Central Garden & Pet Co (CENT) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Central Garden & Pet's fiscal fourth-quarter results conference call. (OPERATOR INSTRUCTIONS). I would now like to introduce Mr. Paul Warburg, Vice President of Investor Relations for Central Garden & Pet. Please go ahead, sir.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on the call today are Glenn Novotny, Central's President and Chief Executive Officer; Stu Booth, our CFO; Jim Heim, President of the Pet Group, and Brad Johnson, President of the Garden Group, and Neil Pincus, President of the Garden Brands.

Before I turn the call over to Glenn, I would like to remind you of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The statements made during this conference call which are not historical facts, including future earnings guidance, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by forward-looking statements. These risks are described in the Company's earnings press release and Form 10-K for the fiscal year ended September 25, 2004 and other Securities and Exchange Commission filings.

And now here is Glenn. Glenn?

Thank you, Paul, and thank you, everyone, for joining us this afternoon. Today's agenda is as follows. First, I will provide an overview of the fiscal fourth quarter and a recap of fiscal 2005, and we will discuss our announced $100 million share repurchase program. Stu will review the operating and financial results, and then we will open up the call for your questions and answers.

Before diving into the fourth quarter, let's put the year into context. The first three quarters were strong, and the results for the total year were excellent. Like other consumer-related companies, rising fuel and energy costs further compounded by the three Gulf Coast hurricanes significantly impacted consumer spending in the fourth quarter. We are pleased to recently see consumer spending approach more traditional levels. Quarter to date through November, our first two months of the quarter, both our garden and pet organic sales are up 3% compared to last year, so we are starting to see some of our sales pick back up.

Now turning to fourth quarter of fiscal 2005, sales for the quarter increased approximately 4% to 323 million compared to the fourth quarter of last year. Branded product sales increased nearly 7% to 254 million. Sales of other manufactured products -- lower margin ones -- as expected, declined nearly 6%. Total organics sales declined approximately 1% in the quarter as a result of these two factors.

Acquisitions contributed 17 million. Operating income was 12.7 million, an increase of approximately 2.5%. Net income increased 29% to 0.7 million, and these results translate into earnings per fully diluted share of $0.31 compared to $0.25 a year ago, an increase of 24%.

Turning to the segments, in the garden segment, sales were $162 million in the quarter, relatively flat when compared to last year. However, branded product sales increased nearly 2% to 128 million. Sales of other manufacturers' products as planned declined 5% to 34 million. Acquisitions contributed approximately 4 million in the quarter. Operating income for garden was $2.3 million an increase of $100,000. Included were $800,000 in costs we’ve communicated previously to consolidate our garden distribution warehouses on the West Coast.

In the pet segment, sales were $161 million, an increase of 8%. More importantly, branded product sales increased nearly 13% to 126 million. Sales of other manufacturers' products were $34 million, a decline of 6%. As a result, total pet organic growth was basically flat for the quarter, and acquisitions contributed approximately 13 million. Operating profit was 18.4 million, an increase of 17% over last year's fourth quarter.

Turning to the full-year results, first of all, fiscal 2005 was a solid year for Central Garden & Pet. We did achieve record financial results. We strengthened our brands, and we accelerated our plans to achieve a 10% operating margin by fiscal 2008. Sales for fiscal 2005 were approximately 1.4 billion, an increase of nearly 9% compared to the prior year. More importantly, branded product sales increased 12%. Total organic company organic sales increased 2.5% for the year.

During the year, as you may remember, we did eliminate low margin sales both in our branded products business and in the sales of other manufactured products. As a result, garden organic sales increased 1%, and pet organic sales increased 4% for the year. As a result of these moves, operating profit increased nearly 22% to $100 million, while operating margin expanded nearly 80 basis points to 7.3%. Net income was 53.8 million, an increase of approximately 30%. These results translated into earnings per fully diluted share of $2.50 per share, an increase of nearly 26%.

We also strengthened our branded product portfolio, leveraging our core strengths of innovation, quality and service. And once again, over 15% of our branded product sales were from products launched within the past 24 months. This is a key metric that we measure ourselves against, and we're excited about our new product pipeline for fiscal 2006.

We also strengthened our branded product portfolio by completing three strategic acquisitions in fiscal 2005. First, the acquisition of Gulfstream Home & Garden has strengthened our portfolio of high margin active ingredients by adding the popular broad-based insecticide brand, Sevin, and a leading fire ant contact killing application, Over'n Out. The acquisition of Cedar Works purposely complemented our wild bird category by combining our leading market share position in wild bird food with a supplier of innovative birdfeeders and houses. And finally, the acquisition of Pets International and its leading brand, Super Pet, combined with our Kaytee brand complemented the category offering specialty food, habitats, toys and other accessories in the bird and small animal category. All three of these acquisitions made us stronger in each category with more complete product offerings.

Our acquisition pipeline is solid, and we are optimistic that we will be able to complete three to four strategic acquisitions in fiscal 2006.

To support our brands, we did increase our brand awareness and promotional activities in fiscal 2005. We launched numerous consumer and retail promotions for our brands, including major league baseball teams and high-profile community events. These sponsorships benefited consumers through product giveaway and redemption opportunities. They also benefited our participating retailers by driving increased store traffic, and for our brands, these sponsorships led to the sale of many important endcap displays and premium shelf space at retail and definitely generated increased consumer brand awareness.

We also initiated a relationship with the renowned gardening expert P. Allen Smith in 2005. We like the results and have significantly expanded this relationship for more of our garden and wild bird brands in 2006. Based on the success of our 2005 promotional initiatives, we are significantly increasing our marketing and promotion spend in fiscal 2006.

Throughout the year in 2005, we took decisive action to accelerate our progress toward our objective of achieving a 10% operating margin. Early in the year we closed a wild bird feed facility that did not meet our profitability thresholds. In the fourth quarter as announced, we also divested our only soils manufacturing facility, and in general we continue to shift the focus of our business toward higher margin branded products and away from lower margin third-party products, particularly in our garden business.

We are also focused on rapidly improving our operating efficiencies in the Company. We formed both the aquatics and garden decor strategic business units or SBUs. And in fiscal 2006, we are creating a dog and cat SBU and a bird and small animal SBU. We think all of these will make a tremendous improvement in our operating efficiencies and effectiveness with our retailers.

We are also very pleased with the improvements in our grass seed operations in fiscal 2005. As you may remember, in fiscal 2004 we reduced our fixed cost overhead by consolidating four seed-related operations, and we integrated the acquisition of Budd Seed, a premium brand, and eliminated operating redundancies across the grass seed operations.

And finally, we shifted our product mix to higher margin proprietary varieties. To that end, we released a series of new varieties, including Princess 77 hybrid grass seed that was used for last February's Super Bowl. Princess 77 also recently received the Breeders' Cup Award from the Turfgrass Breeder's Association. This is a big deal. The result of these actions significantly strengthened our grass seed business and improved operating profits, and I will just say hallelujah to that.

Turning to our announced share repurchase program, yesterday the Board of Directors authorized the repurchase of up to $100 million in stock. We believe in a balanced shareholder-friendly approach to managing our business that includes disciplined strategic acquisitions and periodic share repurchases to minimize the dilutive impact of employee stock options. With this in mind, we will selectively execute the share repurchase program over time.

I will now turn the call over to Stu. Stu?

Thanks, Glenn. Turning to consolidated results for the quarter, as Glenn mentioned, net sales for the fourth quarter of fiscal 2005 were $323 million, a $12.3 million or 4% increase from last year. Sales from acquisitions contributed approximately $16.6 million in the quarter. Gross profit for the fourth quarter increased $7 million or 7.8% to $99.5 million. Gross profit as a percentage of net sales increased 110 basis points to 30.8% from 29.7% in the year ago period as both Garden Products and Pet Products margins improved.

Selling, general and administrative expenses for the quarter were $86.8 million. As a percentage of net sales, SG&A expenses increased 120 basis points to 26.8%. This increase is due primarily to acquisitions completed in 2005 and costs associated with litigation and Sarbanes-Oxley compliance. Operating income for the quarter was $12.7 million, an increase of 2.5%. Net interest expense for the quarter was $3.9 million compared to $4.6 million one year ago. A tax rate for the quarter was 23.2%, down from 33.7% in the year ago period. The effective tax rate in fiscal 2005 was 36% compared with 37.7% in fiscal 2004. The combined federal and state tax rate was approximately 38.4% in fiscal 2005, prior to a onetime benefit of $1.5 million related to a true-up of deferred taxes and liabilities.

Net income for the quarter was $6.7 million, an increase of 28.9%. Earnings per fully diluted share was $0.31, up $0.06 or 24% compared to last year. Depreciation and amortization for the most recent quarter totaled $5.4 million, up from $4.9 million last year. Capital expenditures for the quarter totaled $5.3 million. For fiscal 2005, our capital expenditures totaled approximately $18.7 million.

Turning to fiscal 2005, net sales were $1.4 billion, up $114 million or 9% over fiscal 2004. Acquisitions contributed approximately $83 million to sales. Gross profit as a percentage of sales increased 180 basis points to 32.1%. Operating income increased approximately 22% to $100 million. Net income for fiscal 2005 was $54 million, an increase of 30% over 2004. Earnings per fully diluted share was $2.50, an increase of 26%.

Turning to the balance sheet comparing September 2005 balances to the September 2004 balances, Accounts Receivable remained relatively unchanged at $185 million. Inventories increased $33 million or 14% due primarily to acquisitions completed within the past year and retailers reducing their inventories due to the consumer slowdown in the fourth quarter. As of September 2005, total debt stood at $323 million compared to $306 million last year. The increase in debt over the last 12 months is due primarily to acquisition activity in 2005.

Turning to capital management metrics, we improved return on invested capital to 8.3% in fiscal 2005 from 7.2% in fiscal 2004. Also, return on equity improved to 10.5% in fiscal 2005 from 9.2% in fiscal 2004.

Finally, we spent a tremendous amount of energy and resources to complete our Sarbanes-Oxley Section 404 requirement. I'm pleased to announce that we received no material weaknesses. We are reiterating our fiscal 2006 guidance. Our guidance estimates sales of 1.45 to $1.47 billion for the full fiscal year. We anticipate earnings of approximately $2.80 to $2.90 per fully diluted share, which includes a 10% cost per share impact of our previously announced manufacturer and distribution consolidation program. Without the impact of this program, our guidance would be $2.90 to $3.00 per fully diluted share.

In 2006 the profit acceleration program will cost approximately $7 million and should generate approximately $3 million in benefits for a net cost of $4 million for the fiscal year. We anticipate this program will contribute an additional $7 million of operating profits in fiscal 2007 and ramp up to $9 million per year starting in fiscal 2008.

I will now turn the call back to Glenn. Glenn?

Thank you, Stu. In summary, before we turn to Q&A, due to our commitment to product innovation and the incremental promotional spend, our brands did well in fiscal 2005. We completed three strategic acquisitions, and we continue to take the appropriate steps to expand our operating margins through process efficiency improvements outlined in our manufacturing and distribution facilities consolidation program.

As we look forward to fiscal 2006, we are pleased to see consumers approaching their traditional spending patterns for their gardens and pets. We also expect to launch a series of new innovative products. Our garden retail listings are strong. We are confident about our plans to improve operating efficiencies within our SBU structure, and we believe the acquisition outlook is improving for us for this year.

Operator, we would now like to open the call to questions and answers. Operator?

(OPERATOR INSTRUCTIONS). Bill Chappell, SunTrust.

Just a couple of questions. First on I guess your commentary on the pet and garden kind of quarter to date. That 3% growth, is that combined, or they are both growing identically at 3%, and maybe kind of help us understand how that is versus your expectations? Has the market bounced back quicker than you would have thought, or is it taking a little bit longer than you thought?

Coincidentally, Bill, both of them are 3%. Both pet is up 3% and garden is up 3% at the end of November. I will tell you that November was stronger than October, so we are seeing consumer spending coming back to our two categories, which traditionally they have.

As far as the outlook, we kind of guided you overall for the company for right around the mid-digit 5% for the total year. So that means that we would have to expect sales to get stronger in the second, third and fourth quarters, which if consumers follow their traditional patterns, that should happen.

Got it. On the garden side, I assume now we're done with the 2006 listings and pricing. Can you give us some color on how that looks going into next year?

I -- stronger than in 2005. We know that. And, Neil, would you like to add something to that?

We feel actually very good going into 2006. At this point, most all of our major (indiscernible) with major retailers have taken place. We are working on the second tier accounts, and we feel pretty optimistic. At this point, we've got a lot of inventory and promotions going. So we are locked and loaded.

I think your question on prices, we did take prices up in selective places where we could and should for especially rising transportation and fuel costs.

Okay. And then one last question, Glenn. Just maybe on the focus of the 10% operating margin in '08, it seems like a brunt or really all that you have talked about on the restructuring is going to happen in the next 12 months. Are there more things to happen, or is it just fixed cost leverage after that? I mean help us understand, and also kind of when I'm looking at pet and garden, where are the margins going to be expanding? Is it greater in pet? Is it greater in garden? Is it both? Kind of give me a little more color there.

Well, let's see. I'm laughing as I am looking across the table here. I tell you in the pet definitely what Jim Heim and his group are doing is they have laid out the SBU structure, and that will be taking -- that will be basically combining those businesses into the SBUs we talked about, and that means facilities reductions and getting rid of redundancies. Jim, do you want to say anything else on that?

Just that that is underway as we speak. It has been very well accepted by our customers. And like Glenn said, it should lead to greater efficiencies and help us hit our long-term goals.

And most of the pet really restructuring will happen in our second, third and fourth quarter. In our garden business that we talked about before, we elected to start that really in our fourth quarter of '05 spending 800,000. We will spend about 1.2 million in this quarter to consolidate those facilities on the West Coast we talked about.

Brad Johnson has been with us now for a month. We are looking for him to look at other areas where it will make sense for us to perhaps do more as we understand the garden business and really looking at how we fine-tune the organization. I hope that helps to answer your question.

Yes, I think so. Thanks a lot.

Joe Altobello, CIBC World Markets.

I just had a quick question. On the pet supplies category, you mentioned obviously that that has picked up a little bit in October and November. And I was curious if you have seen a difference between channels whether or not that is more mass versus specialty or more specialty versus mass?

That is a great question, and what we have seen is that on the POS data that mass is picking up a little bit quicker than the pet specialty channels. (multiple speakers). But pet specialty over the last week is starting to show better momentum. (multiple speakers) -- mass has picked up a little bit faster.

And in terms of gross margin, is there a big difference between your mass business and your specialty business?

Our net margins -- I will answer this one. Our net margins are basically the same between those.

Okay. Great. And then second, just to play devil's advocate for a second, the buyback obviously is pretty sizable. And if you wanted to take a negative slant on it, you would say these guys probably don't have as many opportunities on the acquisition front, so they are deciding to invest more in their own shares. Is that correct or incorrect or not really a good way to look at that?

Not a good way to look at that. To just answer you short, Joe. No, we've all talked about this at the board, and we are looking at it. As I said, I think -- I expect that we will do those three to four acquisitions in 2006 that I just discussed. I cannot tell you which ones of course. So we expect to do that, but we are also looking at our, what I call our share creep that we are looking at, and we think opportunistically or selectively it makes sense for us to buy shares at certain selected times. And you can expect us to do that over the next probably two to three years.

Dara Mohsenian, J.P. Morgan.

Your inventory growth was ahead of sales growth. Are you a bit heavy on inventory after the Q4 sales weakness, or is there other factors there, and can you also comment on where inventory levels stand at retail for both the pet business and garden business?

The first part of the question, yes, our inventories were a little heavy this year. Obviously inventories went up year-over-year because of acquisitions, but as you called out, the sell-in to retail was relatively slow in the September months, so we are -- basically inventory is in our barns instead of their barns.

And then what was your second question?

Well, I was just wondering about the retail inventory level versus where I think (multiple speakers)

We knew you would ask that question, so we made some calls. And just like Stu said, what we experienced is because of the slowdown in the September period due to everything we discussed. Retail inventories during that time period when the consumers come through the stores were a little heavy. But they are quickly adjusting back. As we have told you, the sales pickup at POS is showing up, so they are more aligned than normal than they have been.

We will also tell you that in October and November, especially a couple of the pet retailers, we did emergency shipments. They ran out of stock because their inventories ran too low, and that is kind of expected. We do that every once in awhile, though.

Okay. And the share repurchase program, I guess why specifically at this point did you decide to go ahead with it?

Well, a couple of things. We said the dilution of our options -- share of stock options we give the employees was number one. Number two, we were kind of surprised to see our stock drop-off as much as it did recently. And so we look at that and go, boy, it is really what we will look at as we go forward.

Okay. Does your '06 guidance, does that assume any benefit from share repurchase now, the EPS guidance?

No.

No, it does not.

Great. Thank you.

I'm not sure when we will do that.

Alice Longley, private investor.

Alice, we did not know that.

To be announced next week.

Okay.

A couple more questions about inventories. Can you give a sense of when you think they are going to be down at healthily low levels at retail because one would expect your shipments to pick up more at that point, right?

They should. They should pick up. I would say that the biggest question, of course, is when do the garden retailers take their shipments? Do they take them the last week in December or the first week in January? And that changes every year, so that is hard to forecast on the garden inventories.

The pet inventories given that that is picking back up, we should see those come back down more rapidly.

But you think at retail the retailers are going to be pulling down their own inventories in pets through this quarter pretty much?

I think a lot of that has already been corrected. Just like Glenn said, there for awhile we saw a dramatic slowdown, and then I mean we had facilities where we had as many as 30 trucks lined up for emergency shipments here recently. So it is definitely picking back up again. So to answer your question, I think they are pretty much getting close to normal alignment.

Okay. Within this quarter?

Yes.

And have you had to make any pricing adjustments to this quarter because your own inventories were high? Did you deal some of your products more than you would have?

No.

No ma'am.

Okay. And did you experience any inefficiencies in production because you are in this quarter, in the December quarter because your shipments were below par and you had to work down inventories instead of producing at normal levels?

No, not enough to move the needle, no.

Okay. And then in your guidance for next year, will you give us any (technical difficulty)-- excuse me, would you give us any gross margin guidance for next year?

It is 30.5 to 32.5%.

And you might have done this, but any tax rate guidance?

(multiple speakers) -- 38%.

Doug Lane, Avondale Partners.

Do you mind reviewing your organic growth targets for '06? I thought you mentioned 5%, but if I remember right, the weighted number was 3%. Can you just go over that again, please?

It was 5% for the year, Doug, and that is companywide. In garden we are expecting a little bit below that. In pet we were expecting a little bit above that. The organic growth numbers that were called out earlier in the day were through the first two months of --

Of this quarter.

This quarter. The first two months of the fiscal year, which was 3% across the board.

I just seem to remember that the organic growth for '06 was 3% with 2% in garden and 4% in pet. That is not correct?

The overall blend is right around 5%, and you are pretty close to our numbers.

Okay. If I can understand these charges, I mean these cost programs, it is a $4 million drag on '06 and then $7 million add to '07, so I assume that that is an $11 million swing between '06 and '07?

I'm sorry. I did not hear the question, Doug.

I'm just trying to think through your cost savings and restructuring charges. In fiscal '06 it is a negative $4 million drag, and in '07 it is $7 million add. So the swing factor is $11 million from '06 to '07?

Yes.

From your 280 to 290?

Yes.

Okay. And then we should also grow the business by whatever your net income growth is over and above that swing, correct?

Yes.

Okay. I just wanted to make sure that I understood that right.

Okay.

You are laying the trap line for us for 2007, aren't you? (multiple speakers)

What are the next 30 questions? Nothing was -- (multiple speakers)

Go ahead, Doug.

With the stock buyback as a use of cash now to go along with the acquisitions, are you going to revise your slide that you have in your presentation that shows contribution from acquisitions of 10% to sales and 15% to operating income?

It seems like in the last two years we had pretty decent acquisition activity. You kind of got maybe halfway there. Now it looks like it has slowed a little bit. So is that really realistic at this point?

I would say that if you look at 2004, we actually exceeded the 10%. And in 2005, we had a lot of competition as you well know for acquisitions, and we think we will not have the same competition we had in '06 as we did in '05. So that is why I called out I would expect to see us do the three to four acquisitions. If one of those is a big one, then we will go past 10%. If all four of those are what we would call our string of pearls, it is going to be somewhere below that. But I would still think over the next few years on average we ought to be approaching that 10% topline on average. But it will be lumpy from year to year just as you have seen for the last two years.

Okay. And finally, Stu, you mentioned a contribution in fiscal '05 of $83 million in sales from acquisitions. Do you have a breakdown of garden versus pet there?

We're trying to look on our (multiple speakers)

This is Paul. It is about 36 in gardens and about 47 in pet, or call it 37 and 47.

Mike Blahnik, Piper Jaffray.

It sounds like you are seeing some pretty good things in the acquisition pipeline right now. Is there any more detail you can give us? I know you cannot talk specifics, but in terms of a skew maybe towards pet rather than garden, and are you pretty confident you can stay within that five to seven times EBIT range?

Well, I think we told you that in 2004 our average price was right around six times, and in 2005 it was right around seven times. And that was, of course, we had a lot more competition. I think in 2006, I don't know what the average will be. It should not be that much different from seven I would not think, but we do not have -- I don't think we will have one particular large competitor out there bidding against us at this point, but we cannot guarantee that.

I would also think that the private equity, which was very active in 2005 and ‘04 with the increasing interest rates, as well as perhaps the credit lines starting to tighten up now, they may be more rational as well, and that is one thing we like about our balance sheet right now is that we think we are positioned to take advantage of 2006. That is about the best answer I can give you.

Well, any detail on maybe more towards the pet side than garden?

It will probably be more in pet because there is more opportunities in pet. In our guidance, we always prefer to do garden if we can early in the year versus late in the year.

Okay. And then in terms of the significant increase in marketing spend that you mentioned, is there any way to quantify that and maybe give some more detail on where we might see that in terms of what products and whether it will be print or TV?

I will not give you the number because from a competitive factor I would prefer not to do that. Jim, do you want to talk a bit about what you are doing?

Yes, it is non-traditional advertising basically. So we did a lot of things with Major League Baseball. Glenn has mentioned we did a lot of community events, including we are the major sponsor for the Animal Rescue Foundation and Central Park Paws. So those give us what we think is a lot of attention. We are one of the only players in our space in that market. We generated a ton of media attention that was all good. There is not many bad things that can come to you when you are supporting animal rescue and baseball and apple pie. So we will continue down those lines. I'm not going to get into a battle with how much money can I spend in traditional media with the other players.

We think because we're sponsoring them, the Seattle Seahawks are having a great year this year, too.

Yes, they really turned that program around.

Would you like to talk about garden just for a second, Neil?

One of the things we expanded this year was our relationship with P. Allen Smith, and we are going to be taking advantage of several of his media platforms, which will include TV, both national syndicated shows and PBS, and he is the spokesman on The Weather Channel also, and there is a lot of other print publications we will be tapping into also. So we are focusing on -- well, we have four categories this year, which will be our garden decor category, our grass seed category, wild bird and some insect control with Allen.

I think the other change, too, is where the Super Bowl this year will be in Detroit on artificial turf, so we won't be doing a lot about our grass seed at Super Bowl. But the following year we're back to our grass seed again. So you will see a mix there, but we're not going to be big on classic television advertising. It will be more like Jim and Neil are talking about here, more guerilla marketing, very targeted and really tied to both the consumer and retailer.

Okay. And then lastly, in terms of the new product pipeline for '06, would that include continuing to go upscale in seed and other products in lawn and garden?

Absolutely in lawn and garden, and I know Jim is going to show some things at the March Global Expo that I think will hopefully win a bunch more awards.

The answer is yes. You will see a lot more meaningful beneficial products that will really make a true difference in the pet industry. But then there will be upscale.

Joe Norton, Banc of America Securities.

A couple of questions. A few more on inventories. First of all, Stu, when you talk about when you mentioned acquisitions and what drives inventory, did you just mean on an absolute basis, or do you mean that some of the acquisitions actually have higher inventories on a days basis?

No, just on an absolute number basis, Joe.

They contribute to inventory, Joe. (multiple speakers) We looked at buying inventory as well.

Right. So when we look at the change in terms of days, all of that is really related to kind of the channel issues that we have been talking about?

Well, you're breaking up a little bit, Joe, but we don't focus as much on days on an average basis as really our mix and managing each product or category within our collection of operations and manage each one of those as effectively as we can. Some inventories turn once a year. For example, grass seed and others that we manufacture on a continuum, we want to again manage those down to very rapid turns.

Okay. And then on the trade inventory, can you guys hear me?

Yes, we can.

Sorry about that. The question is, it sounds -- are you saying that at this point you are seeing the pet retailers, for example, restock inventories? It sounds like their inventories got too low, and now they are kind of replenishing?

It is more so, Joe, on some products than others. (multiple speakers) They are starting to do that.

I guess the question is, is there some risk that the pickup in sales that you're seeing is really just inventory replenishment as opposed to -- I mean, how do you know that it is not just inventory replenishment versus --?

We don't know that.

Joe, the important thing here on the pet side of it is that most of our retailers are fairly sophisticated, and they are ordering off of a POS system. So the days of us trying to go in, and we don't do this anyway, but if we wanted to front-end load a retailer are pretty much nil.

I'm not asking if you are loading. I was just (multiple speakers) trying to make --

The answer to your question would be that our -- basically our demand and our purchase orders are delivered off of a computerized system that is based on POS. So --

So you are confident that as their orders increase, it is really just based on their POS, not just that they took their inventory levels down too low?

We think they are adjusting their inventories based on their sell-through to the register. Yes.

Okay. And then so if you are just going back to the organic growth target, it sounds like you must be assuming that sort of in the second half you are going to be above that 5% rate. Is that correct?

That is correct.

Okay. And can you kind of walk us through, just give us a little more detail on how you get there?

Sure. In our industry, a lot of our products are introduced right around the end of March and the first of April based around a tradeshow. And that is historic for the pet industry. And we have a new product pipeline. We know what is in that pipeline, and based on that is how we are giving you our forecast. So, we will -- (multiple speakers)

So the rate of new products is just a lot higher in that, in the March and June quarters?

Absolutely.

Okay. And then is that also the case on the garden side? I mean I assume new products are introduced --

On the garden side, the product innovation and new products is just as important for our business. We do start rebuilding our inventories with the major lawn and garden retailers as they refocus back on garden and as they transition out of one seasonal like Christmas and start preparing for the upcoming garden season.

So we are on the -- just on the forefront of actually getting store setups going in preparation for spring.

I guess, Joe, the other thing you ought to think about, too, we do not expect to see a weak fourth quarter again as far as consumer demand in 2006 versus 2005. We cannot guarantee that, but I don't think we will have the hurricanes, and I sure as heck hope we don't have gas prices go back up where they did in July of this last year.

Okay. Thanks. That is a good point I had not thought of. And then finally, just real quick on the income statement, the other I guess the other interest income, was there anything one-time in nature in that? That sum is up pretty high.

Joe, what that is, we started accruing interest on the third-party note receivable.

Okay. So what does that mean? Is that a good number going forward or --?

Until we collect on the note, yes.

Oh, okay. Any idea when that will be?

No.

Well –-

Let's leave it at that.

(multiple speakers) You don't want to get into it, right? Neither do I. Okay, great. Thanks very much. That is all I have.

Karru Martinson, CIBC World Markets.

In terms of the divested businesses, what was the revenue impact for the quarter, and also are there any additional kind of low margin divestitures that you might be considering?

I will answer the last half of your question first. While, Paul, why don't you look up what that is maybe in the quarter?

As far as -- what we do is every year as we do our budgets, and the end of the year, we, of course, wrap up and we look at each of our -- we look at our portfolio. We look at our portfolio, and we look at how their sales growth is doing, and also what we call the RONA. And RONA is return on net assets, which is why Stu also called out return on equity and return on invested capital, because we are committed to make those better.

We look at our facilities and those organizations or those companies that are growing more than 5% topline and have a more than 15% RONA, we basically say, let's grow those as fast as we can. And those that are below that, we look at, do we we want to either keep them, sell them, turn them around or shut them down. We do that every year. And that is just how we live our life. And it is really a classic management style of feed your winners and starve your losers. That is partially how we get to the 10% operating margins that we are talking about getting to.

So will there be other ones that we either close or divest? Undoubtedly there will be each year. I don't think you will see a massive scale of doing that, but it is really how we think about doing that. Stu, do you want to answer his first question?

The question, if I remember right, was what was the impact of the divested activities in the fourth quarter? It is relatively insignificant. I am going to say less than $1 million because those businesses are off season. Again, this is the quiet part of the season for garden. If you were to annualize those sales, it would be approaching $20 million a year. And most of that would be coming from our second and third quarters of our fiscal year, because that is the garden season.

And just looking forward in terms of what should we view as a normalized rate for Sarbanes-Oxley cost? Obviously (multiple speakers)

You know, the whole industry is struggling with that. We have $2.5 million in our guidance for 2006. We ended up the year spending $6 million with a quarter ago we thought it was going to be 5, so it just got to be a higher burn rate toward the end of the process. This was our first year of Sarbanes-Oxley 404 for 2004. The external auditor costs are going to go down, but probably not down as much as --.

They should.

As they should. Thank you, sir. But also the other third-party consulting, that is where we will probably get a lot of reduction.

Tom Malitser (ph), Wachovia Securities.

Just going back to the share repurchase for just a moment, is there a relationship there with your acquisition program? In other words, if hypothetically you were not able to close acquisitions, would you accelerate share repurchases, or if opportunistically more or larger acquisitions came up, would you slow that program down?

You know, I think they are almost mutually exclusive. One thing we are trying to do with the share repurchase program, as Glenn mentioned earlier on the call, is mitigate the impact of share creep with our equity stock option program. You have to take a big step back, and one thing we're trying to do as a company, though, is maintain a capital structure that gives us full flexibility in all markets to do acquisitions. So I don't think -- I don't envision us levering up to accomplish a reduction in share count. More importantly, we want to be poised and able to execute acquisitions as they materialize.

That is our first priority, is to use our money for acquisitions and/or revesting in the business where it makes sense.

Okay and then just one other question relative to SAP. Are you at the point now where you are actually spending dollars on the system, and do you have any implementation scheduled for '06?

We are spending dollars on SAP at the moment. It is a combination of I am going to call it pre-encoding or wiring the thing up. We've done a series of blueprint workshops in the first quarter of fiscal 2006. We have a four-year implementation scheduled for SAP. If you're familiar with the Company, we have over 13 separate IT platforms that we would like to consolidate into SAP over a period of four years. We have three rollouts envisioned for fiscal 2006 as our first wave, and then we will have some following thereafter.

Okay. And those in '06, are those on the pet side?

It varies from pet to garden to corporate.

Both.

Patrick Stowe (ph), Priority Capital.

I wonder as sales have started to bounce back in November, can you give us any color on are there any product lines that are leading that or alternatively any that are continuing to lag a little bit?

In the garden side, grass seed continues to do well with the –- across the system, especially in October and November. On the pet side, Jim, do you want to cover about that?

Yes, really on the pet side, all the divisions are doing well, including our dog and cat divisions, Four Paws and TFH. And even our aviary division, Kaytee, is showing good strength, along with Super Pet. In our aquatic division with widening our aquatics with ESU is showing really good growth so far in the month. (multiple speakers)

One area that is not is our large aquariums. That typically happens, though, when consumers slow down, so we have seen our large aquariums, which is a small part of our business. But that has not grown as it has in the past.

Okay. That is helpful. Thank you. And then just further on the additional ad spending in '06, I assume does the organic growth target I assume that includes some sort of returns on that additional ad spending?

Yes, it does.

It better. (multiple speakers).

So there is upside to that program embedded in the '06 guidance?

Yes.

Okay. And then just one big picture question I have, and I apologize if this is a stupid question, but something I have just been trying to reconcile as I look through your filings, it seems that less than 20% of your pet sales are to the specialty stores. And then industry data I read says that the specialty stores are 50% or so of all pet supply sales, and that just does not seem to add up to me. Is there anything that I missing there or --

Yes, in a lot of industry data, pet specialty includes independent pet. Okay? When we talk in our report, our two large ones with this, Petco and PetSmart. I think that is what you are reading into. Those two make up less than 20%. Okay, but independent is still our largest segment. So if you throw that into there, it is a whole different equation.

And that is driven because all of our pet brands are very high-end premium products.

Yes, that was going to be my question. I thought that the difference might be that maybe the PetSmarts of the world are doing more private-label, and your premium products are going more through independent?

It is really both. I mean you look at some of the things that we sell, especially in our aquatic side, very high-end technology, and that is going to be found in an independent store that is focused on aquatics.

Right, okay. Well, that is very helpful. I appreciate it.

Reade Kem, Banc of America Securities.

Just a couple for me. The distribution sales that you had in the pet segment they were down in the quarter. Could you go into a little bit more detail why that was?

Absolutely. When we had the hurricane that devastated New Orleans and also the hurricane that was supposed to devastate Texas, our Houston facility was closed down for over seven days. And then the hurricanes that also hit Alabama, Mississippi, both affected Texas and also our Florida distribution centers. So if you take that into thought, that is the major reason. And plus what Glenn already mentioned with the gas prices, that all had an effect, but the hurricanes really had a pretty dramatic effect on it.

Okay. So it sounds like that is the main disruption and not because other products were not selling as well or because you had lost distribution or anything like that?

No, no loss of distribution. It all had to do with the things that Glenn already mentioned, the hurricanes and then the initial effect of the energy crisis that we went through briefly.

Okay. And any sort of the data that you see on the pet side -- not just your own products -- but just broadly I mean by species in the quarter. Could you characterize how strong or weak certain species were?

The small animal species is growing quite rapidly, and that is still the case as through the past four weeks. The dog and cat is holding a very good growth rate. Aquatics to get Glenn's point are widening, and specialty products in aquatics are doing quite well. The thing that is not doing quite well there and it is anticipated is that the large tank sales are starting to slowly come back but not to levels where we would like them. Does that give you a little help there?

Yes, that is helpful. And then just another one on the pet side. I have not heard you guys talk of international for awhile. I was just curious how Interpet is doing, and anything we could expect maybe on the acquisition front internationally?

As Glenn said, we are always looking, and we are busy. To address Interpet, we opened up a new world-class distribution facility recently in England and are under the process of having all that function started up and consolidated and moved into. So Interpet along those lines is doing fairly well. The European economy, especially the English economy, is having some of the same issues that the U.S. economy had recently too with the energy prices. So we are seeing that rebound now, too.

We did not call it out on our calls, but Jim is right. In England we took Interpet, and we basically took three or four different facilities and put them into one, and that will help us on our cost going forward, and we are able to move our manufacturing from around the London area down to the Wales area, which is a lot lower cost. So that will help us going forward.

Plus the automatic pick-pack systems that are installed will help our efficiencies going forward.

Okay. I appreciate the color. And just one for Stu. On the stock buyback, I see you had to augment the bank facility for that. I was just wondering if there is any other changes we might see on that front?

No, we had to address the bank facility, and that is it.

Doug Lane.

I just want to circle back on the organic growth. I want to go back and look at my notes. I want to be sure that the 5% organic growth numbers before the divestitures that you mentioned, that $20 million. So if you include -- if you take out the $20 million, then it is really more like 3%. I think that is what you said before.

Yes, that is right. That is right.

Now, on the pet side, I was looking here, and I think in the Q&A, Glenn, this is a month ago, you said pet suppliers grow more like 4 to 5%. And today you are clearly a little bit more optimistic than that. Have you seen that kind of an improvement in the last four weeks in the pet business?

No, I think I answered the same way we did before.

Okay. So you are really of the same mind that you were in early November?

Yes, we are pleased to finally see some more sales come through. I have never seen it be that slow for that long in my entire history in this industry. But I still have the fundamental belief and I think the industry does too that people will revert to their traditional habits of buying things for their yards, gardens, homes and for their pets that they can afford to do.

Sir, we have no further questions at this time.

Okay. Well, first of all, everybody, thank you for your questions. I will just wrap this up very quickly.

As we look forward to 2006, we will continue to execute against our five key strategies, and we will keep focusing on us growing and extending our brands, develop and launch new innovative products and packaging, improve our operating efficiencies, strengthen our management team and pursue and complete strategic acquisitions.

I want to thank you all for joining the call. We want to wish all of you happy holidays and a prosperous New Year, and by the way, this is in answer to one of your questions earlier, don't forget that an estimated 31 million consumers purchase holiday gifts for their pets. Happy holidays to everyone and good evening.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes your presentation, and you may now disconnect.