Central Garden & Pet Co (CENT) 2010 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Central Garden and Pet fiscal second quarter 2010 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 Stuart Booth, CFO.

Please go ahead.

Thank you.

Good afternoon everyone, and thank you for joining us.

With me on the call today is Bill Brown, Central's Chairman and Chief Executive Officer.

Before I turn the call over to Bill, I would like to remind you of the Safe Harbor Provisions of the Private Securities Litigation and Reform Act of 1995.

The statements made during this call which are not historical facts 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 26 2009, and in other Securities & Exchange Commission filings.

Today's agenda is as follows, Bill will provide a business update, and I will review the financial results for the quarter.

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

I will now turn the call over to Bill Brown.

Thank you.

Thank you, Stu.

And thank you for joining us this afternoon.

Overall we continued to make progress with this quarter's performance.

We improved our profitability and our cash flow despite lower sales.

We also continued our tighter control on working capital.

Sales were down 7%, including 11% in garden, and 3% in pet.

Stu will give you the details on the sales in a minute.

Gross margins and operating margins significantly improved this quarter compared to the same quarter last year.

We benefited from our cost improvement actions, product mix, and lower input cost.

Gross margins increased 2.8 percentage points to 36.5%.

And operating margins improved 1.7 percentage points to 13.7%.

We continued to drive down working capital, reduction it by $104 million compared to the end of the second quarter of 2009.

We also reduced our debt by over $130 million year-over-year.

Our leverage ratio was 2.3 times at the end of the second quarter, compared to 3.6 times at this time last year.

We've made significant progress on expense control and working capital management and believe we can make further improvements in these areas.

This quarter we increased our emphasis on growing sales through new product launches and additional marketing programs to support our listings.

Our Pennington seed, smart seed and smart seed complete products will combine seed, fertilizer and mulch, everything the consumer needs to start a lawn, are being well-received.

These activities are the beginning of our renewed emphasis on growing the top line with new products that make a difference for our customers and with brand-building initiatives.

The programs that we are implementing to grow sales will most likely take some time to bear fruit.

We consider 2010 to be a bit of a transition year on this front, and look forward to seeing a significant contribution to sales from these activities starting next year.

Finally, I would like to discuss our recent debt offering.

Since our last conference call we completed an offering of 8-year $400 million 8.25% senior subordinated notes.

We used the proceeds from this offering to retire our 9.125% notes, as well as repay our term loan which was due in 2012.

While our interest expense will increase as a result of the issuance of the notes, we have locked into historically attractive interest rates, eliminated refinancing risk, and extended our debt maturity profile.

The notes also have a flexible covenant package that gives us the ability to invest in the business, do acquisitions, and to repurchase our stock.

We are currently looking at refinancing our revolving credit agreement, which is the final step of our debt recapitalization program.

And now I would like to turn the call back to Stu.

Stu?

Thanks, Bill.

Net sales for the second quarter of fiscal 2010 were $442 million, compared to $476 million a year ago, a decline of 7%.

Branded product sales were $368 million, a decline of 10%, and sales by the manufacturer's products were $74 million, an increase of 10%.

Garden segment sales declined by approximately $28 million, or 11%, to $220 million compared to the second quarter of 2009.

Garden branded product sales decreased approximately $34 million to $185 million.

Sales of other manufacturer's products increased approximately $6 million to $35 million.

The decline in garden sales was driven by both lower unit sales and price reductions, as we flowed through the benefit of lower commodity costs to our customers.

Garden sales were lower due primarily to a decrease in approximately of $12 million in garden chemicals and control products, and approximately $4 million to $5 million decreases in each of grass seed, bird feed, and pottery.

The sales decreases in grass seed and bird feed were due primarily to price reductions, as a result of lower commodity costs.

Chemicals and control products and pottery were impacted both by unit pricing and volume reductions.

Pet segment sales were $222 million, a decline of $6 million, or 3%.

Branded product sales decreased $7 million to $183 million.

Sales of other manufacturer's products increased $1 million to $39 million.

Pet segment sales were down due primarily to a decrease in sales of animal health products.

The decrease in sales of animal health products was due primarily to a supply issue for one product line, expected to continue at reduced level through our third fiscal quarter, and sales in the prior year quarter from a marketing license no longer held by the Company.

Also as an aside we experienced modest sales improvement in our aquatics operation, a category which has been on the decline for several years.

We are hopeful this category will continue to improve.

The Company's gross profit for the second quarter was $161 million, up slightly from the same period last year.

Gross profit as a percentage of net sales increased 280 basis points to 36.5%.

The gross margin improvement was due primarily to our cost containment efforts, product mix, and lower input costs.

Selling, general and administrative expenses for the second quarter were approximately $100 million, a decline of $3 million from the year ago quarter.

Operating income for the quarter was $60.5 million, compared to $57.2 million a year ago.

The operating margin increased to 13.7% from 12% in the second quarter last year.

Garden segment operating income was $36.8 million, compared to $36.7 million in the year ago period.

However, operating margins in the garden segment improved 200 basis points to 16.8% sales compared to the second quarter last year.

Pet segment operating income was $34.8 million, compared to $31.9 million in the prior year period.

Operating margins for the pet segment improved 170 basis points to 15.6% for the second quarter of 2010.

Net interest expense for the quarter was $9.8 million, compared to $5.5 million in the year ago period.

Interest expense for the second quarter of 2010 includes $3.2 million of expenses related to our refinancing activity in the quarter.

These expenses include the unamortized deferred financing costs for both the 9.125% senior subordinated notes and the terms loans we retired, tender and call premiums, and an unamortized gain on an interest rate swap termination.

These expenses negatively impacted EPS by $0.03 per share.

For the remainder of fiscal 2010, you should expect interest expense to be approximately $9 million per quarter.

Our effective tax rate was 36.8% for the quarter, compared to 34.9% a year ago.

Last year's tax rate benefited from a $1.1 million decrease in estate valuation allowance.

We expect our full year effective tax rate to be around 37%.

Net income for the quarter was $31.6 million, or $0.49 per fully diluted share.

This compares to net income of $33.0 million, or $0.47 per fully diluted share in the same period last year.

The higher EPS reflects the impact of lower average weighted shares outstanding in the second quarter of 2010, compared to the second quarter last year.

We have repurchased 5.8 million shares over the last 12 months.

Capital expenditures for the quarter totaled approximately $6.8 million, compared to $3.2 million last year.

Turning to the balance sheet and comparing March 27, 2010 balances to March 28, 2009 balances, working capital, which we define as current assets excluding cash less Accounts Payable and accrued liabilities, decreased by $104 million.

Accounts Receivable were $227 million, a decrease of approximately $40 million, or 13% compared to last year.

Likewise, inventories were $331 million, a decrease of approximately $50 million, or 13% compared to last year.

Accounts Payable were $148 million, an increase of $10 million, or 7% compared to last year.

As of March 27, 2010, total debt stood at $415 million, compared to $547 million last year.

Included in the March 2010 balance is approximately $15 million of our 9.125% notes which were not tendered in March.

These notes were called in March and retired in April.

Our cash balances are much better than a year ago, levels at $27 million, compared to $9 million at the end of the second quarter of 2009.

And I will now turn the call back to Bill.

Bill?

Thank you, Stu.

While we have work to do on the top line, I am pleased with the rest of our results, both for the quarter and year to date.

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

While the economic environment and weather remain uncertain, we continue to be cautiously optimistic that we can continue to make progress as we drive our performance, and place renewed emphasis on growing sales.

With that we will now take your calls.

Operator?

We would like to open it up for Q&A.

(Operator Instructions).

The first question comes from the line of Mr.

Bill Chappell with Suntrust.

Please proceed.

Good afternoon.

Hi, Bill.

I guess first going to the top line, Bill, you had said I think on the last conference call that you felt that you would have full year revenue growth for the Company, and especially evident in the second half.

Can we get an update on your expectations for both second half and for the full year?

And then kind of walk us through a few other things?

I will come back to you on another question.

I am trying to remember back to the last call.

That doesn't resonate with me.

It may be this quarter's results have been sobering on the sales side.

We certainly have, I think two years ago I talked about, let's clean the garage, let's get the balance sheet cleaned up, let's get our expenses tightened up, let's improve our margins.

And all of those things have happened.

We did not focus on the sales, and now is the time to, and some would say last year was the time to turn our energy to sales growth.

But in light of the financial meltdown, we are pleased to maintain our listings, maintain our share of market.

So given what is going on right now, I would be cautious about overachieving on sales for the year.

Part of it is about half of the sales decline is due to price reductions that we have put through that are reflective of the reduction in the input commodities.

The other half is related to unit declines, and in some of these it is as Stu mentioned, the availability of certain products.

And we are not going to have some of those products for at least a good portion of the next quarter.

So I would be more temperate about the sales top line this year.

The real proof of the pudding is what do we do next year, in terms of product innovation and driving our brands and taking share.

But you do have easier kind of comparisons on the second half.

Do you think you can grow sales just for the second half of this year?

I really don't have a comment on that, Bill.

I can try to pin you on guidance.

I guess digging into this quarter can you give us an idea whether pet sales would have actually grown had you not had this supply problem?

Oh, yes, for sure.

And was it 3%, 5%, I mean, can you quantify the number?

What is in the K?

It is not in the Q.

In the Q?

No.

It would be a modest growth.

But it should be cleared up by the end of the third quarter?

We are hoping so.

Okay.

And then moving a little bit to the setup for the garden season, I mean, it certainly from what Spectrum said today and what others have talked about, it seems like it is set up very well for your portfolio.

And are you seeing pretty strong growth during April?

Or are there any competitive issues?

April has made some decent progress.

And instead of reporting declines for April, we actually have some increases.

And one last question and I will give up.

On the share repurchase, does it imply you repurchased about 700,000 shares during this quarter?

Is that about right?

That is about right, Bill.

And are there any future plans of, that is a slowed pace from the prior quarter.

Even though your leverage levels are pretty low.

Is there a reason why you slowed up, or are you closer to look at acquisitions versus share repurchase?

No particular reason we slowed up or speeded up.

We make our judgements on share repurchases as to whether to or whether not, on the merits at any particular point in time about the market, the pricing of the shares and generally what is going on.

There are some restrictions in our current revolver that limit how much share repurchase we can do.

That will change as this gets replaced with a new facility.

But was there a second part to your question?

Just maybe on the acquisition front.

Are there things that you are expecting near-term, do you think you would close a deal this year?

Oh, never preannounce.

And that is for several reasons, no matter what you expect, or what you see in the world of M&A, you never count the chickens until they are hatched.

So really don't know.

I think we have reported that we are in the market exploring what is available, and seeing if there are fits and values that make sense, and complement our portfolio.

But nothing to report.

Great.

Thanks for the color.

And the next question comes from the line of Mr.

Joe Altobello with Oppenheimer & Company.

Please proceed.

Thanks.

Good afternoon, guys.

Hi, Joe.

Hi Joe.

Hi, first questions, I just wanted to follow-up on the top line for a second.

You talked about some of the steps or the increased emphasis I should say on growing the top line.

Could you be a little more specific in terms of what you are doing there?

Have hired some people?

Are you investing more in advertising?

Has the R&D budget gone up?

Just a little more granularity on the investments you are making to grow the top line?

I am really kind of disinclined to talk through those things, both for business and competitive reasons.

Well, you don't have to be very specific.

I am just trying to get a little comfort with how 2011 is going to be this upsloping acceleration of the top line versus 2010.

And it is hard to get that level of comfort, if we don't know or can't look under the hood and see what is exactly going on?

Yes, I would agree with you.

Stu, do you want to add any comment?

Well, if you want to add a little more color.

It is up to you.

Well, if one wants to grow the top line, you do it either by taking share, or by getting more volume with existing customers, more volume with new customers, or you bring innovative product that creates demand that doesn't exist, or you do it through promotional and marketing activities.

And we explore all of the above.

Is your ad budget up year-over-year?

Are we talking about 2011?

And that budget hasn't been finalized.

No, I mean this quarter and for 2010.

He kind of said that nice soft under his breath, we don't disclose that, but I will just put it out there affirmatively.

Okay.

And then my second question on aquatics, obviously Spectrum did mention this morning that aquatics has seen stabilization.

What is driving that stabilization?

Is it the category, or is it end used demand, is it the retailers getting behind that category?

Or is it just that it is lapping such easy comparisons that there is really not much further down to go?

I think, Joe, it is really the decline has subsided, and we are kind of bouncing along the bottom right now.

Lapping comparisons, we have a mix of business.

We have products that move out at good price points, and then we have some very large attractive aquariums that are pretty darn expensive.

And if you think about this time last year, those bigger units were way off in sales.

And so even a modest recovery there averaged in with the more popular models gets you into a better place.

So I would tend to surmise that some of this is lapping some comparisons on parts of the product line that were easy.

Okay.

And then just one last one if I could.

If you look at your SG&A line you guys have obviously made a lot of progress there.

I would say on the annualized basis you are probably down what, $30 million or $35 million from your peak.

Once those sales do come back next year, does part of that $30 million to $35 million come back as well, or are those permanent savings?

Part of it would come back if we don't take out additional savings.

So of the savings that we have already achieved, there is a part of SG&A that is sales volume variable.

Not that big a part.

But a part that is there.

The challenge for the Company is to keep taking its SG&A down, so that we keep driving lower and lower percents.

Okay.

So you can keep SG&A roughly flat, and still grow the top line next year, I guess is the question I am asking?

Well, that would be predictive and I don't think Stu would let me do that.

Okay.

Thanks, guys.

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

Please proceed.

Good afternoon.

Hi there.

Hi.

Just wondering as far as your sales are concerned, do you feel like you have generally held share in most of your key lines?

Or do you feel like you may have gained or lost share?

Oh, I think we believe we have held share.

Okay.

And any product lines that you think the sales were either because of the category or your own performance were ahead or below your own expectations?

On the garden side, the chemicals category was, chemicals and control products were down $12 million.

And we called that out.

So that is the one area that we saw a decline in sales.

A lot of that could be attributed to a little bit later break in the season.

We will just have to see.

The listings are there.

It is really the sell in and sell-through.

Right.

And do you think that your key customers have given the category and your listings comparable shelf space as prior years or better?

I think there is, in the main absolutely, that is true.

But there are a couple of areas where there has been diminished shelf space to the category.

So you always get some puts and takes.

But in the main, I would say yes.

Got it.

And then as far as share repurchases, Stu, I couldn't quite make how much you did in the quarter in terms of dollars?

In terms of dollars?

How many shares did we buy back, Howard?

130,000.

130,000 shares.

Your average price was between $10 and $11 per share.

Okay.

And then as far as your appetite on the share repurchases for the balance of the year, any number that you care to throw out?

Is there a maximum or minimum?

Well, the minimum is zero.

Okay.

And the maximum --

That is under our current credit agreement, we have about $10 million maximum.

But as Bill said, we are addressing the expiration of our current revolving credit agreement.

So I wouldn't consider that a constraint.

But as Bill said, we will look at all of the considerations from time to time and make a decision, as we go along on share repurchases.

Right.

If you are trying to say, do you guys have a preannounced plan and a methodology of buying back shares, we don't.

And we have done that from time to time, and you heard what the aggregate was for this last year.

And what happens going forward will be on its merits and judgment of us at that time.

And then as far as acquisitions, do you find a pool of targets or potential targets as being particularly large at this point in time, or is it slow?

Any color on that front?

Well, it has been very interesting as we have moved back in to the exploration phase.

There is a fair amount of activity and quasi-competitiveness from private equity and other parties, at a level that is a little more visible than I had expected to be at this point in time.

But as you think about the recovery and what is going on, it is out there.

In terms of the number of entities that are actually viable for purchase, I don't see that as being as high as we have seen it historically in the past when we have been active.

So I think it is a little more sluggish and could probably describe it as a little more demand out there than we thought, and a little less availability than we thought.

Got it.

Thank you.

And the next question comes from the line of Colleen Burns with Oppenheimer and Company.

Please proceed.

Hi.

Good afternoon.

Just to follow-up on the garden chemicals and controls decline in the second quarter, was that mostly driven by the overall market decline, do you believe, or do you think that was somewhat competitive as well?

I didn't have any reason to see it as a competitive issue.

I thought it was a combination of mostly timing and demand in the market place, whether it is retailer take-in or POS activity.

Okay.

And then just on the pet decline, what was the supply issue in animal health?

What exactly was it a manufacturing issue?

It was an active ingredient that we had a supply disruption.

We basically have restored the supply of that active ingredient.

And we will be back on line, we are back in line the third quarter but at a reduced level.

Okay.

But you are back on line?

Yes.

We are back on line.

Okay, great.

We just don't have all of the capacity.

It is kind of like if you are short of chocolate chips you don't make chocolate chip cookies for a while.

And maybe this product isn't as sweet as they are, but it certainly is effective.

All right.

On the gross margin improvement, what was the major driver of the 280 basis points?

Was it mostly product mix?

What would you say if you could bucket as kind of the major?

We have tried to cut it a couple ways.

This is a hard exercise because we have so many SKUs.

But it is really I am going to say a third to a half is driven by commodities.

And then I think the lion's share of it beyond that is really mix.

Okay, great.

And then just CapEx budget for the year?

We haven't changed it from what is in the K.

I would say not to exceed $30 million.

Okay.

Great, thanks.

Sure.

And the next question comes from the line of Mr.

Doug Lane with Jefferies & Company.

Please proceed.

Thanks.

Good afternoon.

This is [Per Austin] on for Doug today.

Was wondering is there any, I appreciate the color on the decline in the garden sales this period.

Is there any impact from SKU rationalization going through garden or pet at this point?

Or is that kind of mostly in the rear-view mirror at this point?

No, there is continued activity of SKU reduction, and especially on the garden side.

Yes.

So we think on our SKU rationalization efforts, we are definitely below half done, and maybe a third done.

There is more to do, and one of the interesting things that I look at as we take SKUs out, what is the margin on the SKUs going out.

And the margins on the SKUs going out are substantially below our average margin.

And that is one of the ways the mix is getting enriched.

Sure.

That makes sense.

Is there any way to quantify the revenue that has gone away with that?

Because I think the last couple of quarters you have called it out.

And it has been reasonably material.

I think that knowing that sort of gets, can help sort of frame I guess the core, if you will?

That is not a number that we have with us today.

And your are right, we have called it out in the past.

And I apologize for not putting that together for this call.

Okay.

Fair enough.

Pricing on the bird and grass seed side, it sounds like you took some reductions for commodity costs.

Just looking ahead, are those costs remaining relatively benign?

And then sort of an adjunct to that, are packaging and fertilizers, is there anything you are seeing kind of coming down the pike, putting pressure on you there?

Or is that all still pretty manageable?

Well, the commodities, our biggest input costs are grass seed and bird feed inputs.

All of the grains.

And they have gone down about high teens since last year, compared with last year quarter.

They are relatively flat compared to the first quarter of this year.

So we have seen the decline.

It is kind of bouncing along at a very manageable level right now in terms of volatility.

And the second part of your question was about I think more just about general input costs.

We are not seeing anything that is problematic in terms of volatility.

I know Jefferies has been kind of on the bandwagon about input commodity costs.

We don't see it too much here.

Okay.

Fair enough.

Thank you very much.

(Operator Instructions).

And the next question comes from the line of Mr.

Jeff Kobylarz with Stone Harbor Investment.

Please proceed.

Good afternoon.

Curious about the commodity, lowered cost of commodities and the impact on gross margin.

Do you see that continuing in the near future?

Well, I think the lower cost of commodities is tending to show up in lower selling prices.

So you have got both cost of goods and sell prices coming down.

And gross margin percentages tending to hold pretty steady.

I think we talked earlier about our margins increase heading more at distribution to mix.

I think we have pretty much lapped the opportunities for improving on the commodity input costs for the time being.

Okay.

And then for your continuing SKUs, can you comment about how your sales, your shipments, compare to the POS at your retail customers?

We are not really prepared to talk about our POS right now.

Our sell-in has been strong relative to POS in the past.

So it seems to be tracking pretty consistently.

Your sell-in was strong relative to POS?As of when was that?

I am sorry.

It has been pretty well tracking equally.

Okay.

All right.

Thank you.

Ladies and gentlemen, this concludes the question and answer session for today's call.

I would now like to hand the call over to Mr.

Bill Brown for any closing remarks.

Well, thank you very much for joining us today.

We have got a lot of work ahead of us, and we look forward to doing it, particularly addressing the opportunity to improve the top line.

We will look forward to talking with you on the next call.

Bye bye.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.