Spectrum Brands Holdings Inc (SPB) 2018 Q3 法說會逐字稿

Good morning. My name is Marianna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectrum Brands Fiscal 2018 Third Quarter Earnings Conference Call. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, July 26. Thank you.

I would now like to introduce Mr. David Prichard, Vice President of Investor Relations for Spectrum Brands. Mr. Prichard, you may begin your conference.

Thank you, operator, and welcome to Spectrum Brands Holdings Fiscal 2018 Third Quarter Earnings Conference Call and Webcast. I'm Dave Prichard, Vice President of Investor Relations for Spectrum Brands, and I will be moderating this morning's call.

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

So if we start with Slide 2 of the presentation, you'll see that our call will be led by David Maura, Chairman and CEO; and Doug Martin, CFO. David and Doug will deliver opening remarks, and then they'll conduct the Q&A session.

If we turn now to Slides 3 and 4, our comments today do include forward-looking statements, including our outlook for fiscal 2018 and beyond. These statements are based upon management's current expectations, projections and assumptions and are, by nature, uncertain. Actual results may differ materially. Now due to that risk, Spectrum Brands encourages you to review the risk factors and the cautionary statements outlined in our press release dated July 26, 2018, and our most recent SEC filings and Spectrum Brands Holdings' most recent 10-K. We assume no obligation to update any forward-looking statement.

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

With that, I will now turn the call over to our Chairman and CEO, David Maura.

Okay. Thanks, David, and thanks, everybody, for joining us today. I'd like to start actually by welcoming the new shareholder from HRG Group to Spectrum Brands. That transaction, which is now complete, enables them to participate directly in the significant upside opportunities that I believe our company has.

When I last spoke to everyone 3 months ago, I took on a new role here, and I told you that the second quarter results would in no way define our company. However, I did mention that it would refine us and that we are starting the process of refinery. We're being refined. While we have much more progress to make, the third quarter results demonstrate that the leadership changes, a focus on restoring the ownership and accountability culture of our company, they're already beginning to read through into significantly more positive results.

I'm also pleased to report to you that we are delivering on the positive momentum and the growth that we promised you we would have in the back half of this fiscal year. I would be completely remiss not to thank all my team members and to extend my sincerest gratitude to every one of our employees worldwide, who have responded with determination and extreme resiliency to put our company back on a positive trajectory as we move through this transformational year that I believe will ultimately result in a much less leveraged, much more focused company with 4 streamlined operating core units with much greater growth potential and a much higher margin structure.

Our third quarter results from continuing operations rebounded strongly from Q2. We did deliver increased sales and adjusted EBITDA versus the prior year, and we achieved significant encouraging progress against the operating efficiencies that we've been experiencing in the greenfield facilities for both our Hardware & Home Improvement assets in Edgerton, Kansas and our Global Auto Care assets in Dayton, Ohio.

Highlighted by double-digit growth, our HHI and Auto Care businesses and top line -- strong top line in our Home & Garden, we reported our highest quarterly organic sales growth rate of 3 -- sorry, 7.3% in many, many years this quarter. This quarter is also our largest quarter.

The market demand for our products and brands is solid. New product introductions were launched across our portfolio, and e-commerce growth was exceedingly strong. Perhaps most importantly, customer order backlogs were markedly reduced in the Edgerton, Kansas and Dayton, Ohio facilities, which confirms that our new approach to culture and our new efficiency measures are taking hold and are working.

Our adjusted EBITDA of $206 million did grow about 4%, even as we continue to be significantly impacted by increased commodity input and freight costs, unfavorable product mix, higher operating costs, to name a few, even as we improve the efficiency in the Kansas and Ohio facilities. However, I remain confident that the long-term strategic merits of these consolidations will result in improved operating efficiencies and lower inventories going forward.

As such, today, we reiterate our fiscal '18 adjusted EBITDA guidance from our continuing ops of $600 million to $617 million, and our adjusted free cash flow of about $485 million to $505 million.

We're now anniversary-ing the rawhide recall we experienced in our pet unit last year. I continue to be bullish on the outlook for this business. To be honest, I thought it would turn over a year ago, but we did have this rawhide reset. And this quarter's pet segments were negatively impacted by some short-term start-up issues in late April and May as the consolidation of our European aquatics and pet food distribution centers in the Netherlands had some issues.

But these ramp-up issues are now largely behind us, and we expect to ship the small temporary customer order backlog that was built as we return to efficient operation in the fourth quarter.

In the U.S., the pet business delivered encouraging results in the third quarter and PetMatrix and the GloFish acquisitions are leading the way. And now that the rawhide recall from last year is essentially behind us, I'm looking forward to reporting improved results in pet as we move forward here.

If I turn to Slide 7, if I can get you to turn to Slide 7, I want to highlight some of the aspects of our strong progress in Q3 and the ability we've had to correct some of these operating efficiencies (sic) [inefficiencies] in Kansas and Dayton. First, in Kansas, our order backlog was reduced by about $20 million this quarter, which essentially got rid of the backlog that was created in the month of March. The facility achieved -- this is remarkable. The facility achieved its highest network shipments in the history of our company. And we did it with a single DC model versus the actual -- we had a 3-DC model before and moved to 2. So it proves actually that this one DC facility is going to work. It just wasn't underwritten properly at the outset.

The DC management team has been strengthened, process improvement teams are in place, and they continue to drive down our cycle times. We have brought improvements to help to expand our shipping capacity. And looking forward, I'm confident that a strengthened leadership team, better trained and more experienced workforce, along with newly installed automated picking equipment to improve our product selection speed and accuracy will enable Kansas City -- sorry, our Kansas DC to continue to work down the order backlog to an optimal level by the end of this calendar year. And we're going to continue to drive improvement in our customer service levels as we move forward, which is the most important part of this.

In summary, HHI sales growth of 14.7% in the third quarter was remarkable. As I sit here today reporting these numbers to you, I couldn't be more pleased given the logistic bottlenecks that we found in the month of March. So a real round of applause for the HHI team and all our employees there. Thank you very much. It's been a lot of hard work, and I thank you.

In Dayton, we saw improved and impressive results in the third quarter under the new leadership in that facility. That team did make a number of short-term and tactical fixes in the third quarter, and the clear focus is on servicing the customer. I can't emphasize enough the cultural shift there. There's an absolute maniacal focus on serving the customer. That team shipped its entire $9 million March backlog, ending the third quarter with a modest and normal backlog and meaningful improvement, which is exceedingly important to me. Our on-time shipment rates are now acceptable and I'm very pleased with that.

Dayton employees rose to the challenge. They did an excellent job of what we call shipping the season, given the solid market demand for our products during this peak demand period in the Global Auto Care's seasonal calendar. And as the seasonal demand actually naturally winds down as we get into the fall, we're going to make more significant improvements, and we've already scheduled them for the Dayton facility, especially in the manufacturing production areas.

Under the new leadership team there, we believe Dayton will be operating in a much more efficient and lower cost per unit basis by the start of next year's spring season. And I really -- I have to extend my sincerest gratitude and thanks to Randy Lewis, to Steve Keller and Rob DeRidder. All 3 of these guys exemplified the new culture here at Spectrum Brands: ownership, accountability and bringing their teams together to do whatever it takes to take care of our customers. And the entire GAC team, they really pulled out all the stops to make this turnaround possible and I'm forever grateful for that.

We have much more work to do here, however, but we're off to a great start in turning around the business, and I'm extremely excited about the future prospects for our Auto Care unit.

If I could ask you to turn to Slide 8, please. At this time, the tax-free merger with HRG Group was completed on July 13. The transaction was overwhelmingly approved by shareholders of both companies, and this does result in a much more widely distributed shareholder base. It meaningfully increases the trading liquidity in the company's stock, and it now has provided us a truly independent government structure at the Board of Directors, while additionally bringing us significant tax attributes.

Regarding the pending asset sales, we do -- we are on track to close the sale of our Battery and Lighting business to Energizer for $2 billion. That's a cash transaction and we expect to it close at the end of this calendar year. We remain in active discussions to divest, and we're continuing to market the personal care and small appliance unit. And we intend to use significant net proceeds from these divestitures to mainly reduce debt, repurchase shares and increase our investment in organic growth initiatives. And we'll also be looking at bolt-on acquisitions as we move into the fall for the 4 remaining businesses.

In closing, although we have much to be excited about as we look ahead, I continue to believe that a year from now, Spectrum will be in its best position ever during my nearly 10-year -- during the 10 years that I've been with the company. We will significantly strengthen our balance sheet from our fiscal 2018 free cash flow and from the proceeds from the asset sales in the second half of this year. And now with the resolution of the HRG Group ownership structure, we're well on our way to building a smarter, stronger, much more focused Spectrum Brands for the future.

I'm happy to come back to you during Q&A, but let me turn it over to Doug now, and he can give you much more details on the quarter. Thanks, Doug.

Thanks, David, and good morning, everyone. I plan to take you this morning through our Spectrum Brands operating results as normal, but I want to start by commenting on the form of the merger with HRG Group and the impact on the presentation of our financials. The legal form of the merger resulted in the historic HRG legal entity being the surviving company, while Spectrum Brands' name, operations, board and management team continue on to run the business. As a result of this, however, our Q3 year-to-date comparable period results include both Spectrum and HRG activity rather than solely Spectrum Brands. So the Qs are going to look a little unfamiliar to you when they're filed, and that's really the difference.

So for at least the remainder of the fiscal year, I will be speaking primarily to Spectrum Brands only performance from an adjusted EBITDA and adjusted free cash flow perspective. Reported numbers will include both Spectrum and HRG. Additional details relating to the HRG activities, apart from Spectrum Brands, can be found in our 10-Q. And in addition, a complete listing of separate historical financial information and filings for both Spectrum Brands and HRG Group can be found on our Investor Relations website.

Now turning to Slide 10, let's review Q3 results from continuing operations, beginning with net sales. Third quarter reported net sales of $945.5 million increased 9.6% versus last year. Excluding the favorable impact of foreign currency of $4.9 million and acquisition sales of $4.5 million, organic net sales grew 7.3%. HHI and GAC delivered double-digit growth, driven by solid market demand and tailwinds from reduced backlogs. Home & Garden also reported solid growth as favorable weather finally broke in the latter part of the quarter.

Reported gross margin of 37.5% increased 40 basis points from 37.1% last year, primarily due to lower year-over-year supply chain restructuring costs.

Reported SG&A expense of $198.6 million or 21% of sales compared to $197.2 million or 22.9% of sales last year, primarily due to spending discipline and leverage from strong sales growth.

Reported operating margin of 13.4% increased 170 basis points versus 11.7% the prior year, largely driven by higher gross profit.

On a reported basis, Q3 diluted EPS from continuing operations was $11.51, which increased compared to a loss of $0.51 last year, primarily due to the release of HRG valuation allowances.

Spectrum adjusted diluted EPS from continuing operations of $1.76 increased 23.9% versus $1.42 last year, primarily due to higher sales volumes and changes in the U.S. corporate tax rate. We are using a 24.5% blended annual rate for fiscal 2018 versus 35% last year due to changes in the U.S. tax laws.

Turning to Slide 11. Spectrum reported interest expense from continuing operations in the third quarter of $43.6 million increased $3.8 million from last year.

Spectrum cash interest payments of $60.3 million were $18.7 million higher than last year, driven by the timing of payments on our euro-denominated notes as well as higher debt and LIBOR rates.

Spectrum cash taxes of $7.9 million decreased compared to $9.7 million in 2017.

Spectrum depreciation, amortization and share-based compensation from continuing operations of $37.1 million was equivalent to last year.

And Spectrum cash payments for acquisition and integration and restructuring and related charges were $23.1 million and $27.5 million, respectively, versus $3 million and $12.7 million, respectively, last year.

Restructuring charge increases were primarily the result of operating inefficiencies in the HHI Kansas and GAC Ohio consolidation projects. Higher acquisition costs related to our battery and appliance divestiture processes.

Now onto our business unit results from continuing operations, beginning with Slide 12 on Global Auto Care. GAC reported record quarterly net sales in Q3 of $175.2 million, an increase of 12.5% from the prior year, driven by solid growth in refrigerants and performance chemicals, along with a tailwind from reducing its customer order backlog.

Reported adjusted EBITDA of $50.1 million was slightly below $50.7 million last year, while margins declined 390 basis points, driven by operating efficiencies, inflationary pressures, especially in refrigerants, increased distribution costs and higher Project Alpha marketing investments.

GAC is benefiting this year from its Armor All Ultra Shine Wash and Wax Wipes, which were successfully launched last year, and strong market acceptance of a new line of Armor All automotive air fresheners.

Turning now to Slide 13. Hardware & Home Improvement reported record quarterly net sales in Q3 of $372.4 million, an increase of 14.7% from last year due to continued strong demand in residential security and plumbing and a tailwind in shipments through a significant reduction of our customer order backlog in the Kansas DC. Excluding favorable FX of $1.3 million, organic sales grew 14.3%.

Record quarterly reported adjusted EBITDA of $73.9 million increased a strong 18.8% with a margin increase of 60 basis points. Excluding favorable FX of $1.8 million, organic adjusted EBITDA grew 15.9%.

Profitability in the quarter, however, continued to be pressured by higher commodity costs for zinc, copper and steel, as well as increased freight costs. New product introductions across the security, plumbing and builders' hardware lines continued at a steady pace in Q3 with more innovation scheduled for Q4.

Now to Global Pet, which is Slide 14. Q3 reported net sales of $194.7 million grew 2.5%, driven by $14.5 million of acquisition sales from PetMatrix and GloFish, which are performing really well. Approximately $6 million of orders in-house were unable to be shipped at the end of the quarter due to the consolidation of European distribution centers that began in April and is now largely back to normal operating rhythm.

Also partially offsetting this increase was a decline in European dog and cat food sales, largely from the planned exit of a pet food customer tolling agreement of $5.2 million, while U.S. companion animal sales were adversely impacted by an estimated $6 million from lost business as a result of the rawhide safety recall initiated in June of 2017, which has now been fully annualized. Excluding the impact of unfavorable foreign exchange of $2.9 million and acquisition sales of $14.5 million, organic net sales decreased 6.7% in the quarter.

Reported adjusted EBITDA fell 3.3% to $34.9 million with a 110 basis point reported margin decline, driven primarily by unfavorable product mix and lower volumes. Excluding unfavorable foreign exchange of $0.6 million and acquisition EBITDA of $5.6 million, organic adjusted EBITDA declined 17.2%.

Pet continues to introduce innovation across its food, grooming, health aides and rawhide chews categories, along with further expansion of Nature's Miracle into non-pet channels, which is another one of our Project Alpha initiatives this year. We continue to expect the full year impact of the exit of the European pet food customer tolling agreement to be approximately $24 million.

Moving to Home & Garden, which is Slide 15. Home & Garden reported net sales of $203.2 million, which were a 5.6% improvement from last year, driven by strong sales growth in both the outdoor and household categories. Adjusted EBITDA of $57 million decreased 4.2%, and reported margin of 28.1% fell 280 basis points. The declines were the result of unfavorable product mix and input cost inflation, primarily in oil, corrugate and steel.

Given the distribution of market share gains and an outstanding retail services team, Home & Garden expects to deliver another solid quarter in Q4, as it did in 2017.

Trends to date in July are encouraging.

Now Home & Garden also provided important support during Q3 to the Global Auto Care business by producing certain Armor All lines in our St. Louis facility.

Now moving to the balance sheet in Slide 16. We ended the third quarter with ample liquidity. In fact, very strong liquidity of over $1 billion, including $234 million available on our $800 million Cash Flow Revolver and a cash balance of $815 million, with debt outstanding of $5.4 billion. Our peak working capital borrowing season is behind us and we expect to pay down the revolver through fiscal year-end.

Q3 capital expenditures, including discontinued operations, were $27.8 million and essentially similar to $26.8 million in the prior year.

Turning to Slide 17 and our 2018 guidance. We expect reported net sales from continuing operations to grow above category rates for most categories, including the anticipated modest positive impacts from FX. We continue to expect Spectrum adjusted free cash flow to be between $485 million and $505 million, and the following estimated ranges include discontinued operations. Full year Spectrum interest expense is expected to be between $215 million and $225 million, including approximately $10 million of noncash items. Spectrum cash interest payments are expected to be between $200 million and $210 million.

Spectrum depreciation and amortization is now expected to be between $215 million and $225 million for 2018, including approximately $20 million for amortization of stock-based compensation.

For adjusted earnings, we now use a blended rate of 24.5% versus 35% for taxes. And Spectrum cash taxes are now expected to be between approximately $40 million and $50 million without the impact of any dispositions. We do not anticipate being a significant U.S. federal cash taxpayer during fiscal 2018.

Spectrum cash payments for acquisition and integration and restructuring and related charges are now expected to be between $105 million and $115 million, and CapEx should be between $100 million and $110 million.

Thank you, and now back to Dave for Q&A.

Thanks, David and Doug. Operator, with that, you may now begin the Q&A session, please.

(Operator Instructions) Your first question comes from the line of Faiza Alwy with Deutsche Bank.

David, I wanted to ask 2 questions. One is just around HHI. So it sounds like a lot of the excess backlog has been cleared. So just given the volatility in sales, perhaps you could give us a sense of what the underlying trends in HHI are like? So what are you seeing? There's been some concern around just housing generally. So I'd love to hear your thoughts on just end market demand for that segment. And maybe if you could talk a little bit of -- I know you've gained some distribution at Lowe's and other retailers for private label. So just more color around that. And then I have a second question, but I'll come back to that once we get through this.

It sounded like 4, at least 3. No, listen, I would say, and Doug can correct me if I get anything wrong, we only -- I mean, I'm pleased we got the backlog down by $20 million. But the underlying organic growth there was double digit. Our end markets are exceedingly strong. Our incoming orders are strong. There's a tremendous amount of innovation there. We've got a Smartkey Kobalt toolbox that we've launched, and that's just -- it uses our Smartkey technology, but we're partnering with other toolbox, just other applications with the Smartkey technology, and people love it. POS is good, and look, I think we just went from a position where some previous decisions were made to bring stuff in, and I don't think we used a prudent enough time line, and I don't think proper underwriting of the logistics network was done. And we basically went from a standstill in the month of March with 350 trailers blocking, not only inbound, but outbound. And we don't have any aged trailers in that parking lot today. And that's, listen, that's a yeoman's effort. I would say our on-time in-full from Kwikset and Pfister, our biggest lines of business are satisfactory. And again, I'm not -- if my team is listening, I think you did a great job, but for me, I want to go to the next level. I think we need to -- we still have issues, real issues, with builders' hardware. We have some elongated metal, very unique pieces, SKU-intensive stuff that was brought in from our Carolina DC, and we're not where we need to be there. And -- but we just put in some new automation, and I'll be back down there in that facility in a couple of weeks to make sure that's working. Doug's going to come with me on that trip. But look, you can do the math. If you just back out the $20 million of backlog, the rest of that was organic and that's a double-digit number. So listen, it's a fantastic result for HHI. I can tell you the numbers I see in this quarter remain at that level of double-digit organic growth. Now look, do I think that's the long-term growth rate of the company? No. I think it's kind of a mid-single-digit grower, and we're probably in, let's be honest, we're probably in the seventh to eighth inning of the housing recovery. But we still don't see housing starts or we still don't see the recovery anywhere near where the peak was prior to the financial meltdown in '08. And so there's still room to go, and millennials are buying their first homes and supply of existing homes is still really, really tight. And just because you had the new home sales number this week, that's just -- that's for a very short period of time. It's like watching 5 minutes of a movie and concluding that's the trend, it's not. You got to continue to watch it. So we see fantastic demand. I'm thrilled that we are on-time in-full of our major customers because now it's time to go talk price. We're in the business of making money, and we see tremendous inflation and we need to go price for that because it's now time to restore the gross margin of this business. And if my sales guys don't do it, I'll go do it for them. What's the next question?

Great. So my next question was around the sale of the personal care and small appliances business. So I noticed that you lowered the EBITDA from discontinued operations. I'm assuming most of that is essentially this business.

No.

No? Okay.

No, that's a wrong assumption, but go ahead.

Okay, okay, okay. So I'd love to hear more about that. Maybe if you could break out what the EBITDA for this particular business is, sort of what the holdup is? I know there are questions around tariffs. Previously, you talked about carve-out financials. I believe you're sort of making progress on that front. So just more color around how you are thinking about the sale. Is there a scenario where you might decide to not sell this business?

Yes. I mean, listen, until something's sold, it's not sold and so you own it. And if we don't find the right buyer at the right price, we will put it back on the balance sheet. I mean, that's what happens. That's what M&A is. If I give you an update, the update is we got audited financials done on the business last week. We have numerous buyers that are still interested in it and, quite frankly, want to pursue it. It's a good business. It generates a tremendous amount of free cash flow. But when you put assets held for sale and the battery deal moved faster than we thought, and then we needed to get carved-out financials audited, which we didn't have in the first round, it basically delayed it. And yes, there's been some underlying deterioration in the business because of inflation costs and difficulty getting the margin structure right. Honestly, the tariffs, we're not Whirlpool. I see very, very little impact to our appliance business from all the tariffs being bantered around in DC. And frankly, recent results actually point to not only stabilization, but we might have a pretty good fourth quarter on our appliance unit. So look, I'm still bullish on selling the asset. We -- you guys know my history. I'm basically an M&A guy. Multiples are exceedingly stretched away from Spectrum. I think our multiple is reasonable. I think the rest of the world is excessive. Any PE firm can go get 7x stapled leverage financing out there. Interest rates are still exceedingly low. Private equities got records amount of capital to put to work. Strategics need to find ways to grow. There are worldwide players in appliances that don't like their U.S. ops and they really need to have a bigger, more efficient supply chain, critical mass, go-to-market strategy and we have phenomenal brands and dominant market share position. So look, I just don't want to comment anymore on this than we have. Let's get to a definitive deal and we'll tell you about it.

Your next question comes from Joe Altobello with Raymond James.

So throughout your presentation, David, you mentioned higher commodity costs and higher logistics costs a number of times in pretty much all of your businesses. I'm curious if you could quantify how much of that -- how much of headwind do you think you're going to see this year, maybe next year? And what's the potential to price against that next year?

Yes, I'm kind of getting away from the guidance game. Look, it's a pressure, but we have been taking prices in some of our divisions. They have been sticking, some more easily than others. Obviously, when you have the #1 position where your brand equity is significantly powerful, the retailer is likely to take it. When I see the results come out of some of much larger multinationals, clearly, they're having to go into those retail buyers and demand price increases. And so look, our situation has been one where I just needed to get us healthy from a supply chain standpoint. We've got to be able to service -- get the customer service levels up to where we're on time, we're in full, and then we're going to ask for price. And those conversations we're having now and we're going to go get them. So we are going to restore margins. We're not shy. We're in the business to make money. The more profitable we are as a company, that means the more money we can invest in innovation, R&D, new product development, which helps our retail partners grow and, quite frankly, makes us a better counterparty to do business with. So we're going to take a pretty aggressive stance. And if my customers are listening, we're coming to ask for price increases.

Okay, that's very helpful. And then, I guess, secondly, on the pet business, if you back out the backlog, the tolling exit and the recall, it looks like pet sales were actually up this quarter. You mentioned earlier that you expected that this is to turn last year and it has. And so looking forward, it seems like that's been sort of the problem child here. Would you expect that business to be up in terms of sales and EBITDA next year?

You know what, you're calling me out and you deserve to call me out. I really did think it would turn a year ago, and I would tell you I would've been right other than that pet recall we had with the FDA. It was voluntary. It was on our -- we did it ourselves. It was wildly expensive. It really hurt us with our customers. I personally have visited with the owners of some of these specialty pet retailers recently. We are putting new programs in front of them. I was recently, believe it or not, have been living between Dayton and Edgerton, but I made it to tend to our Ecuador facility. I was just there with them in Ambato, and we've got a fantastic new plant there that comes from the old Salix acquisition and we're making amazing product. I'm telling you, we are -- it's human grade. We're not only treating it with enzymes and all the right cleaning chemicals to make it the healthiest product on the market for your dog, but we've got a radiation in there, I mean, we are producing the highest-quality, best-looking. We've relaunched Dingo. We're relaunching Digest-eeze. We're going back after the private label we lost. So look, it's a long-winded way to say yes. I remain bullish. I think that we are absolutely going to experience growth going forward, and let's talk next quarter and see if I'm right.

Your next question comes from Bob Labick with CJS Securities.

Take a step and talk a little bit about the Home & Garden. You said obviously that facility helped out on Global Auto and things like that. Can you talk about the margins in Home & Garden? Did that impact it? Or was that mix, raw materials? Just a little more color around those margins and the potential recovery there.

Listen, I really appreciate the question. And let me tell you, the reason I really appreciate it is because I believe everything begins and ends with culture, and nobody's asked me yet but I'm going to go ahead and tell you. My biggest surprise since taking the new expanded role, I call myself Chief Encouragement Officer, by the way, not Chief Executive Officer, but we -- this company got way more siloed and too bureaucratic. And in fact, I saw way too many regional, almost matrix-like reporting structures, Bob. And I'm tearing all those down. And to be brutally blunt and transparent, which is one of the things I'm preaching is the new culture here of unvarnished truth. As we get back to kind of clear lines of ownership, accountability, simplifying our reporting structures, I can't stress how important that change has been. And it's most evident if you really peel the onion back to the question you just asked. In the old world, given the capacity restraints in Dayton, one, those people wouldn't have raised their hand to say they had a problem, and we are really encouraging people. We have a new challenge and it's called Speak Up, and I want to know at 6 A.M. where the problems are. And because the faster I know where a problem is, the faster I can bring a solution to it. And we are a solutions-oriented mentality company now. We are not a bunch of whiners and complainers. But what happened here in this quarter and the only reason we're able to do this, and that's why I gave specific thanks to Randy, to Steve, Rob DeRidder, listen, we would've not been able to service our customers, we would have not have been able to produce the results we did this quarter if we didn't produce not only -- listen, we launched a new line of Armor All trigger sprays in Blacksburg, Virginia. I mean, that's amazing. That's my pet division. That's where we make Nature's Miracle. And those guys said, "Hey, we're one team now and we're going to contribute to making sure we keep Global Auto Care's customers in stock." And we ran that line and it delivered fantastically. And Randy opened another line for me in our Chapin plant here. I'm actually sitting in St. Louis today with that team. And that's what made all the difference. And it's this one team mentality, it's breaking down silos and it's everybody contributing to win. And look, on the margin side, look, the entire division only had a 16% EBITDA margin just last quarter. I mean, we had a 30% margin just in the U.S., and 28%, I think, overall international dragged it down a little bit. But Home & Garden, and this is why I'm so excited, and listen, don't get me wrong. We have a lot of work to do. I don't want to oversell this. I mean, I'm glad we had the quarter we did, but we have a lot more to do to become a smarter, stronger, more focused company. But I'm exceedingly pleased that Home & Garden has basically best practices globally, and it's been doing this a really, really long time. And so I'm equally excited to get into the fall and take some of those best practices from Home & Garden and then apply them to Auto Care under the new stewardship, the new leadership team with the new culture. It's going to be exciting. So that's really all I want to say about it. I don't want to overcommit. I don't want people to get overly excited, but I'm very bullish on what we can do. The industrial logic between the assets in Home & Garden and what we have in Dayton for Auto Care, they're one and the same. And Randy and his team were just -- they won't quit until we get that thing just beautiful. And I'm -- we've got to get there, but it's going to take me 12 months.

Bob, just a quick follow-up. This is Doug. The margin difference year-over-year in Home & Garden specifically is related to a little bit of heavier private mix that we -- private label mix that we've talked about. We also, because the season started a little late, didn't sell in as much of our concentrate business, which is also a bit of a margin drag. But over time, the items that David just talked about are going to help us from a productivity and efficiency perspective across the entire liquids and aerosol network.

Okay, great. That's great color and particularly the ability to shift among your similar facilities is a great asset to take advantage of going forward. So without pinning you to a specific number, it sounds like with a very strong recovery in the problems from last quarter. Looking out a year or so, do you believe margins can be back to historic levels or higher across your segments? Or how were you thinking about it medium to long term? I'm not trying to peg you down on raw materials this quarter or transportation in that quarter.

I like you, but you are trying to peg me down. I'm not going to answer your question, but I'm going to give you 2 things. Look, I want to get Spectrum back in the business of under-promising, over-delivering. I want to get Spectrum back in the business of let's do it and then talk about it. And so in that vein, I'm not going to give you specifics. Look, there's a lot more operating efficiencies to get. And give us -- we need 6 to 12 months to go get it and we'll make those additional changes in the fall. And the learning curve that Dayton can go up now given the just incredible legacy of the Home & Garden, native knowledge and their industrial intelligence is exciting to me. Look, it also depends on how much price we can take, right? And so let me go do that and let's talk about it in the future, and that's all I'm going to say.

Your next question comes from Ian Zaffino with Oppenheimer.

So question would be, as you look to shut down the GAC fill plant, does guidance assume...

Whoa, whoa, whoa, we're not shutting down any plants. We're making them better.

Okay. So as you fix it and make it better, what is -- what might be the inventory build? Maybe talk about how you might address some potential issues that might arise, just because I think you've done a very good job on everything so far. But the company has, in the past, had some issues. Is this something where we should be looking at there as far as an inventory build or efficiency ramps? Or any color like that you could give us on how we should be thinking about that would be helpful.

No, no, no. Listen, let's just go through the history real quick. There were 5 different facilities. They were put into one in our Auto Care unit in Dayton, Ohio. What happened there was, one, it's revisionist, and I don't want to be a Monday-morning quarterback and I don't care about the past, I care about the future and I want to create a great future for Auto Care. So look, the problem with Dayton was you tried to do your production there. You tried to do your retail-ready packaging there. You tried to do distribution there. And you assumed you could do all those old volumes, plus more volumes, plus more SKUs and take what's called change-outs. And so if you're running an old line that you brought in from Garland, Texas and you're running a bunch of 24-ounce bottles through it, but then another customer wants an 18-ounce or 12-ounce bottle, there's downtimes on the lines, okay? I personally, and it's not going to be me, I believe in inspiring, empowering, encouraging. Now the other part of that is I believe in accountability big time, too, and the team knows that. But at the end of the day, GAC and Dayton are going to be optimized. And so there'll be additional lines brought in there added to that will increase the efficiency of that. And long term, we probably won't need to use some of these Home & Garden and pet assets to supplement. But Randy Lewis and his team are going to make those decisions and I'll approve them. But there's a lot of optimization to go in there, Ian, and that facility is going to prove to be good. I just think we may have to rethink, do we really want to do distribution all out of there? Would it be better to look at a 3PL? Retail-ready packaging, we never did it and we did a poor job of it. Maybe we use a third party, a co-packer. There's just -- we need -- we're just re-underwriting that, and actually, I have a whole team of consultants that's been ripping through these plants with me personally. I've learned way too much about standard cost accounting recently. But I'm re-underwriting these facilities and they're going to be world class. I'm getting off -- I just wanted to re-baseline what your view of that was because the way you asked the question, I just thought it needed to kind of put a new framework around it.

Ian, from -- specifically, from an inventory perspective, we will probably build a little bit in our Q1 this year as we reorient the facility. But that, as you know, this is a pretty seasonal business. So next year-end, we will be in great shape again on an inventory basis.

Okay, great. And Doug, while I have you, can you give us an update on the NOL balance and the share count pro forma for HRG currently?

Yes, sure. So the NOLs that we expected to get from HRG, we got and the capital losses that we expected to get, we got. So those were about $1.2 billion and $400 million. As you know, we entered the year with a couple of years' worth of NOLs to use at the Spectrum Brands level as well. So no real change in what we said before. And about 55 million is the outstanding share count. And you're going to see something really funny in the 10-Q. The 10-Q is going to show $33 million -- 33 million shares outstanding because, again, the way the legal form of the transaction occurred. And then in the fourth quarter, you'll see that number move up to what will be the normal run rate again for us.

Your next question comes from Jim Chartier with Monness, Crespi, Hardt.

I had 2 questions for you. First, on the Home & Garden business, Scotts came out recently and said that they expected 2% to 3% headwind from retailers, reducing inventory levels in that business. Are you seeing the same pressure there?

We're going to grow our Home & Garden business going forward and next year.

Okay. And then on Project Alpha, just curious what your thoughts are on the early returns from that initiative and if you could give some detail, that would be great. And then, is there an opportunity to maybe expand that going forward?

I'll let Doug hit the specifics, but I'll tell you, Project Alpha originated with me 3 years ago. It is no longer going to be a suggestion or a tiny little side project. It's going to become the way of life. So there is going to be absolute resourcing, investing and driving innovation, new product development and news and excitement across our portfolio of businesses. We are going to be faster, smarter, stronger, and we're going to be a lot more relevant to our consumers as we move forward. We are content providers. We're going to make great content, provided at a great value and drive this business. And Project Alpha will not be part of fiscal '19. It will be part of the culture of '19.

Just specifically, Jim, on the continuing ops businesses, we take -- we took the opportunity with the -- most of the -- almost all of the Alpha spend this year to invest in the future. So we did very little pure advertising this year. Instead, we've invested, for example, in the new line of Nature's Miracle cleaning, which takes us out of pet and into broader applications in the home, and we're very excited about that. That work's underway. We're getting near the beginnings of launch there, but we really invest in the formulations, packaging, distribution opportunities, sizes, all that kind of thing. And that's true in our locks business as well, where we're investing in next-generation electronics and smart home. And as -- so those are 2 really good examples of where we're investing in the future with those Alpha funds.

Your next question comes from Olivia Tong with Bank of America.

So I just want to ask you, now that you closed the HRG deal, what your expectation is for go-forward net interest expense? And then in terms of the priority of cash use, where does your new debt fall in?

Sure, let me hit that. I think a lot of people were expecting us to call the bonds right away and they sit up at a super holdco level. So they're not part of our bank and bond operating agreements at our Spectrum Brands level. They are high cost interest, however, and they do have a call feature that steps down early next year. You guys all know me. I'm more of a capital allocator, and now I'm becoming an operator. But at the end of the day, I want to put up a couple of really solid quarters. I like to see some real rhythm and cadence to the business first. And so my view is I want to get a few quarters under our belt, where we make some deposits back at the trust bank, and we start to earn your confidence and trust back in us as people that do what we say. But then also, I just have a view of the world where -- and I'm not a macro guy, but I do believe that besides us, and I'm being honest, I think a lot of valuations out there are overstretched. And so my view of the world is when the world doesn't price liquidity high, I want to make sure I do price it appropriately. And so you see today we have $1 billion of liquidity. I want to build a fortress-like balance sheet. And I'm not saying that because I have a crystal ball and I think the world is going to fall apart in '19, but I am saying that I want to materially delever this company and I've been pretty blunt about that, and we might go sub-3x levered and we might run it there for a while. We may buy back some shares. But I want to keep the liquidity position of this company extremely high over the next 6 months, call it. So look, I'm putting a premium on liquidity where the market isn't and I want to make sure we have a decent operating track record, and then we'll go and we'll look at those HRG bonds. And we'll look to optimize the cap structure in its entirety, quite frankly. But I want to get there first. I want to earn our way into it.

Got it. I guess, just to follow up. I mean, I guess, looking at the free cash flow for next year, you're looking for about, let's call it, $500 million this year. But obviously, you plan to eventually lose the contribution from the discontinued ops, of course, offset by the proceeds. But kind of curious your view in terms of how the free cash flow outlook, how that looks next year.

Look, again, I'm going to get away from guidance. It's probably going to irritate you a little bit. But I notice a short-termism with all this quarterly guide. And I know you guys love it, but I don't love it. I believe in maximizing sustainable free cash. I believe that you have to make investments today to be strong 3 to 5 years from now. And quite frankly, I think that's going to create a tremendous amount of shareholders for everybody that takes longer than a 90-day view of our company. And so look, I think free cash flow is going to grow materially from here, but it doesn't grow in a straight line and there may be some times where I need to invest more capital to get more efficiencies, to build out certain businesses, to get the innovation and the vitality that I want in the new product development side so that we can create the amount of news and excitement that creates increased velocity of our SKUs on the shelves of our customers. And that's where we're going. So I know that's not the answer you want, but that's the kind of shareholder base I want to attract.

Your next question comes from Sam Reid with Wells Fargo.

Quick question here on the pet segment. It sounds like you guys are well on your way in terms of expanding some of your volumes into the non-pet channels. I guess, I'm just curious though if you could comment on the response you're getting to that from, say, the pet specialty retailers themselves. And is that in any way impacting your shelf space that you're being allocated at those retailers?

That's a great question. And you know what, that was wildly negative 3 years ago. I mean, we absolutely got our heads handed to us. And we have taken some of our brands like Nature's Miracle and we've gone to the mass channels, and it's growing like wildfire. In fact, I'm here in St. Louis. I just reviewed a new line in Nature's Miracle we're about to launch, and I can't wait for it to hit the shelves. So we have a lot of new stuff coming. It's going to be broadly distributed. But I'll tell you this, I have also been recently personally meeting with the pet specialty retailers and their ownership, and we have phenomenal programs to go back into them with. And I think we're going to grow again because I think their customers are desperate for them to put the specialty back in pet specialty. I think over the last 3 years, they commoditized their offering. Their footprint, their store traffic dropped as a result. You simply can't source everything from Asia and not have differentiated product. I mean, the humanization of pets is real. Our consumers want the best for their dogs, cats, et cetera. And they want premium product. And we have the best brands, the best content, and we're going back on the shelf, and yes, we're going to do some exclusive stuff back with the pet specialty retailers. But we think we can bring category management. We think we can build a lot of news and excitement with some in-store displays with some GloFish, and again, I'm talking about the future now, they're not there today. But what you're talking about, that pain between mass and pet happened to us 3 years ago, was a big part of why we've had the struggles over the last 2 years with that channel. We are rebuilding relationships with that channel, and we're bringing win-win solutions to that channel. And I hope I can talk to you in the coming quarters about how that's back on a growth trajectory. But we're not there yet.

Got you. No, that's super helpful. And then maybe just pivoting really quickly over to Global Auto Care here. So I know we've talked a little bit on some of the progress you've made, but I also know, obviously, there's still some work left. I'm just kind of curious, beyond efficiency in the supply chain and -- what are the other levers that you can pull here to really kind of get margins back up to the levels that we might have seen, say, last year, for example?

Look, I think Armor All can expand outside the garage, okay? I think we need to change the mindset of STP. Yes, we like Richard Petty. I personally am friends with Bo Wallace. He's a great guy. We need to get STP into more categories. STP could be a general-purpose lubricant. It could go into 2 cycle engines. Armor All might expand to deck cleaners. We have got to break the mold of a mindset that's been around since Clorox owned it and previous. And so recent -- they call them town halls, I call them real talks, sitting down with our marketing, our innovation, our design teams. I said, look, I want to completely rethink. Nobody knows what STP stands for anymore. You meet a kid today, they think it's Stone Temple Pilots. They don't know it's scientifically treated petroleum. So maybe we need to rebrand it. Maybe we need to have a new slogan. And breaking out of these old mindsets, making what's old new again, bringing new life, new products, expanding into new categories, that's the future of that business. That's going to drive sales and drive margins.

Your last question comes from the line of William Reuter with Bank of America.

The desire for liquidity, you have almost $1 billion of cash, and then you're going to have $2 billion of gross proceeds coming in from the sale of the battery business. I wasn't sure whether that commentary was meant to imply that you were planning on keeping a cash balance that's extremely high or whether you still expected to use the majority of this for debt reduction.

Yes. I think, look, to Doug's comment, and again, this is on the margin, but I want to make sure GAC is the highest-performing auto care operation on the planet. And then that's not an exaggeration come March of next year. We're just not going to -- we're just -- we're moving forward. So that means I want to build some inventory because I don't want a single customer service issue. I don't want to hear about it, right? So we're going to make sure we supply everybody on time, in full at a 99% confidence level. I mean, it's just going to be -- that's where it's going to be, okay? So the benchmark is raised and I have 0 tolerance for anything less. So that will require some capital. But that's small. That's maybe $10 million, $20 million. Your question is a much bigger scale question. Clearly, I'm not going to sit on $3 billion of cash with no yield and I've got my debt structure out there. We're going to delever. But I want to get into -- I want to put some of these quarters behind us. I want to reearn the trust of our investor base. I want to get the balance sheet very, very liquid. And when my debt holders see that, I think it's going to allow me to refinance at a very attractive rate. I think it's going to let me call some bonds cheaper than I can get them today. And I think it'll be very prudent for our company as we get into calendar '19. But we will pay down a lot of debt. We will not sit on $3 billion of liquidity.

Okay. And then just one follow-up for me. It seems like you think that M&A valuation multiples are essentially too high in the market. And in the near term, at least, it seems like you're going to be on the sidelines. At you think about the mix of businesses that you have today, do you see, I guess, a wish list of other businesses out there, that if they were at the right multiples, would fit in well with the portfolio?

So look, I agree that I -- I agree with your first part of your statement or question. I have 2 main focuses and I'm a simple person: drive operational improvement throughout our businesses. That is my #1 goal right now and that's where all my effort are going. Two, massively delever our balance sheet with asset sale proceeds and free cash flow. And then, look, we'll look at tuck-ins, but I don't think you're going to see me do anything aggressive. I view my own stock price as a better place to put my capital than somebody else's business at 14x EBITDA. I'd also say real quick, a lot of the Bloomberg data, Reuters data is wrong. Some people value it. It got the wrong numbers in there because of the HRG merger and we're up screening it like 17x EBITDA, when in reality, we're trading at 8 and 9. And so this is a stock picker's market. And if you're out there, you need to do your old-fashioned homework and figure out what the company's worth.

Okay. Thank you. And with that, we have exceeded the top of the hour, so we will conclude our conference call now. I want to thank both David and Doug. And on behalf of all of us here at Spectrum Brands, we want to thank you for participating in our fiscal 2018 third quarter earnings call. Have a good day. Thanks again.

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