Central Garden & Pet Co (CENT) 2016 Q2 法說會逐字稿

Greetings and welcome to the Central Garden & Pet second quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Steve Zenker, Vice President of Investor Relations and Communications for Central Garden & Pet.

Please go ahead, sir.

Thank you, Kevin.

Good afternoon, everyone.

Thank you for joining us.

With me on the call today are John Ranelli, Central's President and Chief Executive Officer, Howard Machek, Senior Vice President of Finance and Chief Accounting Officer.

JD Walker, Executive Vice President and GM Garden Brands, Niko Lahanas, Senior Vice President Operations and Management Reporting, and George Roeth, a member of our Board of Directors who will become CEO on June 1. Our press release providing results for our second quarter and in March 26, 2016 is available on our website at www.Central.com.

Before I the turn the call over to John, I would like to remind you that statements made during this conference call which are not historical facts, including adjusted EPS guidance for 2016, expectations for new product introductions, future acquisitions 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's Securities and Exchange Commission filings, including in our annual report on Form 10-K filed on December 10, 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.

Revenues in the second quarter of $541 million were the highest for any quarter in Central's history.

Our earnings of $0.65 per share were the highest for any quarter in the last 10 years.

These results exemplify the very strong performance we have enjoyed over the past two years.

In fact, it was our fourth consecutive quarter of revenue increases which have averaged almost 8% over the period.

These results reflect our balanced strategy of focusing relentlessly on increasing sales, while lowering costs at the same time.

We are committed to growing organically.

We are increasing the pace of new product introductions.

We are investing in capital expenditures to provide capacity for our fastest growing businesses, and expanding our products to new channels and new markets.

Another driver in increasing our revenues and profits is actively managing and improving our portfolio of businesses.

Our three most recent acquisitions DMC, IMS and Hydro Organics accounted for $38 million of sales this quarter.

This more than offset the loss of $10 million in revenue due to our exit from two pieces of business that were only marginally profitable.

We have worked hard to bring down costs.

We began by driving out inefficiencies.

We also reduced ineffective marketing spend.

We did this by reallocating marketing resources to areas they would have the most impact on the top line.

In many cases, this meant moving more of our efforts into the store to win customers at the point of sale.

We are also reducing the underutilization of our infrastructure that had resulted in a relatively high cost base.

More recently, we launched a low-cost producer initiative, challenging each of our businesses to lower their production costs, better utilize their capacity and their operating leverage.

This initiative is designed to strengthen the position of our businesses in their markets, and improve profits by reducing the non-demand creating expenditures.

So at the same time we are lowering production costs, we are also investing in faster growing categories by expanding capacity, product development and our sales teams.

Our cash flow, balance sheet and capital structure are strong.

We reduced our leverage ratio to 3.1 times from 4.5 times.

This underscores Central's cash flow generation capability and capital availability to invest in future growth, both organically and through acquisitions.

Based on our recent results and belief in our future, we are raising our adjusted earnings-per-share guidance for FY16 to $1.10 per share or higher.

Howard will provide more detail.

Now I would like to turn the call over to Howard to go more in depth on the financials.

Howard?

Thank you, John.

Good afternoon, everyone.

We issued a press release earlier today outlining our second-quarter financial results.

I would like to give you some color around those results.

As John mentioned earlier, the Company recorded earnings of $0.65 per diluted share for the second quarter, up 38% over the same period last year.

Consolidated sales for the quarter increased 9% versus the prior year to $541 million, due to recent acquisitions and organic growth in the pet business.

Consolidated gross profit rose 13%, and our gross margin increased 110 basis points to 31.3%.

SG&A expense for the quarter increased 10% or $10 million versus a year ago and as a percent of sales, increased by 20 basis points versus the prior year to 20.3%.

Operating income for the quarter was the $59 million compared to $50 million a year ago.

Our operating margin of 11% was up 100 basis points.

Turning now to the Pet segment.

Pet segment sales for the quarter increased 24% or $54 million to $275 million, of the increase, $38 million was from two recently acquired businesses.

From an organic perspective, our dog and cat and Animal Health revenues both professional and consumer were up significantly, with Aquatics revenues and sales of other manufacturer's products up to a lesser extent.

Pet segment operating income increased $5 million or 20% compared to the prior year.

Pet operating margin declined 40 basis points to 11.8%, due in large part to our newly acquired businesses which are still in the process of being integrated and investments for future growth.

Moving to Garden.

For the quarter, Garden segment sales decreased 4% or $10 million to $266 million.

The absence of the $10 million of sales from exited businesses mentioned earlier and lower wild bird feed sales due to a mild winter and early spring were the major factors contributing to the decrease.

Offsetting some of the decline were significantly higher grass seed revenues and higher sales of other manufacturer's products.

Garden's operating income improved 13% to $44 million, and operating margin increased 250 basis points to 16.7%.

The improvement in both operating profit and margin were driven mainly by sharply higher grass seed profitability.

Moving back to our consolidated results.

Net interest expense decreased from $12 million to $7 million.

The $5 million decrease was due to a lower rate on our fixed-rate debt as a result of the refinancing we completed in the first quarter, and lower overall debt levels resulting from our strong cash flow.

Our net income for the quarter was $33 million and diluted earnings per share was $0.65 per share, compared to $23 million or $0.47 per share in the second quarter of 2015.

Regarding our balance sheet and cash flows.

For the quarter, cash flow used by operations was approximately $50 million, compared to cash used by operations of $114 million in the second quarter a year ago.

This improvement reflects a smaller increase in organic accounts receivable and inventory during the quarter as compared to the prior year, even after the effect of a 9% sales increase and also reflects our increased earnings.

The Company's inventory balance rose $8 million from a year ago, and reflects the difference from our recent acquisitions and the businesses we are exiting.

Absent these two factors, inventories were relatively flat.

CapEx was $8 million versus $7 million in the second quarter 2015.

Depreciation and amortization for the quarter were $9 million up from $8 million a year ago.

Cash and equivalents with short-term investments decreased to $10 million from $12 million a year ago.

Our leverage ratio at quarter end declined to 3.1 down from 4.5 last year, despite the $90 million we used for three acquisitions over the last 12 months.

Our total debt decreased to $497 million from $511 million a year earlier.

At quarter end, there was $264 million available under our asset-backed credit facility.

Overall, we have strengthened our capital structure over the last year by repaying $50 million of our 8 1/4 notes, replacing $400 million of our 8 1/4 notes with 6 1/8 percent notes.

Extending our bond maturity to 2023, and resulting in savings of $8.5 million a year.

And extending our bank ABL into 2021 which we just completed in April on more favorable terms.

As our focus is to invest in growth, during the quarter, we did not repurchase any of our outstanding stock and approximately $35 million remains available under the Board approved stock repurchase program.

As John noted earlier, we are revising our adjusted EPS guidance for FY16 to $1.10 per share or higher.

This takes into account a number of factors including, an expected slowing of organic revenue growth for the Pet segment in the second half of the year compared to the unusually high 9% increase experienced in the first half of the year.

Expected SG&A expenses as a percent of sales for the second half of the year coming in above the prior year as we spend to invest in future growth in our sales teams, marketing, new product development, computer systems and infrastructure.

And uncertainty regarding how the weather will play out in our third quarter given an earlier break to the season than last year, and with a significant part of the Garden season still to come.

Now I will turn it back over to John.

Thank you, Howard.

Now I would like to introduce Central's next CEO, George Roeth, who will assume his new role on June 1.

George has an excellent record and highly successful background and knowledge in consumer products.

He also understands Central's strategy, plan, and culture.

He is the unanimous selection of the Board to be CEO.

George, would you like to say a few words?

Sure, John.

First and foremost on behalf of the Board of Directors, I want to thank John for all he has done to lead the turnaround at Central.

His dedication and his leadership leave the Company well positioned to grow and prosper in the years ahead.

And I am in the enviable position of taking the reins at a time when Central has reestablished its strong track record of delivering on its commitments to its customers, consumers employees and shareholders.

I took this role of CEO because I believe Central has a dedicated and talented team, significant potential for growth, and because the Company and I have similar values.

These include a passion for the business, a love for gardens and pets and a strong commitment to winning.

My plan is to continue to drive the strategic things that John has put in place with the leadership team.

These include driving a customer first orientation, increasing our innovation output and success rate and lowering costs to reinvest in growth.

I'm excited to be here and I am honored to be a part of this dynamic Company, and I look forward to engaging with the investment community in the months ahead.

With that said, I will turn it back to John.

Thank you, George.

Welcome.

As I get ready to hand the Central baton over to George, I cannot help but reflect back on my time as Central's CEO.

I continue to be amazed by the skill, effort, dedication and success of our management team and employees.

It was evident from my very first day, and they guided me and drove this dramatic turnaround in growth over the last few years.

I cannot thank them enough both, professionally and personally.

On a professional level, they are the people that have made our outstanding results possible.

It is they who provided the energy and spirit that has made Central today what it is, and more importantly what it will be tomorrow.

I cannot imagine a better time to execute our succession plan.

As I reach 70, we have strategy that is working, a management team achieving record performance, and a talented Board member ready to take Central to the next level.

On a personal level, I cannot thank my teammates enough.

They have given me the gift of an amazing and very emotionally rewarding CEO experience through the relationships and friendships we have built.

This is the truly unique gift I will remember and cherish forever.

Now we would be happy to answer any of your questions.

With Howard, George and me today are Niko Lahanas, Senior Vice President of Operations and Reporting, and JD Walker, Executive Vice President and General Manager of Garden brands.

Operator, please open the line for questions.

(Operator Instructions)

Jason Gere, KeyBanc Capital Markets.

Okay.

Good afternoon.

John, sorry this is our first and our last conference call together.

So I wish you the best of luck.

George, welcome aboard.

The one big question for you, George, is I know June 1 is technically I think when you come on as CEO, so we will probably wait a couple of weeks before pressuring you into an updated strategy.

Just kidding.

I appreciate that.

You know how sell side works.

But the real question here is when you look, and somewhat as an outsider, sitting from the Board and you look at some of the strategy that's been employed, what do you see as the 10 foot -- 10,000 foot big opportunity here?

Maybe bringing in some of your expertise from Clorox, sales, cost-cutting, marketing; you ran the gamut when you were there.

So I was just wondering what are some of the areas that you think you could really strengthen to Central Garden & Pet?

First of all I would say a high level, Central is in terrific categories with Garden and Pet and consumer tailwinds.

So I think we're in a good place relative to a lot of the packaged goods industry.

And I don't think you'll see any hard right-hand turns left or right for me, I've been on the Board and engaged with John and this team as they've done the strategy development work and really you can see me drive a lot of the same themes.

So customer first orientation, increasing the innovation output and success rate I think is critical, lowering costs to reinvest back in growth.

Those are all things I did in a prior life.

And I think what you'll see me and the leadership team try and do is accelerate those activities and build out the pipelines particularly around innovation and costs, so we can have sustained high likelihood of success growth over a long period of time.

Okay.

I appreciate the color.

Now, John, just to get into some of the nuts and bolts on the quarter, and not surprising, your Garden -- the grass seed was strong.

Obviously that was a great March quarter.

We heard from one of your competitors yesterday that April was not very strong.

I was just wondering if you have the data just about where POS stands versus the shipment in retail inventory?

So how are you positioned for the June quarter?

And I know you did comment about some of the uncertainty in weather, but I was just wondering how we should be thinking about the June quarter, which obviously stands to be a very important quarter for that business?

Jason, this is JD Walker.

I will take that question.

While we don't give guidance, and I'm not going to give guidance on the quarter.

I will talk a little bit about causal factors that we can impact and then others that are out of our control.

So we feel pretty good about the things that we can control.

We have a lot of season in front of us, from the end of April on there is 47% of our business still in front of us on a historical basis.

Retailer inventory levels, you mentioned, without going into specifics, I will say that in aggregate they are in an acceptable range.

We have pockets of issues that were working through, but overall in a very acceptable range.

We're going against, over the next couple of months, some relatively soft comps from a year ago, so that gives us some encouragement.

And I think the last thing that we feel very good about is the level of support that we are getting from the retailers, both promotional and display support in our stores.

So all of those things we feel very good about.

Of course the biggest unknown is weather, and weather has already impacted this season to some degree.

So that one is out of our control, but the things that we can control, Jason, we feel very good about.

Okay, great.

And then the last question and then I will turn it over to the next caller.

You were talking about organic slowing in the second -- obviously the first half was very strong.

So I guess it goes back to my question, there are categories are doing well.

I know some of that might be on the distribution side.

So I was just wondering if you could talk about maybe the channel distribution opportunities that still exist for you, mainly thinking about Pet.

I'm sure Garden is probably, on an SKU basis, there's probably some opportunity.

But if you could focus little bit more on the Pet side about the distribution opportunities that still exist and how you're thinking about it over the next one to two years.

Sure.

This is Niko.

We're excited about channel growth.

I think as we look at the Pet business, we are still under-indexed in food drug mass, so there's a lot of opportunity there for us to grow.

Also our acquisitions that we bought are also very concentrated right now.

Using actually our distribution business to gain channels within the independent channel as well as food drug mass, we see opportunity all over the place there.

So we're pretty excited about the growth going forward.

Okay.

Great.

I will turn it over to the next caller.

William Reuter, Bank of America Merrill Lynch.

Good afternoon.

I was wondering, I know that sometimes based upon weather there can be changes in the timing of shipments between the second and third quarters.

I wonder if there was anything that you would call out as being different on a year-over-year basis that impacted the second quarter?

William, this is JD Walker.

I will speak for the Garden side of the business, and then turn it over to Niko.

There's nothing significant that we would call out in shift in timing of shipments between second and third quarter.

I'm sure there's -- it's inevitable there is some carryover from one quarter to the other, but it's -- there's nothing unusual here.

On the Pet side, we saw a nice increase in our production ag business within our pro, that's really more of a fly abatement.

Hard to tell right now whether that was a timing shift or whether that's going to be incremental due to the warm weather.

So we got a nice lift there, we're very pleased with the results.

But I think it's a little too early to tell whether again it's incremental or just a timing shift.

Okay, that's helpful.

And then in your prepared remarks you talked about lowering your production costs.

I was wondering if you could give us a little more detail in terms of what exactly those changes that you were making, and when they were implemented and how they're going to impact your P&L?

This is JD again, William.

So I think that was in reference to low cost producer initiatives.

Really when we talk about low-cost producer, it's really catch-all phrase that touches on a number of different things from lowering cost of goods to improving operating efficiencies, increasing plant utilization, improving productivity, or just reducing complexity in our organization.

We have a number of different initiatives throughout both Garden and Pet that address these very issues.

The whole concept here is really to lower our operating costs, and taking a portion of that to invest it back into driving of our trial of our product, which, again, just beat that entire cycle.

We call it the conversion model; it's working very well for us.

We mentioned earlier in the report or during the script that grass had very strong margins and a very strong quarter.

I think that's a great example of our low-cost producer model, where we've taken initiatives to take cost out, reinvest it back in -- those are operating costs, and reinvest it back in the business with our retailers for display and promotion in the store to drive trial of our products.

It's all about getting the consumer to try our products.

We feel like our products are second to none in terms of efficacy, and if we can get the consumers to try them once, we convert them for the long haul.

I would like to add to that the main point to know about this is we are really just getting underway with this.

This recently started within the last year or 18 months or whatever that it really started taking off.

It's something that's going to continue on into the future.

We are looking at equipment for new products, facility improvements.

Anyway, I'll turn it over to Niko.

On the Pet side, we have a smaller example right now where we have taken in the small animal bedding in house that we used to outsource.

And we've actually been able to lower the cost there, as well, and come out with a really compelling product that we feel has the opportunity to take share.

And in the long run, maybe even grow the category because of attributes that we can put into the product.

Okay.

And then just lastly for me, you talked in your prepared remarks about both organic growth as well as acquisitions.

If you touch a little bit more on acquisitions in terms about how active the pipeline is, and what you expect your participation maybe this fiscal year to be?

This is Niko.

So our pipeline is always active.

We're always looking at deals.

It's all about timing and finding the right opportunity that makes sense for us at that right valuation.

So we don't really give guidance on any specific deals, but the balance sheet is in really good shape.

We're in a great cash position.

We're in that -- we've hit that cadence in terms of doing deals.

We did a two deals, one relatively right after another on the Pet side and we continue to look at opportunities across the entire spectrum in terms of deals that we feel will fit in nicely into our portfolio.

Okay.

I will hand it on.

Thank you.

Brian Nagel, Oppenheimer.

Good afternoon.

Hello, Brian.

First off, George, congratulations on your appointment.

Look forward working with you.

Thank you.

I have a couple -- I guess more numbers around your questions here.

First off, with regard to expense of growth: I think, John, you talked about this in prepared comments, but it did track on year-on-year basis higher here in the fiscal second quarter and then you telegraphed higher expenses going forward.

The question have there is, what's the excluding the one-time items and more trends to our items, what's the actual expense growth for the Company right now tracking?

And then when should we expect to get back to that type of ongoing expense growth rate?

This is Niko.

On the Pet side, the expense growth is really focused on around demand generation.

We're making some investments in marketing, as well as selling expense, expanding our sales force.

We're also beginning to invest a little bit more in the R&D pipeline.

So those are really the key areas around which you're seeing that expense growth.

So it's really, we're investing for growth down the road.

So to that end, any estimate on how long expense growth should remain elevated, so to say?

I wouldn't expend expect that it would remain elevated for that long for two reasons.

But primarily, the reason is that our expenses are little bit higher because we're still in the process of integrating our acquisitions.

We've just done them over the last year.

We are still the process of integrating the computer systems, rationalizing the various functions that are being done at each one, and integrated them into our fiscal distribution system and into our corporate headquarters.

Okay.

The second question, on sales in the Garden section.

You talked about weather was a benefit in Q2.

It sounded like maybe weather turned more of a headwind early here in Q3, but as far (technical difficulty) numbers we report.

If I understand correctly, weather was a factor, which would make sense.

But what was the offset to that then?

Because overall the Garden sales we somewhat detracted and broke a trend from what we saw over the last couple quarters.

Brian this is JD.

I will take that question.

So I would say weather was a tailwind for what I would call our traditional lawn and garden categories, like grass seed, which we mentioned earlier; fertilizer, our garden distribution business.

Our portfolio is a little different than some of the others that we are often compared to, and we did have some headwinds.

Some of those we communicated previously.

And to call some of those out, we [activated] the seasonal decor business, which we talked about on the last call.

We also exited an unprofitable private label relationship.

We've also talked about in the past our pottery business, that's in a reset right now, to borrow John's term, a reset for that business.

And because that's such a long lead time business, it will be 2017 before we see the improvements in the pottery or decor business.

The last item was also called out in the script and that is the wild bird food business.

So while mild temperatures were very favorable for the traditional garden businesses, it's not ideal conditions for wild bird food.

Where people tend to feed the birds when the weather is inclement, and when there is snow on the ground.

So that's just what we think is a short-term blip, not a long-term issue for the wild bird food category.

So between exiting some businesses, pottery and reset wild bird food, those are the offsets to the traditional garden business.

Very helpful.

Congratulations again.

Thank you.

Brian, I just would add to that, the only -- our primary focus, and I repeat this on each call, I think has been to take care of the bottom line.

So while we're in our fix and improve mode on the Garden side of the business, most importantly, we want to deliver the financial metrics, and we feel very good about the operating income and the operating margin improvement

Very helpful.

Thank you.

Bill Chapell SunTrust.

Hello, Bill.

Good afternoon.

Just a couple housekeeping questions to start.

Expectations for tax rate and maybe the adjusted interest expense for the full year after the refinancing?

As far as the tax rate, I think we are -- right now we're heading down lower than last year.

So we'll be looking at maybe 36% or 37% is the expectations, but that gets driven so much by profit and how well we do the second half of the year.

But that's the current estimate.

I'm sorry, I didn't catch the second part of the question.

Just the total interest or maybe the weighted average rate might be?

I really couldn't tell you off the top of my head because we've changed so many things in just the past six months.

I can tell you we've got $400 million at the 6 1/8, and our borrowing rate on the line is much lower, maybe around 3%.

And we're only borrowing against that for couple of months, but I think you could do the math faster than I could.

Okay.

And then just looking at the Garden business, and I'm just trying to understand the puts and takes.

I understand weather is still an unknown as we go forward.

But I thought a big chunk of your business is grass seed, which we've gotten through, or we're getting through the season.

So you have some pretty good visibility there.

So is that the right way to look at it?

And then also on the control side, are you seeing any early demand or incremental demand for -- related to Zika, or is that -- is a little bit different on -- I guess fire ants don't carry Zika the last I checked, but any color there would be helpful.

We need fire ants to carry Zika.

No, Bill, to answer your question, when the weather is favorable, we're seeing a nice lift in demand on the control side of the business.

You're right.

Grass is a big part of our portfolio, but we still have -- at the end of Q2 we still had 68% of our -- on a historical basis, 68% of our POS still in front of us.

Even from the end of April we still have 47%.

So we still have quite a bit of business in the -- from this point on in the second half of the year.

Weather will be a big driving factor during that period of time.

We feel like we're well positioned across all of our businesses to take advantage of it if the temperatures, if the weather cooperates.

Just add a little bit on the Zika, this is Niko.

On the Pet side, the only way Zika would really affect us is in our pro business where we work with the mosquito abatement districts, which are obviously state and local level type of agencies.

And until the funding really becomes available from the Federal Government, we're probably not going to see a whole lot of lift until we see that funding come through.

I missed that part, Bill.

So regarding Zika, some of our general purpose, our broad spectrum-type insecticides, we'll see some lift as a result of the Zika virus as people treat their yards.

But we don't participate in the personal insect repellent market, and that's where I think your seeing primarily most of the lift from Zika.

Got it.

Last one for me just in terms of -- certainly nothing against continuing to beat raise guidance, but as you look at the guidance for this year, at some point do you look to reinvest as we go into 2017?

Or when you say exceeds $1.13, how do you look at reinvestment in the back half of the year if you potentially get up above that?

We're constantly looking at our investments and the timing of those investments.

And as you've seen over the last two or three years, we've increased the level of investments in our future as time has gone on.

So I think you will continue to see our level of investment increasing.

And it is our expectation that our level of sales will exceed the level of investment resulting in SG&A as a percent of sales actually coming down in the future.

Got it.

Thanks so much.

Carla Casella, JPMorgan.

Hello.

A lot of my questions have been already answered, but somewhat related to the M&A question you got earlier.

It sounds like you're in a much better position from a leverage standpoint that you can explore some more opportunities.

And I'm wondering if you have a comfort level, how high you're comfortable taking leverage if the right opportunity were to come up?

I think we've pretty much have been consistent that we like staying in that 3 to 5 times is where our comfort level is.

And for the right opportunity, we would be willing to go above that for a time.

Still the same, same thoughts.

Okay.

It sounds like the most ideal type M&A opportunities for you tend to be with those additional third-party suppliers where you can buy the business and then continue to grow it.

Is that still the case?

Yes.

We have -- especially through our distribution business -- we have significant advantage in the acquisition process, because companies that are starting out or companies that are growing fast that need capital come to us to sell their products.

So since we are selling their products, we get to know the management, we get to know the ownership, we get to know the products, we get to know how well they are being accepted by the consumer.

So we have multiple sources of acquisitions that are coming at us at all point in time.

And as you saw, we did three acquisitions last year.

Okay great.

Thanks.

(Operator Instructions)

Kevin Ziets, Citi.

Hello, thanks for taking my questions.

Just to follow up on Carla's, I think I heard you say 3 to 5 times leverage.

I think in the past I've hear you say more in 3 to 4 range.

I don't think (multiple speakers).

You're right.

You're exactly right, I misspoke.

It is the 3 to 4 times, and we do think of, it is going over that for the right acquisition.

Okay.

On the Pet -- second-half Pet slowing that you mentioned, I didn't catch why the organic growth is slowing, what areas are being impacted of it's just anniversarying a launch.

And should we maybe expect that as we get into anniversarying, like the DMC acquisition, that maybe we'll resume a higher pace of organic growth?

The reason we stated that is if you look at our growth right now, where we're tracking in Pet, I think the first half of the year was right at about 9%.

If you look at overall Pet, the growth rate there is little over 4%.

And really the categories that we are in are tracking at a little over 2%.

So I think it's -- although I would love to continue to growth at this level, I think it's a bit unrealistic to expect that sort of growth.

I think at that point, you become the pet industry if you're outgrowing it by that much.

So I think that's where our heads are as far as the second half.

We'll do everything in our power to continue the growth, but it may be a little bit of a unrealistic expectation there.

Okay.

I just didn't know if there was anything in particular that you were up against in terms of a headwind.

My second question was around advertising and marketing spend.

It seems like I'm hearing more of your ads on the radio and whatnot.

Curious if you could give us a sense for maybe the magnitude of what you're spending, where you're spending, and maybe in general also talk about in-store marketing and what kind of initiatives or efforts you have there?

Kevin this is JD.

I will speak first on it, and then turn it over to Niko.

I'm glad you're hearing our commercials, first of all.

We have year over year increased our spend, that's not something we disclose in terms of our exact spend levels.

So I'll talk a little bit about what we're doing.

You may have seen some television commercials for our grass category.

We do advertise on TV.

A big part of our shift in our dollars though have gone from TV to radio and digital, where we have been much more intentional this year in our advertising.

We've also shifted a lot of spend, as you noted, to in store, because that's a big part of our model.

And that is converting the consumer in the store.

We want them to be familiar with our brands, we want to drive some footsteps into the store for the retailer, but most importantly we want to convert that consumer when they're in the store.

Glad you've heard the commercials.

We have invested in this area, it is a year-over-year increase and it's driving demand.

Niko?

Just to pretty much echo what JD said.

On the Pet side, our primary focus is really the in-store promotion.

We're making a concerted effort to ramp up the digital piece.

So between those two that's really the bulk of the marketing effort.

Okay.

On the Garden in store, do feel like your on par with your -- I'm not sure shelf or where your competitors are spending?

That's a tough question in that one of the competitors is significantly larger than we are.

But I would say that (multiple speakers)business, I think that in terms of the in-store piece I think we're competitive, yes.

Okay, great.

My next question was about inventory levels, and just your own inventory levels it sounded like on an organic basis were down.

And I was just curious how you feel like your positioned, if there is a stronger positive change in the weather?

On the Garden side of the business, I would say that we feel like we're well positioned.

We have taken our inventories down.

But I think we've been able to take our inventories down because we have a much more robust SNOP process, or forecasting process.

As we get better at forecasting, it's about having the right inventory.

I think we're in a better position there now that we have been in the prior years.

In prior years, we've carried much heavier inventory levels because we weren't the best forecasters.

So that improvement has helped us to lower the inventories.

Okay, great.

If I could sneak one in on the commodity outlook.

I know there's quite a few different commodities that impact you.

But maybe as a basket the grains that are impacting you this year, and maybe as you look out into next year are you doing anything to lock in the current prices?

We typically don't provide a lot of commentary on that.

I'd say our commodities have -- two comments I would make.

One I would be that they're relatively flat, and that second would be that they're relatively stable right now, which we feel good about.

Okay, great.

Last question is on your cash flows and your balance sheet.

If you -- if acquisition opportunities that meet your criteria don't come up, would you think about increasing the share repurchase basket and maybe taking leverage higher just through that activity?

Our primary purpose, as we've said, as a Company is really growth.

And that is key.

And so the first thing that we're going to be putting our capital in is working capital to grow with.

The second thing, as you've heard, as part of our low-cost producer program.

And owning and dominating the shelf from our perspective in each of our categories we will be investing in capital expenditures to lower the costs of our products, introduce lines for new products, et cetera.

And then third, would be acquisitions.

As you can see, you heard that we spent $90 million in acquisitions last year.

We are very pleased with our balance sheet, very pleased with our cash flow.

Those will be our priorities for spend in the future.

Okay.

That's great.

And, John, congratulations on a job well done and welcome to George.

Thanks.

Thank you.

Hale Holden, Barclays.

Thank you for taking my call.

Just two quick ones.

I certainly understand the algo of the two outlines between growing sales at a faster rate than the investments.

But I wanted to circle back to Bill's question about the manufacturing efficiencies that you were looking to get from some of the new lines, and then investments in capacity utilization for areas that maybe you were capacity constrained.

In terms of hopefully you can frame out maybe in terms of gross margin what you might be targeting over the next couple years in growth?

Or what we could expect in efficiency improvements from those efforts?

I think there's a couple of things that you're outlining.

First, one of the keys is that we don't have a specific gross margin target that we're working to achieve.

Our objective is to increase our gross profit dollars, which is to increase our profits overall.

Where we're investing in our programs was first in areas where we had growth opportunities that we were not able to achieve because we didn't have the capacity.

We have invested in those areas, and in fact, have achieved a significant amount of incremental sales in that area.

And that was primarily in dog and cat, and we've increased our distribution significantly.

Secondly, with regards to coming up to -- with new product, we have invested in our Aquatics business.

We are also investing in new products in our small animal business, such that we have opportunities to grow and reduce our costs.

Because what we're doing, for example, in small animal is we used to buy from a competitor.

But now since we have our own line we are going to have reduced costs that we are going to be bringing to the marketplace, and also some improved product along those lines.

So the key is for us to manage our gross profit dollars and keep our gross margin targets in balance with our gross profit dollars and go after new markets and new products, and to be able to reinvest the additional profits that we are getting in growth through point-of-sale initiatives, as well as through advertising and promotion.

Understood.

Thank you.

And then secondly, I was hoping you could give us a quick update on the three transactions you did last year.

If their all tracking to plan, if one was doing significantly better than the others.

Just puts and takes.

I'm really proud to say that all three of our acquisitions are doing significantly better than what our pro formas were when we bought them.

Great.

Thank you for the time.

I appreciate it.

(Operator Instructions)

Gregg Hillman, First Wilshire Securities Management.

Good afternoon, gentlemen.

First of all, could you give the industry growth rate for garden?

And you mentioned Pet earlier, it was 4%.

And also how those growth rates have changed over time for both segments?

Industry growth rate for Garden is -- most things that I've read is somewhere in the flat to between flat and 2%.

So call it zero to 1%.

Somewhere in that range.

As I mentioned, pet is around 4%.

In terms of how it's changed over time, I think the way we look at it is the categories have changed, the growth rates there.

So you're seeing dog and cat certain pockets of dog and cat grow faster.

If you look at aquatics, that's a category that has flattened out.

The pet bird business is -- that category would be down.

Reptile is in an upswing.

I think a lot of that when you connect the dots there, it's really tracking on the millennial generation.

Smaller dogs, urban environments.

Premiumization in dog and cat.

Millennials also favor reptiles, believe it or not, which is why we're seeing some growth there.

Not so much with -- they're not as interested in owning pet birds.

So those are the trends in growth rates that we look at.

Gregg, one other comment regarding the garden growth rate.

While it's been low, it's been relatively stable.

It hasn't really changed much in recent years.

We also saw all that during the last recession when the housing market was depressed, people continued to spend on maintenance type projects around their house, beautify their yard and so on.

So small expenditures like the lawn and garden category remained pretty robust during that period of time, or fairly stable I should say during that time.

Okay.

And in terms of the larger strategy of the Company, for your acquisitions, are you intentionally trying to reduce volatility and cyclicality going forward let's say in the garden area where you buy something that's countercyclical to what you already own?

Have you been able -- have you been able to do that successfully, and are you trending towards more volatile earnings in the future or less volatile earnings -- cyclical earnings.

From our perspective, the key is not necessarily the seasonality of business but more the growth opportunity in both sales and profits in that particular industry or particular product that we would be looking at acquiring.

We are very comfortable, as you can see, being in the garden business with seasonality.

Our Pet business is flatter from a seasonality perspective.

So seasonality is not really the key in any way, shape or form.

But what is the key is that we believe the portfolio, just like in your personal investments, the quality of your portfolio or the mix of your portfolio in terms of growth and sales and profits is really the key driver in what we're doing.

Okay.

Thanks John.

You're welcome.

Bill Baker, GARP Research.

Hello, thanks.

I'm trying to get a sense of where you're going in the flea and tick business.

It's been a tough area, a lot of me too products, but you've been successful in the ingredient side of that.

Do you see anything coming out of, for example, your investment in PureShield and ceragenin, or do you see more of your growth coming from using your brand power and distribution to try and consolidate things maybe, or pick up acquisitions in that area?

How do you see that unfolding?

And -- or do you just lay low because it's just been so brutal?

Thank you.

We always continue to look at acquisitions in that space, in all the spaces in Pet.

So that is always on our radar.

What we've seen is the topical market is a challenge.

You've got some really big players in there that have big budgets, and are spending a lot of money for that share of shelf.

We've actually seen some nice lift in our shampoos, our sprays and the ancillary flea and tick products.

We continue to look at R&D possibilities as far as new actives to put together new products in that space.

So to your point, yes, it is a very competitive category.

It's one that we're in and we continue to find new ways to try to grow our own Business.

With regard to CSA, that was a long-term investment and we are still in the early stages.

Right.

Thank you.

Thank you.

We have reached the end of our question-and-answer session, I would like to turn of floor back over to management for any further or closing comments.

Thank you very much for attending our earnings call today, and thank you very much for your very insightful questions.

Thank you.

That does conclude today's teleconference.

You may disconnect your line and have a wonderful day.

We thank you for your participation today.