million, or 7.7% of sales were flat as compared to last year. The improvement in sales was offset by increased costs, primarily higher zinc prices. Zinc carbon batteries which make up the bulk of our Latin American battery business are heavily impacted by rising zinc costs.

Our Global Pet segment generated profits of $20.6 million, representing 15.6% of sales, up significantly from last year's reported results, primarily due to the inclusion of Tetra for three months in this year's numbers versus only two months in 2005. On an apples to apples basis, segment profits were down slightly as compared with last year's results driven by increased selling, distribution, and freight costs. Corporate expenses increased from 3.1% of sales last year to 4% in the current quarter. The largest reason for the increase is the investment we have made in expanding our global operations organization in Asia. We recently relocated our offices from Hong Kong to Shinzen, China and increased our staff in product engineering, quality, purchasing, and logistics.

This expanded organization is responsible for management of our supplier base and all of our sourcing operations in the Asia Pacific region. We are currently sourcing 30% of our finished goods in this region, and we'll continue to expand our sourcing activity as part of the Global Pet integration. Interest expense totaled $45.7 million, up from 38.6 million last year as a result of the additional borrowings for the Tetra acquisition and higher interest rates. Depreciation and amortization expense for the quarter was $22.5 million. The effective tax rate this quarter was approximately 26%. Our expectations for the full-year tax rate have been revised downward to 29%, the result of a change in our geographic profitability mix and strategic tax planning related to prior acquisitions as well as sourcing related to the Asian business operations.

Free cash flow for the quarter was $24 million after CapEx of $21 million, and cash restructuring costs of 10 million. Our projections for full-year capital expenditures are unchanged at around $60 million. We expect to have positive cash flow in our fiscal fourth quarter after CapEx and cash restructuring charges. Outstanding debt at quarter end was $2.3 billion. Our leverage ratio for the third quarter was 7.51, in compliance with the maximum leverage ratio allowed under our senior bank agreement of 7.95. We project that we will be in compliance with our loan covenants under the senior credit facility at the end of our fiscal year. As of the end of the quarter we had approximately $225 million in availability under our revolver.

Turning to an update on our integration and cost cutting programs the most immediate upcoming integration activities are the closure of several distribution centers in our lawn and garden and pet businesses and consolidation of those functions into existing and new facilities. On the information technology side, we have completed several SAP conversions, including the most complex conversion, our home and garden business in North America and now most of the pet group. We closed the companion pet manufacturing and distribution operations in [Hoplock], New York at the end of July as scheduled. And this project alone will contribute approximately $10 million of cost synergies on a go forward basis. Our integration teams continue to make good progress on all fronts, both here and in Europe, and we remain on track to meet or exceed our $100 million synergy target. Now I'll turn the call back to Dave.

Thanks, Kent. I want to briefly update you on the announcement we made a few days ago regarding potential asset sales. And I say briefly because we're still very early on in the process, and it would be premature to give you any specifics today. What I can tell you is that we are uncomfortable with our current leverage given the challenges that we face in our business over the past few quarters, and the underperformance that has occurred versus our forecasts. We recognize that our high leverage hinders us from expanding and investing in the high-growth areas of our business such as pet supplies. And it could on occasion potentially divert our focus away from strategic long-term goals and objectives.

As a result we've decided to analyze whether it makes sense to divest certain selected assets in order to pay down debt and reduce our overall leverage ratio. Thereby providing us more cushion to operate our business effectively. We recently engaged Goldman Sachs to assist us in this analysis. If and when there's something more definitive to report we will provide you with an update, but for now we have nothing more concrete to talk about. But stay tuned.

And lastly, I want to update you on a recent change in our policy towards earnings guidance. In line with current thinking by many publicly traded companies and by industry leaders, Spectrum Brands will no longer be providing earnings guidance. Some of you might point out, and understandably so, that we've not been particularly good at it recently anyway. And that's a fair criticism.

Additionally, we think that in a transitional environment, such as the one we find ourselves in today, particularly since we may be making some significant changes in our overall business structure, we believe our time and efforts will be more productively used to focus on long-term strategies to create value rather than short-term forecasts. We will continue to provide with you information on industry and company trends, so that you can make your assumptions about our earnings outlook, and we will continue to be responsive and available to discuss our business. But we will do so without providing specific financial targets.

Let me conclude my remarks by simply saying that although we've made some progress in certain areas recently, there's still a number of challenges ahead for our company, and there's much work to do. Everyone at Spectrum Brands is focusing all their energy and efforts on addressing the issues at hand, and working towards building value over the long term. I appreciate the support that many of you have offered recently, and I look forward to updating you on our next progress -- on progress on our next call. At this point I'll turn it back over to the operator to take your questions. Operator.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Peter Barry.

Hello?

Hey, Peter.

This is Adam calling in with Mirage Capital. How are you guys better communicating with the dealer channel to respond to challenging customer and market needs?

How are we communicating with whom?

How are you better communicating with the dealer channel to respond to more challenging customer and market needs?

I'm not sure specifically what you're asking. I mean, virtually all of our sales are national or international customers, whether we have key account people that are assigned to specific customers, or we have teams on site at those customers. So I'm not quite sure--?

I guess what I mean is how -- to improve on revenue for the remainder of the year how are you guys streamlining the selling process to reduce order inaccuracies so your customers, channel partners, dealers will have a much more effective time buying from you.

Again, I don't think that's our -- if you were to list the issues that the Company has or is facing, I don't think that is the issue. We have -- we have excellent relationships with our retailers, and we have excellent communications, and in all of our major retailers around the world we have people on site developing programs, marketing programs, initiatives, new product introductions, secondary displays for fall holiday season, et cetera, and it would vary by which retailer specifically that we were talking about. So I don't think that has been the cause of execution for the Company, and it's really not our focus on something that needs fixing.

What are you doing to reduce order inaccuracies right now to improve revenue?

Again, I don't know where you're going with the question. I can't respond to the question because that's really, -- order accuracies, we get POS orders from our major retailers, and we measure their POS by store by region, and we get that on a daily basis. So I don't think that's, again, an issue that we have in our--.

In terms of responding to the customer requirements, most of our major customers are on EDI transmissions. It's computer to computer. We have very sophisticated supply chain here, and we pride ourselves on having customer service levels well up into the high 90s, which are pretty much world-class in each of our business units.

Your next question comes from the line of Dara Mohsenian.

Dave, can you tell us if you're considering asset sales across your portfolio or are there certain businesses that you definitively want to hold on to?

The analysis that's going on is an analysis of all of our businesses, and that analysis would include what's the potential gain if we were to sell the business, what tax leakage, if any, might be involved with the particular sale. Then there's a lot of work going on internally in the Company, which businesses do we deem to be very strategic in terms of our long-term goals in the Company, fitting into our global distribution network, centered around certain important retail customers, et cetera. So the analysis, which it should, starts broad, and analyzes everything, and then fairly quickly begins to narrow in on given the various things that we're trying to achieve, which, number one, if you look what it we're trying to do in terms of asset sales, if we do it, is to do it in a way that significantly pays down some debt and delevers our business. It's all driven here, what we're trying to achieve, by delevering the business. We are not comfortable with our current leverage. We don't think we have enough head room in our bank covenants, and as a result, we -- we're really targeting and aiming to delever the business over the short term.

Okay. That's helpful. And can you give us more detail on the Remington weakness? It sounds like you feel it is more of an industry issue on the retailer support, but it's certainly a big change in trend. Why do you anticipate that retailer support will ramp back up going forward, and also can you just give us the men's shaving market share performance in Q3?

First, let me start and say the industry was down, and it was down significantly. When I say significantly, it was probably down 15, 20%. That's just a directional comment. I don't have the exact number. But it was down pretty far. And our market share was down sort of in 2, 3 share point range for that particular reporting period. So the industry was down significantly. We did a little worse than the industry. Category down -- I'm looking at numbers here as I'm trying to talk to you. Category was down 7%. We were down a little bit worse than that.

But the more important thing here is that last Christmas we saw retailers promote less, and we talked about that -- promote less than historic in the category, and as an example, where they would have promoted in flyers dry shaving, they didn't do it to the same degree, and as a result the industry was down, and we felt, as did other participants that we would get more support from retailers during Father's Day because they, in essence, learned their lesson. The fact is that that didn't occur and there was less promotion than originally predicted, and there was not a lot of new product by anybody. In fact, there wasn't new product in men's shaving by anyone during Father's Day and as a result it was a pretty dismal Father's Day.

If there's encouragement in that, which there is, and always is, some of the very largest retailers have gotten it now, and they are significantly working with our sales, as well as, I'm sure with our competitors, to find ways to boost this category this Christmas and have at least for now, and it's a little preliminary, but for now have indicated that they are going to go back and give historical space and promotional strategies to the category, because what they replaced us with to a large result they replaced dry shaving promotions with wet shaving promotions due to the launches of some of the new products in wet shaving. They really took it on the chin in terms of revenue and profitability. So there's been a lot of internal heat and discussion at -- among our key retailers, and I think it will -- and they're unhappy with their results, and it will -- that will all work and should benefit for the industry having a much better environment as we go into the fall.

So we were unhappy with that in North America. Having said that, we're not unhappy with our Remington business in the other categories in North America women's shaving, grooming, and in personal care, our business has done very well and we gained market share during the period. It's obvious that we're pleased with our results in -- early results in Latin America where we've exceeded our expectations and our continued rollout in Europe which is -- continues to go with very large momentum.

Okay. Then in terms of your marketing strategy, given the new product pipeline ramp-up at Remington and the new marketing program in battery, rumor limited in your ability to invest there given the high debt leverage? And how do you mitigate risk if that spending doesn't pay off in terms of revenue payback over the next couple of quarters?

Well, we're not limited by our debt or leverage to invest properly in our brands, and, in fact, we anticipate that we will have significantly higher spending in Remington related categories this fall, and the Remington product is a very -- it's a gift gifting item to a large degree, and about half of the entire year sales are sold at retail, in about a six or eight-week period. So is it's very concentrated advertising. We will spend significantly more than we did last year and we think it will be much more meaningful because we have an unbelievable celebrity spokesperson that matches the category perfectly that we will be unveiling a little later this fall, and unveiling in all of our advertising, both media print as well as television advertising. So we're feeling good about where we're going. We don't like the most recent quarter's results, but overall we continue to be very positive on our Remington prospects down the road

Okay. Then in NA battery are you anticipating a big marketing pickup there also?

We really think we've turned the corner. While it's not exactly demonstratable in financial results, which seem to lag -- which lag, obviously all the initiatives, that go on, we are seeing sequential quarter to quarter, month to month improvement in our battery business and in POS take-away, which is more importantly, we've stopped the bleeding in terms of market share erosion, and that has stabilized. We had, during this period over the last 18 months, lost a few accounts in distribution. Now we've begun to win accounts back, and we had significant improvement in that during the most recent quarter. And we don't have an inventory overhang, which was you could argue the most significant drag that occurred over the last 12 to 15 months was significant reductions in standing inventory, and we have taken care of that situation, and so that won't be a drag on performance going forward. So all of those things would, over the next few quarters, we should see a good recovery in North American battery business.

Thanks.

Thanks.

Your next question comes from the line of Bill Schmitz.

Dave, can you just start and talk a little bit about what exactly McKenzie is doing? I think they're working both in Europe and North America. And then what you've learned so far, or if it's not too early.

Well, I'll tell you what we are doing. I'm not going to go into too much what we've learned so far. One, it's not finished, and the other, I'd just be overly talking to my competitors on this call. McKenzie was hired to help us evaluate the battery marketplace worldwide, number one. What are the issues, whether there's technological issues or issues with devices, prediction of what market share growth is and is likely to be in the future in both value terms and volume terms, given all of those factors, to look at capacity worldwide, what are the implications of overcapacity in certain categories. Their efforts, they really broke it down into three separate themes working on our battery business. We put a team in Madison, Wisconsin, working on the North American business. We put a team in Frankfurt, working on our European business. Then we also had a separate team working on our global hearing aid business, which is a very large, obviously very profitable and important category for us.

And so three different initiatives, all driven, as well as what I've just said, understanding where the VARTA positioning is, vis-a-vis the other competitors and whether that positioning is as good as it can get or whether there needs to be modification in brand positioning, where our distribution is, where our strengths are by channel, by trade channel or by country and where there's not, and then trying to match those against where the opportunities are. So as an example, we've seen an erosion or flattening of battery sales and volume in western Europe, particularly in central Europe, but we are seeing a huge acceleration of the marketplace in eastern Europe, particularly countries like Russia, Turkey, Poland, et cetera, and part of this analysis will allow us to get our heads around how to redeploy our assets around the world, we have a -- and I'll just use Europe as an example. We have a European business that is centered in Germany, where it's been for 119 or 20 years, and so we have a lot of assets in western Europe. Western Europe is not where the growth is occurring in Europe. Eastern Europe is. And we have very few assets there. And although we do have a business model there, it's not as robust or as aggressive as it needs to be.

And one of the conclusions, because this is not giving away competitive secrets, one of the conclusions from this analysis is that we're going to have to redeploy assets, and we need to put more emphasis on some of these emerging markets and growth opportunities. I mean, it would surprise everyone on this call, and it has us, to know that Germany, which is the biggest market in Europe, Russia is nearly the size of Germany now, and it's growing exponentially. I have five people in Russia. That's not enough. And so part of that is -- will be driven at those type of initiatives. Part of it will be driven in go-to-market strategies, understanding channel shifts, where we may have had historical strength in specialty and photo channels and expertise there, and we're the market leader in a lot of those channels. Well, we're having channel shift to discount, channel shift to big box hyper markets, and the selling strategy is different in store, the way you sell is different, and in some cases, we're not aligned perfectly in terms of skill sets against those trends. That's what we're trying to figure out.

Got you. Great. Thanks. What percentage of the European battery business now is imported from China, and what do you think that number should become?

I don't have the import statistics. What's the latest private label?

Imports into Europe still relatively low, about 10%.

What do you want that number to become?

I guess it depends on whether that we're importing at or others are importing it. What's occurring is that in private label. So in branded product there's not a measurable -- there's no measurable branded products that are being imported by third party -- , tertiary players into Europe, okay. The branded battery business has not really fundamentally changed much, either in terms of market shares or in terms of size and the players, Duracell, Energizer, VARTA, and Panasonic all are relatively stable, and the margin structure is relatively stable. The moving piece here is private label, which has grown, and then within private label, where some retailers have gone to E options, and things like that, that's where you're seeing China, or not just China, but where you're seeing that region of the world supplying some of those products at very low price. That's why you've seen us and others begin to walk away from that type of business.

Okay. Great. Thanks. Then, Randy, a little housekeeping question, can you just give us the free cash flow and operating cash flow numbers in the quarter?

Yes. Free cash flow was 42 million. That's after cash interest and cash taxes. Restructuring cash costs for the quarter were approximately 10 million.

What was the operating cash flow number?

When you say operating cash--?

Cash flow from operations.

Yes, that was at 74 million.

Great. Thanks very much.

Your next question comes from the line of Reza Vehabzadeh.

Just on the European battery side, in terms of price change or volume change, can you give us some data points so that we understand where that market is going and what you're grappling with? Is it getting worse? Is it the same rate of weakness, but just different comparisons? Any data points would be helpful, I guess.

I think if you start from the industry, the industry -- so all batteries in Europe, the industry is sort of flat to declining slightly, but it's fairly stable, the industry. Okay. But underneath the industry number -- and, let me just -- and within the industry, there's branded business, and there's private label business. Okay. The branded side of the European battery marketplace is stable, okay, it's stable in volume terms, and the only dynamic that's occurring in the branded side -- and people's market shares are relatively stable, so the only real dynamic that's occurring is there's a channel shift from traditional specialty retailers and photo channels, particularly in central Europe in markets like France and Germany, Austria, Switzerland, toward modern trade. Modern trade being discounters, food retailers, hyper markets, all of which sell batteries obviously in different ways, and the margin structure is different.

In these traditional channels for a branded product, the margin, gross margin structure may have been 50, okay, and in these new modern trade channels the gross margin structure that participants are able to get is in the 30s. So there's a loss of profit tool there that everybody is having to deal with and figure out how to structure their businesses to overcome. So that's the branded side. On the private label side, private label continues to grow in Europe, and now private label is up to half the volume in unit terms and probably a quarter of the value terms.

30%.

30% of value. And while that steep slide, or steep growth, in terms of private label has moderated some, it still continues. Okay. And under that, so that's an effect, and under that, pricing in that segment is going down, because retailers are going to very aggressive auctions of the private label business, or E-auctions, where that supply chain capabilities, merchandising capabilities, that companies like us have all of those capabilities, are less important because they're just asking a supplier to deliver containers of batteries at a port somewhere, and they're taking over all the supply chain associated with it into their stores. So that piece of the business is horrible for the industry, and for us in particular, since we've historically had such a very large piece of the private label business.

And so we've had to make a decision, which of those private label accounts are important to us and strategic to us. For example, which accounts can we make a decent profit margin or by doing the private label, we're able to get our branded products or lights or Remington products or other things in. And we would say that's an account that's important to us, and one that we will retain. And there's the other accounts which are much more just transactional in nature, and those -- at very low margin, and those are the accounts that we began almost a year ago now moving away from because all we were doing is tying up our capacity against an account where we ultimately can't have any real benefit. And so if you look at revenue reductions, a portion of the poor performance in the European battery business is self-inflicted because we've just decided we can't participate there. There's no -- there's not enough profit pull, and it's not worth tying our capacity, particularly our China capacity, which is in demand everywhere, up with those accounts.

Right. But the rate of decline in European battery business, I guess, has gotten a bit worse in the last couple of quarters. I'm just wondering, is that a trend that we should continue to see, or is this as bad as it gets on the revenue side of the equation?

Well, I think the trend line probably won't be as severe as what you've seen, but the negative factors at work here, industry factors, which are not easy to overcome, will continue. So we will see continued erosion in revenue over the -- at least the next couple of quarters in the European battery market, only offset by how much cost structure that we're able to take out of our business model, which is going to be meaningful. We have talked on the last two calls about we have a significant overhead restructuring that has now taken place in Europe. It's all finished, and we are moving a significant amount of our fixed manufacturing capacity from Germany to China, and we're doing that over the short term, and the net reductions that we've talked about there are going to drive $30 million plus worth of efficiency into the European P&L, and there's a lot of other work going on, which I don't want to discount, in the marketplace, and a lot of work with McKenzie, but the single biggest offset to the trends we're seeing is in restructuring.

On the North America side, how do you feel about your shelf space in batteries and lawn and garden going forward as best as you can tell at this point in time?

Good. We've really -- in terms of line reviews for batteries, those are all done, and so we know -- we know what our space is and we know what our competitor's space is, and all the key and important plan-a-grams. I'd say if you were to compile all of those we feel good about where we are. We haven't had any erosion of space recently, and probably will have some moderate improvement of space here as we go into the fall. So we feel good about the dynamics of the battery business. For a lot of reasons, we're a lot more optimistic than we've been in almost a year in the batteries in North America. In lawn and garden, we're nearing the end of line reviews. We think we've had reasonably good success in the line review process. Once we add it all up, we don't think there will be any large shifts of change that are likely to occur. There's going to be onesies, twosies, and there's going to be some accounts up, some down slightly, but on balance we think it will be nearer the same.

Lastly, for Randy, a housekeeping question. What kind of a source of cash can working capital be for fiscal '06?

For the full year, we're looking at working capital being a slight use over the last six months, though, between Q3 and Q4 we see working capital as a source.

Okay. That seems to be a change from before when you thought working capital would be a source.

Yes. It was really the result of really two things. One was as a result of the sales shortfall. We weren't able to get the efficiencies and inventory reductions, although we do see that going into '07, the ability to get at that inventory. Also, we wanted to be very careful in the first year of doing SAP conversion that we had enough inventory to meet customer service levels first, then really in the second year is where we get the efficiencies of SAP and inventory reduction initiatives.

Thank you.

Your next question comes from the line of Joe Altobello.

Just want to go back to the European battery business for a second. Looking at your European business in general, it looks like obviously sales were down, but your margin was down pretty aggressively and you just mentioned that you're walking away from some low-margin business and you've completed some of the overhead reduction. Is that just a matter of timing that you haven't seen those savings really ramp up yet?

Yes. I think the positive factors with that, Joe, are that as you go into '07 you will see improvements in margin as a result of operating margin, or operating profit. You'll see improvements as a result of restructuring, which now is just beginning to slightly flow into the P&L because the actions are very recent. And then once we get the product shifted to China you will see some fairly significant improvements in terms of that factor because obviously China manufactured product is a much lower cost than German manufactured product, and so those are the factors that are working positively. The factors that are working negatively that it has to overcome are that this channel shift, were one, private label, so even though we're walking away from some private label we're not walking away from all private label, and private label business is growing.

So that, in terms of mix, we're betting more lower margin sales because private label is growing, then we've got this issue with channel shift, which is a significant issue, and it's more significant for VARTA than for our competitors, because we are market leaders in the channels that are reducing in size, specialty photo. VARTA has always been the photo leader, probably as long as VARTA's been in existence, and its photo shops now are just closing all across Europe, and photos going to drug or to feed other outlets, or people getting photography or it's going to digital and there's no real need for the same level of photo channels. That type of channel shift is affecting us probably more than anything else, because the VARTA product, which was a branded product in these traditional channels, had a very high margin structure and a number one market share position. Now consumers are buying the product in deep discount or discount stores or food stores where the pricing is lower and where the margin structure is lower, and that's really the significant thing that's occurring that we have to, through all these other actions, try to overcome, or overcome as best as possible.

Turning to North America, it sounds like the business, at least sequentially, has stabilized. Was down 10% in alkaline year-over-year. You've got ridiculously easy comps for September and December. Would you expect that business to actually show year-over-year increases?

Yes. My prediction would be that in the quarter that we're in, we're going to -- this quarter that we've just finished is probably sort of at or near the end of year-over-year comparison issues, and for a lot of factors, including, last year was a tough year, as you just pointed out, we should sequentially see improvement, and that improvement should start to reflect itself in the quarter that we're in.

Okay. Then lastly, in terms of pricing, I think your competitors in both lawn and garden and pet have both intimated that pricing will go up next year in the face of rising commodity costs. I would imagine you guys would follow suit pretty quickly.

Well, we're always interested in the subject, in particular where we think we have a reason to price, okay, and we do think in lawn and garden there's a reason to price moderately. We have all experienced tremendous increases in fuel and distribution costs. It's been the number one issue, cost issue, for our business in lawn and garden as well as for all of our competitors, and so there's a reason and a story that retailers should understand and be sympathetic to, as long as we do it the right way, and so we do think that's possible and reasonable. Pet's been an area where there hasn't been much pricing, and I haven't heard thank you for pointing out that some competitor said that they're thinking about pricing in the category because that's been a little puzzling to us because we have had particularly in pet categories like aquariums, which are very heavy, take a lot of distribution, glass, which is oil based, there has been increases in input costs that we have not been able to recover, so we'll take a look at that.

And in terms of it batteries, where we've been market leaders, we've been pricing leaders. There is a dramatic need for the industry to price. Zinc has run up at a rate higher than any input cost in the history of the battery category. Particularly in Latin America where we're market leaders we have acted like that, and we have priced first, and we have priced aggressively, and for the most part those prices are sticking in the marketplace. In Europe, where we're not the market leader, we have announced first that we are pricing because we believe that the health and viability of the European industry is based on all of our abilities to get some of that back. In North America, we'll see. We're the number three player in North America, and we hardly can be in a bullish leadership position, but the same dynamics exist in North America, and the same need for the industry to price exists because it's affecting all of us exactly the same way.

One more if I could. On pet, I think you said earlier that that category, or that business was up double digits in July. Was that all of pet or was that companion pet?

That was companion pet. And we do -- we are very bullish on companion pet. I think our business -- if you discount the fact that we got out of category due to an acquisition early last year, our companion pet business was up 6% for the quarter. We've been running 10, 12%. We've gone back, and we've analyzed that pretty heartily. We think all the growth drivers are in place. We were back up double-digits in July in the category. More importantly if you look at the POS of the three major players, which represent two-thirds of the category their POS has been consistent in aggregate and has been very strong and that's really the true factor in terms of future growth there.

Okay. Thank you.

Yes.

Your next question comes from the line of Lori Scherwin.

Good morning. Could you talk a little more about Latin America? Battery sales up only 1%. Does that imply that volume is down because you have taken price increases recently?

Yes, I think that's a good way to look at it. We have aggressively taken price increases. When I saying aggressively, we raised the price of all of our products in Mexico by 10%, as an example, Mexico's second biggest market. We've raised our prices by near that in Chile, Argentina, Brazil, and not just zinc, carbon, where we're the market leader and it represents -- in volume terms 75% of our business down there. And there is a direct effect between pricing and volume, and sometimes it's hard to predict, but it's there, and it always occurs, and -- it always occurs for two reasons. It occurs unless all the competitors price exactly the same simultaneously, which it never happens, so you've got the puts and takes of that. During the most recent quarter we certainly were much more aggressive in pricing than our competitors, and I think it reflected that. Although, long-term, in terms of long term predictability, we believe most or all of that is going to stick, and it's likely that our competitors, because they have the same severe pressures that we do, are going to move, and so that factor will neutralize itself and play out pretty quickly.

The other is consumers. What do consumers do when you price, and do they put off consumption? Okay, or do they change their consumption patterns? For example, if we overly priced zinc carbon and we got that too close to alkaline, would consumers move from zinc carbon to alkaline. Do they postpone purchases? Those are the things that we have little control over. They do happen, and all those trends affect what occurs immediately after pricing. But the long-term growth rates of our battery business in Latin America are very strong, and the long-term dynamics of GDP growth in Latin America, which is running about 4.2% I think latest estimates, in composite, remain very strong and the conversion from zinc carbon to alkaline remains very strong. So we would predict long-term growth rates very healthy. One quarter doesn't break a trend, and if you were to look at the last four quarters, we've had very good growth in our battery business and believe that will continue in the future in Latin America.

So all of this deceleration is really just because of the pricing?

Yes, and timing. For example, a lot of our business is sold through distribution, sold through distributors and wholesalers. And so you announce price increases, there's some amount of push-back, there's some amount of flexing of muscles where once you announce it, they try to make a point to you by not buying for that particular time, let their inventories run low, may threaten to shift to a competitor's product because of that, and so there's a lot of those dynamics that go on that cause -- between the time you do the announced pricing to ultimately what the final conclusion is, is different, and it would affect quarters or months or shipping patterns and things like that. So I would personally not make anything out from we add a 1% growth, and we were running mid to high single digits. I think it's an effect of what we're trying to do in the marketplace, which is act like the market leader, and we know in many markets almost all markets down there, that we have to be the pricing leader, and we have to be the initiator, and that's what we're doing.

In Latin America, how big is that Remington business on an annualized basis now, and is it growing just because of new distribution, or can you shed a little bit of light on what's going on in places where Remington has been rolled out for some time now?

We did -- we rolled out for the first time Remington a little over a year ago in Chile. It was a small market for us, but one that we had very good knowledge of the category, and it's one that we could test, figure out what works, what doesn't work. And so we did that in the market, and then in earnest we began, I guess, over the last six to nine months, rolling out into what we could call key markets, markets like Brazil, which is largest market, represents 40% of all GDP growth, and women's personal care products. There's nowhere in the world quite like Brazil in that respect. So we have begun launching there in several other adjacent markets, and the success has been overwhelming. We've gone from zero, or near zero to a $17 million run rate already. Okay? And we do think that we have exponential growth opportunities because we have barely begun to roll it out country by country or product category by product category. And so we think -- I really don't or can't predict how big this could eventually be, but we think we have a lot of growth, and that it can be an important market, and we do like everything about it, including the margin structure, what consumers will pay, from a first launch, we're achieving gross margins of roughly 40% throughout the region, which is an unbelievable sort of first launch strategy, and we think there's an ability to move it up even higher. And we like the competitive set as well.

Okay. Great. Thank you.

Okay. Next question. Operator.

Your next question comes from the line of Karru Martinson.

Just to clarify, any divestiture that you would undertake would be a deleveraging event, correct?

Yes. That's our principal focus. It's not about -- think of it -- it's not about paying down debt. Okay? That's a byproduct of what we're trying to do. It's about leverage. Okay? Our leverage is too high, it's higher than we are comfortable with, and the single most important priority of early stage asset sales is all related around deleveraging. So that fundamentally means that we would look at an asset sale where that we could get an attractive multiple, have little tax leakage, so that we could have a real impact on leverage as a result of the transaction.

Okay. And not to press on the matter, but in terms of timing, would you expect to have this by the end of the calendar year or by the end of the fiscal year?

Well, certainly the end of the fiscal year is right upon us, so there's no -- we may have a strategy articulated by the end of the fiscal year, but we wouldn't have it executed in the marketplace. I think you could look at the end of the calendar year next spring is probably a reasonable time frame that it would take to do what we would be contemplating doing.

Okay. In terms of Remington, I was under the impression as we were going into the Father's Day period, you were talking prior to this, considerable marketing spend, worried about getting spots for the holiday season based on Father's Day sales. Did that marketing spend take place, did you pull back on that? Or was this a competitive response beyond just the retailers pulling back on the category as well since you seem to be declining faster than the category?

Yes, well, I think you could -- we decline faster in the category for this period, but if you were to look at our category -- our market share over the last five years has been very strong, and up until the last six months was at the highest market share level that we've ever been in our history. So I don't think it's fair to characterize one quarter as a long-term trend, but to get to your first question, we did advertise during Father's Day, and we were the only participant to advertise during Father's Day. But once it became apparent to us that retailers were not going to run the same number of flyers or -- for the category, or to -- the same amount of secondary displays as what we and others had anticipated, we did pull back from what our original thoughts were. But we were the only one out there advertising during the Father's Day. Philips may have advertised some. So probably Philips and us. That's probably a better way to characterize it.

Does the market share loss for Father's Day, does that affect your plan-a-grams at all for the holiday season?

No. Our concern and historically Father's Day results or market share results in stores have pretty much been a precursor for what you get for the fall, but I think it's a different environment here because nobody was satisfied with Father's Day. No retailer was satisfied. They believe they shot theirselves in the foot. The big ones are relooking and redoing their strategies for the fall in total. We think we have a winning proposition. We have the new products out for this fall. We have an entirely new shaving line out for this fall, and we have a celebrity spokesperson campaign that has been previewed with all of our key accounts that is fantastic. We think all of that is going to give us more than our fair share.

With retail trends outpacing your factory sales in lawn and garden, should we see a pickup in the fourth quarter?

I think we're hopeful in that way. We were, I guess, a little surprised going into the third quarter that some of our important lawn and garden retailers were during season cutting back ours and our competitor's inventories, compressing them. That did occur. We took our pain, and in some categories we think that's probably been a little overdone, and rain that's occurred here over the last few weeks around the country has driven some incremental category growth that was sort of not occurring in the past quarters, so, July -- who knows, is the answer, but July we had very good POS, and we also had very good shipments in July. So we'll see.

When you complete the European battery production shift over to China, which you said would be coming up in the near future, what percentage of the importation will be from China if you're around 10% now? Where should we see that number go?

I think in terms of our business, that we'll probably end up with a business model that probably has a little more than half of our business still manufactured out of Germany, and that manufacturing focus against our branded business and our high performing alkaline batteries, we have several levels of performance of our VARTA batteries. Then the low performing VARTA batteries, or the private label batteries will be less than half, but meaningful, probably 40 to 50%, and that will be sourced out of China. And that will be completed we think by the end of this calendar year.

And how much business, if I missed the number, I'm sorry, how much business did you walk away on the private label side, in terms of a dollar figure?

It's going to be as much as $30 million worth.

And I think we said -- I'm trying to go back on previous calls, but I think I talked--.

-- it was in the previous calls. So have you walked away from additional private label business, or that was part of regional?

Not yet but I think it's likely that we'll walk away from more, and there's a -- it's part of the McKenzie analysis, doing a detailed by account analysis of which of those we should support and which we shouldn't support. So it's likely that we'll walk away from some more.

And what are you seeing on the aquatic side of the business that one of your competitors mentioned mid to high-priced aquariums especially with the gasoline pricing have been under pressure, lower end has been selling better. Is that something that you're seeing in your markets as well?

That's the general trend. Makes sense. We're seeing high-priced aquatics products, people don't have to spend -- the Wal-Mart or discount shopper who is paying 3.50 a gallon for gas to get to the Wal-Mart stores -- we're obviously seeing some deferral or move down the value chain in terms of that, and for whatever reason, and I'm not an expert in this story and on the aquatics marketplace, but there's been a pretty good correlation between gasoline prices, overall say the economy and how the aquarium marketplace, particularly the aquarium marketplace as you defined it, is reacting to it. Now, in terms of the disposable part of the pet -- the fish food part, which is obviously we're the world leader in, we're seeing pretty good dynamics there.

We do have time for one more question. And your final question comes from the line of Alice Longley.

Hi, good morning.

Hey, Alice.

Hi. You said the U.S. battery business should pick up soon, and then you later said something about it should be up within the next few quarters or something. In the September quarter there was a huge amount of inventory, destocking going on at retail for batteries. Can your shipments be up in the September quarter in the U.S. battery business?

We think they will, Alice.

Okay. Great. And then for the pet business, what do you think your POS was in the June quarter, your increase in the U.S. at retail?

We track POS by our three major accounts, okay, and our POS -- let's see if I have got a total number here. POS in the June quarter, if you were to aggregate those three major accounts were up sort of 9, 10%, in that range, 8 to 10% in total. So--.

And that includes aquariums not being very good.

Yes, that includes -- yes, because it's been driven by companion animal. Companion animal continues to run low double-digit growth for us and for the industry, particularly among the most important retail participants in the industry.

Well, isn't companion pet, though, less than 50% of your business?

It's actually a third of our business.

So if you're up 8 to 10% overall your aquatics have to have been up pretty well overall?

You just gave the big customers.

I gave you big customers. I gave you the effects of three customers.

What percentage of your business--.

They're about 60%, Alice. The other 40% is obviously -- there's -- if you were to composite, there's no growth occurring because the consumers are going to the big three, or moving more purchases towards the big three.

Okay. That's fair.

I don't have POS for the other 1,000. I do for--.

Fair enough. And then -- but your point of sale accelerated from -- in those three largest retailers from 8 to 10% to something even faster in July?

If you look at -- I was trying to answer on the call the way that we look at our business, how it performed in the June quarter. Okay? Companion pet, companion animal was up about 3% for the quarter, and for the last three or four quarters it's been up double digit. And so except for we shut down a product line, it was up 6%, but still off the trend line, and I was trying to describe that POS consumption has remained solid during that period, and so we do think part of that is timing. We do think that that trend line, long-term trend line, is still good and I think it's further evidenced by that, or July, shipments, into retailers was back up into our historical range of double-digit growth. And I think that's all you should take away from what I was trying to explain.

So it's not so much that there's been a change at POS. It's that there's been a change in -- the retailers have stopped their destocking.

There's been no significant change in POS.

Okay. Have you seen any positive response to aquatics from Pirates of the Caribbean in your licensing agreements?

I asked that same question in business reviews, and it's not evident in -- it's not evident in terms of performance yet, okay. But then again that takes a little time to play out as well. If we are going to see -- if we're going to see a lift in the overall aquatics business, or ours specifically because of Pirates of the Caribbean, we're going to see it in the quarter that we're in right now.

Okay. Thank you very much.

Okay. Well, I think we should cut it off. Listen, thanks for being on the call. I know it's been a tough few quarters for us as well as for you all. We are making progress. It's not evident in all areas yet in terms of financial performance, but particularly in North America we're making progress. We've been very open. We still have some work to do in Europe. Our newly acquired businesses continue to perform well, both in lawn and garden and particularly in pet, and over the long term we believe we'll get problems largely fixed and behind us and there will be better days. So thanks for your continued support. Have a great day.

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