Central Garden & Pet's (CENT) CEO George Roeth on Q4 2016 Results - Earnings Call Transcript

| About: Central Garden (CENT)

Central Garden & Pet Company (NASDAQ:CENT)

Q4 2016 Earnings Conference Call

December 01, 2016, 04:30 PM ET

Executives

Steven Zenker - Vice President of Investor Relations and Communications

George Roeth - President, Chief Executive Officer, Director

Howard Machek - Acting Principal Financial Officer

Nicholas Lahanas - Senior Vice President of Finance Operations and Management Reporting

J. D. Walker - President of Branded Garden Business

Analysts

Bill Chappell - SunTrust

Brian Nagel - Oppenheimer

Frank Camma - Sidoti & Company

Bill Reuter - Bank of America Merrill Lynch

Kevin Ziets - Citigroup

Gregg Hillman - First Wilshire Securities Management

Mei Chang - JPMorgan

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's fourth quarter and fiscal year 2016 financial results conference call. My name is Tim and I will be your conference operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Steven Zenker, Vice President of Investor Relations and Communications. Please go ahead.

Steven Zenker

Thank you Tim. Good afternoon everyone. Thank you for joining us. With me on the call today are George Roeth, Central's President and Chief Executive Officer, Howard Machek, Senior Vice President, Finance and Chief Accounting Officer, J. D. Walker, President, Garden Branded Business and Nicholas Lahanas, Senior Vice President, Finance Operations and Management Reporting.

Our press release provided results for our fourth quarter ended September 24, 2016, is available on our website at www.central.com. Also on the website is the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call.

Before I turn the call over to George, I would like to remind you that statements made during this conference call, which are not historical facts, including EPS guidance for 2017, 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 filing, including our Annual Report on Form 10-K intended to be filed later today. 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 our CEO, George Roeth. George?

George Roeth

Thank you Steve. Good afternoon everyone. It's great to be with you today. The fourth quarter ended with what was a very successful year for Central on a number of fronts. I will leave the quarterly numbers for Howard to cover but I do want to highlight some of Central's 2016 achievements.

First, Central's topline growth of 11% was the highest in 10 years, driven by acquisitions and meaningful organic growth. The largest impact was in our pet segment, where our acquisitions of IMS and DMC helped drive pet revenue growth up 21% for the year. Over a third of the company's revenue growth was organic and was above category growth in the majority of our businesses. Pet's organic growth was 6% while garden also grew organically by 2% when adjusting for the holiday decor business that we exited during the year. These revenue gains reflect the key strategic goal for the company, driving sustainable topline growth through a laser-eyed customer focus and increased investment in demand creating activities. I will talk a bit more about this later on the call.

Second, Central achieved meaningful cost savings during the year, which was reflected in both the 60 basis points gain in our gross margin and a 50 basis point decline in our SG&A as a percent of sales, even with increased investment for future growth.

Third, we continue to position our portfolio for the future. We exited the holiday decor business which had not been profitable for us and added DMC, the largest pet bed manufacturer in the U.S. We also worked on integrating our other purchases from late 2015, IMS and Hydro-Organics. On top of all of this, we worked diligently on identifying new opportunities, which led to our purchase of Segrest, the largest provider of wholesale aquarium fish in October 2016. We are excited about the prospects of our overall aquatics with Segrest in our portfolio.

Finally, during the year, we refinanced our fixed rate notes and renegotiated our ABL line of credit reducing our interest costs by over $8.5 million annually.. The increased revenue and cost savings from all these actions resulted in GAAP EPS of $0.87 compared to $0.64 the prior year. Adjusting for the items that Howard will detail in a moment, 2016 non-GAAP EPS climbed to $1.26 from $0.74, an increase of 70%. Well, of course, this magnitude of EPS growth is not sustainable, and we do expect to continue to be able to generate consistent growth in both revenues and earnings in the future. I will be back to give you some insight on our initiatives as we move forward after Howard goes through the financials for you.

Howard, take it away.

Howard Machek

Thank you George. Good afternoon everyone. We issued a press release earlier today outlining our fourth quarter and fiscal year financial results. I will be using non-GAAP numbers in some instances, which exclude the effects of certain items during the year and the prior year to make it easier to compare our results.

The 2016 non-GAAP numbers excludes four items. One, $14.3 million of charges in the first quarter related to the refinancing of our fixed rate notes. Two, a $2.4 million gain on the sale of plant assets in our third quarter. Three, $1.8 million of non-cash intangible charges in our fourth quarter that affected operating income. And four, $16.6 million of non-cash impairment charges in the fourth quarter related to our investment in two joint ventures that did not impact operating income and shows up below the line in other income and expense. In 2015, there were non-cash intangible charges of $7.3 million in the fourth quarter, all of which impacted operating income.

Since George did such a great job covering some of the highlights of the year, I will start with the details of the quarter. Starting at the topline for the fourth quarter, consolidated sales rose 7%. Excluding businesses we purchased and exited impacting the year, organic sales grew 2.6%. Consolidated gross profit rose 11.3% and our gross margin increased 120 basis points to 29.1%, benefiting primarily from Central's exit from the holiday decor business.

SG&A expense for the quarter increased 6% or $6 million versus a year ago and as a percent of sales declined by 20 basis points to 25.5%. We do continue to expect SG&A to increase as we invest for future growth.

Operating income for the quarter rose to $13 million compared to $1.3 million a year ago. Our operating margin of 3.1% was up 280 basis points, due primarily to the lower pet impairment charges versus a year ago as well as the absence of the holiday decor business.

Net interest expense decreased from $9 million to $7 million. The $2 million decrease was due primarily to a lower rate on our fixed rate debt as a result of the refinancing we completed in the first quarter of our fiscal year.

Our net loss for the quarter was $5.6 million and our diluted loss per share was $0.11 compared to a loss of $4.4 million or $0.09 per share in the fourth quarter of 2015. Non-GAAP earnings per share excluding the impairment charges in both years was $0.13 compared to $0.01 in the fourth quarter of 2015.

Turning now to the pet segment. Pet segment sales for the quarter increased 14.9% or $35 million to $270.7 million. Pet organic growth was 2.6%, which was widespread across many of our pet categories. Pet segment operating income increased $4.3 million or 23.8% compared to the prior year quarter, and includes the benefit of the lower charges for the intangible impairments that I mentioned earlier. Pet operating margin increased 60 basis points to 8.3%, impacting both operating income and operating margin, our investments made in some of our businesses to drive growth in the years ahead.

Moving to garden. For the quarter, garden segment sales decreased 5.3% or $8 million to $142.8 million. The impact from our exit from the holiday decor business was $13.6 million, which was partially offset by organic growth. Adjusting out the sales from that exited business, it was generally a good quarter for the garden segment which saw organic revenues grow 2.7%. Higher sales of other manufacturer's products and increased grass seed revenues were the largest contributors to the organic growth. Garden's operating income increased to $2.7 million and operating margin rose 130 basis points to 1.9%. The improvement in both operating profit and margin were due in large part to the exit from the holiday decor business which was not profitable as well as lower raw material costs and manufacturing efficiency improvements. Those lower costs more than offset increased costs related to moving and increasing capacity in our garden distribution business.

Turning to our balance sheet and cash flows. For the quarter, cash flow provided by operations was approximately $61.8 million compared to $30.8 million in the fourth quarter a year ago, driven by an increase in cash flows from working capital accounts primarily receivables as well as stronger operating performance and better management of our working capital.

The company's inventory balance rose $26.1 million from a year ago and reflects the increase from our recent acquisitions, partially offset by the business we exited. CapEx was $8 million versus $4 million in the fourth quarter of 2015 as we invested in the quarter and as we expect it to continue to do so in fiscal 2017 to support future growth.

Depreciation and amortization for the quarter was $11 million, up from $9 million a year ago. The primary drivers of the increase were one, we wrote down or accelerated the depreciation on some assets we don't intend to use going forward and two, the impact of the additional amounts related to our recent acquisitions.

Cash and equivalents, including short-term investments, increased to $93 million from $48 million a year ago and our total debt was relatively flat at $395 million. Subsequent to the end of the fiscal year, we made two strategic moves to strengthen our product portfolio. In October, we purchased Segrest Inc. for $60 million. And in November, we sold our veterinary products business, which represented approximately $8.6 million of sales in fiscal 2016 and was not profitable for us. We ended the quarter with a leverage ratio of 2.2 times, down from 2.8 times a year ago.

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.

Now I will turn it back over to George.

George Roeth

Thank you Howard. I would now like to talk about our key strategies and initiatives as we move forward. These are fundamental to our efforts to achieve sustainable revenue and profit growth and ultimately increase shareholder value in the years ahead. The key change vectors are accelerating Central's portfolio momentum, increasing our innovation output and success rates and driving higher value cost savings and productivity improvements. At the same time, we expect to continue to build upon and leverage our strong differentiating customer relationships.

There will be a cost to driving these changes which will slow down earnings growth in the near-term to drive shareholder value creation over the longer term. The first change vector, accelerating portfolio momentum, is about aligning our array of businesses around higher growth. This starts with managing each business differently based on its role in the portfolio and strategy.

For example, it is critical to designate which businesses are being managed more for topline growth and may need incremental demand building investment and which are being managed more for profitability and align those businesses with the appropriate resources and capabilities to drive more profit. In cases where business is performing poorly, on both the top and bottom line, does not have a competitive advantage and has no path to improvement, we have to take a hard look at that business. It maybe that we need to alter our strategy and see if we can make a difference. If we can't find a path to acceptable profitability, we will consider exiting as we did with holiday decor and veterinary businesses.

Another important element of creating more portfolio momentum is leveraging our strong cash flow to make successful acquisitions. We like to ideally acquire businesses where we can leverage our capabilities and grow faster than the company average. We have talked in the past about acquisitions that we have made over the last 18 months, The IMS treats and chews business, the DMC pet bedding business and Hydro-Organics, a small organic fertilizer business, all are performing well and are meeting or beating expectations and we are investing and expanding these businesses.

In addition, in late October we purchased Segrest, the largest wholesale supplier of aquarium fish. We are excited about this business. It's a natural fit with our existing aquatic business gives Central an even broader array of aquatics products that are second to none. Segrest comes with a highly knowledgeable and seasoned management team that is remaining with the company. The wholesale live fish category is $350 million and we believe that Segrest's market share of that highly fragmented and often localized category is roughly three times the next largest competitor. We are confident that we can continue to leverage their superior capabilities and scale for consistent market share growth as well as coordinate with our existing aquatics business to drive incremental mutual growth.

Increasing innovation output and success rates is another important change vector in which we are focused. Developing differentiated products that grow the categories and are value add to our retailers and consumers is instrumental in helping drive revenue growth. For example, this spring we will be introducing a new slow-release high-efficiency fertilizer under the Pennington Ultragreen brand. This product utilizes a technology that we believe is unique in the market, yields better results and requires less water. We believe this is a winning on-trend proposition.

Innovation, however, is more than just about a new product. It can encompass how we talk to our consumers or how we go to market. We have been increasing our overall investment not just in R&D but in consumer insight and demand creation activities, including digital, to an appropriate level for each business to drive sustainable growth. Innovation can also do more than just drive topline growth. It can also contribute to a lower cost structure. Developing improved products while at the same time creating a step function reduction in the cost to produce that product is truly a win-win win for Central, its retail partners and consumers.

A good example of this is our reformulated Pennington One Step Complete patch product for lawns which debuted in the spring of 2015. We successfully developed a better and more cost effective mulch that goes into the product and while doing so we created a more efficacious product. This allowed us to promote the product more aggressively in stores, thus increasing and profits for us and our retail partners.

Finally, we are also keenly focused on driving more pure cost savings and productivity improvements. These efforts provide the fuel for growth, both topline and bottomline. We are focused on developing for each business a three-year lien of sight on initiatives to reduce cost, consistent with that business' potential around the company portfolio. These actions extend to manufacturing, procurement, distribution and administrative areas of the business. They are sometimes business specific or can relate to the entire enterprise.

To this end, we have hired Bill Lynch as our new Senior VP of Operations. I have worked with Bill in the past and I am confident he will be a meaningful resource to the organization in a number of ways. First, he will be instrumental in helping the company think strategically for the long term. In partnership with our business leaders, Bill will also be looking at lowering or cost by helping optimize our supply chain footprint, improving our operating efficiency and facilitating coordination across our businesses by sharing best practices and aligning for scale.

One example in the area of supply chain optimization is in our small animal business, where we have made significant manufacturing changes. For example, we brought in-house the manufacturing capability to produce our small animal bedding. Not only will this lower cost on a superior product, but we have been able to bring out new colors and fragrances more aggressively.

Another example would be in our dog and cat business where we are taking seven facilities and combining them into two larger facilities, adding capacity while increasing efficiency by reducing the complexity of producing, packaging and shipping these products.

Finally, in our garden business, we recently opened a new garden distribution center in Eastern Pennsylvania and closed one in Taunton, Massachusetts. This puts us closer to our customers, some of our fastest-growing vendor partners and adds capacity to support our growth.

All of these efforts, be it manufacturing, procurement, distribution or administration, are expected to drivers of cost savings and higher margin in the years ahead while ensuring we can meet the growing demand we expect in these businesses. There will be some negative impact on margins in 2017 as we incur the cost to make these types of changes going forward. The benefits from these cost savings initiatives will likely not start to be felt until late 2017 and to 2018. But even with these additional expenses, we would still expect our margins to grow during the year.

We are very fiscally disciplined as we invest in the business and hence, we fully expect fiscal 2017 earnings per share to grow to $1.34 or higher despite increased level of spending to drive future sales and profit growth. With upside hinging on the strength of the garden season, the timing and efficiency of transitioning to the new facilities we are opening and whether the recent deceleration in growth in the overall pet industry that we discussed on our last call continues.

Fiscal 2017 also has 53 weeks compared to 52 week for 2016. That extra week however comes at the end of our fiscal year, which seasonally is a much less meaningful quarter for our garden business. That extra week is expected to add approximately $0.01 to the year's EPS, so not a big impact. Finally, we would expect our CapEx to be between $40 million and $45 million for 2017 as we continue to invest in the future.

I would also say that while we were reluctant to and are not going to be giving out annual revenue guidance due to our small size, seasonality and third-party nature of our distribution business, I can say over the long term, we expect to outperform our categories organically and to add at least one to two acquisitions annually similar in size to IMS, DMC and Segrest. That means we should be averaging, let me repeat, averaging 2% to 3% organic revenue growth with M&A adding to that figure. However, it should be noted that we don't control the timing of M&A and therefore, do not depend on it for our annual plans and guidance.

Now we all would be happy to answer any of your questions and operator, please open up the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Bill Chappell of SunTrust. Please proceed with your question, Bill.

Bill Chappell

Thanks and good afternoon.

George Roeth

Hi Bill.

Howard Machek

Hi Bill.

Bill Chappell

George, as we are looking to the 2017 EPS guidance and I understand it's at least $1.34, but just trying to understand, do you expect meaningful gross margin expansion? Is there opportunity this year and that's just being offset by higher SG&A or is it more leverage off the topline growth on G&A?

Howard Machek

Well, we expect, first of all, earnings obviously to grow faster than sales, so margins must expand. We are not giving gross margin or operating margin guidance, but I will tell you, our cost savings projects are heavily weighted in the gross margin area and we would expect our gross margins to be improving on a great number of our businesses.

Bill Chappell

Okay. And then on Segrest, and I am sorry if I missed it, could you give us a rough idea of what the revenue base was for that business just for modeling purposes? And then do you expect any synergies out of that business? I mean it's a different business from kind of what you have, so maybe if you could help us understand how that works with your existing business going forward.

George Roeth

We are not giving out the revenue base of Segrest. We can tell you, we paid about $60 million for it. We are public with that. So you can probably make a decent estimate as to the size, given the valuations that we pay. There are synergies on both the cost and revenue front. They are stronger on the revenue front. We think there's a lot we can do between coordinating the live fish business where they are clearly the leader in the marketplace. In our overall aquatics business, we are going to be the biggest and I would say broadest soup to nuts aquatics business in the industry. And there's a lot we can do, simple things, in terms of leveraging their retail sales force in-store for the overall aquatics business as well as leveraging our sales force to help extend their penetration.

Bill Chappell

Okay. And just last one for me. Maybe you can give an update on what you are seeing in the overall pet channel. I know we have heard over the past three or four months about some tightening, some weakening in the pet specialty channel, and I didn't know if you are seeing that, if that's being offset by the mass in the other channels? And what you see as we move into 2017.

Nicholas Lahanas

Bill, this is Niko. Yes. We are seeing the same thing. When I look at my Nielsen reports, we see overall pet growth decelerating. One thing to keep in mind is what those reports are tracking. Obviously, Nielsen is not tracking e-commerce, which is growing more rapidly than the brick-and-mortar. We don't really have the independent channel reflected there nor do you have the club channel. So we are seeing the same thing, but again we are going to control what we can control, which is making the best products and outpacing those industry growth.

Bill Chappell

Okay. Great. I will turn it over. Thanks.

Operator

Our next question comes from the line of Brian Nagel of Oppenheimer. Please proceed with your question.

Brian Nagel

Hi. Good afternoon.

George Roeth

Good afternoon.

Howard Machek

Hi Brian.

Brian Nagel

Congratulations on another nice quarter.

George Roeth

Thank you.

Brian Nagel

So with regard to – I think you said on a call on the 2017 plan, maybe drill down a little bit more if you can to just possibly think about the actual expenses that are weighing upon earnings, mostly to the amount and maybe the cadence through the year. It sounds like you are expecting to get some benefit on these or are starting to get some benefit at least from these issues in 2017. But just to be clear, should we look to the first couple or first half of the year to be more impacted by the expenses associated with these initiatives than the second half?

George Roeth

You were tough to hear. So let me play back what I thought you said. You are trying to get an understanding of how the expenses will be paced and the impact in the gross margins over the year. I will have Howard or Niko jump in if I get it wrong, but I do believe our expenses tend to be more front loaded than back loaded. A lot of our major capital spending initiatives, the dog and cat facilities projects which I talked about, hit the first half of the year significantly more than the back half.

Brian Nagel

Okay. I am sorry about my cell. So maybe it's not as clear as it should be. But then also, just as we think about the investments you plan to make in 2017, could you help us get to like how much of those expenses are incremental expenses, those incremental investments will actually be?

Howard Machek

We are not giving an incremental investment. What I can tell you is our capital spending target this year is $40 million to $45 million, which is a significant upgrade or I should say up-spending from what we are currently doing in 2016, which was $34 million. So we spent $34 million in capital this year. Next year we are projecting $40 million to $45 million, which should give you a sense for the order of magnitude of change.

Brian Nagel

And the second question I had, with respect to weather. We have been talking about weather quite a bit. In your business and maybe you can expand this line and talk about the cadence of sales through the fiscal fourth quarter. But weather, has it been more of a benefit to you? Or is it still a hindrance?

J. D. Walker

So Brian, this is J.D. I will respond to that question. From a weather standpoint, both for the fourth quarter and what we have seen extend into the fall, we have heard this on retailers' earnings reports as well as some of our competitors, that the milder weather was favorable for the lawn and garden category, and I would say that was the same, that was our experience, as well.

Brian Nagel

Okay. Thank you.

J. D. Walker

Thanks.

Operator

Our next question comes from the line of Frank Camma of Sidoti & Company. Please proceed with your question.

Frank Camma

Hi. Good afternoon, guys.

George Roeth

Good afternoon.

Frank Camma

Hi. I know a couple of people who have drilled down on this, but maybe ask it a different way, because, George, I think you said the negative impact to your margins would be more weighted towards the first half of the year. I just want to make sure, you are talking more from a SG&A or more from a cost of goods sold? That wasn't clear to me.

Nicholas Lahanas

This is Niko. So a lot of these expenses are hitting the pet side and we are going to see a little bit in both, to be honest with you. So hard for me to break out what exactly is going to be hitting the growth in that EBIT margin, but you are going to see it in both buckets.

Frank Camma

Okay. Fine. Fair enough. The other question was, it was good, I liked the table with the organic, obviously bringing out the organic in the press release. But I was wondering if you could just talk, I am assuming, well I have an assumption about it, but maybe you could just clarify how much of that was price versus volume, that organic growth?

Nicholas Lahanas

So on the pet side, this is Niko again, almost entirely volume. Right now being in the deflationary environment that we are all seeing, there is not a whole lot of pricing being taken, at least in our businesses. So I would say that probably 90% was volume.

J. D. Walker

And Frank, it's very consistent on the garden side of the business as well. It's from volume primarily.

Frank Camma

Okay. Great. That's what I assumed, which leads to my next question which is, due to the obviously pretty favorable commodity picture, are you getting much pushback from the retailers to go the other way? Typically, you get a lag on your pricing going forward, but are you getting any pressure to give back? Have you felt that?

J. D. Walker

So Frank, J.D. again here. I think you know our customers well and you know the way they do business with their vendors. And I think that while we have had favorable commodity cost, you can look at retail pricing in the marketplace and see that some of that's been passed through already. Our retailers pay very close attention to the commodity markets themselves. So that's an ongoing dialogue really. So while it's been favorable this year, I wouldn't say that it's a long-term and accretive trend for us.

Frank Camma

Got it, okay. My last question is just on the vet business. That was purely, obviously you called out the sales, they are not a huge dollar amount. Was that more of a financial reason you got rid of it? Or more of a strategic?

George Roeth

It was absolutely strategic. We evaluate our portfolio on an ongoing basis and it's a situation where we really take a hard look in the mirror and say do we have a right to win in this category? And this is a very specific category, the vet channel and it's not one that we have really had the requisite scale to win in that category. And at some point, the business becomes a pretty big distraction and we decided to focus more on our core businesses.

Frank Camma

Okay. A last one if I could. Did you get any benefit at all from just mosquito care or anything like that? or was that really not meaningful this year?

J. D. Walker

Frank, we got some benefit. This is J.D. again. We got some benefit from that in our insecticide business, more in our multipurpose type insecticides. But we would not get to see the same benefit of others that are playing in the insect repellent business like the Spectrum Brands or SC Johnson.

Frank Camma

Okay. Great. Thanks guys.

George Roeth

Thank you.

Operator

[Operator Instructions]. Our next question comes from the line of Bill Reuter of Bank of America Merrill Lynch. Please proceed with your question.

Bill Reuter

I have a question on the acquisition from October. You mentioned that you weren't going to disclose the multiple, either from a revenue or EBITDA standpoint, but you said it was kind of in line with what you guys traditionally pay. Can you remind me what you guys goal is in terms of what multiples you would like to pay from an EBITDA perspective?

Howard Machek

Typically, we like to pay between six to eight times EBIT.

Bill Reuter

Okay. And that's from EBIT. Okay. And then you mentioned that you expect to grow faster than the industry. I am wondering if you could share with us a few of the reasons why you expect your growth will outpace that of industry growth.

George Roeth

Well first of all, we have been doing it. So we have had a track record, particularly recently of our ability to do it. Second of all, we tend to be leaders in a lot of the categories in which we compete. For example, wild bird feed or the biggest aquarium manufacturer in North America. So we have strong market shares in the categories we compete, which we believe gives us scale and competitive advantage. Lastly, we are feeling strongly about our innovation pipeline. We have had a lot of recent success and I have described some of them in the talk, for example on the Pennington grass seed business, where we booked share in the current year.

And I also believe there's a lot of opportunities that won't necessarily show up in the reports you see, for instance, in private label where we have excess capacity. My predecessor John Ranelli would talk quite a bit about that as we look for ways to leverage our operations. So we are a low-cost producer in a number of categories and have excess capacity and we have been actively pursuing private label business and successfully garnering that, which is helping us well. So given the recent track record and the opportunities we set out in front of us, we are not worried about our ability to grow share over time.

Bill Reuter

Okay. And then lastly for me, the last time I had heard a leverage target from you guys it was in the low threes. You are obviously a lot below that now but you guys still didn't do any additional share repurchases in the quarter. Can you remind us or maybe update us on where you guys want your leverage to be?

Howard Machek

Based on how we are viewing the business now, we are refining that to a comfort range of three to 3.5 times. So we would still be willing to go outside that just like we have always said, for the right acquisition. But that would be our intention to bring that right back down.

And I would also say, our primary priorities for the use of capital are for the current operation and you are seeing us dial up our capital investment there, particularly to drive cost savings and build capacity, grow our businesses and then M&A obviously being a key area of focus that we continue to keep active.

Bill Reuter

Okay. I will hop out and allow others to ask questions. Thank you.

Howard Machek

Thank you.

Operator

Our next question comes from the line of Kevin Ziets of Citigroup. Please proceed with your question.

Kevin Ziets

Hi. Thanks for taking my question. The fourth quarter, it looked like the pet operating income was down, if you exclude the impairments from the prior year. And I think you called out that that was due to some of the investments that you are alluding to going forward. So maybe if you could just talk about in the quarter, what those investments were and where they hit P&L, whether it was COGS or SG&A, to give us some flavor for where we might see them going forward.

Howard Machek

Sure. Most of those expenses hit in the SG&A and I will briefly go through them. The selling expense was up about $3.4 million. A lot of that had to do with the DMC acquisition. So that added some selling expense. We also increased selling expense in our pro business where we added some heads, specifically in the production ag business which, by the way, was up 22% this year. So we were very pleased with the performance there. We also added some extra heads in our pet distribution business due to the growth there as well. Another area that went up in SG&A was marketing. Again, we spent some money behind brand development as well as consumer insights, primarily in our avian and small animal business, aquatics and pro business.

Nicholas Lahanas

And I want to add, we have started incurring some of those costs on those facility moves that we have been talking to you about. So some of those costs are also starting to impact our SG&A.

Kevin Ziets

Okay. That's helpful. And is that the magnitude of what we might see going forward? Or is that not a fair read there?

Howard Machek

The magnitude, I think that it's hard to answer because we are going to evaluate each business and each opportunity as the quarter goes. But I think what you can look for is continued investment and continued demand creation across our businesses, because we are really prioritizing growth and outpacing each category.

Kevin Ziets

Okay. You may have touched on this before, but you have given some good guidance around how the topline might look. In the past, you have talked about not being as focused on margin as much as margin dollars or margin percentages versus margin dollars. And given that some of growth might be more in private label or professional, should we not expect much out of margin percentage going forward still? Or do you think that the combination of efforts around innovation and whatnot, that we should see both topline and margin accretion?

Howard Machek

I think what we are striving for is really a balance. So we are going to do private label where it makes sense, where we have added capacity, where we can round out a category and really attack the shelf with our brand and a private label product. We are also going to continue to innovate and bring new products to the shelf that may have higher gross margins. So it's really a balance between the dollars as well as the percent. So we don't really want to get caught up with one or the other. It's not really a one or the other question in our mind.

Kevin Ziets

Okay. You mentioned bringing some production in-house. Is it more likely to be the case that you will make moves like that going forward? Or are there outsourcing opportunities as well that you are evaluating?

Howard Machek

I would say we are optimizing. So we are looking at each business and there are some specific examples where we have actually outsourced a product that we have recently produced and a number of examples where we have actually in-sourced. And the small animal bedding was the one that I gave you. So it's both and we are going to find the best, most cost-effective way to meet the customer's needs where possible.

I did want to add on tuck-in line, I did want to correct one thing before looking through our notes. I want to clarify, the capital spending for this year, we are projecting to be $40 million to $45 million. Last year, we came in at $28 million, actually. The actual number.

Kevin Ziets

That sounds right. What is the balance between in-house and outsourced manufacturing at this point, roughly?

George Roeth

We are not going to give out that number for competitive reasons. So that's not something that we reveal. Although we do a fair amount of both. So it's not extremely skewed either way.

Kevin Ziets

Sure. And then lastly, I guess just two more. Could you remind us where you are in terms of in-store presence and your thoughts around whether that effort needs to be enhanced at all or pulled back?

George Roeth

Can you clarify what you mean by in-store presence?

Kevin Ziets

I guess I mean having in-store reps during your busier seasons as well as when you are launching new products?

J. D. Walker

Kevin, this is J.D. I will speak to the garden side of our business. We do have a dedicated in-store merchandising team, sales and merchandising team, that work with our largest retailers across the country. And it's a pretty significant investment on our part. And it's a big part of our go-to-market strategy and that is converting the consumer in the store. So whether it's through pricing, off-shelf displays, packaging, we want our merchandisers in the stores to ensure that we have multiple locations, the discretionary space on the floor and driving incremental sales.

Kevin Ziets

Is that your own team or do you outsource that function?

J. D. Walker

That's our own dedicated team. Those are Central employees.

Kevin Ziets

Great. And then lastly, if you could just comment on, you mentioned you are encouraged about innovation for next season. Is there anything in terms of quantifying space gains or maybe distribution wins that you could call out at this point?

J. D. Walker

So for the garden side of the business, I will have to be a little bit cautious in what I say here because a lot of the products haven't hit the stores yet. The retailers will be setting their stores for the spring shortly after the holiday. But we feel very good about our going-in position right now, both in terms of distribution gains, expanded distribution and listings, as well as in-store support from the retailers.

Niko?

Nicholas Lahanas

Yes, I would echo that on the pet side. I think if you looked at our overall shelf space, it's filling up at the major retailers on the pet side and we are pretty excited about that.

Kevin Ziets

All right. Thank you guys.

George Roeth

Thank you.

Operator

Our next question comes from the line of Gregg Hillman of First Wilshire Securities Management. Please proceed with your question.

Gregg Hillman

Yes. Good afternoon. George, what do you consider to be the synergy between pet and garden? What's the synergy between those two businesses and why should they stay together?

George Roeth

Well, that's a broad question. First of all, we do have some common customers, for example, Walmart. A lot of the basics of consumer packaged goods, innovation, innovation processes and how you think about innovation, consumer insight is similar. Yes, they are in different categories, but much like there's business across our pet businesses that are rather different, but all rolled up under pet. So we are not troubled by pet and garden being together. There's a lot of synergies just in how you approach packaged goods industries. And I also want to make one other point, when you think about the distribution business and independent garden as well as independent pet, those businesses have a lot of similarities, can learn and leverage from each other.

Gregg Hillman

Okay. And have you said publicly how much money is invested or how much capital is involved, is tied up in both businesses, both fiscal capital and working capital?

George Roeth

I don't think we disclose that number.

Gregg Hillman

Can you talk about it now? Or you would rather not?

George Roeth

Rather not.

Gregg Hillman

Okay.

George Roeth

Those are not numbers that I would roll off the top of my head. I will tell you that.

Howard Machek

The only thing we could tell you is that internally, we do track it very closely. We look at the return on net controllable assets very closely. It's not something we are ready to share with the public.

Gregg Hillman

Okay. Thanks for your comments.

Operator

[Operator Instructions]. Our next question comes from the line of Carla Casella of JPMorgan. Please proceed with your question.

Mei Chang

This is Mei Chang, on for Carla. So you mentioned, saying how high margins in 4Q. Should we see a bigger impact on 1Q as a result? And if you could give us a number for sales of holiday decor in 1Q of last year?

George Roeth

You were tough to hear. It sounded like you wanted understand the impact of the holiday decor business?

Mei Chang

Yes.

George Roeth

Can you be specific about what you wanted?

Mei Chang

Yes. So as more a margin impact of any sales or large impact specifically we should look for in 1Q in comparison to? And then maybe a number from last year's 1Q, so we can gauge how much we would have got?

Howard Machek

What we can tell you is the $13.6 million that impacted us in Q4 is its largest quarter. So it's smaller than that. And I don't remember the number off the top of my head. And as far as the earnings from it, we didn't have any in that Q1. So the comparisons will be much easier than this quarter, let's put it that way.

Mei Chang

Okay. Thank you.

Operator

There are no further questions at this time over the audio portion of the conference. I would now like to turn the conference back over to George Roeth for closing remarks.

A -George Roeth

Thank you everybody. We appreciate your time and we will talk to you in a quarter.

Operator

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.

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