Central Garden & Pet Co (CENT) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Central Garden and Pet's third quarter of fiscal year 2013 financial results conference call.

My name is Sue, and I will be your operator for today.

At this time, all participants are in a listen only mode.

Later we will conduct a question-and-answer session, and instructions will be given at that time.

(Operator Instructions)

I would now turn the call over to Steven Zenker, Vice President of Investor Relations and Communications.

Please go ahead.

Thank you.

Good afternoon, everyone.

Thank you for joining us.

It is my pleasure to welcome you to today's call and introduce our other speakers.

With me on the call today are John Ranelli, Central's President and Chief Executive Officer; Steve LaMonte, President of our Garden Segment; and Lori Varlas, Central's Chief Financial Officer.

As a reminder we issued a press release this afternoon providing results for our third quarter ended June 29, 2013.

The press release is available on our website at www.Central.com.

Before I turn the call over to John 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 expectations for future revenue growth, margin improvement and improved profitability 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 risk are described in Central's Securities and Exchange Commission filings.

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

Now I will turn the call over to John Ranelli, President and CEO of Central.

Thanks, Steve.

Good afternoon, everyone.

Obviously, none of us are pleased with the financial results.

As we announced last quarter, we expected our third quarter earnings would be lower than the third quarter last year.

We knew that this quarter would be difficult because our results would be compared against our performance in the third quarter of 2012 when our sales were up over 10% the prior year.

Difficult comparisons aside, our actual results for this quarter were lower than we anticipated at the time of our second quarter earnings call.

In last year's third quarter, the Pet segment benefited from the shipment of backlogged orders and the initial sell in of high margin flea and tick products in a new channel of distribution.

We didn't have either of these factors working for us this year, resulting in lower sales and profitability in our Pet segment.

Although our Pet business was down, it performed in line to our expectations, but our Garden business results were disappointing.

While Garden sales in the quarter were close to the prior year level, we had expected them to grow even when comparing against a strong 2012 third quarter, which like the Pet, benefited from the shipment of delayed orders.

Our margins were negatively impacted by several factors that Steve and Lori will elaborate on later in the call.

But, suffice it to say, we are looking carefully at the businesses to address the margin and other issues we are facing.

Our key priorities for the future have not changed since I spoke to you in May on my first call as CEO.

As a reminder, they are to bring profits to the bottom line through a more balanced approach of increasing sales, improving margins by providing customer first service, delivering customer first innovation through our strategy of product, product and more product while improving on whatever is not working as planned, all while reducing expenses and building our brands.

To support these priorities, we have recently completed putting in place experienced leaders in each of our major businesses.

They are working with their functional counterparts and their recently introduced matrix organization and are directly accountable for the results of their business.

We are also establishing more collective partnering relationships with our retail customers.

We are building the retail environment of the future as we develop products, marketing, and point of purchase displays consistent with our retailers' plans.

Leaders from our sales, marketing, supply chain and shared service areas are coming together to work as an integrated team.

As just one example of how this is benefiting the Company and our customers, our fill rates have improved significantly.

This improvement is being enthusiastically received by our customers, and it is also energizing our sales force.

We will not be satisfied until our customers recognize Central as the industry leader in customer service.

With regard to innovation, as we improve customer confidence, we are working hand-in-hand with our retailers at developing new products to meet our customers' and consumers' needs.

Due to the length of the product innovation cycle, from product development to shelf placement, it takes longer to deliver results from innovation than it does to improve fill rates and customer service.

We have a lot of work ahead, but developing innovative, new products is a real critical priority.

Turning to improving profits in the near term, during May earnings call, I highlighted two specific actions which we took to immediately begin increasing our profitability.

These actions demonstrate my commitment to expense reductions and margin improvements.

The first action was a new expense reduction initiative, and the second action was the implementation of price increases in our Pet segment which we undertook in my second month.

These initiatives are intended to begin addressing our gross margin and expense issues which prevent earnings from reaching the bottom line.

Our expense reduction initiative had two parts.

The first part was a reduction in employee expenses, and the second part was the elimination of certain non-employee costs.

These reductions were made after identifying both horizontal and vertical layers of management not critical to the business and projects and other areas of spend where ongoing costs were not justified by the expected pay back.

Since quarter end, we have implemented a second round of cost reductions including additional employee related reductions and non-employee expense cuts.

The impact of all these reductions resulted in savings of roughly $4 million in the third quarter, and we expect that they will result in savings of approximately $5 million in the fourth quarter.

The impact of these savings in the third quarter was partially offset by previously committed increases in marketing spend to support our Garden business.

Our second major initiative was a systemic review of pricing in our Pet segment.

After completing this review, we worked with our customers and adjusted the pricing of many of our Pet products which took effect throughout the third quarter.

While these specific actions are not yet visible in our financial results in a significant way, they should be more apparent in the upcoming quarters.

Now that we have improved our service levels, taken the additional steps to reduce our costs and selectively increased prices in Pet, we are broadening our focus to include reducing Central's inventory levels over time.

We are committed to doing so in a way that will meet our customer service objectives in addition to freeing up working capital.

Our plan is clear.

We will provide industry-leading service to our customers, collaborate with our retailers to give our consumers the most compelling, relevant, solution driven products in the industry and, while building our brands, to stand for the best in the marketplace, all at the lowest possible cost.

These actions are designed to deliver on our commitment to provide a superior return to you, our shareholders.

Unfortunately, this will not happen overnight.

It will take time for the improvements to show up on the income statement and balance sheet.

While the road will be bumpy and patience required, I am confident our actions will lead us to greater profitability.

We are already starting to see results in the reactions of our customers and employees.

As Central's CEO, I am committed to addressing our under-performance and to driving shareholder value.

With that, I will turn it to Steve.

Thanks, John.

Is a pleasure to be here today to provide an update on our Garden business.

This quarter, our Garden sales declined 2% compared with last year.

While a small decrease, sales did come in below our expectations as John mentioned.

We had anticipated higher contributions from our new products and our control products in general.

The late breaking garden season adversely impacted sales of many of our higher margin control products.

Grass seed and birdseed sales this quarter were higher than last year but were not enough to offset the declines in controls.

Last quarter sales were up 8% as retailers prepared for the garden season, and we launched our new products.

However, due to soft demand for control products by consumers, resulting from the slow start to the season, demand for replenishment orders was soft in the third quarter.

This certainly was a significant factor in sales coming in below our expectations.

Although consumer demand did pick up in the third quarter, it was too late for our control products to make up the lost ground.

Our biggest disappointment was the drop in our margins.

The major reasons for the decline were lower profitability in our controls, decor and fertilizer businesses.

Profitability was impacted by higher promotion and marketing expenses including costs related to the launch and support of the two new innovative products we brought to market this spring.

These new products were the Amdro PowerFlex system and the Pennington Smart Feed Sprayer.

The adoption curve for market disrupting new products in the garden industry can be slow to build, however, we had very strong retailer interest and support.

Both we and our retail partners had high expectations for these innovative new products in the marketplace.

In hindsight, these expectations were too high for their initial year.

Several factors including the unfavorable weather for the entire controls category and the launch timing impacted sell through performance.

Our customers believe strongly in these new products and have committed shelf space and support as we plan for our second year to successfully establish these truly innovative products in the marketplace.

Our retailers like us believe these innovations offer unique consumer benefits.

As we look back, we experienced a sales gain of 2.5% over our second and third quarters combined with a modest pickup in consumer take away as measured at point of sale.

Our margins, however, are simply unacceptable.

We believe we have many levers to address profitability, and we have developed a plan of action to do so.

With that, I will turn it over to Lori.

Thanks, Steve.

The press release we issued this afternoon covers the financial results, but let me spend a little time commenting on a few aspects of the quarter.

I'd like to speak to the numbers on a consolidated basis and then provide some details on our Garden and Pet segment results.

Total sales for the third quarter declined 7% compared with last year primarily due to lower sales in our Pet segment.

As you may recall, last year's third quarter sales increased 10% benefiting from the delivery of backlogged products in both the Garden and Pet segments.

Certainly the third quarter comparisons versus a year ago were very difficult.

Our consolidated gross margin for the quarter declined from 33.8% to 30.9%, a decline of 290 basis points from the third quarter of 2012.

But the Garden and Pet segments experienced a drop in gross margin for the quarter.

The lower sales and gross margins translated into a lower operating margin, although the decline in operating margin was less than the decline in our gross margin.

This is due to reduction in SG&A expenditures primarily in Pet including initiatives set in motion since John became CEO.

SG&A expenses as a percentage of sales improved to 24.2% from 24.7% in the third quarter of last year.

Our third quarter operating margin was 6.7% down from 9.2% last year.

Let's take a minute to talk about our Pet segment results.

In the Pet segment, sales were down 12% reflecting the difficult comparisons mentioned earlier.

Last year, Pet sales were up 19% and reflected the initial sell in of our flea and tick products for distribution in the club channel and the delivery of backlogged products from the second quarter.

These events did not repeat this year.

Our animal health category which includes our flea and tick business represented the majority of the Pet sales decline.

Operating margins in our Pet segment decreased 100 basis points.

The operating margin was significantly impacted by the drop in volume in the flea and tick business which carries higher margins.

Further the margins were grossly impacted by higher ingredient costs.

We did see improvement in our birdseed margins reflecting price increases taken to cover it last year's commodity cost increases.

SG&A expenses in our Pet segment as a percentage of sales improved 190 basis points due to decreased marketing and salary expenses.

The actions taken to improve SG&A and helped offset the impact of the segment's lower gross margin on its operating margin.

Moving on to our Garden segment, as mentioned earlier Garden sales decreased 2% versus the prior year, however the mix of sales was meaningfully different from a year ago.

Our higher margin control product sales were down significantly impacted by the late start to spring in much of the country.

Grass seed and birdseed sales were areas of strength still showing growth.

Operating margin in our Garden segment decreased 330 basis points to 5.3%.

The decline was predominantly due to lower profitability in our controls, decor and fertilizer businesses.

The decline in the controls business margin was due to costs related to the loss in support of two new innovative products we brought to market this spring.

The decline in decor was primarily due to seasonal product return.

The decline in the fertilizer business was attributable to a change in customer mix in our private label fertilizer business.

As a reminder, as we move into our fourth quarter, the garden season primarily expands our second and third quarter, and our fourth quarter Garden sales are a much smaller percentage of our overall annual Garden revenue.

Turning back to our consolidated results, with respect to the P&L impact of our cost saving initiatives initiated in the second quarter, third quarter results included savings of approximately $4 million.

Our Q3 effective tax rate was 34.3% compared to 37.9% in the third quarter of last year.

The reduction of our effective tax rate reflects additional tax credits available in the quarter that have a larger impact due to lower earnings in the quarter versus a year ago.

We expect our effective income tax rate for the fiscal year to be in a range of 36% to 38%.

Our net income was $13.7 million compared to $22.7 million a year ago, and our third quarter diluted EPS was $0.28 versus $0.47 in the third quarter of 2012.

A few comments on our balance sheet, net debt at quarter end was $471 million versus $391 million a year ago.

Our total leverage ratio at quarter end was 4.9 times an increase from 3.9 times a year ago.

Although we were in compliance with all of our covenants at quarter end, we subsequently amended our credit facility to provide us with more favorable terms.

Our amendment interest coverage ratio was reduced to 2.25 times from 2.5 times, and an asset coverage ratio of 1.1 times was added.

Both covenant modifications are effective through March 2014.

Our inventory balance increased $78 million compared to the prior year.

As we have mentioned on previous calls, we had planned a higher level of inventory this year to support our customer needs and ensure robust service levels in light of last year's supply chain disruptions in both Pet and Garden.

Secondly, with a weaker than anticipated garden season, we had a higher level of inventory than we planned for this time of year.

Additionally, commodity cost inflation and strategic buys in our distribution businesses were also a factor in the increase.

We are focused on working down our inventory balance and expect to reduce it over time.

Our CapEx for the quarter was $3 million versus $10 million in the third-quarter of 2012.

Last year, as you may recall, we were aggressively implementing SAP in a number of our businesses.

In the current year our focus has been on optimizing our systems with no significant implementations currently underway.

We expect our capital expenditures will be less than $30 million this year.

We did not purchase any stock under our authorized share buy back plan in the third quarter.

Approximately $50 million remained available at the end of the third quarter.

In summary, we have events that were included in our prior year that did not recur, and our Garden results did not meet our expectations.

We are taking actions to improve our sales and profitability.

We expect these actions, together with a focus on more efficiently servicing our customers will deliver improved financial results over time.

We appreciate you joining us for the call this afternoon.

John, Steve and I would like to take your questions.

Sue, would you please open the call to Q&A?

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions)

Joe Altobello, Oppenheimer.

I guess I'll start with the cost savings.

You mentioned $4 million in the quarter.

Were there any costs related to that $4 million?

As you may recall, we talked on our second quarter call.

We'd taken the actions toward the end of the quarter, and any associated costs were pretty much expensed at the end of the second quarter.

The actions we took most recently were actually after the end of the third quarter, and the costs with that are fairly small.

So the $4 million is a clean number.

It is not a net number essentially?

Yes.

And the $5 million is similar to that?

(multiple speakers)

It will have a small amount of expenses associated with the action, but it is not very big.

Okay, great.

And then secondly the second round of cost savings you guys alluded to, I assume that's incremental, and if you could quantify for us what you think that second round of cost savings could bring to the bottom line?

I think the way to look at that is we took some actions toward the end of our second quarter which we indicated what the impact would be in the third quarter.

The fourth quarter number has combined the actions so the ones taken in the second and the ones taken most recently at the end of the third quarter.

Okay, so the second round was part of the original plan is what you're saying?

Joe, this is John.

It is really part of a continuous improvement program.

As we mentioned in our prior calls, what we are doing is we are focusing continually on reducing our cost and also focusing on increasing our sales and increasing our gross margin.

So from a balanced approach, we expect to have a continuous program of reducing costs going forward.

Okay, got it.

One last one if I could.

On the last call you mentioned -- you guys did warn us that sales and earnings would be down year-over-year.

We did not get that same warning on this call.

It looks like you still have a pretty tough comp on the pet side at least on the top line.

Is that, are we to infer from that that you expect that numbers will be better year-over-year in the fourth quarter?

We don't typically provide forward-looking guidance.

We did give you some qualitative guidance because we knew last year's third quarter in 2012 had significant sales especially the sales of flea and tick as well as the shifting of backlogged products from the second quarter into the third quarter.

So we wanted to make sure we called that out for investors, but we typically don't provide specific quarterly guidance.

Okay, understood.

Thanks guys.

Bill Chappell, SunTrust.

Following up on Joe's questions on the fourth quarter, I understand you are not giving guidance, but can you help us understand I guess on the garden side, would you have any benefit from the long season or the late season on the controls products?

And certainly with the rain on the East Coast and some in the Midwest you would think there's plenty of bugs and weeds to get rid of.

And then also maybe give us an idea of with the excess inventory, will that put a drag on gross margins for a couple of quarters or should you work through that a little bit faster?

Sure.

I will address the first part of it.

This is Steve.

Put in the context of the very slow start to the season as you called out, while we have shown some growth in the controls category and for our business in the last two four week periods, in a magnitude of about 10% to 12% from a consumer take away standpoint, we are now looking at a period of a year that is much lower in value obviously than the core of the season itself.

So you can infer from that what you would like, but the bulk of the season has passed us, and we are looking at good gains to smaller volume periods versus year ago.

On the inventory side?

Will that?

With respect to inventory, clearly our inventory values are elevated over a year ago, and we talked in previous calls that we thought it was important to build our inventories to ensure that we had really good customer service and fill rates.

As you may recall in the spring of 2012 we had some supply chain disruptions.

We certainly didn't want that to recur.

That being said, when we look at what's in our inventory balance certainly it includes some elevated inventory levels for our garden business.

It includes some strategic purchases for our distribution businesses as well as some commodity cost inflation so that's all reflected in there.

As it relates to inventories going forward for the garden season, I'll let Steve speak to that.

The inventories for garden are higher obviously year-on-year as a result of this off-season that we are coming out of.

Having said that, our inventories have a long shelf life to them and can bridge multiple seasons.

Okay.

And then last one, maybe you can help me understand on the changes to the covenants.

Is that going to change your annual interest expense, and was that just due to the lower than expected results for this quarter, or does it reflect expectations going forward?

Sure.

On the amendment to our debt covenant we lowered one covenant and added an asset coverage one to one times ratio as well and that's really effective until March of 2014.

We just want to ensure we've got appropriate cushion, and -- but as you think as we exited our June quarter, third quarter, we had -- we were compliant with the covenants as they were.

Okay, great.

Thanks so much.

Frank Camma, Sidoti.

A lot of emphasis was placed on the flea and tick product.

I know you don't quantify that or give us sales by brand.

But I mean can you just tell us were sales disappointing for flea and tick products?

That's what I wasn't -- I know you had a large fill in last year -- a launch of the product.

But were your expectations for the flea and tick season this quarter disappointing?

Can you just give us a little more flavor on that?

Sure.

If you look at last year's season and 2012, we had a large sell in.

In fact flea and tick was a major contributor for the our increase.

Last year pet sales were up 19%, and our operating margin was up 49%.

So we had large comps.

That of course was the initial sell in that did not repeat itself.

We also had it as you think about our flea and tick season, there's a little bit of seasonality to that.

We had, since we had a delayed spring, part of that build into the third quarter.

But we think our products are well-positioned, they are strong and I think they met what we expected they would do.

And did you say that the margins for the flea and tick product are higher than your average?

I think they are certainly higher margin product if you think of things like active ingredients such as controls, flea and tick products, they typically carry a higher margin than some of our other products.

John, now that you've had some time to review the brands, have you identified any brands that may be dragging down your overall margins here?

I mean the margins are still -- whether we count the savings or not -- are still well below where even you were historically.

So have you identified anything that might warrant getting rid of?

As I'm sure you're aware, we look at all of our brands in our portfolio and in fact all of our businesses in the portfolio and are constantly evaluated them.

Right now, we don't believe there is any brand in our portfolio that would continue to be a problem.

We think we have opportunity in all of our brands.

Having said that, going forward, we will be identifying which brands we want to invest in more than others that we believe have the opportunity to be super-brands.

And we would have much more leverage in investing in them.

That is a process that is ongoing, and we look forward to rolling some of those strategies out.

Got it.

And just a quick question on just more the macro environment, did you not see any -- housing obviously numbers that are coming in strong, did you not on the lawn and garden side I'm talking about now, do you not see any improvement from that coincidentally?

Or is it -- I'm trying to figure out are you losing market share or is this really the category themselves are down?

We'll there are some indicators that are showing improvement.

The current view looking out is for low single-digit growth within lawn and garden, more toward the low side of 2% to 3% for the category overall.

That at a high level is our view.

From a point-of-sale standpoint for us, we did have an increase on a year-to-date basis on our business, a modest one of about 1%.

And based on where the category is, I can't address that because when we talk on the last call, this is a category unfortunately that does not have robust syndicated data to report category versus your own business.

Okay.

That's all I had.

David Mann, Johnson Rice.

In terms of the cost savings that you've identified, how should we think about those numbers falling to the bottom line, or will there be reinvestment of some of those savings and future savings back into the business?

So the actions we took as we had highlighted both employee related and non-employee related, and so we anticipate those will continue to contribute as we move forward.

As you think about that on an annualized basis, clearly some of that is going to benefit this year, and some will benefit next year.

We had some activities such as the investments in some of our new products and some marketing that was previously planned that somewhat masks some of the savings going forward as we think about the business.

We will certainly invest where we think it's appropriate but our overall goal is clearly to increase profitability.

John, can you talk a little more about the new product development lifecycle?

In perspective the two products that you called out this year that were most important were relatively a minority piece of your business.

So talk about maybe the timeline for new product development, how much can you impact in '14, and what percentage of the business might you expect to impact in '14 and '15?

Well with regard to percentage of the business, we're trying to identify a new product in essentially all areas of our business.

And, based on that new product, and the potential of that new product, we will decide which we will invest in more than in investing in others.

But as you know, we are really at the beginning stages of it.

So if we are starting to design and develop product now, it will be a significant amount of time before we can get those products presented in front of our customers and then on to the shelves to help our growth rate.

So, we are pulling as many products as we possibly can essentially from every division that we possibly can and every business unit hat we possibly can to get them to the marketplace as quickly as possible.

And then just to follow-up on the earlier question on inventory just to clarify that, it sounds like we should expect this heightened inventory level to continue pretty much through into the spring of next year?

I think it has various elements in there.

Some of the garden products may have a little bit longer [carrying life].

As it relates to overall, I think we've made great progress on improving our customer service versus a year ago when we had supply chain disruptions.

And so I think based on where we are working very closely and very carefully at how we can bring those inventory levels down over time without being disruptive to customers.

So we think there's opportunity there to bring them down over time.

On that point, we are essentially beginning meetings every Monday to bring our inventory levels down.

So we are going to take an aggressive approach to reducing our inventories, but, however, we will not do it so aggressively as to impact our relationship or our performance with our customers.

One last question, in the past when the Company has talked about their transformation there was discussion about closing facilities and savings coming from that.

It sounds like since I haven't heard talk about consolidation along those lines, is that no longer even on the board to be done in the future?

Or should we start seeing some benefits -- excuse me, some additional cost savings as you ramp that up again?

Our goal and strategy right now as we have mentioned is to focus on sales, gross margins and expense reductions going forward.

And I believe that the sales and gross margin opportunities that we are aggressively pursuing will lead to significant results, as well as the expense reductions that we are putting in are not necessarily related to investments.

What we are doing is looking at areas in management that, both vertical and horizontal where we may have to look at or not business critical functions being done as well as any projects that are going on.

So the concept right now is to review those projects and cut them back, et cetera, while at the same time, going after sales and gross margin.

So the amount of investment that we have and that we would have to execute is really nonexistent compared to what we were doing before.

Thank you.

Karru Martinson, Deutsche Bank.

When I look back at I think the fourth quarter call we talked about exiting the year kind of at a $20 million run rate in terms of savings, and now were looking at $9 million of savings here for the second half.

And yet when I look at the first nine months of the EBITDA, I'm just not seeing those savings anywhere close to dropping to the bottom line.

So I'm wondering is it all in sales and in investments that we're making in gross margin?

Or where is that big shortfall coming from?

As it relates to the end of the fourth quarter, we had talked about $20 million as an annualized run rate, and remember part of that was realized in the 2012 fiscal year.

We left it where we were part of the process and part of it is this year.

Part of it has definitely been masked buy our investments in marketing and brand building and other areas of the Company.

At the same time I will point to our SG&A expenses which we have been ratcheting down this quarter.

They were down to 24.2% from 24.7%, so there's been some incremental progress in that area, but I think some of the savings clearly are being masked and not hitting the bottom line.

We are committed to improving that.

I think that's the key here -- the struggle I'm having is that SG&A you guys have done an admirable job of bringing that down, and yet we just kind of seem to be not getting anywhere on that front.

In terms of that $5 million for the fourth quarter that you guys talked about, is any of that already committed to marketing spend, or is that money that can come down to the bottom line?

There is no commitment on that $5 million into marketing spend in the fourth quarter.

Okay.

When you guys talked about a slower adoption rate on the Pennington Smart Feeder, what does that mean?

Does that mean it just wasn't getting any kind of sell through, the replacement parts in terms of the cylinders going into them?

What seemed to be the big impediment to sales there?

It's a great question, and I think I have to kind of start by saying, major innovations in the garden category that we have studied really indicate that it takes multiple years for them to queue them up to a mature sales rate.

That's a function of many things, generating awareness, generating initial trial, and getting consumers behaviorally to stop purchasing what they are purchasing now and used to purchasing now, to stop, learn and listen what the alternative can do for them.

As we look at where we are after our first season, as I said, we are disappointed with the performance.

It fell below the expectation that we and our customers had.

We have many learnings coming out of this year that will impact some modifications to strategy and tactics as we go into the next season.

But I think it's important to stress our retail partners believe that these are very important innovations, and they will support them in the next garden season.

And we are committed to increase the momentum as the rate of sale on them going forward.

They are part of our power brand strategy for both the Amdro trademark in the kill space and Pennington in the growth space under the fertilizer segment there.

So they are important initiatives.

It is going to take time to build them, and that's what we are committed to do.

Thank you very much, guys, appreciate it.

Carla Casella with JPMorgan Chase.

I am wondering if you could talk about the increase, which raw materials are actually up in the period, and are there any that are more favorable for you this period?

I would assume some of them are coming down that are grain related?

As it relates to the inventory balance, we have certain commodities that we sometimes buy in advance.

It obviously depends on where the markets are, so we've had some commodity placements.

If you look at last year, there could be certain raw materials that were -- we had the same volumes year-over-year but if the commodity price has risen, then the value of that inventory obviously escalates as well even if it's the same amount.

So if you look at commodity prices over time, they continue to have increased so there's a little bit of that in our inventory year-over-year.

And additionally there are some areas in our business where if we have an opportunity make a strategic buy we will do that as well.

We have a little bit about on our distribution businesses this quarter.

Could you just say which commodities are up though?

Is a grains, is it controls, is it something else -- packaging?

It varies a little bit by business so if you think about some of our birdseed ingredients, sometimes they go different ways.

Right?

So in the last several months, the last six months probably, millet has been very high.

It took off this year, so that is something that would be potentially a higher price while sunflower has gone the other direction.

So different ingredients are doing different things in the marketplace.

Okay, but when you said your inventories were up related to commodities it was more the grains and not like packaging or something else like that?

It's more related to not packaging but the actual raw ingredients going into our grass season.

And then the new products in controls, I think I didn't hear properly.

Did you say they were introduced at price points that were maybe too high?

No, I didn't say that price points being high was the root cause.

There were many factors that contributed to it, one of them being the fact that we had expedited the shipping of those new products into the marketplace which necessitated them being on the display space in floor versus being cut into the retail sections where retailers are used to shopping for those products.

When we correct that going into next season, we expect that that will have a positive a impact, and that's just one example of some of the things that will be corrected next year.

Okay, great.

And then, did you also see just given your new product introduction was there a competitive response that may have also made the performance weaker?

There's always a competitive response to any major innovation brought to the marketplace.

It was anticipated that we would see meaningful competitive response.

So I don't look at that as a driving contributor to the shortfall against our lofty expectations.

Okay.

Great.

Thank you.

(Operator Instructions)

Hale Holden, Barclays.

I just had one.

Trying to put all your comments together, it takes a while to get new products innovated and developed.

You've got covenant relief through to March.

You're not repurchasing shares at lower levels.

So I was wondering, how long do you think it takes to get back to historical level margins?

Is this a 3 to 6 months, is it 6 to 12, is it 12 to 18?

If you could kind of give us some guideposts on that.

I know you said it's going to be a bumpy road but anyway you can narrow that down?

There are plenty of opportunities out there in looking at our sales, gross margin and expense reductions going forward.

Prices are one aspect of it, and it's a delicate balance between what we need to bring to the marketplace to reflect on our increased costs as well as the impact on the consumer and on our volume.

We are constantly looking at that tool that we have to increase prices, and, as you can see, I'm very pleased that we were able to increase prices in our pet business in my second month here.

We will be aggressively looking at prices going forward.

But that's not the only thing we will be looking at as we go after improved gross margins.

Okay.

Thanks.

Kevin Seagraves, Fort Washington Investment Advisors.

I was curious on CapEx.

I had I think at the end of the first quarter guidance was $40 million.

It sounds like now less than $30 million.

Can you talk about the bridge there in terms of is that related to some of the projects that you have backed away from?

Can you talk about what's driving the change there?

Sure.

As we began the year, we knew that we were going to moderate our pace in order to ensure that we were working hard operationally and making sure things function as we had intended.

So we delayed our SAP implementation as well as some other actions and we weren't quite sure when that might ramp up as the year has progressed.

We are now into our -- exiting our third quarter into our fourth quarter, and so activities that have taken CapEx haven't resumed, and so we've brought the amount that we expect to spend in CapEx down.

Okay.

And then again going back to the new product development, John had said it takes time which makes sense I guess to some degree.

But then you guys launched new products last year.

You launched new products this year so I was trying to see -- you guys have obviously been developing new products and talking about products for the last two or three years, so does that mean you're going to accelerate that that's what you mean?

You want to accelerate and it takes time to get new products in the pipeline?

Or I guess I was having trouble making sense of that in terms of what you meant by it takes time to develop new products.

Does that mean in terms of the acceleration from where you have been historically?

Because I thought that you guys were focused on the last couple years.

Looking at our new product pipeline, it's not exactly where we would like it to be for it to be a distinguishing factor for our Company going forward.

As it is going to be a milestone and a critical factor, we will be increasing our spend towards improving and increasing the number of new products that would be coming to the marketplace.

Okay.

And then, Lori, can you talk about on a covenant relief I guess how much cushion you have there in terms of -- because I'm calculating your interest coverage in the low 2s right now.

So I just trying to see I don't know if you guys quantified that but I don't know if you could talk just in terms of if the business let's say doesn't get better over the next couple of quarters, do you have enough room or do you need the business to get better to have the cushion?

I'm just trying to understand how much cushion you have with the new covenant?

As you think about our -- at the end of our third quarter, the covenant was a minimum of 2.5 times.

We're at 2.6 so we cleared the previous covenant hurdle.

As it relates to going forward, through March it's 2.25.

We think we're in pretty good shape.

We typically don't talk at that level of detail.

We pass through in the third quarter as we have a little bit more cushion.

We thought that was prudent as we go into the springtime.

And I think we're in good shape.

Okay.

Can you guys talk about the core -- I think you mentioned the last couple quarters being seasonal returns.

Is that a different seasonal issue or is it the same thing that's kind of going over more than one quarter?

Sure.

As it relates to the core business during the third quarter, we had some sales returns that impacted our results.

I think given the flow of our operating income it probably stood out more and then it would have historically done.

And so, some seasonal purchases that was returned back by the customer.

And again I think it just kind of stood out because our results were a little lower than normal.

Did you guys call that out in the second quarter or not?

Am I remembering that incorrectly?

In the second quarter we actually had some products that changed out where we were working with the retailers to replenish different SKUs, so it was a different matter.

This was basically a one SKU this quarter, last quarter it was a different matter where it was a change out to support product at the retailer.

And, Lori, if I could just build on that another piece of the decor profitability is related to gross margin in a segment of the pottery business at the commodity side that we've seen some increases in input costs, and, due to competitive pressure in the marketplace, we've also seen some depression on pricing.

And for strategic reasons we have supported that business.

Okay.

Thank you.

William Reuter, Bank of America Merrill Lynch.

This is actually Spencer in for Bill.

I appreciate you guys taking my questions.

I was wondered if you'd be willing to quantify the amount of excess inventory versus planned increase in inventory in the quarter?

The thing that we were looking at is our businesses have different seasonality from each other as well as from quarter-to-quarter.

We had, as I mentioned earlier, deliberately built our inventories up to ensure that we did not have customer fill rate disruptions, that we're not having repeat of a couple [disruptions] last spring in 2012.

As we look at those inventory values we just want to ensure that they are at the right level.

We will take them down for there.

As you can imagine with all the number of businesses we have they have different targets, different amounts that purposed for those businesses.

So I don't think a specific target -- it's really targeted business by business looking at turns and what do we need to support the individual.

Okay.

And then in the controls business during the quarter, the promotional or the increased promotions, how much wood of that would you say qualitatively was due to increased competitive pressures or more competitors versus just the weather not being what you needed it to be

In terms of the promotional spend, it was planned spend at an investment level to initially launch these new products that we already talked about.

One of the issues that created a challenge is the controls category being down quite significantly on a year-to-date basis.

So as you look at the total revenue base for controls being lower than planned due to weather, and point-of-sale sell through rates lower than the high expectations that we had, those factors contributed to the profit story that we talked about before.

Okay.

Thanks it that's it for me.

That was the last question.

Okay, thank you very much, and thank you for your questions and for joining us on our call today.

We look forward to our next call.

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