Central Garden & Pet Co (CENT) 2009 Q2 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to Central Garden and Pet's fiscal second quarter 2009 earnings conference call.

(Operator Instructions)

I would now like to introduce Paul Warburg, Vice President and Treasurer for Central Garden and Pet.

Please go ahead, sir.

Thank you, operator.

Good afternoon everyone and thank you for joining us.

With me on the call today are Bill Brown, Central's Chairman and Chief Executive Officer, and Stu Booth, our Chief Financial Officer.

Before I turn the call over the Bill, I'd 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 are forward-looking statements.

Central undertakes no obligation to publicly update forward-looking statements to reflect new information, subsequent events or otherwise.

These statements 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, Form 10-K for the fiscal year ended September 27, 2008, and in other Securities and Exchange Commission filings.

Additionally, the discussion on this call may include the use of non-GAAP financial measures.

We have provided a reconciliation of the measures to the nearest comparable GAAP measure in our earnings press release, which is available on the investor relations portion of our website at www.central.com.

Today's agenda is as follows.

Bill will provide a brief business update and Stu will review the financial results for the quarter.

We will then open the call up for question and answer.

Our plan is to keep the call to approximately one hour.

I'll now turn the call over to Bill Brown.

Bill?

Thank you, Paul, and thank you for joining us this afternoon.

My plan today is to provide an update on the business and the operating environment.

We continue to focus on our three core priorities in order to improve our business and drive on profile performance.

These priorities are, as I'm sure you will remember: one, to reduce our investment and working capital; and two, to lower expenses; third, to improve our gross profit margins through a combination of lower cost of goods, pricing increases and new innovative products.

In the second quarter, we made progress and good progress on all fronts.

Our investment in working capital decreased $68 million compared to the same period a year ago.

We are managing our inventories better, we're improving our collection of our receivables, and we're working to obtain improved terms from our vendors.

We reduced operating expenses both in terms of dollars and as a percent of sales.

SG&A expense was $12 million lower than last year.

SG&A dropped 210 basis points to 21.7% as a percent of sales.

Both segments continue to demonstrate expense management discipline.

Our gross profit margin improved 70 basis points compared to the prior year.

Also during the quarter, demand for our products held up well.

POS for the quarter increased double digits in garden.

Our sales declined primarily due to continued inventory control by retailers, a later breaking lawn and garden season compared to last year, continued softness in aquatics, and an unfavorable currency translation related to UK sales.

Also, as part of our operating efficiency initiatives, we've been actively discontinuing lower margin SKUs, which adversely impacts our sales comparison.

In summary, we had a solid quarter.

We are now at the midpoint of our fiscal year and my observations are as follows.

In general, our portfolio continues to demonstrate resiliency in this challenging economic environment.

Though year-to-date sales are down slightly, we're encouraged by our POS performance.

While we clearly have more work to do, gross margins are beginning to expand.

This is due primarily to improved pricing and lower costs related to our wild birdfeed products, a greater contribution from our higher margin active ingredient based businesses, and the discontinuation of lower margin products.

We performed well controlling our operating expenses without compromising our brand building initiatives.

We've successfully extracted meaningful savings from the business.

However, it's important to understand that the pace of savings for 2009 is likely to moderate significantly.

We are annualizing many of the cost reduction initiatives implemented last year and we're beginning to support our brands in earnest as a result of the late breaking garden season.

Our balance sheet is considerably stronger today than it was a year ago.

Debt is $148 million lower compared to a year ago.

Our leverage ratio today stands at 3.6 times compared to 4.5 times last March, nearly doubling our effective borrowing capacity.

Clearly, Central's foundation is meaningfully improved.

Revisiting the outlook for the remainder of this year, we continue to believe that the uncertainties we face are more external than internal.

As I have said in the past, what remains unclear is the magnitude of the current recession.

Whereas we believe our portfolio is resilient, it may not be insulated from a broader based economic downturn in consumer purchases.

Additionally, we can't predict with certainty the outlook of our retailers or their buying and restocking patterns.

That being said, we remain cautiously hopeful that our performance in the second half of the fiscal year will be superior to the second half of 2008.

Please keep in mind, as I mentioned earlier, we expect to increase our brand building efforts consistent with the start of the lawn and garden season and with a view towards increasing long-term market share.

Therefore, SG&A could be higher in the second half of this year when compared to the second half of fiscal 2008.

Before turning the call over to Stu, I want to take a minute and address and recognize Stu's contributions to Central.

As previously announced, Stu will be transitioning into a new role within the company upon the successful completion of a search for his successor.

In his new capacity, Stu will be a consultant to the company for key corporate projects.

Stu has made and continues to make significant contributions to Central.

He has been a key player in helping us strengthen our financial position and I'm pleased that we will be able to continue to rely on his expertise and his perspective.

With that, I'll turn it over to Stu to recap the financial highlights for the quarter and then we'll take your questions.

Thanks, Bill.

In recapping the quarter's performance, we performed well implementing cost reduction initiatives, further reducing working capital and modestly improving gross margins, which drove significant earnings per share performance.

Turning to reported financial performance, net sales for the second quarter of fiscal 2009 were $476 million compared to sales of $485 million a year ago, a decline of 2%.

Branded product sales were $409 million, a decline of 1%, and sales of other manufacturer's products were $67 million, a decline of 5%.

Garden segment sales declined by approximately $6 million or 2% to $248 million compared to last year, due primarily to the later start of the garden season and continued tightening of inventories at retail.

Garden branded product sales decreased approximately $2 million to $219 million.

Sales of other manufacturer's products declined approximately $4 million to $29 million.

Pet segment sales were $229 million, a decline of 1%.

The modest decline was due primarily to unfavorable currency translation and continued weakness in the aquatics category, which was partially offset by gains in dog and cat.

Pet branded product sales decreased $3 million to $190 million.

Sales of other manufacturer's products increased $1 million to $38 million.

The company's gross profit for the second quarter was $161 million, relatively unchanged compared to a year ago.

Gross profit as a percentage of net sales increased 70 basis points to 33.7%.

The improvement was due primarily to margin expansion in garden chemicals and a combination of lower input costs and improved pricing related to our wild birdfeed operations.

Selling, general and administrative expenses for the second quarter were approximately $103 million compared to $115 million a year ago, a decline of $12 million.

The improvement is due primarily to the recent consolidation within our garden distribution operations, lower freight and fuel costs, and companywide cost management.

Operating income for the quarter was $57.2 million compared to $44.7 million a year ago, an increase of 28%.

Garden segment operating income was $36.7 million compared to $26.1 million a year ago, an increase of 41%.

Pet segment operating income was $31.9 million compared to $28.2 million in the prior year period, an increase of 13%.

Net interest expense for the quarter was $5.5 million compared to $9.5 million in the year ago period.

The lower interest expense is due to lower balances and lower borrowing rates.

Our borrowing rate for the quarter was approximately 3.9% compared to 5.6% a year ago.

Net income for the quarter was $33 million or $0.47 per fully diluted share, this compares to net income of $20.5 million or $0.28 per fully diluted share in the same period last year or an increase of 61% and 66% respectively.

Capital expenses for the quarter totaled approximately $3.2 million compared to $4.9 million last year.

Turning to the balance sheet and comparing March 28, 2009 balances to March 29, 2008 balances, accounts receivable were $318 million, a decrease of approximately $25 million or 7% compared to last year.

Inventories were $380 million, a decrease of $37 million or 9% compared to last year.

Accounts payable were $138 million, an increase of $11 million or 9% compared to last year.

As of March 28, 2009, total debt stood at $547 million compared to $695 million last year.

Addressing our credit agreement, our current debt to EBITDA ratio, as defined by our credit agreement, is approximately 3.6 times compared to 4.5 times a year ago.

The maximum for the leverage covenant in our bank credit agreement is 4.75 times.

And finally, during the quarter, we repurchased approximately 1.4 million shares of our common stock at an average price of $6.55.

I will now turn the call back to Bill.

Bill?

Thank you, Stu.

We're pleased with our results for both the quarter and year-to-date.

We're doing a better job of controlling costs, managing working capital and driving gross profit margin expansion.

While the economic environment and the weather remains uncertain, we continue to be cautiously hopeful that we can continue to make meaningful progress as we drive towards on profile performance.

With that, we'll now take your questions.

Operator, we'd now like to open it up for Q&A.

(Operator instructions) Your first question comes from the line of Bill Chappell with SunTrust.

Good afternoon.

Hi, Bill.

Hi, Bill.

I guess, starting on the revenue side, can you give us a little more color on the timing of the garden season?

We didn't hear that type of commentary from Scott's and just want to know if that's where you're geographical focus or your product focus that changes that.

And then also on the same lines on the aquatics business, when do we hit a bottom and where we start having year-over-year comps that are at least flat?

Well, I wish I could answer the last part of that.

You know, we're just not in the business of predicting.

I think the good news for us is our share remains strong and probably continues to expand.

And so from that standpoint we feel good.

We just keep adjusting and resizing the business to meet the market that's out there.

It could be that this year will be the bottom, but there's no reason to go out and predict that.

With the garden season, you watch the weather.

You're familiar with the drought in the southeast, which has now had the rain come but, as our folks tell us, the municipalities haven't changed their attitudes about we're still in a drought and there's water restrictions, and so consumers have mixed reactions.

There's not a lot that I would add.

Paul, what do you hear from our folks?

I think by and large the weather conditions have improved considerably but, as Bill did mention, there still are restrictions in certain regions.

But by and large the conditions are, obviously, better this year than they have been in the past two years for what I would characterize as a sustainable lawn and garden business this year.

And did the garden revenue include any revenue acquired or picked up from Spectrum?

Oh, sure.

Was it meaningful enough?

I think absent it, Bill, the sales decline still would have been mid single-digit on the garden side.

Okay.

And then just two other questions then I'll turn it over.

Historically in normal years, if there are such a thing, 2Q and 3Q had fairly similar EPS or net income contributions.

Are you saying that probably is not the case this year because of the timing of marketing?

And then the last one for Stu, can you kind of give us an idea where you would expect interest expense tax rate should be for the full year?

So, to the first part of the question, clearly since we put in place a whole bunch of cost reduction initiatives that, you know, remember I came back in late October and we made changes in December/January and the effective of those changes on our expenses didn't show up much in the second quarter, and they did show up in the third quarter and the fourth quarter.

And so in my comments I talked about us lapping the annualized effect.

So, we're not looking for those kinds of expense reductions to go forward and that means that you're not going to see the kinds of comparative shifts.

There's also been somewhat of a shift in the more recent years to more strength in the second quarter than the third quarter, which I haven't fully noodled through as close as I am to the business.

So, those would be the perspectives I'd give you on that, Bill.

Stu, do you want to pickup the other part?

Sure.

Bill, on the tax rate, it's going to be somewhere around 38%.

Interest expense, obviously, we're halfway through the year.

I'm just going to give you a rough number of maybe somewhere around $20 million for the year.

$20 million?

No, it will be higher than that.

I'd say $25 million.

$25 million.

Well, there you've heard the debate.

There's the debate.

I'll model $20 million.

The tax rate for the quarter was it 35%, is that right?

Yes, we had a state tax valuation allowance that was an offset to the tax rate.

So, will it go up in June and September quarter to get to that 38% rate?

Yes, absolutely.

Thanks so much and congrats, Stu, on the new role.

Thank you.

Next question.

Your next question comes from the line of Joseph Altobello with Oppenheimer.

Thanks.

Good afternoon, guys.

Hi, Joe.

First question just to clarify the garden POS you said was up double digits, but that's excluding the Spectrum pickup, right?

That includes Spectrum pickup.

If you were to back out the Spectrum pickup, it would still be up double digits.

Got it, okay.

Now, in terms of the third quarter what you've seen so far in garden, have retailers started to purchase more normally?

Is sell-in going to be close to sell-through this quarter do you think?

Haven't seen it yet.

Okay, so it's still trailing?

Yes.

Yes.

Got it, okay.

And then in terms of the garden operating margins, obviously up pretty solidly.

Is there something that you guys are doing uniquely on the garden side versus pet that's really improving those margins?

Well, there's a lot of hard work on the expenses associated with buying and the pricing.

A good amount of work on our pottery business and the consolidations that we've done.

So, a lot of different factors and then, as we mentioned in the opening comments, we've really worked on taking out poor performing SKUs.

Got it, okay.

It also sounds like the garden side has probably gotten a greater share of the lower commodity costs and better pricing this year versus pet.

I would say so.

Okay, got it.

And then lastly on the share repurchase side, it sounded like you bought 1.4 million this quarter, plans for the rest of this year?

We never preannounce any plans or any buys with regard to shares and we'll make good judgments we think on behalf of our shareholders as we go forward as to whether that's a prudent use of capital or not.

How much is authorized right now?

$100 million.

Got it, okay.

Thank you.

Thanks, Joe.

Your next question comes from the line of Peter Keith with Piper Jaffray.

Good afternoon, guys.

It's Peter calling in for Mitch.

Hi, Peter.

I just want to say congratulations on a successful quarter.

Thank you.

I was wondering with the discontinued products that you're taking out if you were able to quantify that for us and how much it may have impacted the quarter.

In the mid single digits in millions.

Okay.

And we could maybe factor that same number going forward for a little bit?

It would probably be skewed a little more towards the third quarter because, obviously, garden seasonality.

So there is a little bit more on the garden side than there is on the pet side.

Okay, that's helpful.

And then it looks like CapEx keeps coming in pretty far below where we were modeling it.

I think previously you guys said it should be under $30 million.

Is that a number you could maybe tighten up a little bit for us at this point?

Not at this point.

I mean, obviously, we're trending much lower.

We're really just spending more on maintenance CapEx right now and really supporting those businesses that have a requirement for new plant equipments for new product introductions.

But, there's still a lot of stuff under review for the second half of the year.

Yes, I'm with you, Stu.

It doesn't take us -- for us to go out and make a decision and buy much to change those numbers.

Okay.

And then I just wanted to just circle around on your comments for the garden area.

So, it sounds like the weather in the southeast is fairly favorable.

If I'm reading it correctly, sell-through is strong and that you're going to ramp up some marketing dollars.

So, I guess, does it seem like you may expect the sales growth in garden to perhaps be a little bit better in Q3 compared to Q2?

I'm hesitant to say that.

This is a funny economy and there's a lot of -- it's just not an easy place to predict what's going on out there.

We think we need to do the things that drive the brands, but to start going there I'm not so sure I'm ready to do that.

Okay.

That's fair enough, thought I'd just ask.

Thanks for your help and good luck.

Thank you, Peter.

Your next question comes from the line of Reza Vahabzadeh with Barclays Capital.

Good afternoon.

Hi, Reza.

On the SG&A decrease, obviously, a pretty significant decrease.

Can you provide a little bit more detail as to what drove that nearly $12 million decrease and how much of that is sustainable and how much of that is not.

Well, I think first of all we suggested that a good chunk of what's sustainable is already in last year's numbers.

The other thing that I would tell you is there are one-time costs in last year that aren't in this year because they were one-time, so it makes the change a little more dramatic than it otherwise would have been.

Those are the two things that come to my mind.

Stu, what would you or Paul, what would you add?

I think we've kind of hit it nail on the head here.

It's really the garden distribution operations where we made some significant consolidation and saved millions of dollars there and then, you know, lower energy, freight costs example, which everybody's experiencing.

And then we just have been very diligent about cutting costs throughout the company.

But as Bill said, we started this effort in the second half of last year so the trend will change a little bit from the year-over-year comps.

Right.

Of that decline, I mean how much of it would you say is due to, you know, permanent cost savings as opposed to, you know, the lower freight costs in ballpark terms.

Well, I think its, you know, first of all we said that of the $12 million there's three chunks.

There's the chunk that is costs that were there last year that are kind of one-time costs because we had folks leaving the organization and we had costs associated with that.

We had some other one-time charges in last year's expenses, so that becomes a chunk of it.

There's structural cost reduction, which is long-term permanent costs.

So, you've got to look at all the different pieces.

And I think that's why, Reza, I think you heard in Bill's prepared remarks, you know, SG&A could in fact be, you know, higher in the second half of this year compared to the second half of last year.

So we're obviously not quantifying how much higher, but it could be higher.

Right.

And that higher portion that you were referring to, that is reflecting a tougher year-over-year comparison, as well as just brand support.

Yes.

Okay, thank you.

And then on gross margins, obviously, an improving quarter this quarter.

I mean, should the pace of margin increase the next couple of quarters be, you know, comparable to this quarter give or take because of the similar factors?

I think give or take.

I don't think we're expecting a massive ramp up but, obviously, we do expect the second half -- we're hopeful that the second half of this year will be better than the second half of last year.

That would imply that there would be some gross profit movement.

Right.

And then lastly, you talked about the POS staying strong on the garden products, but then, obviously, sales being weak on the aquatics.

Any other product lines that you are worried about as far as sales trends and the category being soft.

No.

I think the overall portfolio, Reza, given the economic conditions is performing pretty well.

Okay.

Last question, share repurchases, how significant of a role will they play in terms of application of free cash flow?

Well, I think that's another way of asking the same question that I didn't answer with a definitive comment earlier.

We'll make our judgments as we go forward.

One of the things that we have said is that to the extent that there is dilution from equity comp we would tend to have a view towards buying that back in to offset that dilution as a general thought and practice versus not paying any attention to it.

And I think that you can see that on average we've at least done that and probably more.

Got it.

Thank you.

I had to try on that question.

Thanks, Reza.

Thank you.

Your next question comes from the line of Reade Kem with Bank of America.

Hi, there.

Hi, Reade.

Just a couple questions.

I know it's small, but the international business did that have any impact on your, for example, your pet top line in terms of perhaps weakness or foreign currency translation?

Yes, that's what the foreign currency translation was in large measure.

Okay.

So, if we took that out, could you hazard to guess at what your branded sales of decline would have been year-over-year in pet?

Currency was somewhere between $2 and $3 million, I'll call it $2.5, there about.

Okay.

Within about a percent.

On garden, I was wondering if you could just -- based on comparing it to history season to date -- characterize the grass seed season and just in terms of demand and conditions.

Yes, I think -- Reade, this is Paul.

You know, grass seed this year hasn't been nearly as robust as it was last year.

Certainly, there is significantly more moisture in our key regions, which are the South and Southeast.

But the weather conditions for weekend planting and such, from what I'm hearing from the field, have been wet or it's been exceptionally hot, and so the season for grass seed just didn't break like it has for the past two years.

So in the 2007 and 2008 garden seasons, you had an early break and that largely spurs grass seed sales.

So, grass seed sales to-date are lagging that compared to the prior two years.

Okay.

And then jumping back to pet on the -- thinking about how to model out the gross margin trend for the rest of the year.

I guess, if you could just characterize maybe some of the pricing you've taken in that portfolio and whether there were any, you know, you retailers are maybe looking to grab a little bit of that back or whether those discussions are fairly quiet.

Well, I think on that subject there's as lot of moving parts and there's quite a mix of products.

And so to try and parse that in response to your question kind of goes beyond where we're prepared to go.

Okay.

Do you think that maybe in general you're not being faced with kind of demands to maybe rollback some pricing across the portfolio that would really show up.

I think everybody faces those kinds of challenges in a market like this and, of course, we ourselves are working on our input costs.

So how it all shakes out is really hard to comment on, and that's one of the reasons that we're cautious.

Okay.

My last question for you is just if, depending on how you do at the end of the year, I mean, you could potentially be headed back to a leverage level that you've traditionally targeted and I was wondering if that's changing your thoughts about looking at acquisition opportunities and sort of how hot or cold that is these days?

Thanks.

Well, on that front when you don't have the borrowing capacity and you don't have the equity currency, you don't do acquisitions.

As those things strengthen, we'll look at our overall business and see if there is anything that makes any sense.

But I got to tell you, we are prudently focused on those three key initiatives reducing our operating expenses to get greater efficiencies, reducing our working capital and debt, and increasing our margins.

And we think that sticking to that and then focusing on building an organic growth plan to drive our businesses forward is really powerful.

Great.

Good luck, thanks.

Thanks, Reade.

Your next question comes from the line of Alice Longley with Buckingham Research.

Hi, good afternoon.

Hi, Alice.

Hi.

The POS being up double digits in lawn and garden, what is the period that you're referring to?

Our fiscal second quarter ending in March.

And why are you saying that's a late breaking season?

Why?

Because we can tell when you take a look at how, let's say, grass seed sales are materializing, when you see how some of the other products are selling and we take a look at retail inventories and where they are compared to last year, which is lower.

That's how we arrive at that conclusion and how our field arrives at that conclusion.

Has that kind of increase continued in this quarter to date?

You know what, Alice, I haven't checked that data.

Okay.

And does that include that, POS being up double digits, does that include the unbranded products you distribute?

That's all in.

It's all in.

Does it take the discontinued products out of the base?

It includes the discontinued products in the base.

All right.

And can you tell us what POS was for pet?

We don't get that type of data, Alice, because as you know one of the sources or some if it you could track that would be IRI, you know, food, drug, mass and Wal-Mart.

Most of our sales are, obviously, going to be going to PetSmart, Petco, Wal-Mart and a specialty independents that are all out of IRI and so we don't share that data.

Do you think that destocking by retailers is going on in that channel, too?

Absolutely.

Oh, yes.

Yes.

And then on pricing, what would be your best guess to what pricing is in lawn and garden versus units.

I would say pricing and units when you blend it all in are probably pretty close.

Well, if lawn and garden was down 2, I don't know what to do with that, pricing was down and units were down 1.

That doesn't make sense.

How much was pricing a positive?

If it's more than 1%, maybe 2% at the max.

Okay.

So price is sort of 1% to 2%.

Yes, it's not much.

Okay.

Is that true for pet, too?

Yes.

Okay.

And I'm noticing in backing up the numbers, it looks like your corporate line went up year-over-year, is that because you're paying yourself more because you're doing well?

Why is that up?

External services.

External services.

Yes, things like lawyers, things that we don't like to pay for.

Lawyers, accountants.

Yes.

I guess that's all.

Thank you.

Thanks, Alice.

Your next question comes from the line of Doug Lane with Jefferies & Company.

Yes, just a follow-up on that questioning.

How is double-digit POS growth -- what were you expecting if double-digit POS growth was in the face of poor start to garden season?

Well, there's a difference between what we sell and what the retailers are selling, and it's just a difference in the mix and the break.

Paul, let me kick this one back to you.

So, Doug, are you asking why the discrepancy?

Yes.

I mean, what would POS have been in a good season, 20%?

Well.

I mean, when you say late break to the garden season, we're asking in the context of consumers.

Doug, so one of the things I think perhaps maybe you and, perhaps, some others are missing is so -- we've had a significant competitor leave us, our relative competitive position, whether you factor in that significant competitor or otherwise, you know, it has strengthened.

We as a company our position within the lawn and garden category continues to improve.

Right.

But you said even without the share pickup of their business...

The person asked only about Spectrum.

So maybe we've done well in other categories that are outside of those former Spectrum categories.

Who else left?

I mean, Doug, isn't a matter of leaving, it's just our competitive position continues to strengthen.

I mean, that doesn't mean that the competitor is gone.

Okay.

No, I mean the way I'm reading this, is you did double-digit POS growth in a poor weather quarter, which sounds like you guys are extremely confident about your garden business.

Our garden business, you know, I mean look we have come off of two relatively weak garden seasons back to back in '07 and '08, and now we're having a much better garden season.

You used the words extremely confident.

In this environment, we keep using the word cautiously and cautiously hopeful, and I want to keep reminding that and not having people jump to inferences.

This is a good quarter for us.

We have challenges coming up ahead, as everybody else does in the marketplace.

These are -- if they're not unprecedented times, they're certainly unusual times.

All right.

I want to stay on the garden for one more question.

On the grass seed, you mentioned it was lagging the past two years.

I'm going to jump to the conclusion that the POS there was not up double digits, so what I'm going to ask is, what categories were even stronger to make up for the lagging grass seed business?

Wild birdfeed very strong, garden chemicals very strong.

Which garden chemicals in particular?

We're not going to go that deep into the details.

Just curious.

I would be too, but we're not going to go there.

Appreciate the quality of the probing.

All right.

Let's move over to pet, without getting into too much particulars, can you give us about what pet would have been up in sales if you exclude the aquatics part.

I haven't even looked at it that way.

Again, I just don't see going to that level of detail.

We report segments.

Well, can we assume the aquatics was the only negative segment in the pet business?

I wouldn't say that.

There probably are some pieces of it that are very modestly negative, but not everything is up.

Okay.

Well, that's helpful.

And then lastly, you mentioned the increase in marketing.

I mean, you've been pretty consistent the past three years at 2.1%, 2.2% of consolidated sales has been going to advertising.

Are we going to see a meaningful change in that percentage this year and next year?

Really don't have a comment on that.

We'll have to see how it unfolds.

I don't think about the numbers that way and I'd be disinclined to wing it.

But, I mean, marketing is the key area that's going to see the increase within your SG&A line.

That is an area.

Is it the biggest?

It's an area.

Okay.

All right, thanks.

Thanks, Doug.

Your next question comes from the line of Karru Martinson with Deutsche Bank.

Just to follow up on Doug's question on the wild birdfeed side of it, which was up nicely.

How much of that was pricing and what are you seeing kind of push back from the retailers as input costs for sunflower and millet and milo and stuff kind of ease off from year ago levels.

Well, relative to last year, there is some pricing because last year crane costs were very high and we had to move with it.

There's been some small amount of moderation in some pricing and there's been some decline in relative grain costs.

So we've had some favorable affect from that and there are adjustments working their way through the marketplace to deal with all of those factors.

Okay, but you're not seeing any sort of wholesale giveback in terms of retailers pushing for that.

Well, pushing for it is one thing and --

Okay, you're not granting any, let's put it that way.

We have not seen that kind of movement, no.

I mean, as the market leader here for your categories, I mean, are you seeing other brands in the smaller ones kind of struggle in this environment and perhaps maybe not one where you need to use equity, but opportunities for tuck-in brands and product lines.

Haven't been focused on that, I've really been focused on the three leverage initiatives expense management, working capital, and increasing margins.

There's so much internal to do.

The meaningful work that delivers meaningful results and that's where our heads are.

Okay.

I'm trying to think of a third way of trying to ask the same question that Joe and Reza asked in terms of the priorities for the use of cash.

I mean, clearly we're going to continue to invest in our business invest in the brands.

But after that, I mean, it sounds like acquisitions really aren't at the forefront here, and between debt and shares how would you prioritize your uses of cash.

Well, you know, it's a very interesting thing.

If you go back a year ago and everybody was concerned about where the debt was and what the ratios were and we have driven very, very hard to change that dynamic.

And now on this call, everybody's going to say what are you doing with it?

What are you doing with it?

Well, the number one thing is to get more, to get the debt down harder and to create more space and to create a stronger currency through the performance of the business.

I think it's relatively easy after that to start focusing our energy on the allocation of that, whether that's internal growth initiatives, external acquisitions, or buying back shares, and we'll look at all those on their merits.

But right now, we're not done doing what we set out to do.

Well, I'm a bond guy so I'm always focused on debt, whenever we can, if there's cash, we want to see it put to good use.

In terms of the aquatics, I mean, do you feel that this is just the market in general or do you feel that there is continued destocking going on with some of the larger retailers shifting focus away, competitive responses or just the market, as I said.

Well, retailers as a category has softened.

Retailers have changed their mixes and their allocations of shelf space to some degree in response to that.

So not only do you have consumer takeaway, but you have these adjustments at retail that have to work their way through.

There will come a point when all of those moves have stabilized and, as long as the consumer demand remains reasonable or healthy at these new levels, business will be fine.

But, we're still working our way through it.

All right.

Thank you very much, guys.

Thank you.

Your next question comes from the line of Jeff Bronchick with RBC Investment.

Jeff?

Sir, your line is open.

If you're muted, please unmute.

Can you hear me?

Yes.

Okay.

Sorry, was gardening.

Away from the quarterly yak-yak, with all the work you've done with focus on higher margin products and in some point in the next two or three years a reasonable economy and reasonable growing conditions, is there any reason to not assume that you should comfortably exceed your former peak margins of, I think it was about 8.5 or 8.6, given the base and the foundations of the company that you've changed over the past year.

You're asking for reasons that one wouldn't assume that.

That's just not a place that I think about.

There may be a number of them, but off the top of my head I don't sit here and go, think, think, think like I do about expense reductions, working capital and driving increased margins.

Just really don't have much to share with you there.

So, let me rephrase that maybe more directly.

On the current base of business, assuming not a wonderful gardening season and not a wonderful pickup in the economy, do you think that over the next two to three years, we were in this funk, we go two to three years exactly like we're doing, have you done the work to establish an operating margin basis that is closer to what was your long-term target of 10%?

I personally never focused on that as an important metric.

I'm driven by return on capital employed and the growth of the capital employed, and those kinds of metrics will take care of themselves as appropriate, depending on how we shape the business.

Sorry, if there's a pause here.

So obviously, operate margins are, as you're focused on, are a key issue as part of a return on invested capital mathematical equation.

Let me try and add a little color to that.

And I'm looking long run, I don't care what you're going to do next quarter.

Sure.

So, let me try and add a little color to that.

If we have parts of our business that to return 15% or more on sales.

If all of the business were shaped to that mix of portfolio, we'd easily go over the 10%.

We have other parts of the business, the distributing part, that could be 3% or 4% on sales.

If the business were shaped that way, we might attain a 20% or 25% return on capital, but it would pull the weighted average way down.

And I'm not suggesting that we're going to go out and push the growth of distributing other people's products, that's clearly not our strategy, but it does illustrate the point that the mix of the types of businesses are important to that ratio, as well as the growth in margins within the existing businesses.

And how all of that shapes up forward is largely going to be driven as where are we going to get the best returns on capital and where can we grow the business.

On just another note, the Spectrum issues, would it be fair to say that you didn't really realize all the longer term benefits of Spectrum going away in its categories they did because this happened quickly in the middle of the season and all else been equal it would have been -- the numbers would have been higher if you had three or four extra months to position it and, therefore, next year you'll see a much bigger benefit.

Is that a fair statement?

For the products that we are carrying now that they formerly serviced, I don't think that's an accurate statement.

We were able to respond quite quickly and I think the question is for next year, are there products that they are servicing this year that we will be able to move to us and increase our market share.

But I wouldn't think that it's related to products that we service this year.

So, in conclusion, you feel comfortable with the amount of effort and work you've done that the return on invested capital for your company will -- should be higher all else being a lot of things equal than its former levels back in 2006.

I'd have to sit and look at those numbers.

What we aspire to do is to outperform that.

Thanks, gents.

Okay, Jeff.

Your next question comes from the line of James Jago with Pangaea Asset Management.

Hey, guys.

I've just got a couple pretty simple questions, here.

What are the respective gross margins at the garden and pet segments?

We haven't broken that out.

Is one kind of materially more, you know, carry a higher gross profit, perhaps, than the other, are they about equal?

What would you say?

Everybody's looking to look at some of the documents.

It may be a simple question, but it wasn't a quick answer.

What's your next question?

The answer is pet is a bit higher.

It's a little bit higher on the pet side.

Okay, great.

And then this is probably, you could probably dig this up pretty easy, but is the revolver is that governed by a borrowing base or is that just governed by a leverage test?

It's leverage test, it's cash flow.

Got it.

Thanks.

Thank you.

Your next question comes from the line of [Thomas Share] with Federated Investors.

Congratulations on the quarter.

Thank you.

I think most of my questions have been addressed, so I'll try to keep it simple here.

Did you state what stock comp expense was for the quarter?

No, we didn't.

We'll see if we can't pull it out for you.

Do you have a second question?

Yes.

As you think about advertising going into the second half of the year, is this a response to competitive activity you've seen or more just market share defense given the environment?

It's our folks implementing the plans that they put in place back when they planned for this year.

Okay.

So, this isn't a response to competitor pressure you've seen late from anybody else.

It's not reactionary, it's planned.

Okay.

And back to the stock comp question, I believe, Howard, is it $5 million?

It's about $5 million.

Okay, that's pretty similar to last year, if I remember correctly, is that right, $5.8 million last year?

Sounds right.

Okay, thank you.

Your next question is a follow-up question from the line of Alice Longley with Buckingham Research:

Hi.

Two things, I know you're not breaking out gross margin by division, but were gross margins up more in lawn and garden or in pet?

One sec, I believe it's lawn and garden.

Lawn and garden had the recovery this year.

Yes, lawn and garden.

Okay.

And then we've got the SG&A ratio, or at least SG&A going up in the second half because you said you want to do more brand building efforts.

Aside from advertising, what are other brand building efforts that would be in SG&A?

Anybody want to comment on that?

We don't have any takers, Alice.

Is that it?

Maybe you can talk to Paul offline on that.

I mean, is there anything besides advertising?

I mean, you have your advertising, marketing promotion, R&D, you know, those are --

I mean, is it putting like more sales people out or?

No, it's building the brands and building the new products.

All right, but how do you build them besides advertising?

I mean, R&D is a long-term thing, that isn't...

No, but you do in-store display work and promotional work and things like that.

So, it's promotions, in-store promotions?

It's a variety of things, Alice.

We're just not going to give you what you're looking for, Alice.

Not because we don't want to, it just isn't sitting here and we haven't talked about what we would disclose or wouldn't disclose and what the competitive aspects of all of that are.

I think you can talk with Paul and he'll give it some thought and so he'll share with you what he can.

All right.

And then why is your non-branded business down in lawn and garden but not pet?

Is there some reason for that?

We had a competitor in the west coast come in and I think we would characterize it as buy some market share and that was okay.

Okay, thanks.

Okay.

Thank you, everybody.

We appreciate you joining the call today and we'll look forward to chatting with you next quarter.

Thank you.

Thank you for your participation in today's conference.

This concludes your presentation and you may now disconnect.

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