Central Garden & Pet Co (CENT) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by.

Welcome to the Central Garden & Pet fourth quarter 2011 financial results conference call.

My name is Kathy, and I'll be your conference operator for today.

(Operator Instructions).

As a reminder, this conference call is being recorded.

I would now like to turn the call over to Steve Zenker, Vice President of Investor Relations.

Please go ahead.

Thank you, Kathy.

Good afternoon, everyone.

Thank you for joining us.

It is my pleasure to welcome you to today's call and to introduce our other speakers.

With me on the call today are Bill Brown, Central's Chairman and Chief Executive Officer; Gus Halas, President and Chief Executive Officer of the Central Operating Companies; and Lori Varlas, Central's Chief Financial Officer.

As a reminder, we issued a press release this afternoon providing results for our fourth quarter and fiscal 2011 periods ending September 24, 2011.

The press release is available on our website at www.central.com.

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

The statements made during this conference call which are not historical facts 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 different materially from those set forth in or implied by forward-looking statements.

These risks are described in the Company's Form 10-K for the fiscal year ended September 24, 2011, to be filed in the next several business days, and other Securities and Exchange Commission filings.

This presentation includes the use of non-GAAP measures.

A reconciliation to the most comparable GAAP measures is included in our earnings release, which is available on our website at central.com in the Investor Relations section.

Now I will turn the call over to Bill Brown.

Bill?

Thanks, Steve, and thanks to everyone on the phone for joining us this afternoon.

As most of you know, the Board and I asked Gus Halas to join us full-time in April, because we recognize that Central needs a reboot, a completely fresh way of looking at the Company's opportunities.

We identified in Gus the key skills and experience to get Central to where it can be, it should be, and where it needs to be.

Since he joined the Company, Gus and I have developed a very strong partnership in implementing a dramatic remake of Central.

On our last call we previewed what we have in mind, but we did not give much detail.

Today we hope to convey the scope of the transformation that is underway and have significant upside expect we will deliver for the Company, our people, our customers, and you as investors.

The fact is Central has operated always as a portfolio of companies.

Each has its own brands and focus.

For years this allowed our entrepreneurial portfolio of companies to prosper.

However, today, with larger retailers demanding a more efficient supply base, the siloed portfolio approach that worked before simply doesn't cut it anymore.

This transformation is about eliminating silos and the unnecessary cost that they impose on our Company.

It is also about given us the ability to invest in some of the savings in our brands and innovation in the core product areas to achieve profitable growth.

Gus has a strong track record of delivering on these kinds of transformations.

He's done it before, and with him we are already making good progress in mapping out Central's future.

Most of our call today will be focused on what that future looks like.

Gus will describe our transformation process and milestones.

Then Lori will give you the headlines on this quarter and fiscal year 2011.

There's some bright spots in our performance this quarter and fiscal year, primarily in sales growth.

But our performance is clear my not where it needs to be.

Over the next year, we are going to reposition Central for a return to long term growth.

Clearly this comes with cost, and it will impact near term results.

We will give you what visibility we can on our initiatives.

But we aren't going to give quarterly or annual guidance for 2012.

We do expect, however, that our bottom line performance will be better in the second half of calendar 2012.

What we will do is give you our cost reduction targets, the anticipated costs associated with them, our broad expectations for overall investment spend in our brands, and our longer term growth and margin goals.

We will also tell you about our views on capital allocations supporting our transformation.

And with that I will turn it over to Gus.

Gus?

Thank you, Bill.

Let me start at a high level and reiterate the core principles and strategies of our transformation plan.

While we touched on the transformation on our last call, today we will give you more detail, color, and clarity.

Big picture, as Bill previewed, the most fundamental changes here are actions to structure Central as an integrated multibrand company.

We are getting rid of the silos that create inefficiencies and unnecessary cost for our business.

We are also focusing on growth, innovations and brand building.

Simply put, we can compete more effectively and on operate more efficiently if we set ourselves up as a unified company instead of a collection of disparate businesses.

To accomplish this we are well along in reorganizing operating units, shifting reporting lines and realigning accountability, and more importantly, aligning compensation incentives to reward whole Company performance.

We're implementing Lean Six Sigma improvement initiatives that we expect will significantly improve our performance.

To assist us, we have added a small number of experts who have already helped achieve significant process.

They are also training other employees as future leaders in operations and enterprise excellence, and I'm pleased to say that our people are catching on fast.

In addition to increasing our efficiency and effectiveness, our leaner streamline structure will save us money, lots of it.

We have done a thorough and detailed enterprise-wide evaluation for cost saving opportunities, and now are actively executing against those opportunities.

The end result is that over the next two or three years we think we can take out at least $120 million in annual costs.

The fact is I believe we can do much better than that, but that's what we are prepared to say today at this stage of the process.

We expect to achieve about three quarters of these savings through various supply chain initiatives, with the balance coming from SG&A.

We with believe that as we exit calendar 2012 we will be at a run rate of about $30 million of annual cost savings.

Let me offer a few examples of specific initiatives under this strategy.

First, we're pursuing significant saving opportunities on the warehouse and distribution side.

We are combining our garden and pet products in the same warehouses where practical.

And we expect to reduce the number of our distribution centers by at least six by the end of the first half 2012 --fiscal 2012.

Related to this, we intend to reduce inventories by $60 million to $70 million by the end of the fiscal year, with the goal of doubling that over the next two to three years.

This should result in huge improvement in turns.

On the manufacturing side we have a team responsible for optimizing the number, location, and size of our manufacturing facilities.

We are also realizing a number of efficiencies holistically across garden and pet by using excess capacity to produce products using similar technologies, regardless of which specific business they operate in.

For example, there are opportunities to shift pet production to use excess garden capacity during seasonally slow times for garden production.

Another major area of savings is the SKU rationalization.

Candidly, we have too many SKUs to manage efficiently, and too many of them are unproductive.

Those of you who have followed the company over time know that this is not our first effort at reducing SKUs, but it is by far our biggest and most comprehensive.

Our target is to reduce the total SKU count by at least 30% to 35% from today's levels.

This will reduce the cost and complexity of managing our SKUs, and more importantly strengthen our brands by having a more targeted portfolio of products.

The next area of focus is procurement.

We're extracting savings by consolidating purchasing across the entire organization.

This will help us achieve better prices through volume discounts and sharing of cost information.

For example, we have a strong team in China in our dog and cat business.

That team has a very good relationship with suppliers.

And now they work closely with those suppliers on behalf of many product lines instead of just one product line.

Another big bucket of savings is coming from sales.

We are consolidating our sales effort by category and channel.

Our sales teams have undergone new and more extensive training to better know their product lines and customers.

We are now serving accounts through one sales team instead of many handling different product lines.

This approach allows us to be more responsive, makes it easier to do business with us, and it eliminates redundant activities.

Turning to marketing.

Our old siloed approach had created many duplicate functions.

We are already doing a much better job of sharing resources across the Company.

In addition to taking out costs, we are also investigating in marketing to grow the top line.

I'll comment on that in a minute.

We have a host of initiatives underway to make better use of information and leverage the knowledge of our talented employees.

For example, we are standardizing many systems and processes for employees across the Company.

This includes everything from performance reviews to payment systems, and very importantly, we are accelerating our ERP implementation.

We started out with 25 ERP systems.

Today we have 11.

By the end of calendar 2012 we expect to have 2.

We are standardizing data and reporting so analysis is easier.

This will allow for better decision making across the Company.

And importantly, if you spoke to Central employees, I think you'd hear that there's a new cultural dimensions here now.

We're encouraging people to cooperate and share ideas across our Company.

Previously, the business units had no incentive to help each other.

That's a quick summary of where we are targeting cost savings.

Lori will give you more detail on how much we expect to save and the near term costs to get those savings.

We will be updating you in the coming quarters on our progress.

Shifting gears a little.

While cost savings and structural changes are key, we are also laser focused on growth opportunities before us.

We have several initiatives underway to grow the top line.

I already mentioned that we have new marketing teams.

They are focused on using our strongest brands to drive new products and brand extensions.

They have some excellent early successes with in-store promotions and other marketing and brand building efforts under a master brand strategy.

For example, we more than doubled the advertising of our premium grass seed products behind new positioning and new packaging.

The new positioning emphasizes the Pennington Smart Seed, requires up to 30% less water and contains no fillers.

We marketed this through a wide range of channels, including television, radio, in store, digital, and social media.

Our total grass seed sales for 2011 increased by double digits over 2010.

The Pennington Smart Seed products and the strong promotional support that we put behind it led us to win Home Depot partner of the year in the outdoor products.

We beat out more than 500 other suppliers.

And I'm proud to say we won vendor of the year award for lawn and garden from Ace Hardware.

This was a further recognition of our success in meeting the needs of our retail partners.

We are also consolidating certain brands, expanding others, and launching new brands.

An example in our pet business is the consolidation of our pet dental product lines under Nylabone brand, further strengthening the franchise and increasing shelf presence.

In pet nutrition, we launched a new product line of dog food under the Breeder's umbrella called Simply Natural.

This targets the rapidly growing segment of natural dog food with early promising results.

We will also continue to pursue co-branding strategies where we can highlight the benefits of more than one of our brands.

All in all, we expect to invest about 7% more in marketing and brand building in fiscal 2012 than we did in 2011, and 20% more than we did in 2010.

Much of this investment is in expanding the capabilities and talent of our brand management and product innovation teams.

We are also tightening our focus and improving the effectiveness of marketing investments with better planning, analysis, and management.

Coupled with these marketing efforts we are increasing distribution, particularly in the FDM and home improvement channels.

For example, in our pet product segments we have expanded our relationship with Kroger and now are supplying Lowe's with pet products.

Innovation has always been one of Central's strengths, and it continues to be extremely important.

We begin rebuilding the innovation pipeline in fiscal 2011, and we expect to launch a significant number of new products in 2012.

These include flea and tick products, our first pond products in the US and dust free pet bedding among others.

Our goal is to have about 15% of our revenue in any given year from new products introduced in the last two years.

This will be a big improvement over recent years.

We are also executing our selling strategies more effectively, even as we reduce SG&A.

We have improved communication to key accounts.

And we have more effectively explained our challenges on raw material prices.

This has led to a better customer acceptance of price increases, many of which will be in effect during all of 2012.

Net-net, we believe we have struck the right balance between pricing and consumer satisfaction in our key categories to drive consumption and share gains.

As Bill described, the investments we are making toward our longer term goals will have an adverse impact upon our short-term operating results.

Frankly, as a management team, we are focusing at this point on long-term value creation than on the impact of transformation on any one quarter's results.

Let me repeat that.

As a management team, we are focusing more at this point on longer-term value creation than on the impact of transformation on any one quarter's results.

We are keenly intent on repositioning Central to where we have a platform capable of four main objectives.

Generating sustainable overall top line growth of 10% of more, both organically and through acquisitions; significantly improving profitability; operating more effectively and efficiently to support our customers; and quickly and successfully integrated any future acquisitions that we may make.

In terms of margins, our objective coming out of the transformation two or three years from now is to be able to produce EBIT margins of at least 10% and as high as 15% if we with are really firing on all cylinders and achieving an optimal mix of product and distribution.

Let me now turn over to Lori for some commentary on quarter and fiscal year ended.

But again, let me remind you and emphasize that we as a management team do not view any quarter's results at this point in time as reflective of where we are taking this Company over the next two or three years.

Lori?

Thank you, Gus.

The press release we issued this afternoon details our fourth quarter and full year results, but before we move to Q& A, let me call out a few key themes that are important.

Despite the challenging operating environment and the significant proportion of management's time and attention being devoted to our transformation, we delivered our fourth consecutive quarter of sales growth, with fourth quarter revenues increasing a healthy 9%.

Our growth in the quarter came from the Garden Products segment, with sales up 24%.

For the full 2011 fiscal year, a 14% increase in garden sales led our Company sales up 7%.

Pet product segment sales were relatively flat for the quarter and full fiscal year.

As we have noted, we were disappointed by our growth and operating margins during the quarter and year.

Fourth quarter gross margins continued its year-over-year decline.

We, along with many other consumer product companies, continued to feel the impact of the high cost of raw materials, which rose quickly and steeply throughout 2011.

Most notably the cost of grains we use in our bird feed was up 41% for the full fiscal year versus 2010, and up 84% when comparing the full -- the fourth quarter of 2011 to the fourth quarter of 2010.

These increases outpaced our ability to take price increases, a primary reason for the margin decline.

While the market costs of these materials have recently come down somewhat, they are still much higher than historical levels.

It's too early to tell where 2012 input costs will settle.

We believe the first half of 2012 will remain challenged.

Other factors impacting our gross margins were the mix of garden sales, specifically a decline in higher margin control products and increased sales of lower margin fertilizer products and bird feed.

In our Pet Products segment, the drop in margins was driven by a rise in input costs to our bird feed and dog and cat products.

We were also impacted by the presence of generic fipronil in the flea and tick market.

Although we expect results to be challenged in the first half of 2012, as we achieve operating efficiencies and cost reductions, we expect margins to improve gradually, beginning in the back half of calendar 2012.

Moving to SG&A.

Although we stepped up our investment in brand building during the year, selling, general and administrative expenses as a percentage of sales improved over the prior year.

In the fourth quarter, SG&A decreased to 27% from 28% of sales in the comparable prior period.

For the year, SG&A declined to 25% of sales from 26%, reflecting a decrease in variable compensation.

Operating income has been impacted by the drop in gross margins.

The fourth quarter operating loss was $4.6 million.

This compares with a similar reported loss in the fourth quarter of 2010, although the 2010 number included an impairment charge of $12 million related to a write down of intangible asset in our Pet segment.

Fiscal call year 2011 operating income was $85 million, compared with $109 million in 2010 on a GAAP basis.

A quick note on our fourth quarter effective tax rate, which was 17% of our operating loss.

The change in the effective tax rate was due primarily to our reduced ability to use tax benefits due to decreased fiscal 2011 income and increased tax valuation allowances.

This lower tax rate for the quarter resulted in a full year fiscal 2011 rate of 40.8%.

We expect our tax rate for fiscal 2012 to return to a more normalized range of 36% to 38%.

Our balance sheet is pretty straightforward, but I do want to highlight our inventory balance, which is $44 million higher than last year.

The difference is predominately related to higher chemical and control inventory in our Garden segment, in part due to our acquisition earlier this year of a privately held maker of fertilizer.

Additionally our bird feed grain inventory reflects substantially higher costs than a year ago.

During the fourth quarter, we purchased -- repurchased approximately 3.2 million shares of our common stock and non-voting class A stock at a combined cost of $25 million.

As of September 24, 2011, approximately $72 million remains available for future share repurchases under our current authorization.

Let's turn to our transformation.

I also want to give you some details on our capital allocation priorities and budgeting to support the long term strategic initiatives underway here at Central.

First, given the growth plans that Gus outlined, we expect our capital expenditure requirements for fiscal 2012 to be about $40 million, a larger investment than the roughly to $25 million to $30 million we spent annually over the last couple of years.

The increase relates primarily to the capital requirements for our warehouse consolidation of approximately $10 million, which should yield substantial savings, as well as the capital component of our accelerated ERP system implementation.

Clearly, to realize the cost savings and efficiencies that we have been talking about today, we are making certain investments, particularly in reorganization costs, productivity tools and technology.

Gus described our target of achieving a run rate of $30 million in annual savings as we exit calendar 2012.

We expect the investment to realize that level of savings will be about $10 million in 2012.

To get the total of $120 million or more of annual savings, we'll be investing in the range of $30 million to $40 million over the two to three year time frame.

Our goal with these cost savings and investments is to reposition Central as a platform to generate sustainable top line growth year after year, and substantially improve bottom line results.

We believe these initiatives will make our operations more efficient, enable us to serve our customers more effectively, and give us the ability to quickly and successfully integrate future acquisitions in order to realize operational and strategic synergies.

Thank you for joining us this afternoon.

Bill, Gus, and I would like to take your questions.

Kathy, would you please open the call to Q&A?

Thank you.

(Operator Instructions).

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

Thanks.

Good afternoon, everybody.

Just a couple quick questions.

The first one on the quarter, one of the things that stood was the Garden sales up very strongly.

Could you just give us more color into what was driving that?

Was there anything that was pulled forward, or were there any timing issues, or was that just purely an increase in demand?

On our Garden sales we have had a strong fiscal year throughout 2011.

We talked about the improvement in our grass sales, largely fueled by our increase in brand building and advertising to strengthen that brand.

There isn't anything that really jumps out at me as it relates to the sales.

I think we just continued the momentum that we have had throughout the year.

Okay, so that's nothing that's being pulled forward in December?

Okay.

No.

And then secondly, just in terms of the cost savings and the -- I guess the restructuring that you guys announced today, it seems like it is almost too good to be true.

You are spending $10 million this year to get $30 million in savings, or a run rate of $30 million.

Over the next two to three years, you are spending $30 million to $40 million to get $120 million of savings.

So it seems like the expenses are far outweighed by the benefits, at least relative to other companies that I have seen do these sort of things.

So could you walk us through -- or at least give us more comfort as to -- or at least give us comfort that it won't require more spending to get these savings?

The portfolio approach had a lot of duplicative efforts, both in organization, structure, and even how we went to market and so forth.

So you are seeing the proverbial low hanging fruit in this situation.

As we go forward -- and as I mentioned later, and we will let you know when that happens -- we think there's more opportunities, and that might be a little harder to reach, a little more expensive in the process.

But what we said now, we're being fairly conservative in terms of what it is going to cost, because there is a great deal of low hanging fruit just fundamentally because of how the Company operated in the environment that we went to market, and also the duplicate organizations across the spectrum.

And how much of the savings is head count?

I think we mentioned that in there.

It's a bit hidden.

Overall I think we said somewhere between the $120 million, I think we said about 85% of that is supply chain and the rest is SG&A.

Okay.

Thank you.

(Operator Instructions).

The next question comes from the line of Bill Chappell of SunTrust.

Please proceed.

Hey, good evening.

This is [Mike Schwartz] filling in for Bill.

I just want to touch on gross margin, commodity cost.

It came in a little higher than we expected on the commodity costs front this quarter.

I was just wondering, is this -- in fourth quarter, is this the peak of the commodity costs?

And do you have any pricing set to go through in fiscal year 2012?

Sure.

How you doing, Mike?

As it relates to commodity costs, as we had mentioned, if you look at the trajectory of commodities -- and again our key are milo, millet, sunflower -- if you look at those over time, they rose faster and more steeply in 2011 than they did even in 2008, which is also a high commodity price year.

As you look at quarter over quarter, if you look at the fourth quarter in 2011 versus the fourth quarter in 2010, they are up 84%, so pretty significant year-over-year comparisons.

They have come down slightly, but still well above historical norms.

As it relates to pricing, we have taken pricing throughout 2011, throughout -- and there is still more pricing to come.

We continue to work with our retail partners to cover those increasing commodity input costs, which we along with a lot of other consumer products continue to experience.

Okay, great, and then one last question was, with the -- I think you said $30 million of cost savings exiting fiscal year 2012 with this new cost reduction program.

Have you seen any of that through year end, fiscal year 2011, or is that all to come in 2012?

We started the transformation in fiscal year 2011.

I think when you see the K, you will see some of our facilities, warehousing and G&A has come down a little bit.

But what we are talking about today is really I think a much larger shift of run rate, just from a standpoint of we've begun, but we have a lot of work to do, and we will exit the year -- our run rate is going to be $30 million on a run rate basis as we exit calendar 2012.

But we have work to do between now and then.

Right, thank you.

Our next question comes from the line of Kevin Seagraves of Fort Washington Investments.

Please proceed.

Hello, thanks for taking the questions.

I was curious, in terms of the increased CapEx and then with commodity costs -- you talked the first half of 2012 continuing to be weak --- can you talk about how you guys are thinking about stock repurchases in the context -- and liquidity and leverage with all the different moving pieces on the restructuring side?

Sure.

With us capital allocation starts with funding organic growth, and so anything to do with organic growth, whether it's new products, innovative initiatives, expanding working capital to support sales growth, that's priority one.

Priority two is good acquisitions.

And what comes in and fills in the balance is stock repurchases when the prices are attractive.

You asked about how we are feeling about the balance sheet and our leverage ratios, and they are good.

And we expect with the transformation they will get better and better.

In terms of specific actions on stock repurchases, we don't disclose those.

We do them on their merits from time to time.

You guys don't have a -- I guess a leverage target or a leverage ceiling maybe that you wouldn't go through at some point?

Or is that -- or you have one and you aren't willing to disclose it?

I'm just kind of curious as to what your tolerance is for leverage?

We've said three times EBITDA is basically a spot that makes a lot of sense to us as a place to be.

The range around that, sometimes down to two.

For specific acquisitions and other things we might push it up to four.

Okay.

And then how do you feel about from -- I guess a manpower perspective?

It sounded like with the restructuring -- I understand low hanging fruit, but it sounded like there's a lot of things to be done.

How do you feel about your ability to balance all the different projects that you've got going?

Well, let me -- I want to reiterate that the cost cutting is the first step.

Our whole goal is to transform the Company from where we were into more of an operational company -- more of a multibrand operational company, as opposed to the portfolio Company that we had before.

But having said that, let me answer your question directly.

Each item that we're focusing on has a champion, has a timetable, and has a desired result.

So there isn't any overlap, and we have already figured out any constraints within the management team that may occur by resources that we may need in order to execute.

Let me just give you a for instance.

The centralized supply chain is led by Paul Hibbert.

Okay, he plays a big role in the cost reduction, and we didn't have this centralized before.

We do now.

He's focused on it.

His targets are clearly understood, both in supply chain, in facility rationalization, in warehouses that will be consolidated.

And there's a very clear point with a clear Gantt chart, if you will, with a -- every action is taken into account.

So it's -- there's not a lot of overlap, and there's some pretty -- there's clarity among the management team in terms of what we all have to do in order to achieve our results.

Okay, great.

And then with the success that you guys had this year in Garden, have you seen or are you concerned about competitive response, I guess, as we go into the next selling season?

I think we would be naive to think that there wouldn't be a response.

And we have to look and act accordingly.

Okay.

And then last, I don't know if you said this -- I didn't hear or it see it anyway, the -- what the availability is on your revolver at the end of the year?

At the end of the year, our revolver is $375 million in total.

We had borrowings of $35 million against that at September 24.

So the rest is available?

Yes.

Okay, great.

Thanks.

Our next question comes from the line of [Brett Kaufman] of Columbia Management, please proceed.

Yes, my questions were answered.

Thank you.

(Operator Instructions).

The next question comes from the line of [Carter Dunlap] of [Dunlap].

Please proceed.

Hi, yes.

I understand the lack -- or the reason for not providing any granular guidance in 2012, but as we think about the top line versus the operating income line, is it reasonable to assume that the revenue lines would be less impacted with the puts and takes that will obviously hit the operating income line?

Yes, we're going to continue to focus on growth, as Gus described.

We have had a continued and stepped up investment in brand building and advertising to grow our top line.

A lot of the activities on the cost saving side obviously wouldn't impact top line, but at the end of the day we are here to grow the Company, both top line and improved profitability.

Okay.

That's what I would hope for.

Thanks.

(Operator Instructions).

The lines are now open at this time.

With no questions in the queue at this time, I would now like to turn it over to management for closing remarks.

Thank you, and thank you for joining the call.

This transformation is about fundamental change, about improving the performance for our customers and our shareholders for the long run.

It's about removing silos and creating one Company that is focused on a clear unified set of goals.

We think the opportunity is terrific.

Thank you for joining us.

Thank you for joining the call.

You may now disconnect, and have a great day.