Spectrum Brands Holdings Inc (SPB) 2006 Q4 法說會逐字稿

Good morning, my name is Mandy and I will be your conference operator today. At this time I would like to welcome everyone to the Spectrum Brands fourth quarter earnings conference call. [OPERATOR INSTRUCTIONS]

I will now turn the call over to Nancy O'Donnell, you may begin your conference.

Thank you, and good morning everyone. Welcome to our fourth quarter earnings call. With me this morning are Dave Jones, our Chairman and CEO, Kent Hussey, President and Chief Operating Officer, and Randy Steward, our Chief Financial Officer.

Before we get started, I'd like to remind everyone that our comments this morning include forward looking statements. These statements are based on Management's best current assumptions and projections and as such contain an element of uncertainty. Actual results may differ materially. Due to that risk, Spectrum Brands encourages you to review the various risk factors and cautionary statements outlined in our most recently filed Form 10K and Form 10Q. We assume no obligation to update any forward looking statements that we make today.

We also discuss adjusted diluted earnings per share during our remarks in order to provide information regarding our results of operations before restructuring and certain other costs. We provide a reconciliation of adjusted diluted earnings per share to GAAP results in table three of our press release and our website at www.spectrumbrands.com. Spectrum Brands Management and some investors through the adjusted earnings per share as one means of analyzing the Company's financial performance and identifying trends in its financial condition and results of operations. Provide this information to investors to assist in meaningful comparisons of past, present, and future operating results and to assist in highlighting the results of ongoing core operations.

While Management believes the adjusted diluted earnings per share provide useful, supplemental information, adjusted results are not intended to replace the Company's GAAP financial results and should be read in conjunction with those GAAP results. At this point, I'll turn the call over to Dave Jones.

Thanks, Nancy. Hello everyone, and thanks for joining us. We're very pleased to report fourth quarter revenue of $608 million this quarter, a 4% increase verses Q4 of last year. We generated an adjusted diluted loss per share of $0.07 before restructuring and other charges and a noncash impairment charge. I think it's fair to say that our Q4 results reflected transitional status of our business. There's positive news on a number of fronts, but there are still challenges ahead and there's much work going on across all of our product categories and geographies.

First, let's look at our product category sales on a global basis. Worldwide battery sales increased by 2% this quarter. The first increase we've seen from batteries in sometime. This growth reflects the tremendous progress we've made in the North American battery market this quarter, as well as very strong sales results from Latin America. We're still challenged in the European marketplace, but again, our global fourth quarter results are an encouraging sign of improvement for this legacy business.

We're quite pleased with the results from our home and garden business, where sales increased 8% in a strong ending to the '06 season. Global pet sales as finished our fiscal year on a high note with 7% growth on a worldwide basis. Remington was the one underperformer this quarter, with a global sales decline of 2%. In looking at geographic results, our North American segment generated sales of $258 million, a year-over-year increase of 5%. It's gratifying to report our first year-over-year increase from this region in five quarters. A welcome sign that our North American sales and marketing efforts are getting back on track.

We're particularly pleased that North American Rayovac battery and lighting product sales showed a very robust growth of 16% year-over-year. The key driver was the strong customer support we're getting for our new power challenge launch which was rolled out this quarter. We also benefited from the anniversary of last year's retailer inventory reductions, which began in Q4 of '05. The alkaline category in North America grew about 3% during the September quarter. Rayovac's dollar share in alkaline has stabilized and has actually improved slightly in each of the last three months.

In support of the power challenge launch, we're putting some additional dollars behind targeted advertising of the Rayovac brand this year, including print and TV ads with our new spokesperson Brett Favre, and we're doing some high impact promotions with partners like Fisher Price and Disney. We've recently gained distribution as a result of the new campaign and we have commitments for increased facings at a number of key retailers. So we think we'll get our fair share of consumer battery spend this holiday season.

We've announced battery price increases for implementation effective January the 1st. These increases are much needed and will go a long way in helping to cover a continuing, higher raw material cost once this increase is realized in the fiscal second quarter and beyond. However, Q1 will continue to be margin challenged in this segment until price increases begin to take place in early January.

Remington shaving, grooming, and personal care sales declined in North America and a seasonally slow fourth quarter. In Q4 of '05, we experienced some low margin closeout sales that did not recur this year as we continue to make progress in our execution of inventory management in this category. So while the total sales dollars are down, gross margins were up, both on a percentage basis and an absolute dollar basis.

We're very excited about the introduction of our new men's shaving platform, which was designed and engineered by BMW Design Works USA, and incorporates cutting edge advanced shaving technology. This new shaving platform is now available in stores. As a matter of fact, we have a line up of new and attractive men and women shavers, grooming products, and personal care products in stores for the holiday season. Including two new Remington shavers which are listed as Best Buys in the December issue of Consumer Reports.

Yesterday, we officially launched a new exciting print and TV advertising campaign featuring Cindy Crawford. We have already gotten good success with retail placement in anticipation of the significant advertising investment we're putting behind the Remington brand during the upcoming holiday season.

Moving to our home and garden business. We finished out the season with strong fourth quarter growth of 8%. Consumer purchases of Spectrum Brands products at retail also grew 8% verses 2005 with particular strength from fertilizers, growing media, grass seed, and insecticides. We're currently wrapping up one of our more successful line reviews ever for FY '07, so we continue to be excited about our home and garden business.

Now turning to our international businesses. Sales from the Europe rest of world business segment declined by 7% this quarter. European batteries turned in a solid performance driven by continued industry-wide market share increases in the private label segment and an unfavorable channel mix. While disappointing, this was a sequential improvement verses the battery revenue results of the last few quarters, and we're beginning to see some moderation in the overall negative trends that we've been experiencing.

We're working very hard to adjust our business model to accommodate the structural challenges we're experiencing in the marketplace with significant costs coming out of this region over the next six months. Our recently announced price increases have been accepted with differing degrees of success in various countries and retailers and will help offset some of the sales decline. We believe we've seen signs of moderation in the negative trends in this region, but we have much more work to do yet to stabilize this business.

Our European Remington business, on the other hand had another very strong quarter. Remington sales and market share across continental Europe continue to improve, reflecting very encouraging steady distribution gains as well as organic year-over-year growth, and we're encouraged about this segment of our business as we enter the key holiday season.

Latin America had an excellent fourth quarter. Sales increased 20% year-over-year, continuing a trend of very strong performance throughout fiscal 2006. Battery sales growth was robust in double-digits, largely driven by pricing increases. Remington sales continue to grow rapidly in the region, particularly in our women's personal care segments. We plan to continue to invest in Remington rollout with a major advertising launch this fall, utilizing Cindy Crawford in selected markets.

And our global pet segment generated sales growth of 7% this quarter. The strongest performance since our acquisitions of UPG and Tetra in 2005. Our aquatics business rebounded dramatically from the softness we saw earlier in the year and had a very strong fourth quarter. Particularly, with the Tetra brand. We did very well across North America and in Europe, although Asia continues to be somewhat sluggish.

Overall, we were very pleased with the revenue and market share performance in our pet supply business for the quarter. And believe it provides us a solid foundation to build on as we step up our marketing, advertising, and product development in key product segments around the world. I'll now turn it over to Kent at this point to walk you through the financials, then we'll wrap up and move to your questions.

Thanks Dave, and good morning everyone. While we were pleased with our sales growth this quarter, we faced a number of head winds on the cost side of the equation. Gross profit margin for the quarter was 35% or 37.6% after adjusting for $18 million in restructuring charges. Gross profit margin is flat when compared with last year's adjusted number. Higher raw material costs brought margins down. Zinc alone had a negative $7 million impact in the quarter. We also had negative manufacturing variances due to manufacturing utilization issues in several business units. However, we did get an offsetting positive impact from cost savings from better margin contribution from Remington.

In Q4 of fiscal '05, we had some low margin closeout sales, which did not recure this year resulting in significantly increased Remington margin contribution despite lower sales. We reported Q4 operating losses $423.2 million or a positive $37 million if you exclude the asset impairment charge and restructuring and other costs. This compares with last year's $46 million adjusted on the same basis. For adjusted operating margin, was 6.1% of sales, 180 basis points lower than last year. Distribution costs which were significantly higher than anticipated in both home and garden and pet during the quarter, were major contributor to the increase in operating expenses.

The $433 million noncash impairment charge we took during the quarter relates to goodwill and intangibles. U.S. GAAP requires that we test goodwill and intangible assets not subject to amortization for impairment at least once a year. Impairment is judged to exist of the carrying value of the goodwill and intangibles exceeds the fair value of those assets. Fair value is determined using discounted cash flow valuation methodologies to require various judgments and assumptions, including assumptions about future cash flows, long term growth rates,and discount rates. The asset values are also tested to reasonableness by comparison to the Company's market cap.

As a result of the most recent annual analysis, which included the systems from an independent third party valuation firm, we recorded an impairment charge of $433 million or $398 million net of tax. And as Dave mentioned, this is a noncash charge.

Moving on to segment profitability. North American segment generated profits of $20.5 million or 8% of sales compared with 17.5 million and 7.1% of sales last year. Positive impact of sales increases was offset somewhat by higher raw materials and distribution costs and less efficient manufacturing utilization. Distribution costs were well above historical levels as we incurred excess costs to meet customer needs during the peak season in the post SAP implementation period in our home and garden business. Some poor demand planning and inexperience with SAP led to inefficiencies in the supply chain. We believe these issues are solved and distribution costs will return to historical levels next year absent the impact of fuel surcharges.

In Europe, segment profit declined to $13.7 million from $21.2 million last year as a result of lower battery sales volume, negative product mix changes and higher raw material costs. We've discussed before we're in the midst of restructuring our entire European organization. We recently completed negotiations with the German manufacturing unions and our Dischingen plant is scheduled to be downsized by the end of the calendar year with European private label battery production moving toward Nenghao facility in China. Upon completion of this downsizing which will take place in several steps, currently anticipated to be complete sometime in fiscal '08, this initiative and combination with other cost reduction measures could result in over $30 million in annualized cost savings in our European business unit.

Latin America segment profits were $9.1 million for 13.5% of sales. Compared to last year's 5.4 million or 9.6%. Improvement in sales was a primary driver of the increase, partially offset by increased costs primarily higher zinc prices. Just as a reminder, there's actually more zinc in a zinc carbon battery than a comparable alkaline battery. As a result Latin America has been hit hard by the run up in zinc costs.

Our global pet segment generated profits of $21.2 million representing 15.1% of sales, up significantly from last year's 17.1 million or 13%. 2.6 million of the increase resulted from an inventory valuation charge taken in 2005 as a result of acquisitions, it did not reoccur this year. Remaining improvement came as increased raw materials and distribution costs were more than offset by higher sales volume. As I mentioned in both the North American and pet sections, fiscal '06 suffered some short term cost inefficiencies as we groove into our new systems and supply infrastructure. We believe these issues are behind us. However, as a result of the learnings from fiscal '06, we've slowed the pace of plant closure and change primarily in the global pet business.

Closure of our Moorpark aquatics products plant originally planned for Q1 of fiscal '07 will now be delayed until the end of Q2 allowing us more time to ramp up production at new manufacturing locations including China. As a result, synergy savings will now be lower in fiscal '07 than previously projected. However the projected total synergy savings are still expected to exceed our target of $100 million by the end of fiscal '08.

Turning to Corporate expenses, the increase from 3% of sales last year to 4.3% in the current quarter. The increase is largely due to the fact in Q4 of '05, we recorded a reversal of an incentive bonus accrual which had the effect of lowering G&A expense for the quarter last year. Another reason for the increase is the investment we've made in our global ops organization in Asia. Talked about before, we've increased staffing in Asia to support our expanding supplier base and sourcing operations in the Asia-Pacific region.

We incurred $47 million in interest expense this quarter compared to $40 million last year. Effective tax rate this year was approximately 15%. The reduction in tax rate is compared with last year is the result of the impact a full year's benefit from tax planning strategies implemented in connection with our acquisitions made last year, along with the change in the worldwide net income mix from the prior year. We expect our effective tax rate to return to a more normal 33% in fiscal '07.

We generated free cash flow of $26 million this quarter after capital expenditures of $9 million and cash restructuring costs also of $9 million. For the full year after CapEx of $60 million, cash restructuring costs of $41 million, and $95 million in cash proceeds from the sale of Nu-Gro in the Bridgeport facility generated a net cash inflow of $80 million. Outstanding debt at quarter end was $2.3 billion. Our leverage ratio for the third quarter was 7.68, compliance with the maximum leverage ratio allowed under our senior bank agreement of 7.75. As at the end of the quarter, we had approximately $221 million in availability on our revolver. The role where we've been uncomfortably close to our maximum leverage in minimum interest coverage ratios for most of the past year due to the underperformance of the business.

Told you last quarter that we intend to address this ongoing issue through a selective disposition of assets and reduction of debt. Until a transaction is finalized, however, we will remain overleveraged and in danger of pumping up against our covenants, particularly in Q1 when advertising spend is the highest, and before we see the benefits of battery pricing in North America. As a reminder, advertising is expensed as incurred, and most of our advertising for fiscal '07 is planned for Q1 in support of the critical holiday season. We've been in discussions with [Viava] our administrative agent relating to potential covenant issues, will continue to work with them very closely. I'll turn back the call to Dave now for his wrap up and then we'll take your questions.

Thanks, Kent. Okay, before we close, I know you are all interested in the status of potential divestiture activity. Unfortunately, I can't say a lot at this point because we're in the middle of the process and there's just not much I can share. I will tell you that we're making good progress and there is strong interest in many of our brands and product segments from a number of interested parties. We'll update you as soon as we have something definitive to report.

I'll conclude my remarks by offering some summary thoughts about fiscal '06 and our outlook for '07. As I pointed out at the beginning of the call today, there're a lot of moving parts at Spectrum Brands right now. First the positives. Looking back at FY '06 results, we're very proud that we maintained momentum in our home and garden, and global pet businesses during a challenging year. Latin America had a very strong '06 with both Rayovac and Remington products. And we're encouraged that we've recently turned the corner on the North American battery sales. In addition, we took significant costs out of the organization in FY '06 with a manageable amount of disruption to our business.

On the other hand, we significantly underperformed in Europe due to all of the battery industry issues that we've talked about. We also underperformed in our global Remington business, particularly in our North American shaving product segment. An input cost, particularly raw material and distribution costs were significantly higher than anticipated, and more than offset the considerable synergies we realized this year as a result of the acquisition integration activities.

So what about the outlook for next year? Well, although we made progress, particularly at the revenue line, there's still many challenges ahead, there's a lot of work to do. Here are some of our goals for '07. One, complete a major asset divestiture and use the proceeds to reduce our outstanding debt, our interest burden and our overall leverage. When completed this will significantly improve our balance sheet and improve our flexibility to grow our business again.

Two, stabilize and begin to grow our battery business in Europe. Capitalize on the momentum in the North American battery business while maintaining the sales and marketing energy in our Remington, home and garden, and pet supply businesses. These initiatives will require additional investment and advertising marketing and new product development. Significantly more than we spent this past year, particularly in the upcoming first quarter. We will be investing to grow our share during FY '07 in many of these key segments. Year-over-year we plan to spend 25 to $30 million more on marketing, advertising, and brand building in FY '07 verses FY '06 spending levels.

Three, manage input cost, which will remain a major issue particularly in our battery business. While raw material costs have moderated in some areas, major increases are anticipated in zinc and other precious metals such as copper and nickel. Zinc alone has recently spiked about $4,200 per metric ton on the spot market. While we have significant hedges in place for the first half of the year, and some in place for the full fiscal year, we currently anticipate raw material costs to increase in fiscal '07 above already elevated 2006 levels.

Four, once a divestiture is completed, we will need to look at our business model with an eye towards bringing our overhead cost structure in line with the new product portfolio. Spectrum Brands grew significantly through acquisition in 2005. We have undergone much change as a result of integration activities and other cost cutting measures in '06. And we will now go through further significant change as we proceed with the divestiture activity. And that's a lot of change to manage. Further organization restructuring while necessary will need to be managed carefully to achieve our cost cutting goals successfully while maintaining product quality, customer service, and employee retention objectives.

Some of the integration initiatives planned for FY '07 have been pushed back to FY '08 in anticipation of the challenge we have before us. But we believe the original targeted integration cost savings are still achievable and once implemented, these and the other cost cutting measures we're pursuing should have an appreciable impact on the bottom line.

So in terms of our expectations, my prediction is that the upcoming year will be a year of significant transition and much hard work. We have to stay focussed on what is right for the long term success of the business and that means there may be some short term earnings pressure along the way. While the first quarter will be earnings challenged due to increased levels of advertising spending, I believe you will see steady sequential improvement as we move through the year and begin to see the benefits from the work we're doing. And I firmly believe we will exit 2007 a much stronger global competitor, with a much greater visibility and clarity to our business model. 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 Chris Ferrara with Merrill Lynch.

Hi guys, I was wondering if you could talk about what the consequences of bumping up against your covenants, just get a little more detail there as you get into Q1. I'm guessing, like you said, you're talking [B of A], so what could come out of this?

I think the key thing is that we're moving on track in terms of the asset dispositions, they're aware of that, they're fully aware of the process. Obviously those things take a little time to implement. I think they're very pleased with the progress we're making and I think if there is a short term issue, there is strategy to deal with that.

Could you elaborate a little bit on what the strategy -- I mean what would a strategy be to deal with that? I mean is there pressure -- is there. like--

Potentially, if we have not closed a transaction, which is highly likely, what we have discussed with them is potentially a one quarter waiver until we can actually close the transaction and significantly reduce debt. So I think that's the conversation we've had at this stage of the game.

Got it, that's helpful. And then can you just talk a little bit more in detail about the supply chain inefficiencies you saw and how you're getting past it, and inexperience I guess you said with SAP?

Yes, we implemented SAP. We have what I call, a very good technical implementation, so the system was up and running last year at the end of '05. But as we got into the peak season, the people in home and garden, it was their first season using the system, and so the lack of full knowledge about how to set up new products, and as you know new products are a major part of both of our pet and our home and garden business, get them into the system early enough to get the demand planning done, doing the right level of demand planning to have enough product in the right places to meet customer demand. So is largely a training and learning experience for the people using the system.

We had major disruptions, in terms of meeting customer service levels as we went through the peak season including into the summer. We spent a lot of money to move product around the country, to expedite shipments of product, to meet customer needs, which is what you have to do in a short term season like home and garden is. But as we got towards the end of the season, I think as people learned how to use it, we worked our way out of that.

We're also in the process of obviously integrating home and garden into our case goods distribution, a network in order to take costs out of the distribution system. But there are some one time costs to begin to move product from one distribution center to another. As you know, we've closed some of the older facilities, moved to newer expanded facilities. So that kind of transition also contributes to short term costs. And in the case of pet, we closed Hauppauge, which is the major companion animal supply and manufacturing facility at the end of July.

We had built up safety stock of inventory as we transitioned production from that plant to other locations in-- within the pet supply network, and what caught us somewhat by surprise was the surge in demand, and so we didn't have enough safety stock. And again, we ran into service issues with major customers, with product outages, poor service levels. And again, when you're not meeting your key customer needs, you spend whatever it takes to get the product there to get it back on the shelf.

And so Q4 for us was a quarter of a lot of spending to restore service level, which was the right thing to do to meet our customer needs. It was a short term pain, but we believe the learning is behind us now, the supply has been restored. And other than in a few skews, we're back totally in stock and meeting service levels. There are a few skews, where because of the length of the supply chain we're still working through those, but we anticipate all of those issues will behind us within the next month or so. Hopefully that helps.

That helps a lot. Are you yet more efficient with SAP now than you were on your legacy system?

Yes, we are, but again, we went through a big learning experience and some inefficiency in year one. But I think we've gotten through that now and we're looking forward to all the benefits of being on a single platform as we go forward.

Thanks a lot.

Your next question is from the line of Connie Maneaty with Prudential.

Morning.

Morning, Connie.

How much of the synergy savings moved from 2007 to 2008? Can you tell us what you expect now in each year?

Well, we haven't given specific numbers, Connie, as you know, we talked about the total target. We did roll up at the end of the year based on all of the experience in '06 and the rescheduling of some of the initiatives, like the closure of the Moorpark plant, we've now pushed out about six months in the budgeting process. The total number is the same, we're still going to exceed the $100 million, but roughly $10 million of the savings we thought we'd have in hand by the end of '07, now we will not see until the end of '08.

Okay.

Should also point out that there have been some rescheduling of home and garden initiatives. But if you look on a go forward basis, significantly more of the integration savings in the home and garden business have been accomplished. Whereas in the pet business because of the major closures involved in some of their manufacturing facilities and the time that it takes to source product in China, which is where a lot of their products are moving to. A lot of their integration savings were scheduled for '07 and some of those now basically have been pushed out to '08.

Okay, about this impairment charge. What businesses did it affect? What brands?

We could spend about two hours going through the detail, Connie. And everyone individually is complex. It did affect several of the brands and several of the business units. I think probably the easiest way to think about it is the total enterprise value of the Company certainly has been reduced as a result of the equity capitalization value of the Company today. And in the simplest terms, you take our total enterprise value, which the total value of our debt plus the market capital of our equity, and look at the total asset value of the Company including all the intangibles, we significantly were above what the market says the Company is worth.

And in the world of accounting today that's something that we had to address, very, very complex. We could spend an hour talking about the details of how it was done, but in essence we've written down those intangibles to get more in line with the overall valuation of the Company.

Okay and finally if I could ask, when you say the first quarter is going to be challenged, does that mean it's going to decline year-over-year?

Yes, yes it's going to decline, Connie, principally because that we're investing significantly more money in advertising to support the Remington brands, the Rayovac brands in the Americas, the VARTA brand in Europe, as well as some of our strong brands in pet. And I mentioned in my comments that year-over-year -- and last year was a year where that you may recall we cut back on our advertising spending significantly, particularly in Q1 because of our profit challenges facing and cash challenges facing the business.

So we have a lot of our businesses in very good shape now and we think it's not the time to underspend. In fact, it's probably the time to step up our spending. And a lot of that spending, particularly Remington spending occurs for Q1. And so that alone is going to make the -- be profit challenged during Q1.

So of the 25 million in increase marketing support, how much goes into this coming quarter?

18 million.

18 million. Okay. Thanks.

You're welcome.

Your next question is from the line of Joe Altobello with CIBC World Markets.

Thanks, good morning, guys.

Hey, Joe.

First question is on the distribution costs, is there a way to quantify the one time impact in the quarter?

Yes, we probably could, but I can't give you that number right now. But we're not talking $1 million, we're talking multi-millions of dollars.

Okay, but it's less than $10 million, let's say?

Yes, but it's certainly well into mid-single-digits.

Got you. Okay. Secondly, on the pet side, it sounds like the category as a whole improved pretty rapidly in the back half of the quarter, was there anything that you saw that caused that? Or it's just a general overall improvement off of, off of a pretty low base?

I think the sort of the take away is that the entire pet industry across all categories is doing very well right now. If you were to track it in key retailers around the world, they're all doing very well too. Sort of the positive surprise beyond that is that our aquatics business where we're the world's leader, and it does represent 2/3 of our global pet supply business, had an excellent quarter. I think that's due to a lot of things, including Disney's movie that came out last summer, Pirates of the Caribbean. And all of the marketing initiatives that we've undertaken as the industry leader to drive growth.

And a huge number of new products that we've launched in the aquatic sector in both the U.S. and in Europe, in all--and as well as some of our competitors. And as a result, aquatics, we rung up-- we haven't had a quarter since we've owned the business as strong as what we experienced in aquatics. And as we go through this current quarter, we're seeing good growth continue in the whole pet supply sector. So we're very encouraged with what we think is a long term sustainable growth rates. And now just like when I was answering Connie's question on advertising, now's the time for us not to let up there.

And we are doubling down, we're putting more money behind our marketing and brand advertising and product-- new product development initiatives because we think we've got a unique opportunity here to not only sustain the growth that's occuring, but to potentially accelerate our growth in a category.

Okay. And then lastly on lawn and garden, it sounds like you guys are pretty excited about the line reviews. Do you expect to take shelf space next year?

We expect to maintain or slightly improve our shelf space next year. I would characterize it as probably no great movements by any of the major competitors. The category had a very good category growth if you add up the whole season, our growth was at the high end of category growth. And so we feel real good about what occurred. Albeit that Kent mentioned that we spent a lot of money for it to occur, we think that learning's behind us. But we all anticipate that home and garden's going to have an excellent year next year, weather-- somewhat weather dependent obviously. Not only for us, but the entire industry. It's a healthy-- it's a very healthy industry and very healthy category.

And pricing for next year? You taking it up?

I'm sorry?

And pricing on lawn and garden, you're taking that up, as well?

Yes, but we're taking it up moderately. Unlike batteries where the industry has been forced to all of us respond by significantly taking pricing up because of the input cost. We don't have the same sort of input cost pressure in home and garden, not on raw commodities. Natural gas has subsided and price of urea subsided. We've got some issue with distribution cost in fuel surcharges, but that's fairly moderate. And so we'll be taking our pricing, but it'll be taken up low single-digits, selectively where that we -- where that we have the justification to do that.

Great, thanks.

Your next question is from the line of Bill Chappell with SunTrust Robinson, Humphrey.

Good morning.

Hey, Bill.

This is actually Mark in for Bill.

Hey, Mark.

On the European business, it sounds like your price increases had some mixed success. Is there any way you could actually elaborate on that a little bit and give us your outlook for that going forward?

It's just a-- mixed success is probably the wrong way to look at it. In-- unlike in the U.S. or in Latin America where that we just say here is the list price increase, it's going up 5 or 6% and it's doing it January the 1st. In Europe, all major retailers in Europe, you do business with them under contracts that are one or two years in duration. This isn't just for us, it's for all industry participants, and you have certain times when you're able to affect price increases due to contract terms. Okay so even though that we might have, as an example a desire to take prices up in Europe right now or January the 1st, some of those contracts don't allow us to do it until certain times. And as a result, it's much harder to affect price all at once, obviously or to get a handle on just what the overall affect is.

We are having success in the discussions with key retailers and I think all industry participants are having similar success. It's just harder to quantify when it will affect the P&L. So that's probably the best way that I can articulate it. Maybe on the next call, we may have clearer visibility, but we've gone to all of those key retailers in the last 60 days. We've entered into contract discussions and negotiations with them. But it takes a little longer to execute.

Okay. And then on the North America battery business, do you think you're going to follow some of the other players that have announced plans on January 1st to take price increases? Do you see Rayovac doing that, as well?

Yes, we've announced it and we've had discussions now with all the major retailers in North America and we expect that January the 1st we'll be increasing our prices.

Okay. Great. Thanks.

Your next question is from the line of Karru Martinson with CIBC World Markets.

Good morning. 2007 the guidance that you talked about, short term earning pressure, but we would be seeing sequential improvement. So on a quarter-over-quarter basis here going forward in the second half, significant improvements or are we just talking incremental improvements here?

I think think of it as incremental improvements. It's-- and then maybe the best of all worlds is we'll be positively surprised for a change. So think of it as incremental improvements, quarter-after-quarter, we've done a lot of basic blocking and tackling and those things should begin to come our way. But it's still-- we're not out of the woods yet, we've still got this issue in Europe we're trying to deal with. It will still drag us for probably a few more quarters. And then, other than that, we are going to, as I mentioned more than once, we are going to spend more money behind our brands and the net effect of that is in future quarters our market share should improve and our sustainable growth should be there.

In terms of the sales process, were there any one time costs associated with that during the quarter, and timing of an announcement?

No one time -- we didn't incur any one time charges for that process during the quarter. I'm not going to talk about timing. We are-- other than what I said, which we're sort of in the heat of the battle of the sales process right now. And hopefully we'll have something to talk about here in the near future.

Okay. In terms of the manufacturing utilization issues, in what were the problems that you were running into? And should we see that going forward or is that all corrected now?

Well our manufacturing utilization issues reside in large part in our batteries. When you have negative battery trends that are occuring around the world, which we certainly had for the first, let's call it for the three or four quarters preceding the last quarter that we were in, we were running our plants at less utilization than prior periods and far less than we would like to run them at. And one of the benefits of finally getting revenue growth up is it starts to flow through manufacturing variances and of absorption significantly. And that's been the biggest issue that we've faced.

And also closed the news production capability, in Dischingen which will certainly help us in fiscal '07.

And just to put some numbers around the zinc hedges that you referenced, I believe on the last call you talk about being about 75% hedged for the first half of '07-- fiscal '07. How much has that number changed?

We're over 80%. We're close to 85% hedged now for Q1 -- I mean, excuse me for the first half of '07, which is about as much hedge as we want to put in place. Because we don't want to buy hedges that-- because we still have variability in the manufacturing process and in our volume assumptions. We don't want to buy hedges that we can't use. So call that nearly fully hedged and then in the back half we're about 50% hedged.

Thank you very much.

Your next question is from the line of Lori Scherwin with Goldman Sachs and Company.

Hi good morning.

Hey, Laurie.

Can you talk a little bit more about the European battery business? Dave you mentioned you're seeing a moderation of some of the negative trends, and I'm curious if that's more about less private label impact or less negative channel mix, or both, and what you think is driving this?

The answer is both. And it's -- but it's principally of the two, it's principally private label. We saw a huge mix shift occur as you're well aware over the last 18 to 24 months, driven by central Europe, which is our strongest markets. German speaking markets, Switzerland, Austria, Germany, et cetera, were we're market leaders. We saw a huge shift to private label because of the, I'll call it the [Audi] and [Leado] effect. [Audi] and [Leado] decided to sell batteries and sell private label batteries and they did it at a much lower price and all of the retailers, the jerk reaction was, well we have to have a similar offering at a similar price point. That has moderated somewhat and so we're not seeing this huge move to private label in central Europe, we're seeing a sort of a trickle, continued trickle to private label where that is changing two or three share points in our projection this year and not 10 or 15 share points. So that's having some good moderating effect.

And then we've seen this channel mix where that we've seen a near collapse of the traditional photo, or traditional channels more towards food and mass that began occuring, call it the same 12 to 18 months ago. And while that continues, a huge amount of it's already been done and factored in. So if I were to predict going forward, I would predict a moderation of the negative trends, but I would still predict negative trends that are going to occur in that marketplace that we have to deal with. Thus, that's why you've seen us go in aggressively, take out the overhead cost structure in Europe and now to downsize our largest plant in Europe and move all of our private label production to China. Which will-- the net effect of that will sort of improve our margins in that margin challenge business there.

All of that should mean in the future we'll have better outcome, or moderating of the outcome that we've experienced. But I don't want to-- I want everybody on the call to know that we're still challenged in Europe, we're still working hard, we have not solved all of the profit pressures that we're experiencing and have experienced. And it will take us still several more quarters and more initiatives before we're able to neutralize all those negative trends.

I guess, Dave, recognizing all of that, one of your priorities you laid out was you want to stabilize and grow the European business. Is that not going to be possible to the back half of next year? And is that-- are you still developing Company specific initiatives to help you through that? Or is that more about banking on a continued moderation of some of these issues?

I think it's a combination of both, including -- think of Europe. Well, one, our Remington business is Europe-- in Europe is doing great. So we want to continue that and we don't want to diminish our support for that category. But in batteries specifically, our branded business, which has held up extremely well, both in terms of market share and in terms of margin, our profit pool to us, we want to build on that. Okay so we have pricing actions going on our branded business, we have distribution actions going and we have product development stuff going that we believe will not only stabilize, but grow that business segment.

It's all about private label. Private label while it is a big part of our business, it is margin challenged because right now our private label product is manufactured up until very recently, manufactured out of our German plants. And the biggest single thing that we're going to do over the next couple of quarters is move 100% of that business to China. And once we've done that, we will have significantly enhanced the margin that we're able to drive out of that business. And that's the biggest single thing that we can do.

So there's little we can do with what's occuring in private label take away in Europe. And so we're more focussed on the cost of private label. There's much that we can do on branded take away because the branded business, not just for us, but for the entire industry is very healthy in Europe. The issue that we're all dealing with is private labels.

Okay and just lastly on European batteries. I'm assuming a lot of the changes you're making have come from the McKenzie study, I'm just wondering is that study complete or is there-- could there still be more announcements to come about how you're dealing with Europe?

The study is complete in Europe and McKenzie is no longer on the ground in Europe. And we've implemented a large number of the things they recommended in their study and there are a few more that we'll be implementing here in '07.

Great. Thank you.

Thanks, Lori.

Your next question is from the line of Bill Schmitz with Deutsche Bank.

Hi, good morning.

Hey, Bill.

Hey, can we just give an update on the cost savings, what you have so far to date from both the United and Pet integration and also the ongoing European and U.S. restructuring cost savings, and then kind of what's left in the pipeline?

On the $100 million integration savings, home and garden and pet, basically through the end of this year, we're approximately 50% realized. Unfortunate circumstances in spite of all of that good work and all of that savings as we've talked about run up in input costs particularly zinc and some of the shorter term issues have eroded a lot of that. So you did not see that at the bottom line this year. But those projects are done and, and should benefit us on a go forward basis. So we're roughly half the way through the [inaudible] [objective].

And in Europe, Bill, the two major initiatives, one is the overhead restructuring that we call Slim and Fast, and the other is the downsizing of the Dischingen plant and the movement to China. The overhead portion is implemented. It takes a little while for that to start flowing through the P&L. That's worth about $15 million annualized. The manufacturing restructuring is worth somewhere between 15 and $17 million annualized. And while we have reached negotiation, as Kent pointed out with the unions and we have begun that activity, it's still going to take us a few more quarters to complete it and have that production coming out of China, where then you can begin to see it, but in total the European restructuring's worth about 30 to $32 million.

Okay and how about the U.S.?

U.S. restructuring absent of what we just talked about was relatively small. It was somewhere between 5 and $7 million, those actions are complete. Some of that began flowing in the-- in Q3 and Q4, the rest of it will flow this year.

Got you. So it sound like about 60% of the savings are already accrued, is that a rough good number just by what you just told me?

Yes, I think that's probably -- yes that's probably right. About 50,60 something like that.

If you just can think back to $1,000 a ton we'd appreciate it though.

I know you're wishing for $1,000 a ton.

And you would see the effect of everything we're talking about, immediately.

I got you. And then can we just talk about the account reviews you had with the trade? I know there are some [serve] issues obviously but you are getting incremental facing? So what's the selling proposition and why are these people so willing to kind of give you more shelf space, if you were forced to air freight stuff in and out of stock became a problem?

The key thing that is part of our strategy is, we're the value player, we have a very important position in home and garden. Things we pride ourselves on here is product innovation and a continuous flow of exciting new product to the market whether it's in home and garden, or in our pet supply business, we are the ones who bring that to the retailer. So it was very painful for us to not be able to support them at the levels that they're accustomed to which is 95% plus, orders delivered on time complete first time. That's their expectation and that's our expectation. And so it's very painful and we fall off of that. And so we spent a lot of money to get back to that.

But at the end of the day, we are a major part of the success of their business in terms of that flow of new product to the shelf and the margin story that we bring those retailers along with exciting products. It's that- any cases those products are significant profit dollar generators for those retailers. So we're an important part of their retailing strategy.

And let me add, Bill, that in home and garden, separate the service issues that existed at home and garden and pet. At home and garden we went to SAP earlier last calendar year and we began to experiencing service issues, new system, brand new category for us, new people, so think about all of the opportunities to screw that up. And April/May time frame and our service levels were significantly affected to major retailers in the early lawn and garden season. And we did everything in our power, including spending any amount of money to make sure that we solve those service issues and consumers weren't affected.

Okay and the net result of all of that is our retailers while it was painful for those weeks, I think all of them viewed that we stepped up big time as a manufacturer to make sure we didn't affect their business model or the end consumer in a meaningful way. Okay that's done. Our service levels in home and garden are all up above 95% now and have been for several months.

In pet, where we closed Hauppauge, the huge facility in July, we again had a similar issue, not SAP related, but issue with product delivery and again, we went to our retailers real fast and we said here's what we-- here's the issues we have, here's where our solutions are, including air freighting products around the world, doing whatever that we had to do to satisfy their needs. And as Kent said, while we're not completely through the woods there, we're at least 95% through the woods. And I think there is recognition in the pain-- there's always silver lining in the cloud. Recognition that our pet business-- and other pet groups stepped big time and at any cost made sure that we didn't affect the sell through of our retailers, and ultimately my belief is that as in all cases, we'll be rewarded for it whenever somebody has a problem and openly discusses it, and then at our cost in our expense makes sure that we protect our customers.

Let me add on to that, Dave, that in reality if we're really honest with ourselves, we did lose in Q3 and Q4 25 to $30 million worth of loss sales because of our inability to book customer orders. And those orders that we had, we had to cancel because we couldn't deliver the product. That's behind us know, we're back up where we need to be. So it did have an impact on the revenues of the Company.

The other good news here, is particularly in lawn and garden while we did go through some issues during the season, the fact that we stepped up, spent whatever was necessary to get back to where we needed to be, actually resulted in no impact on line reviews. As you know, the line reviews take place basically at the end of the lawn and garden season. Most of those took place in most recent three or four months. Had we been in the penalty box, we could have potentially been hurt by losing in the line review process, and essentially we a came out of the line review process with a net increase in skews and distribution with our major customers. So they would not have given us that distribution if they were convinced that we had solved the problem.

Great, thanks. And then just to follow up on that. What's the difference between sell and sell through now? Do you think that the sort of trade destocking or the bulk of it is already done?

If we were to track, take home and garden as an example in the last quarter, our sell through, our off the shelf was 8% and our major accounts and our sell in was 8%. We have destocked our key retailers in all the categories that participate in. And we believe as we said right now that our inventories have never been in any better shape than they are as we go into Christmas, and our key battery and Remington seasons where that we have significantly improved our inventory levels and our strategies with Remington. And we think our home and garden business is in very good shape as we get ready for early season next year and our pet businesses have always been in good shape.

Got you. Great. Sorry and I promised there was only one more. But I guess can we just follow up on distribution costs? Is all the inflation up on freights, was it all in SG&A? Or is there an inbound component too in cost of goods sold?

No there's a lot of inbound freight expediting material to get in. And there is a lot of what we call intra-distribution center freight where we had-- we actually had product put in the wrong place and so we had to move a lot of stuff around North America to get it where the customer needed it. So a combination of inbound freight expediting product to get it into our system and then moving it around within the system from place-to-place, and having too much inventory in some places not enough in others, excess storage space, excess handling cost, these things when they-- when you get into a whole, the harder you dig, the deeper you get sometimes.

And so we spent a lot of money, we're out of it now is the good news, but we did spend a lot of money in the distribution. If you look at the distribution line in our P&L, the number is much higher than we've historically run. But as I said during the earlier comments, I think those problems are behind us and absent whatever happens with fuel surcharges, we think we'll be back in the more normal kind of distribution expense next year.

Some of it's embedded in cost of sales.

Okay. Just a small piece and the rest is in SG&A. Okay, thanks very much.

Okay we've got time for one more question. We're beyond the hour. So somebody --

Okay, your next question is from the line of Carla Casella with JP Morgan.

Hi, I had a follow up question on batteries. You talk about good inventory in the channel. I'm wondering if you can give us an idea of how much this quarter sales were driven by the loading in for the new power challenge?

None.

Okay. So --

We loaded -- the power challenge is a marketing campaign. Okay. We began shipping months ago new product, new performance, new packaging, that's everywhere, okay, and there are no -- there's no incremental build up of inventory at retail as a result of it. None.

Okay. And now it's the execution of the power challenge where we -- we say on package and in print and advertising that our products as good as the other guys and it sells for less and if you don't believe us, try it, we'll give your money back. So that's going on, that's a marketing and advertising campaign that's going on in the marketplace now designed to improve sell through not sell in.

Okay. Great. And that would be similar -- the battery performance would have been similar to the home and that you're selling and sell through were the same?

Actually, I think our sell in's probably less than our sell through and has been for at least for-- at least three or four quarters.

Okay, and the-- because the market share doesn't pick up Wal-Mart. Can you talk about the trends in that category and if you're seeing anything different from Energizer and Gillette in Wal-Mart, any more aggressiveness?

In our-- in total? I'm not going to talk account specific. Okay in total, market share trends are stable -- they're stable for us, our trends over the last three months have showed moderate incremental growth in market share, which is what we would have predicted given what we're doing. We would hope that that would continue here in this quarter, which is the most important quarter. There's, I think I would characterize the whole industry as pretty stable in terms of market share, stable in terms of promotion, probably the most rational that the industry has been in at least the last three or four years.

That's good to hear. And then just one housekeeping. On the-- of the charges this quarter, are all of those noncash? Or will any of those be cash charges?

No as we-- as Kent said in his message, 9-- there's 9 million of cash charges in the quarter.

Related to restructuring.

Yes, related to restructuring.

Okay. Great. Thanks a lot.

Okay. Well, I think I'm going to cut it off now. And thank everybody for their time and their patience. We're working hard to improve this business. We're not satisfied with our results. We're very dissatisfied with our results in '06, but not our effort. I think our effort's been strong everywhere around the world and it will begin to pay dividends for us in the future. So thanks for your continued support. Have a great day.

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