Central Garden & Pet Co (CENT) 2015 Q4 法說會逐字稿

Greetings and welcome to the fourth-quarter fiscal year ending 2015 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to Steve Zenker, VP, Investor Relations and Communications.

Thank you, Mr. Zenker, you may begin.

Thank you, Tim.

Good afternoon, everyone.

Thank you for joining us.

With me on the call today are John Ranelli, Central's President and Chief Executive Officer; David Chichester, Central's Acting Chief Financial Officer; J.D. Walker, EVP and GM, Garden brands; and Nicholas Lahanas, Senior Vice President, Finance Operations and Management Reporting.

Our press release providing results for our fourth quarter and FY15 ended September 26, 2015, is available on our website at www.central.com.

Also on the website is the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call.

Before I turn the call over to John, I would like to remind you that statements made during this conference call which are not historical fact, including adjusted EPS guidance for 2016, expectations for new product introductions, future acquisitions and improved and improved revenue and profitability.

Are forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements.

These risks and others are described in central Securities and Exchange Commissions filings, including our annual report on Form 10-K, expected to be filed December 9, 2015.

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.

John?

Thank you, Steve.

Good afternoon, everyone.

Thank you for joining us today.

2015 was a year of major accomplishments for Central.

The operational and financial successes we are achieving are now very evident in our financials.

They validate that the multi-year plan we outlined in 2013 is working and Central is on the right path.

In 2014, our adjusted earnings per share increased 65%, from $0.20 a share to $0.33 a share.

In 2015, it more than doubled to $0.74 per share.

This increase in earnings is indicative of the dramatic, strategic, and operational improvements our Company has and is continuing to achieve.

At the same time, we've also improved our balance sheet and our cash flow.

We reduced net debt by another $9 million in 2015, for a total reduction of $87 million over the last two years, while concurrently investing almost $60 million in acquisitions and repurchasing $15 million in stock.

We accomplished all of this by moving from an inwardly focused cost-reduction strategy to a balanced approach.

Balanced in focusing on our customers needs, while at the same time, driving greater efficiency and lowering costs.

While earnings gains now reflect some of these efforts, there are several other initiatives we started in 2015 that we expect will drive profits even higher in the years ahead.

Let me share with you some of our accomplishments over the last year.

First, we are back to where we want to be in customer service.

We're once again among the leaders in fill rates, and functioning as a strategic partner with our customers.

We are again the flexible and nimble Company our customers want to do business with.

Second, in addition to providing our customers the broadest supply of products, we are also actively helping them plan their pet and garden businesses over the next few years.

Our market-smart program is designed to provide market intelligence for our customers, to understand the changing preferences of consumers and the drivers behind industry trends.

This year, we also launched a low-cost producer initiative, with the goal of lowering our production costs across many of our businesses.

By lowering our costs, we will be able to better-protect our market share, be more successful in winning new business, increase our inventory turns, and offer the retailer and consumer a better value proposition.

The low-cost producer initiative also frees up dollars for promotional efforts and other valuable in-store activities to support our customers and drive consumer takeaway.

To give you some examples of our success in 2015, we gained shelf space in a number of places, including our branded dog chews and aquatics businesses.

We won the private label fertilizer business at a major customer.

We secured the dental chews distribution at a major club business.

We won a major dog food distribution contract.

These examples reflect our shift to a growth strategy, away from the defensive posture we adopted to correct prior inefficiencies in the Company's operations.

We now have our offense on the field.

During the year, we continued to emphasize product development.

We brought to market new products, most notably, in our dog and cat and aquatics businesses.

For example, Nylabone has always been known for premium quality, long-lasting chew toys and edible treats.

In 2015, we brought out a new product line: Healthy Edibles Wild flavors, a specially formulated line of edible chews made with real bison, venison, and salmon.

They have been well-received by retailers and consumers.

In Garden, we've test-marketed a new one-step complete product: grass seed, fertilizer and mulch, all in one.

We will be rolling this out nationally in 2016.

We are about 50% of where we want to be in our new-product development efforts.

More will be forthcoming in the future for many of our businesses.

We re-instituted our acquisition growth strategy beginning in 2014 with the purchase of Envincio.

In late FY15, we acquired IMS to strengthen our position in the high-growth edible treats and chews category.

Envincio was accretive in 2015.

IMS is expected to be accretive in 2016.

With our house now in order, we are intently focusing on the actions necessary to grow our top line.

Through increases in shelf space, increased distribution and targeted acquisitions, we are beginning to see the positive results of our efforts.

Our Pet segment sales grew 6% in 2015, and were up 9% in the fourth quarter.

Even though our Garden sales declined 1% for the year, we believe we gained market share in most of our Garden categories.

On the financial front, I mentioned earlier our increase in adjusted earnings per share from $0.33 in 2014 to $0.74 in 2015.

This came about partly from higher sales, but most importantly, from higher operating margins.

We have worked hard to rationalize our spending and more effectively utilize our resources.

We have eliminated inefficiencies and reallocated spending to areas we believe will get the highest return on our investment.

One other area I would like to address is the management changes that Central expects in the upcoming calendar year.

Regarding my planned retirement late in 2016, which we previously announced, the Board is very engaged and is taking the lead in the search for the right CEO.

With the Company's strategic and operating foundation in place for growth in the years ahead, we will be looking for a candidate who will continue our strategy and culture, and build on the successes of the last few years.

Our Acting CFO, David Chichester, who stepped in on an interim basis this summer, is expected to return to the Board in February of 2016 and be available as needed.

We are in the process of positioning our key senior financial officers to assume David's responsibilities in an orderly fashion when he completes his tenure as Acting CFO.

To summarize, 2015 was a great year for Central, and as I said, I couldn't be happier with our results.

Now I'd like to turn the call over to David to go over the full-year and fourth-quarter financial results.

Then I'll be back to discuss some thoughts for 2016.

David?

Thank you, John.

Good afternoon, everybody.

Earlier today we issued our press release.

Over the next few minutes, I'll provide some financial highlights, starting with an overview of the year, before moving to the quarterly results.

As John indicated, our Company reported a robust increase in earnings per share for the year, up 124% on an adjusted basis, to $0.74 per share.

For comparability purposes, I will be using adjusted figures on the call, except when I indicate otherwise.

The adjusted numbers take into account the effects of a $7.3 million non-cash intangibles impairment charge in our Pet segment in the fourth quarter, as well as a $16.9 million charge for the discontinuance of garden products in 2014.

Also in 2014, there was a $4.9 million gain on the sale of garden plant fixed assets, $2.9 million of which occurred in the 2014 fourth quarter.

Consolidated sales for the full year increased 2% versus the prior year.

Our consolidated gross profit rose 4%, and our 2015 gross margin increased 40 basis points to 29.6%.

SG&A expense for the year declined 3% or $13 million versus a year ago, and as a percent of sales, declined to 23.6% from 25% in the prior year.

Operating income for the fiscal year rose nearly $99 million, a strong gain of 45% or $30.5 million compared to 2014.

Our operating margin is 6%, was up from 4.2%.

We're delighted with the progress made in increasing our operating profit and margin.

For the full year, Pet segment sales increased 6%, or nearly $50 million to $894 million, on the strength of increased dog and cat and professional revenues, as well as higher sales of other manufacturers' products.

Pet segment operating income increased $18 million or 20% compared to the prior year.

And operating margin rose 150 basis points to 11.9%.

Higher sales and lower SG&A expenses increased both Pet operating income and margin.

Our dog and cat, flea and tick, and professional businesses drove the increase in operating profit margin.

For the year, Garden segment sales were down 1% or $9.7 million, attributable primarily to a drop in grass seed and decor revenues.

Despite the sales decline, Garden operating income rose 13% to slightly over $60 million, it's second most profitable year ever.

And operating margin increased a healthy 110 basis points to 8%.

The gains in both operating profit and margin were driven by higher controls and fertilizer sales, and higher gross margin in those businesses through a favorable product mix, as well as lower SG&A expenses.

Moving to the fourth quarter results, although the fourth quarter has been a loss quarter for Central in recent years, we are very pleased that adjusted earnings turned positive this year.

Starting at the top line, consolidated sales for the quarter increased 3% over fourth-quarter 2014, on the strength of pet sales.

Gross profit dollars were relatively flat compared to the prior-year period, while gross margin declined 80 basis points to 27.9%.

Both our Garden and Pet segments contributed to the decrease.

SG&A expense as a percentage of sales declined significantly by 340 basis points, due in part to a decline in corporate expenses, principally the non-recurrence of $5.9 million of software costs in the prior-year period.

Operating income rose by over $10 million to $8.6 million, compared to an operating loss of $1.5 million in the 2014 fourth quarter.

Operating margin improved 2.2% compared to a negative operating margin in the fourth quarter of last year.

Now I'd like to give you some color on the quarterly results by segment.

Pet revenues grew 9% versus the fourth quarter of 2014, on strength in most of the pet categories.

Dog and cat was the fastest-growing category, benefiting from two months of sales from our IMS acquisition, as well as higher revenue in our Nylabone business.

Higher professional businesses with the natural higher professional revenues in the natural insecticide business-analyzed stock production business contributed to the increase.

Also, our pet distribution business, which as you know, distributes products manufactured by other companies, achieved higher sales, benefiting from an expanded relationship with a food, drug and mass customer, and increased sales in the e-commerce channels.

Pet operating income for the quarter increased 21% to $25.5 million compared to $21.1 million a year ago, and margin increased 110 basis points to 10.8%.

Both benefited from higher sales and lower SG&A expenses in our flea and tick, small animal, and dog and cat businesses.

Partially offsetting those gains was lower profitability in our aquatics and equine businesses.

Garden segment sales for the fourth quarter declined 4% versus the same period a year ago, due primarily to a decline in grass seed sales, which continues the weakness experienced in that category over the course of the year.

Less weather-related lawn damage, the timing of sales to a major retailer and, to a lesser extent, lower export sales through a stronger dollar, were factors in the sales reduction.

Decor sales were down this quarter, due to lower promotional spending and unfavorable product mix.

Higher wild bird feed revenues and higher sales of other manufacturers' products offset some of these weaknesses.

Garden operating income for the quarter was about $1 million compared to $3.6 million in the fourth quarter of last year.

Operating margin declined to 0.6% compared to an adjusted 2.3%.

The chief cause of the decline in operating income and margin was lower profitability in the decor category, which we are now resetting in 2016.

This category is impacted by lower volume and unfavorable product mix, inventory reduction and unanticipated rework costs.

Partially offsetting decor weakness were higher operating margins in our grass seed and wild bird feed businesses.

Moving back to our consolidated results for the quarter, net interest expense decreased $1.1 million from the prior year to $8.6 million, primarily due to lower average borrowings, including the impact of the redemption of $50 million of our 8.25% senior subordinated notes in the second quarter of 2015.

Our adjusted net income was $285,000, and diluted earnings per shares were $0.01, comparing favorably to an adjusted loss of $5.9 million or $0.12 a share of fourth quarter of 2014.

I'll wrap up with a quick review of our cash flow and balance sheet.

By the way, these are all GAAP numbers.

For the full year, cash flow from operations was $87 million.

Fourth-quarter operating cash flow was $31 million.

The Company's inventory balance rose by $9.6 million from a year ago to support increasing sales of existing products and the IMS acquisition.

Full-year 2015 capital spending was $22 million, modestly below our historical annual run rate of $25 million.

We would expect 2016 to be somewhat above historical levels, as we build capacity and businesses that are experiencing a high level of demand, and as we continue our low-cost (technical difficulty).

CapEx for the quarter was nearly $4 million versus $3.5 million in the fourth quarter of last year.

Depreciation and amortization for the year was $33.7 million, down from $35.8 million a year ago.

Our debt declined $50 million to $400 million, and significantly improved our financial flexibility.

As per the bank credit facility calculation, our leverage ratio at year-end declined 2.8 times, down 4.4 times.

At the end of the year, there were no borrowings outstanding under the credit facility, with $384 million of availability.

In fact, for the majority of the year, we had no credit facility borrowings.

Interest expense for the year totaled nearly $40 million, down from nearly $43 million in 2014.

In early November, we refinanced $400 million of the 8.25% coupon notes at a very attractive 6.125% offering of eight-year notes, saving 2.125%, cutting about $8.5 million of annual interest expense.

The issuance of our new notes and the redemption of the old notes will result in a first-quarter charge to interest expense of approximately $8.3 million related to the payment of the call premium and a $3.2 million non-cash charge of the write-off of unamortized financing costs.

Additionally, we have an overlap of one month interest expense from the old and new notes that had a $2.8 million impact.

In total, we expect a $14.3 million charge for these three one-time items in the first quarter of FY16.

During the quarter, we did not repurchase any of our outstanding stock, and approximately $35 million remains available under the Board-approved stock purchase.

Now I'll turn it back over to John to provide some perspective on the year ahead.

Thank you, David.

I would like to now share some of the additional actions we are undertaking that we believe will have an impact on 2016 and beyond -- initiatives that should allow us to grow our top line and further our goal of being the supplier of choice to our customers.

I spoke earlier about the organic growth we achieved in 2015 due to retail distribution gains.

These gains, along with our initiatives to increase capacity in our faster-growing areas like dog and cat and our pet professional business, will allow us to keep up with strong demand, as we release new products and seek additional markets for our goods.

We are also beginning to determine how best to grow our international business.

Currently, we have a business based in the UK we are looking to leverage, to expand in Europe.

We are in the early stages of this initiative, but we believe Europe could be an attractive growth area.

We will be working hard this year to better-utilize our capacity to gain additional sales, balance our gross profit dollars and gross margin initiatives.

We want to leverage our fixed costs across a greater number of units, to lower our per-unit costs.

We are increasing capital expenditures in 2016, not only to increase capacity in certain key businesses, but also to make some strategic moves that we think will have a positive effect on our margins.

Beyond these steps to grow organically, we have increased our focus on growing Central by acquiring businesses that participate in categories that are growing and fit in well with our current operations.

As I mentioned earlier, we acquired Envincio, an organic pesticide company, in 2014, and IMS, a dog treat and chew company, in 2015.

Just a few days ago, we closed on a $61 million acquisition of the leading dog and cat bedding company.

This acquisition gives us an instant presence in a large category of the dog and cat market.

I should note that typically, it takes several months for the profitability of our acquisitions to reach a somewhat normalized level.

We do expect our newest acquisition to be accretive in the first year.

With strong cash flow and significant borrowing capacity, we expect to continue to be an active acquirer in the years ahead.

The recent refinancing of our fixed-rate debt provides us with a strong capital base for years to come, and reduces our annualized interest expense by $8.5 million in future years.

While adjusted 2016 first-quarter earnings are expected to be relatively flat compared to a year ago, due primarily to revenue timing differences, we are confident that we can attain adjusted earnings per share for 2016 of at least $0.95, or a gain of 28%.

This includes the interest savings from the refinancing, and excludes the one-time costs that David mentioned earlier.

So to summarize, we are excited, very excited, about Central's future.

With a strong team contributing to our success, we realized significant operational achievements, sales gains, profit increases and balance sheet improvements in 2015.

Finally, with the initiatives we are now executing, we believe Central's future is very bright in 2016 and beyond.

Before we open the line for your questions, I would like to introduce J.D. Walker, who has 18 years of experience in the garden industry, and runs our branded Garden business.

Also, Niko Lahanas, Senior Vice President, Operations and Management Reporting, who has been with Central for almost 10 years and has extensive knowledge of our operations.

Both are examples of the depth and experience of our management team, and are available today to answer any of your questions.

Operator, please open the line for questions.

(Operator Instructions)

Brian Nagel of Oppenheimer.

Congratulations on a nice quarter.

I had a couple of questions -- more than that -- but I guess, first on the financial side.

You guys discussed this a little bit in your prepared comments, but as we look at the cost side on the P&L, you leveraged costs, you controlled costs very well this quarter.

Going forward, should we think about that as -- was there anything one-time in nature there?

Or was that more of a sustainable trend which we model going into 2016?

This is David.

We think that's sustainable.

We continue to appropriately focus on our cost savings opportunities under the program we refer to as low-cost producer, which enables us to be more competitive, to also defend our existing position.

So we feel comfortable on where we are heading with that.

As we've outlined before, we have a balanced strategy, where we are growing sales and improving margin and reducing costs at the same time.

We believe there is still more costs to reduce as we go, and become more efficient in the future.

Got it.

I -- (multiple speakers)

This is David again.

I would add also that, I think as we mentioned with respect to capital spending, we're looking to put those dollars to work in the businesses that have the most demand.

And that also includes on the manufacturing side for us, and distribution, as well, just becoming more efficient and effective at what we do.

Got it.

And then the second question I have I guess is a little shorter-term in nature.

But if you look at the sales [route], a bit weak in the Garden segment.

To what extent did weather impact that business?

And I think the temperatures could be normalized somewhat across the country.

Have you seen a rebound in sales since the quarter end?

Hi, Brian, this is J.D. Walker.

I will take that question.

Yes, weather did certainly play a large factor in our business this year.

Let me first speak to grass, which is -- our grass seed business-- which is a significant portion of our portfolio.

It was a challenging year.

We had a well-publicized drought in the West and Pacific Northwest.

We had flooding in other parts of the country.

We had not as much lawn damage in the mid-Atlantic and Northeast as we anticipated, therefore, there wasn't a need for a lot of repair for lawns.

We have seen, to answer your question, some rebound in that business in the fall.

And I won't get into any detail on that, but we have seen that strengthening.

So we believe a more normalized grass seed season is in front of us.

Well, thank you very much.

No, thank you.

Bill Chappell of SunTrust.

Anything you can kind of quantify, in terms of the data you gave us, as we look towards next year?

In particular, you said CapEx would increase.

Any kind of rough idea where that would be?

New product launches -- how that would compare versus new product launches over 2015?

Also, any initial thoughts of what you think the categories, both Pet and Garden, will grow over the next year, and what the health of those categories look like?

Hi, Bill, this is Niko.

I will talk a little bit about the Pet segment, regarding your question.

CapEx, on the Pet side, it's going directly into both expansion and innovation.

We are looking to come out with some pretty exciting new products there.

As far as -- I'm sorry -- what was the second part of the question?

CapEx, the number of new products expected in 2016 versus 2015, in just a rough -- is it 30% more, is it 20% more, or is it just more?

And then also overall growth rates in the Pet and Garden category, for the category growth?

As far as how much more, we typically don't give out that information.

We think it probably will be more than 2015.

But in terms of the exact percent, we typically don't give that out more.

As far as the growth rates in Pet, we see the categories there as being pretty healthy.

Dog and cat, obviously, are the leaders there.

We're seeing some nice growth in the trees business.

The other businesses remain stable.

We feel like we've seen sort of a bottoming out in aquatics.

So we feel like we are really well-positioned in a lot of those categories.

Okay.

Switching just to Garden, I think, John, you alluded to winning some fertilizer business.

How big is the fertilizer business?

And also on that, we had talked last quarter about maybe -- I think it was last quarter -- a greater push into private label.

Maybe an update on how that is going, as well?

Bill, I'll stay away from providing specific guidance on how big the fertilizer business is.

But that was a significant win for Central.

We continue to pursue private-label business that's important to us, to our portfolio.

It drives more throughput through the plant, as you know.

It makes us more efficient, and lowers our overall operating costs, which benefits both the private-label businesses, as well as our branded businesses.

In terms of where that business is going from here -- was that the second part of the question?

Yes, just in terms of private label, I think we had talked in prior quarters that, that was going to be a greater focus of the Company.

I didn't know if this was just one part of that strategy, and whether you expect to pick up more private-label business in the coming quarters?

We will continue to pursue private-label business.

But I don't know if that's necessarily a shift in focus away from our branded business.

Actually, we find that it supports our branded business.

We find it puts us in a more strategic relationship with the retailer, as you work with them on their proprietary brand, and it gives you more leverage with that retailer.

And what we try to do is leverage efficiencies or expanded business for our branded business through the private label.

Bill, this is Niko again.

As far as private label on the Pet side, as J.D. -- I just want to echo what he said -- we look at this private-label business as: someone's going to do that private-label business.

And the way we view it on the Pet side, is, it may as well be us.

We can provide that quality and that service level to our retail partners.

Sure.

Last one for me.

With where the balance sheet stands, is it safe to say you have about $500 million-plus of capacity for M&A?

I can't remember if there was a leverage ratio you were comfortable getting up to for M&A?

This is David.

Yes, you're pretty close.

And we would temporarily -- this would deal with an acquisition, if there were one -- be willing to take our target leverage, which is about 3.3 [times], and we like to stay in that three to four times range.

But we could live at the upper end of that range for a period of a few months, as we integrate an acquisition.

Again, we feel very good about our financial capacity and the flexibility we've got today.

Got it.

Well, congratulations on the year.

It's been a long time coming.

Thank you.

Thank you.

William Reuter of Bank of America/Merrill Lynch.

In terms of the most recent -- the pet bedding acquisition, is there any way you can provide us any sort of financial metrics -- I guess that could be before or after the synergies you guys expect to achieve?

It's been our historical practice, which we will continue, not to provide specific financial information with regard to our acquisitions.

Okay.

When you were doing the most recent bond deal, you guys talked about how you guys have built this Company, being able to buy brands largely in the six-times range.

But you then followed up with saying that you didn't know if you'd be able to build the business again at those types of multiples.

As we think about the next going-forward period here, where you guys are going to be focused on M&A, should we expect that those targets will likely be in that same context?

Or how do we think about that?

No.

I think that our whole objective will be to buy brands and companies at the lowest multiple that we possibly can.

And I think we've been able to do that in the acquisitions that we've done, especially at an outright purchase price.

But more specifically, our percentage is -- we've been very comfortable with the prices that we've paid.

And as I mentioned, our acquisitions are accretive in their first year.

Given that you guys just completed an acquisition, how robust would you say the pipeline is for 2016?

Are you talking about the acquisition pipeline?

Yes.

We continue to see a lot of deals coming our way.

I think people know that we are an active acquirer.

I think people know that we are a growing business, and acquisitions are a part of our modus operandi, part of our heritage.

I think people know that we have the cash to buy it, and we have the management team to implement and consolidate them into our Company to achieve the synergies that are available in acquisitions.

So I think we are in active player in that market, and people know it.

Okay.

Just one last one for me.

Assuming you guys didn't make large acquisitions, how would we think that stock repurchases for 2016 will probably look?

As I look at our cash loan requirement, our whole strategy is to grow our Company.

And the first place that we are going to put our cash flow is in working capital, to grow our businesses.

The second place that we're going to put it is into capital expenditures.

As we talked about during our presentation as well as in Q&A, our whole low-cost producer program is specifically aimed to make sure that we have capacity for growth, lower costs, and are able through additional lines -- manufacturing lines, I'm talking about -- to grow our businesses.

The third area that we will grow is as we just talked, in acquisitions; we're an active acquirer.

And the fourth would be to reduce our capital base.

But I think you'll see as we go forward into this year, that with our strategy of growth, there are things available for us to grow through increased distribution, as well as acquisition.

Okay, all right.

Thank you very much for the time.

You're welcome.

Karru Martinson of Deutsche Bank.

Just on the warm seasonal weather, does having the season extend late into this year change at all the outlook, in terms of spring?

Do people buy more grass seed as you come in, having used their lawn longer, as we ramp up for the new season?

This is J.D. I don't know that it sends any indication of spring.

Again, the largest a single causal factor that impacts our business is weather, and you can't project spring weather based on fall weather.

However, what it has done is, worked down inventories at store level, which should give us a head start as we head into the spring season.

Okay.

There was a lot of talk over the summer, a large retailer looking for amended payment terms and fees from its vendors.

Has that process played out?

Do you feel comfortable with where you stand with that large retailer now?

This is J.D. Again.

I will make a comment now and turn it over to Niko.

First of all, with regard to customers, we have a policy about making too many statements about the customer.

I don't know whether they would appreciate us talking about their strategy.

But I will say this: we have almost a four-year relationship with that retailer.

We've worked very closely with them.

I would call it a collaborative partnership that we have with them, and we've worked closely with them as they implement their new strategies.

So their new strategies are going to impact our businesses a little -- they'll have varying degrees of impact on our businesses.

But I would say, in aggregate, we feel very good about the go-forward plan with that particular retailer.

I would echo -- this is Niko -- I would echo what J.D. has said.

We view most of our -- all of our retail partners -- as partners.

And really, a lot has been made out of that in the news, but we see that year in and year out, as far as our partners go.

And we want to see them be successful, and we'll be successful at the same time.

So it's nothing that we are overly concerned about.

Okay.

And lastly, when we think about the pipeline of M&A opportunities, should we think of them as solely garden and pet?

Or are there other areas that you would look at as you grow your business?

We think -- we really believe in the garden and the pet businesses that we have.

We think that those are two great businesses or two great segments, to begin.

We have some great expertise in those areas.

We have great relationships with our customers.

And the size of that, of both of those industries, is significant.

We believe we have all the opportunities that we could use within these industries, and there's no need to go outside of them.

Thank you very much.

Appreciate it, guys.

You're welcome.

Carla Casella of JPMorgan Chase and Company.

You talked how you're turning from defense to offense on the revenue side of the business, and some new contracts.

As you go forward, could we see you getting a little bit more aggressive to grow sales at the expense of gross margin?

Or do you have a certain margin threshold that you like to keep your margins above, given the spending for new products, et cetera?

No.

Our total strategy is to balance gross margin and gross profit dollars -- to be at the pinnacle, if I could say that, of the margin or percentage in units that occur.

We feel very comfortable that we're going to be able to reduce our cost, to improve our margin by our low-cost producer program, by putting more units out through incremental distribution.

We feel very comfortable that we will be able to reduce our under-absorption in some of our factories by doing this, which will all offset any potential declines in the margin.

When you also include private-label business, as you go forward, we believe those units will also allow us to increase our gross margins.

Another factor is that our new products that are coming out, we are targeting higher gross margins than we have in our current product line.

So all in all, although there will probably, for example -- the current of the last two acquisitions that we've been talking about today, have lower gross margins -- I think that's, essentially, on an initial basis.

And as we put our programs in place, we expect them to improve.

And the other programs will allow us to increase our gross margins over the longer haul.

Okay, great.

Thank you so much.

You're welcome.

Hal Holden of Barclays.

You mentioned a couple of times distribution gains, and I was wondering if that was on-shelf in the same retailers, or if that was new retail partners that you'd gained initial distribution on?

And akin to that, the two recent acquisitions that you just closed on, do they have the same kind of distribution network that you're currently serving?

Or are they potentially new avenues for you?

Great question.

The distribution gains are with our current customers, and they enter in new channels of distribution, which we plan to continue doing into the future.

And what was a second part of your question again?

The pet bed business that you just bought, does that have a similar kind of distribution mix to what you are currently serving, or is it potentially different channels?

That is another great question.

The reason is that there are two types of synergies.

One is the synergies that you get from cost reduction.

But second and more importantly, in our view, is that we have distribution channels that we can bring these products into, which would significantly increase their revenues above where they are today.

Both of those are very applicable, with regard to both of those acquisitions.

Got it.

And then my last question is, I just was hoping to pin you down a little bit more on CapEx.

I've heard you say you are going to increase it a couple times here on the call.

Is that potentially doubling it, or just incrementally higher than where you were this year?

If you could give us a range?

Our CapEx this year came in at around $22 million, $23 million.

I see us taking that up to about $35 million next year, as we go forward and invest in our growing businesses.

Great.

Much appreciated.

Thank you.

(Operator Instructions)

Kevin Ziets of Citigroup.

My question was on the -- you mentioned European growth strategy, and I'm curious what segments you think have potential there, what the competitive landscape is like?

And it sounds like you want to do it organically rather than maybe working through distributors, if I'm understanding that right.

So if you could help us understand the decision process there?

Sure.

This is Niko.

We already have an existing business in the UK.

It's primarily on the pet side.

So initially, what we're looking to do is to grow that, to really start pushing our own pet brands into that business, and really gaining a bigger beachhead in the UK, for now.

Later on, we will explore Continental Europe.

But for now, we're really looking to grow that UK piece of the business, really using our own brands to support that growth.

Okay.

And what kind of investments are needed, I guess, to help get that business grow?

You know, not a ton there, because we have a business there.

We have distribution, we've got a sales force.

So we've got the necessary overhead to make that happen.

There will be incremental spend, promotionally and on the marketing side, but it's all very variable in nature.

So the fixed piece is really there and ready to go.

Okay, great.

The other question I had was just on the commodity outlook for next year for some of your key exposures, and how you're thinking about pricing?

This is Niko again.

The commodities we're primarily in, we're seeing they are pretty much flat to down.

There's really no real earth-shattering news there.

The retailers obviously know this, so we're seeing pricing being flat, commodities being relatively flat.

Barring some unforeseen event, we are anticipating that to continue on.

Okay.

And do you have pricing mechanisms in the private-label fertilizer business, if there were to be changes there, that you could respond to?

In other words, (multiple speakers) plus-plus, or are you hedged [store]?

Without getting into specifics here, we have an opportunity once a year, as we meet with our retailers, to take pricing.

Our pricing this past year have been surgical, not unilateral.

We take pricing when we have justification for it.

Given that commodity costs have been relatively flat, there's been no need for any significant movement in pricing.

If there had been any extreme movement in commodity pricing, that would call for pricing outside the cycle, which the retailers -- we've gone to them before when we've had that need.

Okay, great.

And then just a couple of quick ones.

On the M&A side or on the leveraged target side, was that a gross target, the three to four times?

Or is that a net number that you think about?

That is a gross number, so that the target would be a little bit different if we took into account the cash.

And the cash, as you probably know, varies up and down.

As we enter the current season, we'll start instituting our borrowing under the bank ABL for seasonal working capital needs.

Okay, great.

And then, my last question was just -- you mentioned, I think, some sales timing was going to impact the first quarter, and I was wondering if you could elaborate on what that is?

Because it sounded like you said inventories were pretty clean.

I think that was related to our grass seed business.

Last year, there was an order that (technical difficulty) right at the end of our fiscal year.

This year, that order shipped after the end of our fiscal year, in the first quarter.

This is Niko.

On the Pet side, last Q1, we hit, actually, a record for any Q1 that Pet had ever done.

So as you can imagine, once the quarter ended last year, I thought: wow, we had a really great quarter.

And then I thought a little bit more, and I thought: oh, we've got a really hard comp to go up against.

So I think that's where we were thinking it's going to be flat on the Pet side.

Because we did set a new bar, if you will, last year, on the Pet side.

Which is a good thing; it's a great challenge.

And we're going to really work to hit it.

Okay.

But you still think you could be up in the pet business for the full year, organically?

Again, we're not going to give out more projections other than the one EPS projection that we put out there.

As you know, we increased the amount of information that we are providing, and the guidance that we're giving.

So we feel very comfortable, having given the EPS guidance of the 28% increase.

Makes sense.

Thank you.

At this time, we have no further questions in the audio portion of this conference.

I would like to turn the conference back over to Management for closing remarks.

Well, thank you very much for attending our conference today.

And thank you very much for your great questions.

We look forward to talking to you again next quarter.

This concludes today's teleconference.

We thank all participants for their participation today, and you may disconnect your lines that this time.

Thank you, and have a wonderful rest of your day.