Central Garden & Pet Co (CENT) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Central Garden & Pet fiscal third quarter 2009 earnings conference call.

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

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

(Operator Instructions).

As a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce Mr.

Paul Warburg, Vice President and Treasurer for Central Garden & Pet.

Please proceed, sir.

Thank you, operator.

Good afternoon, everyone, and thank you for joining us.

With me on the call today are Bill Brown, Central's Chairman and Chief Executive Officer and Stu Booth, our Chief Financial Officer.

Before I turn the call over to Bill I'd 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 expected further margin and capital efficiency improvements, are forward-looking statements.

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

These statements 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 the Company's earnings press release, Form 10-K, for the fiscal year ended September 27, 2008, and in other Securities and Exchange Commission filings.

Additionally, the discussion on this call may include the use of non-GAAP financial measures.

We have provided a reconciliation of the measures to the nearest comparable GAAP measure in our earnings press release, which is available on the investor relations portion of our website at www.Central.com.

Today's agenda is as follows.

Bill will provide a brief business update and Stu will review the financial results for the quarter.

We will then open the call up for Q&A.

Our plan is to keep the call to approximately one hour.

I will now turn the call over to Bill Brown.

Bill?

Thank you, Paul, and thank you for joining us this afternoon.

My plan today is to provide an update on the business and the operating environment.

Overall, we had an excellent quarter in terms of earnings and balance sheet metrics.

Our business is considerably stronger and we are cautiously optimistic that this momentum will continue.

Turning to the quarter, we made progress against our three core operating objectives.

Compared to the third quarter last year we improved gross margin percentages by over 300 basis points.

We lowered operating expense by approximately $6 million in the quarter and we reduced our investment in working capital by $92 million.

In garden, as the season draws to a close we benefited from improved weather conditions.

It was a good year for our controls portfolio.

Additionally, compared to the last two years we've benefited from lower commodity costs and we did a good job of controlling expenses.

Furthermore, during the quarter demand for our products held up well.

Our POS for the quarter increased nearly double digits in garden.

In pet, consumer side of our business continued to demonstrate resiliency while in the professional and the animal health channels we experienced softness.

This softness was related primarily to our active ingredient-based products.

Consumables, particularly those associated with the dog and cat category, continue to perform relatively well.

However, pet retailers are tightening inventory levels.

We are seeing inventory decreases anywhere from mid-single digits to strong double digits, depending on the retailer.

Having said that, our data continues to suggest that the POS for pet supplies in general and the POS at our key retailers for premium products remain healthy.

The softness in pet sales is reflected in the gross profit, which was partially offset by continued progress and expense control.

Turning to the balance sheet metrics, both garden and pet did a superb job.

We reduced our investment in working capital by $92 million compared to the third quarter of last year.

As a result of our working capital initiatives and our strengthening operating performance, our quarter-ending leverage ratio is 2.7 times compared to 4.1 times a year ago.

I'm really proud of our folks and what they accomplished on that.

In summary we had a sold quarter and we believe we are poised to drive additional performance improvements.

On the basis of a significantly stronger business we are now developing our plans for fiscal 2010.

When I returned two years ago I said our objective is to get the business back on operating and financial profile, to return to and ultimately surpass historical performance.

We accomplished a great deal since I laid out that objectives.

Our folks have done a fantastic job.

Our operating performance is significantly improved and our financial foundation is sound.

We are hopeful that our reported earnings per share this year may approach our high water mark of $0.95 in 2006.

We are now turning our focus towards surpassing this historical performance.

We are in the process of implementing a series of initiatives that we believe, if executed with excellence, will drive continued operational and financial improvements.

We are going to achieve further progress and capital efficiency.

For example, inventory levels are still too high and we carry too many SKUs.

Additionally, we're focusing on creating greater operating synergies.

Our plan is to further consolidate key functional areas to drive additional operating efficiencies.

And most importantly, we are developing exciting new strategies to grow our brands, which is absolutely the key to the long-term future.

We will do this by leveraging our core competitive strengths, which are a commitment to innovation and quality, our shelf presence at retail, our distribution network, and our strong relationships with our retail customers.

In summary, we've made substantial progress solidifying the business over the past 18 months.

Central's foundation is meaningfully improved and we believe we're poised to build upon these accomplishments.

I am cautiously optimistic that our momentum will continue.

With that I'll turn it over to Stu, who will recap the financial highlights for the quarter and then we'll take your questions.

Stu?

Thanks, Bill.

Recapping the quarter's performance, we performed well due to improved weather conditions, gross margin expansion, cost reduction and reduced working capital, which drove significant earnings per share improvement.

Turning to reported financial results, net sales for the third quarter of fiscal 2009 were $482 million compared to sales of $493 million a year ago, a decline of 2%.

Branded product sales were $407 million, a decline of 3%, and sales of other manufacturer's products were $76 million, an increase of 2%.

Garden segment sales increased approximately $14 million, or 5%, to $267 million compared to the third quarter of 2008 due primarily to sales of garden, chemical and control products.

Garden-branded product sales increased approximately 6% to $231 million and sales of other manufacturer's products were $37 million, essentially unchanged.

Pet segment sales were $215 million, a decline of 10%.

The decline was due primarily to pet products that sell into the professional and animal health channels and inventory reduction initiatives at retail.

Pet-branded product sales decreased 13% to $176 million.

Sales of other manufacturers' products increased 3% to $39 million.

The Company's gross profit for the third quarter was $165 million, an increase of 8% compared to a year ago.

The decrease was due primarily to a combination of higher sales and improved margins in garden, partially offset by lower sales and margins in pet.

Gross product as a percentage of net sales increased 320 basis points to 34.2%.

The improvement was due primarily to greater contributions from higher margin garden control products and a combination of lower input costs and improved pricing for our wild birdfeed products.

Selling, general and administrative expenses for the third quarter were approximately $113 million compared to $119 million a year ago, a decline of $6 million.

The improvement was due primarily to the consolidation within our garden distribution operations, lower freight and fuel costs, and company-wide cost management.

Operating income for the quarter was $51.6 million compared to $33.9 million a year ago, an increase of 52%.

Garden segment operating income was $35.3 million compared to $12.6 million in the year-ago period -- an increase of 180%.

Pet segment operating income was $29.8 million compared to $32.7 million in the prior year period -- a decrease of 9%.

Net interest expense for the quarter was $5.2 million compared to $9 million in the year-ago period.

The lower interest expense is due to lower balances and lower borrowing rates.

Our borrowing rate for the quarter was approximately 4.1% compared to 5.3% a year ago.

Our effective tax rate was 32.3% for the quarter compared to 37.3% a year ago.

Our rate for the quarter was lower than our statutory rate, due primarily to the realization of approximately $1.7 million of research and development credits.

Year-to-date we have recognized approximately $0.05 per fully diluted share in tax benefits.

Net income for the quarter was $31.1 million or $0.44 per fully diluted share.

This compares to net income of $15.6 million or $0.22 per fully diluted share in the same period last year, for an increase of 99% and 100%, respectively.

Capital expenditures for the quarter totaled approximately $3.3 million compared to $4.2 million last year.

Now turning to the balance sheet comparing June 27, 2009 balances to June 28, 2008 balances, accounts receivable were $263 million, a decrease of approximately $30 million or 10% compared to last year.

Inventories were $314 million, a decrease of $57 million or 15% compared to last year.

Accounts payable were $117 million, a decrease of $2 million, or 2%, compared to last year.

As of June 27, 2009, total debt stood at $409 million compared to $584 million last year.

Addressing our credit agreement, our current debt to EBITDA ratio as defined by our credit agreement is approximately 2.7 times compared to 4.1 times a year ago.

The maximum for the leverage covenant in our bank credit agreement was 4.75 times.

And finally, during the quarter we repurchased approximately 550,000 shares of our common stock at an average price of $9.36.

I will now turn the call back to Bill.

Bill?

Thank you, Stu.

All of us are pleased with our results for the quarter and the progress we continue to make.

As you may guess, there are a number of our managers and our employees who listen to this call as well, and to all of them I want to say congratulations and thank you.

It's your energy, your focus and your commitment that have allowed us to deliver these kinds of results.

We are doing a better job of controlling our costs, managing our working capital, and driving our gross profit margin expansion.

While there are a number of factors that could conceivably adversely impact our results, including the economic environment and weather, we continue to be cautiously optimistic that the momentum that we have generated will continue.

And with that, we'll now take your questions.

Operator, if you would open up the call to Q&A?

Yes, sir.

(Operator Instructions.)

Our first question comes from the line of Joe Altobello of Oppenheimer.

Please proceed.

Thanks.

Good afternoon, guys.

Hi, Joe.

How you doing?

Good.

The first question is on the top line.

This year you're down year-to-date about 2% or 3% or so.

How much of that is business that you guys have chosen to walk away from?

I haven't thought about a lot of business that we've chosen to walk away.

There's some of it, but I think most of it is reflective of the economic climate and in particular what's going on in the animal and the vet and the professional pieces of the business.

Okay, so it's more macro than anything you guys are doing internally.

Go ahead.

Joe, we've talked about SKU rationalization and the fact that we have 177,000 SKUs in our portfolio right now, and one of the things we have been doing, as we've talked about before, is systematically going through our SKUs and eliminating those SKUs that are not profitable or not showing as much margin as we'd like in terms of contribution.

And we've probably reduced our sales somewhere in the range of $15 million to $20 million year-to-date related to SKU rationalization or discontinued items.

But as Bill said, the large measure of it is really the general economic conditions.

But that's just kind of an undercurrent that's working through this as well, though.

Got it, okay.

The important thing is we see ourselves either holding or increasing share.

We do not see ourselves losing share and we're strongly positioned to move forward from this.

Okay.

And then in terms of the things you talked about earlier, Bill, about growing the brands, I think you were talking about more fiscal '10 and beyond.

Could you sort of elaborate on what types of things you're doing, whether that's promotion spending or increasing distribution?

It's more a focus on what are the leverage points around each brand and what's the best way for that brand to move forward and grow.

We have tremendous competitive strengths, and those I enumerated on that deal with the brands and the positions they hold in the marketplace, the relationships with our retailers, our distribution network, and we're looking at how to energize that even further.

And most importantly innovation, innovation, innovation and super-commitment to quality.

So all of those points are going and the strengthening of the kind of folks that we have working on branding and the branding initiatives is shifting in a very strong, positive way.

That's an important element of our long-term growth.

Okay, so it doesn't require any significant increase in investment, it's more just doing things differently is how I interpret that.

I would say that's a good way.

How about you, Stu?

We're still very disciplined.

Yes, very disciplined and using our investment and people, and basically marketing and advertising promotion and innovation dollars more wisely.

Okay.

I would add one additional comment.

Sure.

Where we see strong gross net contributions from products that can benefit from large marketing spend, we're very prepared to make those investments and those commitments.

But you've got to see it and you've got to know you're going to get the pay-off, and that's where the discipline comes in.

Okay, and then one last one -- the operating margin this year, I think year-to-date you're up -- well, actually on track to do plus 200ish basis points or so.

In terms of order of magnitude, what should we expect for fiscal '10?

Is it something similar to that or is it going to be difficult to replicate that going into next year?

Well, our goal is always to surpass, and I don't like to think about difficult to replicate.

But we're not in the business of doing forecasting or guidance, so I think I'll stop right there.

Okay, fair enough.

Thank you.

Our next question comes from the line of Bill Chappell from SunTrust Bank.

Good afternoon.

Hi, Bill.

Just want to dig a little bit more into the pet top line and just try to understand why especially the vet channel would be so weak and should that continue on a go-forward basis or is this really a one quarter type issue?

Well, I think one of the good examples is in the cattle.

One of our good products, not the most important, but an important product has to do with control of parasites and flies with feed-through product for cattle.

I think you're well aware that the cattle market, the dairy market collapsed.

People are slaughtering animals and not taking care of their herds in the same way they used to because it doesn't pay.

And so we see contractions there that are quite dramatic.

I think on top of that, Bill, at least building on the whole cattle piece, is it appears that the cattle industry has bottomed out and so is it something that comes back quickly?

That, I don't know, but at some point you will probably see the replenishment of the herds.

And so we think if it's not at the bottom, it's close to the bottom here.

I guess I'm just trying to understand the down double-digits for the quarter, if that's something that really continues for the next two or three or if that's kind of a trend that we've seen the worst of it this quarter.

Well, Bill, the economic animal and vet channel is one contributing factor to the decline.

The other one that I'd call out is we're still seeing inventory reduction at retailers, and I would say that's probably the number two contributing factor to the decline in the pet segment this quarter, is that across our major retailers, that we've seen still contraction in inventory.

So my own view is that as those inventory contractions bottom out and they can only go so far down and then they've got to re-stock, we certainly saw some of that in garden when -- this is a very strong quarter where they've been cleaning out inventories and then they had to start getting on to a normal replenishment cycle.

The same thing, I expect, will happen in pet, and I think in these professional segments our belief is a year from now those'll be running.

Which quarter will it bottom?

Couldn't tell you for sure but I would think next year we wouldn't be seeing this kind of level of activity.

Well, that leaves -- this is a long-winded way of asking.

Gross margin for the quarter was the highest in 10 years, and that's as far back as my model goes.

But it seems to imply with those high-margin products that weren't sold it can go a lot higher.

Is that the right way to look at it?

Directionally correct.

Directionally, it's correct.

Okay.

Then one last thing -- is there a goal on the leverage ratio where you would start using cash for other purposes?

As we get closer to 2.5 times, you want to get to two times or are you pretty comfortable where you are?

Well, Bill, we've had for years our house limit of three times debt to EBITDA and we're really just pleased where our leverage ratio is right now, at about 2.7 times.

We'll kind of manage the leverage ratio somewhere in that range, but obviously we have total maximum flexibility where we are right now to manage our capital structure and optimize it for all of our growth initiatives that Bill's outlined.

So we're really in a very good position right now, but for the time being we've paid down debt, we've accumulated a little bit of cash, and we're waiting for basically the execution on a very disciplined basis of our growth strategy.

Great, thanks so much.

Sure.

Our next question comes from the line of Peter Keith of Piper Jaffray.

Hey, good afternoon, everyone, it's Peter calling in for Mitch.

Hi, Peter.

Hi.

Congratulations on a good quarter.

Thank you.

I know you had talked last conference call about ramping up the marketing initiatives here for the back half of the year, so now that you're one quarter through that, could you just talk a little bit about the success you might have had in that and some of the programs that you're running?

Well, if you remember, Peter -- this is Paul -- we were evaluating as to whether or not we thought that the increased spend in advertising would help us drive incremental sales, and I think the overall feeling was that we stuck to our original budgets and plans because obviously we felt that the garden season was progressing as we had hoped or perhaps even a little better.

So we opted not to increase the spending materially.

Okay.

And is that -- so you'd spoken before that it would be increased for both Q3 and Q4.

Should we expect a similar pattern for Q4 now?

I think it's too early to tell and quite honestly wouldn't want to telegraph what we might be doing to the marketplace.

Okay, that's fair.

On the SKU rationalization program, and you talked about some of the sales that you may be forfeiting in order to drive profit, do those sales tend to be more weighted towards pet or towards garden, or is it pretty evenly divided?

I think our SKU rationalization issue runs across the Company, and I don't see -- the SKUs that we would rationalize are not going to have a significant impact on sales or profits.

It's possible that as we take these SKUs out we're going to benefit from more profits when you look at just the cost of dealing with SKUs that don't have the proper velocity.

Okay, thanks.

And the last question is there's been some commentary out that with the favorable weather and perhaps higher precipitation levels that you're seeing a longer lawn and garden season this year, extending perhaps through the month of July.

Is that the type of trend that you're seeing within your business to date?

We think it's a good year, we don't think it's a great year.

The country, as always, is split.

Here in California we have some degree of weather softness.

Is it Texas that's still running the drought?

Yup.

So we've got that going there.

It's a good season; it's not a great season.

Okay.

Thanks a lot and congratulations again.

Thank you, Peter.

Your next question comes from the line of Reza Vahabzadeh of Barclays Capital.

Good afternoon.

Hi, Reza.

A couple of housekeeping questions for you.

One is what was the CapEx in the third quarter and what's a good CapEx level for the year?

CapEx for the third quarter was -- I think it was $3.3 million and a good -- what we have, we'll file our Q in a couple of days, but we now [have an MD&A] and capital expenditure maximum number of $20 million for the year.

Got it.

Do you think that's sustainable over time, since you've had higher CapEx levels, historically?

It's probably going to be somewhere in the 20s.

If you look back over time, we weren't ramping up SAP.

Our CapEx was somewhere in the 20s.

We've been investing CapEx and basically general repairs and refurbishments for our existing plant equipment, and then also making incremental investment for the support of new products that we're developing and manufacturing.

So that's kind of our standard run rate right now.

To the extent that we do some further expansion or growth development, capital expenditures may go up.

Got it.

And then what's your appetite as well as your ability to make share repurchases?

Well, the ability is quite large and growing daily.

The appetite is what's reasonable and prudent in our judgment to attract shareholder value.

All things being equal, we would rather invest in organic internal growth as the first priority, perhaps very disciplined and selected acquisitions that are clearly going to be very, very strong performers for us and play for 20 years in a powerful way is a second priority, but I want to emphasize the discipline.

And third, the repurchase of stock.

One of the things that we've said about stock repurchases is that as a general practice we would want to at least offset the dilutive effects of equity comp and I think we've more than done that.

Got it.

Paul, do you know what the RP basket is in your bonds as far as that would govern share buyback?

Oh, it's about -- it's not in the bonds, it's in the credit agreement.

I think we have about $70 million left between the board authorization and what's in the credit agreement.

Yes, that's right.

Got it.

And then --

Rough numbers.

Got it.

And then your income is rising, and so what is going to be your contribution in terms of taxes to our fairly large federal budget deficit?

Huge.

We're going to be almost a full statutory taxpayer this year.

Okay, so cash tax is about the same as book taxes?

Maybe not that high.

I think we're probably cash taxes year-to-date from 12 to 13 -- just for rule of thumb, just kind of halve what our book would be and that would be our cash taxes.

I'm sure the rest of the country will appreciate that, thank you.

We're here to help.

Our next question comes from the line of Alice Longley of Buckingham Research.

Hi, good afternoon.

Hi, Alice.

Are you hearing anything from retailers indicating that inventory cuts by them are nearing their end, or are they doing it as robustly into the fourth quarter as in the third?

At my level I'm not hearing from them specifically what they're doing, they just do it and you can get some measure of what they're doing by our folks that work closely with the accounts and size up what's going on.

So it's more monitoring and seeing the activity than it is a function of talking to an executive and laying out a plan.

And what's your sense of inventory cuts in the fourth quarter, same type of trend that's in the third quarter?

Got to tell you, Alice, I personally don't even bother thinking about that There are things that we can control and we work like heck on maximizing those.

They're things like inventory adjustments, which are transitory, and I frankly don't think about it.

Paul or Stu, can you add any light?

I don't have much to add, other than Alice, we always have to be inventoried right to deal with the just-in-time delivery capabilities and demands of our retailers, which are always increasing now.

But that said, as you noticed, we've reduced our inventories dramatically over the last couple years just through some better insight and operating efficiencies within the Company.

And we're not done.

All right.

My other question is about the professional and animal health demands being weak, and I understand the dairy market issue.

But I'm sort of surprised about the theme, because I would think that the one category that might hold up just fine during a recession would be animal health.

So can you give us another example of brands that are doing weak and why they would be weak at this point?

Alice, I think the key thing to point out, as Bill said in his prepared remarks, is that the consumer side of the portfolio is actually holding up relatively well.

It's the professional side, the economic animal, and the vet channel.

So the vet channel, where you have -- for example, discretionary vet visits are down, and so when you know, combine the economic animal, i.e., cattle, and there's a decline in vet visits, that's going to have some impact on our business.

The consumer -- as I said and I reiterate, the consumer side of the business continues to perform relatively well.

Dog and cat continues to perform very well.

And some of those products are moving through distributors who specialize in those channels, and we can look at that and see where they're pulling their inventories down.

You can see where individual consumers are pulling back on inventories.

So you've got both issues of usage and you've got issues of inventory contraction throughout the channel and I personally am okay with it.

It's just the country working through what it's got to work through.

Thank you.

Our next question comes from the line of Doug Lane from Jeffries & Company.

Good afternoon, everybody.

Hi, Doug.

Just have one sort of bigger picture question, and that is you've got segment margins now in the peak seasons, March and June quarter, that are multiple hundred basis points above prior peaks, and yet sales have been down seven of the last nine quarters.

So I'm just wondering, how do you get sales reaccelerated again without spending back some of that margin?

Well, I don't think -- first of all, I think sales are proper for the products and the demand in the marketplace, and sometimes it would be -- where there isn't a demand, trying to stimulate a demand doesn't make sense to me and to us in general.

So I think that where we spend, we'll be spending where the incremental contributions are quite significant, and we'll do just fine with that.

I just am not particularly concerned about the decline in sales, given what's going on in the general economic climate.

Our categories are good categories and our position is really good, to.

I guess I wouldn't have thought that your categories were particularly economically sensitive, but I guess it's turning out more so that way, particularly on the pet side.

And if you break the pet into the two pieces that we've described today, the garden business I think we've always said is slightly up in recessionary times, it's been the historical pattern.

For whatever reasons, we've seen a lift this year and it's terrific and we're delighted with it.

What we're seeing on the pet side where the companion pets are doing just fine, and what we're seeing on the professional and the vet, it's different.

We're recessionary resistant, we're not immune.

And then, Doug, again, the second contributing factor to the decline in sales in pet again was inventory reduction in retail.

So it's a stabilizing effect going on here as well.

Okay, thank you.

Sure.

(Operator Instructions).

Our next question comes from the line of Jon Anderson from William Blair.

Good afternoon, everybody.

Hey, Jon.

Hi, Jon.

We've been hearing that in the lawn and garden season this year there's been a lot of support from the major DIY retailers given that consumers aren't really spending on big-ticket items but are spending on some of the seasonal and consumable businesses.

Are you expecting kind of a similar level of support from retailers as you look at the 2010 season?

I wouldn't see any reason why it would be any less, and it has the potential to be more.

Okay.

And just a couple of housekeeping questions -- the current share repurchase authorization?

Yes?

In terms of a number?

Yes, outstanding?

I think we answered that just a few minutes ago.

I think in rough terms we have about $70 million remaining on our board authorization and about a like amount remaining under our credit agreement.

Just rough terms.

Okay.

And I guess this is the fourth quarter in which SG&A expense has been down on an absolute basis, and I'm just wondering as we kind of look ahead and think about modeling should we expect that kind of trend to continue or would there be some reason to believe why we'd see it diminish, that year-over-year decline diminish going forward?

Well, if we were to double sales you wouldn't see a year-over-year absolute decline, but on comparable sales we would expect to be continuing to take expenses down.

And again, the sales do recover or start to accelerate.

We've built a platform that we can leverage our SG&A pretty effectively now.

Okay, thank you very much.

Sure.

You have no further questions at this time.

Well, thank you very much for joining us on the call today.

We look forward to providing additional updates as we move through the year as Stu and Paul are out at the investment events.

Thanks again.

Bye-bye.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a good day.