Central Garden & Pet Company
Q2 2013 Earnings Call Transcript

Published: 9 May 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden & Pet's Second Quarter Fiscal Year 2013 Financial Results Conference Call. My name is Laura, and I will be your conference operator for today. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Steven Zenker, Vice President of Investor Relations and Communications. Please go ahead.

[Steve Zenker:]

Thank you, Laura. Good afternoon, everyone. Thank you for joining us today. It's my pleasure to welcome you to the call -- today's call to 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 second quarter ending March 30, 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 lower fiscal 2013 third quarter results and future increased revenue and profitability from the company's transformation and other initiatives are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by forward-looking statements. These risks are described in 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.

[John R. Ranelli:]

Thanks, Steve. Good afternoon. It's a pleasure to meet with you today for my first earnings call as Central's CEO after taking the reins in the middle of the recent quarter. In addition to touching our financial results, on today's call, I'd like to take the opportunity to share with you

[Steven LaMonte:]

Thank you, John. It's a pleasure to be here today. I'd like to begin with a brief update on how the Garden season is shaping up thus far. This year, spring began late in much of the country. March and April were much cooler than normal for the eastern half of the U.S. Last year was the opposite, with spring arriving earlier than normal. We shipped our initial sell-in to the Garden season in the second quarter, but poor early-season weather resulted in slow consumer sell-through and consequently, low replenishment of goods [ph]. Fortunately, sales at retail have significantly improved over the last few weeks. The Garden season still has a long way to go and most of the control's product season is still ahead of us. We believe we have the right products, marketing and service model in place to support our customers. As John mentioned earlier, we launched 2 new exciting innovations this quarter. For those of you who have not yet seen these new products, they offer truly innovative ways to apply control and fertilizer product formulations for homeowners. Our new AMDRO PowerFlex System was designed to provide easy, cleaner way to apply Home Pest, Yard & Garden Pest, Broadleaf Weed Killer and Weed & Grass Killer products. The new Pennington Smart Feed system is an easy and clean way to fertilize plants. With uniform release of nutrients, this innovative sprayer-and-tablet system uses less water than competitive system and better meets the demands of consumers. While the weather impacted early retail sell-through of these and other Central Garden products, we believe we are well positioned to meet the needs of consumers and our retail partners as we continue to focus on long-term profitable growth. With that, I'll now turn it over to Lori.

[Lori A. Varlas:]

Thanks, Steve. Our financial results are included in today's press release, but let me give you a little color. Our consolidated sales for the quarter increased 7% with solid revenue gains in both our Pet and Garden segment. While bird feed, which is represented in both our segments, is a primary driver of the increase. Our consolidated gross margin for the quarter decreased 90 basis points compared to the prior year due to lower margins in the Garden segment. I'll speak to the Garden gross margins in a minute. Our consolidated operating margin decreased slightly from a year ago from 9.7% to 9.4%. The lower gross margin was offset by lower SG&A expenses as a percentage of sales. Let me give some details on our segment results, starting with Pet. In the Pet segment, second quarter sales increased 6%, benefiting from strength in Dog & Cat care, professional and Wild Bird feed business. To expand a bit, in Dog & Cat care, our Nylabone brand was aided by the introduction of NutriDent Complete, a new innovative dental chew product launched in the second quarter in the pet specialty channel. We're also comparing against a period last year where our Dog & Cat care business had some shipping disruptions. Those delays resulted in some orders being deferred in the third quarter of 2012. Our professional business also did well due to increased purchasing by municipalities of mosquito abatement products and gains in the farm ag channel. Operating margin in our Pet segment increased 230 basis points, aided by a mix shift with a greater percentage of sales coming from higher margin products. Our Pet operating margins also benefited from lower selling and marketing expenses in the quarter. In our Garden segment, second quarter sales increased 8% versus the prior year. Bird feed sales increased significantly, offsetting weaker sales of grass seed. Sales of control and fertilizer products were also favorable versus a year ago, aided by the launch of our AMDRO PowerFlex and Pennington Smart Feed products that John speaks -- spoke about earlier in the call. Operating margins for the Garden segment decreased 210 basis points, impacted by lower gross margins and higher marketing costs. The decrease in our growth and operating margins in the Garden segment reflects higher marketing and promotional cost around the launch of our new Garden Product innovations and lower decor and fertilizer margins. The launch of the new Garden Products included display unit cost and other promotions that made the initial shipments less profitable than what we expect the margin will be on future orders. Let's spend a few minutes on SG&A expenses. On a consolidated basis, SG&A expense as a percentage of sales for the quarter improved to 21.4% from 21.9%. The improvement was largely due to the higher level of sales, which more than offset the increase in our marketing and selling expenses. With respect to our transformation activities, we continue to pursue savings principally in supply chain areas, which include procurement, manufacturing and distribution. In the second quarter, we completed the closure of 3 distribution facilities. Since we began the transformation, we've reduced the number of our manufacturing and warehouse facilities by a total of 8. Our second quarter results include approximately $4 million in savings related to our 2012 and 2013 transformational initiatives, offset by transformation expense of approximately $3 million. John mentioned earlier some specific actions that we undertook to reduce costs shortly after he started CEO. We should expect to benefit the second half of the year. We incurred approximately $1 million of nonrecurring expenses in the second quarter associated with these actions. John also spoke to the importance of balance in supporting our customers and reducing costs. While we're continuing to pursue transformational savings at a pace that is harmonized with other business needs, going forward, we'll only be reporting on our actual savings achieved and not on future targets. Additionally, we will not be distinguishing between transformational savings and new actions taken under John's leadership. Our Q2 effective tax rate was 35.8% compared to 36.8% in the second quarter of 2012. In terms of bottom line results, our second quarter net income was $22.2 million versus $21.6 million in Q2 2012 and our second quarter earnings per diluted share were $0.46 versus $0.45 in the prior year. Let's spend a few minutes on the balance sheet. Our accounts receivable balance was $13 million higher than last year due to the increase in sales. However, while AR was up, our DSO slightly improved. Our inventory balance at the end of the quarter increased from the prior year. There are 3 reasons for that increase. First, as we've highlighted in prior calls, we deliberately raised our inventory levels this year to ensure we could meet the needs of our customers. Secondly, we've built inventory in support of our product launches of the new AMDRO and Pennington innovations. And lastly, with a late start to the Garden season, we had more inventory at the end of the second quarter than in prior years in readiness for the Garden season. Our increase in inventory was focused on our higher revenue items and supporting our product launches and were not across the board. We anticipate the balance will decrease as the Garden season progresses. Net debt was $565 million, up from $539 million a year ago, partially reflecting our increased investment in inventory. Our total leverage ratio at quarter end was 5.1x, above our year end targeted range of 2.5x to 4x, but lower than last year's 5.5x. Keep in mind that seasonally, our borrowing meets peak during our second quarter as we build inventory for the spring Garden season. Our borrowings didn't come down significantly as we approach fiscal year end as we collect on our trade receivable balances from the Garden season and pay down our revolvers. Our capital expenditures for the second quarter were $8 million, flat to last year, and depreciation and amortization increased to $8.3 million versus $7.6 million in the prior year. We did purchase a small amount of stock for $1.5 million during the second quarter. We have $50.1 million remaining under our board-approved share repurchase program. Before we go to Q&A, I want to comment on our expectations for our third quarter. As you may recall, in our Pet segment, we had very strong third quarter results a year ago, as we've benefited from the initial sell-in of our flea and tick products in a new channel and the launch of our new innovative applicator. We will not have a similar initial sell-in benefit like last year, making for difficult year-over-year comparison. In addition, last year, we shipped some backlog [ph] orders for both pet and Garden in the third quarter. These shipments were delayed out of our second quarter in 2012, increasing our third quarter 2012 sales, making for a difficult compare. Based on these events, we believe it's likely that our fiscal third quarter 2013 results will be lower than the prior year. So in summary, we're intently focused on driving shareholder value through a balanced approach of reducing cost while growing revenue through superior customer service and product innovation. Thank you for joining us on the call this afternoon. Now John, Steve and I would like to take your questions. Operator, would you please open the call to Q&A?

[Operator:]

[Operator Instructions] And our first question is from Joe Altobello of Oppenheimer.

[Joseph Altobello:]

First question. I know you guys aren't going to talk about the transformation in particular going forward and you're kind of lumping it in with the other cost savings. But I'm just curious where that stands today in terms of the progress you made. And is the $120 million target that you put out there 18 months ago still something you're aspiring to at this point?

[Lori A. Varlas:]

Great. Well, thanks for the question. So just as, you know, recognition of what we've achieved thus far, we've talked about and integrated more than 20 separate businesses, we've consolidated facilities. We've reduced our ERP systems, we've built supply chain and shared services organizations, reduced SKU count, built master brands and additional items. And so we continue to focus on that transformation going forward. We believe there's significant opportunity to improve our results. However, we won't be reporting specifically on the $120 million going forward. We're going to work at a pace with more balance towards really focusing on our customer, growing the business in addition to achieving cost savings. So specifically reporting on the $120 million going forward, we won't be reporting on that. What we will do is talk about our profitability and accomplishments in a given quarter.

[Joseph Altobello:]

Right. I understand. I'm just curious if that $120 million is still operational at this point.

[John R. Ranelli:]

We believe that we have significant sales and margin opportunities beyond just cost reductions. Our plan is to increase profits with a balanced approach of increasing sales and improving gross margins, while still implementing cost reductions, on a timeframe that makes sense for our business and taking profits to the bottom line.

[Lori A. Varlas:]

So Joe, I think we really believe that the opportunity still exists, but the pace -- and there may be additional items that we put on our transformation list as we go forward, so we think there's significant opportunity.

[Joseph Altobello:]

Okay. And just shifting gears to the Pet price increases you mentioned earlier. Could you quantify what the impact that might be on top line in the second half?

[Lori A. Varlas:]

Yes. So we went through our -- a really detailed review of our Pet SKUs. We've taken those into account, worked with our customers. They're going to roll all of it in the coming months. We haven't quantified specifically, but we certainly think as we balance price increases with the cost of our products, it should have a positive impact on our financials.

[Operator:]

And our next question will be from Bill Chappell of SunTrust.

[William B. Chappell:]

Can you just talk a little bit -- just as we have looked at both this quarter and the third quarter, if you take out kind of the easy comp this quarter and the tough comp next quarter, kind of what would the growth rates look like? I mean, would you be posting growth for both quarters, or is it more than just the tough comp?

[Lori A. Varlas:]

So if we think about the third quarter, it's clear we're in early innings of the Garden season given it's growth late this year. So as we -- I think we're well positioned with our products and marketing, and the team is ready to go as this unfolds. So we think there's certainly opportunity to build our businesses in Garden. But if you look at year-over-year, if you take April for -- since last year, our April month was, when compared in 2011, was up in the 18% range just for that month alone, so we had a very high comp compared to April. So that being said, we've got a lot of season to go this year in 2013. And with new product innovations, we are certainly driving to build our business. But year-over-year, pretty tough comp.

[William B. Chappell:]

So would -- I mean, would your third quarter results be below a year ago even without the comp? Just want to understand like are trends improving or are they deteriorating a little bit near term?

[Steven LaMonte:]

So for the Garden business, year-to-date, we're showing slight gain from a sales standpoint. We have high expectations for in-season performance, not only resulting from the new innovations, but strong support across the board for our Garden business. But we are encouraged by recent point-of-sale trends where we're looking at nearly 20% growth for the point-of-sale on our products in the most recent period.

[Lori A. Varlas:]

And that's on the Garden side. Of course, on Pet, as we've talked about during the call, we have another tough year-over-year compare given that we had some initial sell-in and a new channel last year that obviously were now ongoing business.

[William B. Chappell:]

Okay. And then just -- one, just to make sure I understand. You -- the price increases, the cost-cutting that you're doing in the second half, that will be largely offset this year with higher marketing. So you don't expect to see a benefit to the bottom line this year, is that right?

[Lori A. Varlas:]

Well, we're certainly looking to target some of that at the bottom line, but we we're going to make smart investments. We need to support our product launches, both on the Garden side and the Pet side, and then work to improve profitability over time.

[Operator:]

And the next question is from Frank Camma of Sidoti.

[Frank A. Camma:]

I know you don't report sales by brand, but I was just wondering if you could give us some indication of how your -- and clearly seed business has been impacted, but whether you can give us any trend in the market share that you're experiencing there.

[Lori A. Varlas:]

Are you referring to our Garden grass seed, bird feed? Can you elaborate?

[Frank A. Camma:]

Yes, I'm sorry, the grass seed business specifically.

[Steven LaMonte:]

So what I'll say is that, first of all, we have had a strong performance on the grass seed business over the last few years, growing the Pennington trademark and most notably, in the premium segment of grass. It's a little bit challenging to give precise market share information. The Garden category, you may or may not know, is not tracked by most syndicated data sources for point-of-sale. Where we think we ended up last year on multiple data points was a modest share growth on the grass seed business, and the data that we have thus far, which is more anecdotal again than syndicated information, shows us that modest share growth again.

[Frank A. Camma:]

Right. So not to keep focusing on Q3, but if that's the case and we're very early in the season, obviously and obviously, the cold weather in the first quarter, wouldn't you expect to see a fairly decent gain in -- at least in the grass seed business in the third quarter?

[Steven LaMonte:]

Yes. So last year -- let me put it a little bit in perspective. Last year was a very challenging year for the grass seed category by all indications. The category actually declined about 15% last year, coming off of an exceptionally mild winter in the 2011-2012 season. So this year, we have had expectations of a stronger comparative season. Thus far, that hasn't materialized. The good news is, on the most recent week basis and 4-week basis, we see double-digit growths in the grass seed segment for us. So we're hopeful and encouraged by the warming weather in the Northeast, Southeast, the Midwest, which are the highest volume grass seed markets overall.

[Lori A. Varlas:]

We have a lot of season still ahead of us. Pretty early to call it.

[Frank A. Camma:]

Yes, yes, understand. Great. Just a clarification really on the savings or the nonrecurring charges. Lori, I think you mentioned $1 million of nonrecurring charges in the quarter. Is that correct?

[Lori A. Varlas:]

There's 2 pieces. On the going forward, these will all be merged together and shall be cleaner. So as you think about our transformation cost, we incurred about $3 million of transformation cost. And you think of what's in there, it's things like severance or you've got a workforce that might be working on 2 locations as we consolidate a location. And so pre the consolidation they're working together and you've got clean up because of the tail after we merge the 2 together, so there are some obviously costs associated with that consolidating facilities. There could be lease costs in there as you have a lease overlap period. So those are the kinds of things that we include in our transformation cost. As it relates -- there was another number I gave you, which is $1 million, and that was specifically related to the actions that John mentioned that under his leadership were taken in the most recent quarter.

[Frank A. Camma:]

And those are more severance and salary reduction-related, correct?

[Lori A. Varlas:]

Yes.

[Frank A. Camma:]

Okay. So those would hit SG&A versus the other ones that might hit cost of goods sold?

[Lori A. Varlas:]

For the most part, yes.

[Frank A. Camma:]

Okay. And a final question is just -- if you could just give us some perspective on the tax rate going forward. It was a little lower than expected. Is that something that we should kind of model going forward? Or will it creep up over time to where you were at last year?

[Lori A. Varlas:]

Okay. Sure. Happy to talk to that. So this year, and as you mentioned, our tax rate was 35.7% versus 36.8%. Now it's primarily attributable to tax credits available during the quarter. As we move forward, we expect that rate to be down maybe slightly as we make our way through the rest of the year.

[Frank A. Camma:]

Do you expect the tax rate to actually go down? Is that correct?

[Lori A. Varlas:]

Compared to the last fiscal year.

[Operator:]

And our next question will come from William Reuter of Bank of America.

[William M. Reuter:]

You noted that POS for the most recent period was up 20%. And in your -- in some of your Garden -- was that Garden or was that Pet? And then do you know how -- can you tell us how that was on a year-to-date basis?

[Lori A. Varlas:]

Okay. Yes. So what Steve was referring to was the point of sale for the last 4 weeks, what we see in the month of April. Again, the spring season came late, and he's referring specifically to gaining traction with the consumers, a takeaway through our POS.

[William M. Reuter:]

Okay. So do you have -- I guess I'm just curious how, given the more challenging results at POS early due to weather, how kind of, if we were to think about that, plus April -- so the first 4 months of the year, how that POS might have trended?

[Steven LaMonte:]

Sure. So we were down -- the category was down at the beginning of the season. The beginning of the season, just to put a perspective, is a very, very small percentage of the total garden season. So as you think about this, we have much of the garden season ahead of us, certainly for the controls business in excess of 60% of the point of sale going forward, and slightly less for other segments of Garden. So the numbers that I quoted before are for the point of sale of our products on a most recent 4-week basis, which has us up nearly 20%, which is good. But again, beginning of the year looking at calendar year Q1 was a very, very soft period comparatively to the year before. So...

[Lori A. Varlas:]

For the whole category.

[Steven LaMonte:]

For the whole category. So our expectation, we're encouraged by the 4-week and weekly trend that we see now, and weather forecasts are favorable for the highest-volume markets for the balance of the season.

[William M. Reuter:]

Okay. And then you talked about 2 challenges to third quarter year-over-year top line trends. One was the introduction of the flea and tick products; the second was the later shipments, deposit of the impacted third quarter of '12. Do you know how much the 2 sum of those might have been in dollar terms?

[Lori A. Varlas:]

We haven't quantified those. And last year, you may recall, when we talked about that, as far as trying to quantify it, we were actually in the second quarter of 2012 and the third quarter is -- oftentimes, an order might come in. And while you might not ship it that day, you might ship it the next day. So this makes it challenging to figure out in a quantitative form. But -- again, so I go back to how we performed for the quarter. And if you look at the third quarter, Garden last year is up significantly in 2012 over 2011, largely due to the shipments that slid from Q2 to Q3. And then we're comparing against that tough third quarter comp this year.

[William M. Reuter:]

Okay. And then just lastly for me, birdseed was called out as an area of strength in both of your segments. I'm curious how much of this might have been units versus price. And just to get a sense of where those key inputs are going on a year-over-year basis, the comparisons for the next couple of quarters?

[Lori A. Varlas:]

Sure. So I'm taking that in 2 pieces. As it relates to birdseed on the Garden side, it was -- volume and pricing helped us with our revenue gains. If you think about Pet birdseed, it was primarily pricing. But volume also was a secondary driver of those sales gains. And I'm sorry, can you please repeat the second part of the question?

[William M. Reuter:]

Yes, just where those input -- I guess where -- the input costs for the back half of this year, whether those are going to be at favorable year-over-year comparisons to last year or kind of at similar levels? So the milo, millet, sunflowers, that stuff?

[Lori A. Varlas:]

Yes. So if you look at -- a little broader trend, if you think about 2011 and 2012, commodity prices rose quickly and they rose steeply. And so we've spent a good part of the time chasing the pricing, trying to catch up. Those have somewhat stabilized somewhat. So our pricing has caught up and certainly helps the margins for birdseed. As we look across the summer into fall, we're really going to have to wait and see how the yields from farmers and the markets play out. So probably too early to call. As we think about most recent trends, while certain commodity costs such as sunflower have come down over a year ago, things like millets have really escalated quickly. So it's been a bit of a mixed change as far as what's higher or lower. So wait, see how it plays out in the months to come.

[Operator:]

And the next question is from Carla Casella of JPMorgan.

[Paul Simenauer:]

This is Paul Simenauer on for Carla Casella. First, I just wanted to see if -- you mentioned your pricing is out of line in Pet. Can you discuss how much of the Pet categories your end is made up of private label products?

[Lori A. Varlas:]

Yes. We haven't broken that specifically, and private label is an important component for both our Pet and Garden segments. But we haven't broken that specifically.

[Paul Simenauer:]

Okay. And are you seeing growing penetration at all in private label in the Pet categories?

[Lori A. Varlas:]

Well, I think as we think about our retailers, private label is an important part of their portfolio and it's really advantageous for us because we play in both. We work and collaborate with our retail partners in both the branded space, as well as the private label space. So they're both important parts of our portfolio.

[Paul Simenauer:]

But have you seen any penetration there? Growing penetration?

[Lori A. Varlas:]

Again, I think the longer-term trend has certainly grown over -- over the last 10 years. You certainly see growth in private label out in all categories. And again I think we play in both those spaces, which makes us nicely positioned.

[Paul Simenauer:]

Okay. And what is the typical price differential between private label and branded?

[Lori A. Varlas:]

Oh gosh, we're in so many different categories and it varies from private label to private label among our retailers. Hard to call that out.

[Paul Simenauer:]

Sure. And one last one, do you guys anticipate any margin pressure from higher corn prices this year? And are you hedged?

[Lori A. Varlas:]

So if you look at the major components of, for instance, our bird feed, it's milo, millet, sunflower and corn. Corn is certainly a component of that. So real pressure this year has come from millet. It is -- this really rose quickly and steeply this year. We'll see how next year plays out.

[Operator:]

And the next question is from David Mann of Johnson Rice.

[David M. Mann:]

In terms of what you're talking about on the third quarter for the -- for your third quarter guidance, I guess the question I would have is what kind of garden season are you kind of embedding within that guidance given the sort of Jekyll-and-Hyde nature of the season thus far?

[Lori A. Varlas:]

As we think about the third quarter again, we're early. We have seen certainly strength in the last 4 weeks. And as Steve alluded to, there's a lot of garden season ahead and I think we're well positioned to take advantage of that. The season is later. So if you think about the garden season historically, for the most part it spans Q2 and Q3. Sometimes it's heavier sales period in March and sometimes in April, May, June, more of the later part of the season. This year, it slid from the second quarter to the third quarter more heavily.

[Steven LaMonte:]

Yes. And I would just be reinforcing Lori's comments. We have 2 strong innovations in the marketplace. We have exceptional retailer support behind those innovation [indiscernible] of the Garden portfolio. The season that has gotten off to an extremely slow start, weather-related, is beginning to pick up. So we're encouraged by where we are and where weather is at this point.

[David M. Mann:]

In terms of the comment in the release about the decor business, can you just elaborate a little more what's going on there? And is that something that's -- we should expect further drag going forward?

[Lori A. Varlas:]

Yes. So as it relates to our second quarter compared to Q2 in 2012, this year we had a product launch where we had some product we've put on our retailer shelves, and that certainly impacted our second quarter.

[David M. Mann:]

Okay. And then in terms of flea and tick, I know you've called out the tough compare from the launch last year. But in general, how would you characterize how the flea and tick season has been thus far this year? And what would you expect that to -- how would you expect that to continue for the rest of the season?

[Lori A. Varlas:]

Yes. It's interesting. If you think about the flea and tick, there's absolutely a seasonality to it. There are others who buy flea and tick products year round. This year, obviously, weather impacts that. And so just like the garden season has slid, the flea and tick season has slid as well, kind of following the same weather pattern. So I think we'll just wait and see how that plays out.

[David M. Mann:]

You kind of gave a little bit of information on the Garden side in terms of POS. Has the flea and tick business sort of recovered as much in the last several weeks?

[Lori A. Varlas:]

I don't have that information available. We'll have to have the head of our Pet segment join us at some point. I don't have the point of sale in front of me. But I think with regards to flea and tick, I think we've got great products. We're well positioned and we're looking forward to the season.

[Operator:]

[Operator Instructions] And our next question will be from Gregg Hillman of First Wilshire Securities Management.

[R. Gregg Hillman:]

John, can you talk about the importance of manufacturing to the company going forward? In particular, what percentage is contracted out versus manufactured in-house? And are there certain key areas that you're going to retain in manufacturing? And also, are you going to do like some sort of big consolidation in manufacturing into some big 200,000 square plant, something like that.

[John R. Ranelli:]

As we talked about -- in the transformation, we started some of the consolidations. But at this point in time, we're evaluating our alternatives. But I would not expect in any way a major change from the way we're manufacturing things today versus our subcontracting.

[R. Gregg Hillman:]

Do you know what the mix is right now between in-house and subcontracting for the whole company?

[John R. Ranelli:]

No. It's because it's really -- I'm not sure it's a meaningful number because it's so different by business to take a look at our whole portfolio, the numbers -- just some is 100% U.S.-made, some has a larger portion. And when you take an average, it's like having one foot in one quarter and one foot in ice. It just doesn't really make any sense.

[R. Gregg Hillman:]

All right. But in addition to just sourcing and supply chain rationalization, you expect to have cost savings in manufacturing on a shop floor level 2, improved efficiencies?

[John R. Ranelli:]

Of course. As we mentioned, while we've slowed down the transformation, we still believe in the transformation going forward. And as our transformational activities that we preferred are backed up to our standards, it really makes sense for our business. We will be continuing our transformation.

[Operator:]

And our next question comes from Hale Holden of Barclays.

[Hale Holden:]

Just 2 really quick ones. On the pricing actions you're taking in Pet. I guess was curious how you feel about the elasticity of the product there and why you think you have the ability to take those pricing increases.

[John R. Ranelli:]

Obviously, doing price increases is a very delicate thing, and we took a lot of time and really analyzed just about every aspect of where we were taking the increases. And we took in -- and elasticity was a big, big factor in our analysis. We feel very comfortable that we targeted areas that we would not take a significant decline in unit volume as a result of our pricing change.

[Hale Holden:]

Great. And then just -- last question for me is -- I mean, you gave a longer-term leverage target of 2 to 4, but, John, I was wondering if you had any thoughts on excess cash or how you were thinking about capital allocation, whether it was debt repurchases, further share buybacks or M&A?

[Lori A. Varlas:]

Yes. So from a cash perspective, let me just kind of outline for you how we think about use of our cash. The first and top of our list is investing back in the business. Clearly, we want to invest in our brands, our business for growth. Behind the investment internally and our operations would be M&A, and we're always out there looking at what companies might be accretive to our bottom line, might be a good fit, whether large or small. We've got lots of relationships out there and always looking for something that might be a good fit for Central. And then the third on our hierarchy would be share buybacks, stock buybacks. But that's generally how we think about how -- the use of our cash.

[Hale Holden:]

So I guess you feel like you have -- I mean, you have a lot of balls in the air right now. Do you feel you have the ability to do modest bolt-on M&A should it occur if it was accretive -- you're not solely internally focused at the moment?

[Lori A. Varlas:]

Yes. I think it depends on what it is and what the opportunity is, but we're always keeping our eye out there. And as John described, we want balance. And so we make sure that whatever we take on, we could do a good job and deliver the benefits to the bottom line.

[Operator:]

And our next question is from Kevin Seagraves of Fort Washington Advisors.

[J. Kevin Seagraves:]

I'm curious from -- I guess with a couple of things from your -- your conversations with customers and talking about maybe there was a change in your ability to service the customers, et cetera. Have you seen anything that would indicate any kind of damage to the customer base in terms of your ability to -- I mean, just in terms of the business in general that can't be fixed?

[John R. Ranelli:]

No, not in any way, shape or form. In fact, we are started on the process, and we are seeing significant improvements already in some of our service levels. And our customers are responding very positively towards that improvement.

[Lori A. Varlas:]

This is Lori. Just to add to that, as you might recall in the second quarter of last quarter when we had -- or excuse me, of last year when we had those disruptions, it was that as we merged a couple of facilities together and it was disrupted, we worked very hard over the course of the last year to ensure that we were servicing our customer well. And I think -- and Steve can attest to the fact that we've had gained ground there.

[Steven LaMonte:]

Right. So I think discussed previously, we did impact some shipments in the beginning of the garden season last year. As John and Lori pointed out, the organization worked diligently to this point, continues to work diligently on making certain that we're ensuring fill rates that meet the requirements of our customers. And those metrics are dramatically improved this year versus last year. And I think that's one of the contributing factors that had us get the award from Walmart as Vendor of the Year after '11.

[J. Kevin Seagraves:]

I guess I was just trying to -- I guess I'm trying to understand the desire or the need to slow down the transformation if things were getting better. Had you already started to slow it down? I'm just trying to connect the dots there, I guess.

[John R. Ranelli:]

We started to slow it down last quarter. And right now, what we're doing is we're going around and finding all of the areas that are not meeting or living up to our expectations. We're improving on those areas. And as those improve to our levels of our satisfaction, then we will continue the transformation. And we'll continue it on the basis that it makes sense from both a timing and an amount to our customer, our shareholder and our management team.

[J. Kevin Seagraves:]

Okay. And then with the inventory levels where they are, I guess given the visibility you have right now, does that -- do you see that changing the way you need to run the business during the season? Or is it going to depend on the weather? Comment on that.

[Lori A. Varlas:]

Yes. So great questions. So again, just to -- the reason our inventory levels are up are really threefold. Right? One, we want to ensure we can meet the demands of our customer, and we've built inventories for that; product launches in both Pet and Garden and then of course the late garden season. We're ready for the season when we exited March. It just broke a little bit later. So that's a contributor of that increase. As we think about going forward, I think as the season unfolds we'll certainly see those inventory levels come down. I think -- based on what we know today, I think we're in good shape from an inventory perspective, and we'll always be focused on how do we improve the best use of our working capital. But these priorities really rose to the top given where we are today. But as we evolve over the coming months, I will anticipate those balances to come back down.

[J. Kevin Seagraves:]

And then you talked about taking some of the savings and investing them in marketing, and then you talked about cost to promote the products. I guess can you talk -- is that proactive because you've got a lot of new releases? Is that response to competitive activity? Can you just kind of talk about the drivers and what's kind of -- not only in this quarter but then kind of going forward, the drivers behind the marketing spend or the promotional spend?

[Lori A. Varlas:]

Sure, and I'll let Steve add to this, but this is kind of in general. We want to be strategic about how we spend our marketing dollars. In this year, we had some important product launches, and it was important that we invest behind those introductions in support of our customers, to draw the consumer to the new innovations. And so as we look at our second quarter results, we had -- those initial shipments had promotions, they had display units that impacted our results. But going forward, we certainly expect to see the profitability around those new products to pick up. So the initial investment to launch the projects -- products right and bring consumer awareness to the new innovations.

[Steven LaMonte:]

Yes. And the only thing that I would add is, as John mentioned, we're committed to accelerated profitable growth. We have 2 strong brands in Pennington and AMDRO. In the case of AMDRO and Pennington, we have 2 breakthrough innovations that demand that they be well supported in the marketplace. And we're going to make certain that we do that.

[Operator:]

And the next question is from Carter Dunlap of Dunlap Equity Management.

[Carter W. Dunlap:]

In some -- the answers to some of the earlier questions just now, I'd say it's probably the first time since December I've kind of heard and understood sort of the logic behind the slowdown of the transformation. And as you just answered, I mean, the year-ago stock up problem was sort of an early onset of the season, and then you said the first sort of movements towards changing delivery sort of performance has just been in this last quarter. So I guess my question is I know we're not going to discuss quantitatively anymore, but qualitatively, it sounds like goal 1 is to sort of make sure you get your delivery performance back up. And then would you say #2 is -- I mean, originally, we were talking about capital intensity and ultimately, long-term costs. So once you address that as the prior question or 2 questions ago, I mean, it seems like your delivery rates are already back where they ought to be. So I guess a lot of us are still confused as to why the brakes are on so much on the transformation. Maybe you could try to elaborate.

[John R. Ranelli:]

I wouldn't say that the brakes are on, on the transformation. That's just not true. We are continuing certain aspects of the transformation such as in our purchasing and also in our OpEx. So those are continuing and active and are moving at a relatively quick pace. The areas that -- where we have had our internal challenges as we've changed systems, we've changed procedures, we're just bringing those back on now, focusing on them and making sure that they're living up to our standards. And while our fill rates had gone back up or are coming back up, they're still not to the levels that we feel very comfortable with.

[Carter W. Dunlap:]

But aren't fill rates a function of working capital?

[John R. Ranelli:]

They're a function of working capital and many other things as well, including forecasting capabilities, et cetera.

[Carter W. Dunlap:]

Okay. I'm just trying to help shape what I think a lot of us are trying to figure out.

[Lori A. Varlas:]

And maybe just to help, Carter, as you think about our procurement savings, we're still pursuing those very diligently, looking to make sure we drop that to the bottom line. But as it relates to facility consolidation -- so we just completed 3 of them. We want to make sure those are completed, that the people are trained as they ought to be before we take on the next one. That might be illustrative of kind of the thoughtful process we're going through.

[Operator:]

[Operator Instructions] And our next question will come from Steve Crystal [ph] of Clark Estates [ph].

[Unknown Analyst:]

I was wondering, when you talk about the long term, what sort of economics I should be thinking about. When I look back over the recent years of this business, it seemed that the operating margins were in a range of 6% to 8%. They fluctuate a little bit, but that was kind of a range. Is that still a reasonable range to think about?

[John R. Ranelli:]

One of the most impressive things that I have seen since I have been here, that the opportunities to grow revenue and increase margins are really significant for Central. It's really too early to tell how high and when we can drive margins and revenue growth. Right now, we're totally focused on increasing our sales, improving our gross margins and reducing our costs. I believe that if we focus on these, the actual results will tell the story and we will deliver increased profits quarter by quarter.

[Unknown Analyst:]

Okay. Just as a quick follow-up, is there anything that you've seen in your short term so far evaluating the business that suggests that you couldn't do that kind of historical range that the business once did?

[John R. Ranelli:]

Again, I would just say it's too early for me to give you a read as to how high and in what time frame.

[Operator:]

And the next question is from Gary Poltash of PTA.

[Gary Poltash:]

If you look, Lori commented on balance. And if you look at the past 4 quarters of this company and certainly on the stock performance, it's been underperforming. So CENT has 2 stocks trading, CENT and CENTA, where CENTA -- where you have the Director -- Chairman of the Board of Directors controlling the voting shares and basically potentially not creating an independent board. What are you looking to do to change this impression?

[John R. Ranelli:]

I think that the capital structure and the voting structure of the company is really a board issue. I do know that the board reviews it quite often and feels very comfortable with the capital structure and the voting structure that we have.

[Gary Poltash:]

But it's not an independent board. And you've had shareholders complaining, major shareholders complaining of change -- for change. So what kind of change is the company going to institute with respect to 4 quarters of poorly performing stock price? Why should I be a shareholder of Central?

[John R. Ranelli:]

Well, I think you should be a shareholder of Central because of the business opportunities that we have in front of us. I think that we treat all of our shareholders the same. And I believe that the board considers our options with regard to our capital structure and does it in a very diligent way and feels comfortable with where we are today.

[Gary Poltash:]

I disagree. It's just -- if you had a situation where you had everybody equally voting, you would have an independent board. You don't have that, and that's what's creating a reluctancy of investors.

[John R. Ranelli:]

I believe our board considers themselves very independent and we are very comfortable.

[Gary Poltash:]

I'm sure they do, but it's perception. And that's why the stock is stuck in the mud.

[John R. Ranelli:]

Well, I'm hoping that as part of our going after the new opportunities that I talked about in sales, in gross margins, in taking our balanced approach, I think that we have significant opportunities ahead.

[Gary Poltash:]

Last question, John. Have you purchased any shares in the open market?

[John R. Ranelli:]

I have purchased shares in the open market. I think I own about 60,000 shares.

[Gary Poltash:]

That you purchased out of your own pocket money -- out of your own pocket, not option?

[John R. Ranelli:]

Some of which I paid out of my own pocket, some of which was my compensation.

[Operator:]

And next we have a follow-up question from Gregg Hillman of First Wilshire Securities Management.

[R. Gregg Hillman:]

Yes. I just wanted Steve to talk about the underlying growth of the segment for Garden. And maybe somebody could address that for Pet also or subsegments within those categories, just what the industry is growing at.

[Lori A. Varlas:]

Yes. So we've got a lot of different businesses where each of our segments are all growing at different rates. But I think from a standpoint of going forward, we hope obviously to grow faster than the market and take share. That would be our objective.

[Steven LaMonte:]

Yes. I would agree with that. And where we are in category overall is low-single-digit growth. And as Lori said, our focus is to do significantly better than that category growth rate. And the expectations that we have for this year are doing better than the category growth rate.

[R. Gregg Hillman:]

But is the category -- is each of those categories growing faster than GDP or slower than GDP?

[Steven LaMonte:]

Different categories have different growth rates. And as I alluded to in an earlier question, unfortunately, this is a category that does not have robust syndicated data reporting, similar to most other consumer packaged goods companies that might have IRI data or Nielsen data that gives you the accurate glimpse of all the individual subsegments of the category. So as you look at the published reports that are out there, what is quoted on a macro basis is low-single-digit growth. Obviously, within our portfolio, there are varying degrees of performance. And I think for competitive reasons right now, I think we'd rather not get into our own projections of where we think those segments will go going forward.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Steve Zenker for any closing remarks.

[Steve Zenker:]

Thank you for joining us today. We look forward to speaking with you again in the future.

[Lori A. Varlas:]

Thank you.

[John R. Ranelli:]

Thank you for your questions and for joining the call today. I look forward to talking to you in the very near future. Bye.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.