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Operator
Ladies and gentlemen, thank you for standing by.
Welcome to Central Garden & Pet's first quarter 2012 financial results conference call.
My name is Mike, 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.
(Operator instructions).
As a reminder, this conference call is being recorded.
I would now like to turn the conference over to Steven's Zenker, Vice President of Investor Relations and Communications.
Please go ahead, sir.
Steve Zenker - VP of IR
Thank you, Mike.
Good afternoon, everyone, thank you for joining us.
It's 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 Company; and Lori Varlas, Central's Chief Financial Officer.
As reminder, we issued a press release this afternoon providing results for our fiscal first quarter, ended December 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 differ 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, filed on November 21, 2011, and other Securities and Exchange Commission filings.
Now I will turn the call over to Bill Brown.
Bill?
Bill Brown - Chairman, CEO
Thanks, Steve, welcome and good afternoon.
On our year-end earnings call a couple of months ago, we provided you considerable detail about the significant transformation that we are driving at Central.
We are becoming an integrated, multibrand company as opposed to a portfolio of businesses.
We are focused on eliminating silos and the unnecessary costs that these silos impose on our Company.
Beyond simply becoming a more efficient company, we intend to invest some of our savings in our growth.
We are investing in our brands and in innovation to achieve sustainable, profitable growth over the long-term.
Today we will provide you with a few data points that demonstrate our progress in the initial stages of our transformation against the goals we laid out.
The teams working on the transformation initiative are making good progress and I am very proud of their efforts.
We fully expect to achieve the cost savings and growth targets that we provided in November over the next two to three years' course of the transformation.
As we said on our last call, we expect our performance will be better in the second half of 2012 that in the first half.
This is due to input costs that remain high and the cost of repositioning Central, which will impact near-term results.
We expect that our cost-saving initiatives will begin to gain momentum and our revenue growth will benefit from our marketing and our brand-building activities.
And now I will turn it over to Gus to update you on specific milestones for this last quarter and our path forward.
After Gus, Lori will talk about our operating performance for the quarter.
Gus Halas - President & CEO of Central Operating Companies
Thank you, Bill.
First of all, I am pleased to report that we delivered our fifth consecutive quarter of revenue growth in the first quarter.
Lori will give you some additional details in a few minutes.
Meanwhile, it has been a good quarter of progress under the transformation plan we outlined on the last call.
The organizational structure we described previously is now in place.
We have reorganized operating units, shifted reporting lines, realigned accountability and aligned compensation incentives to reward whole-Company performance.
We may continue to fine-tune aspects of this structure, but the new organizational foundation is fully functional.
The Company looks totally different today than it did six months ago.
Let me provide you with some color.
In the sales organization, the consolidation of our sales efforts by category and channel are now complete.
We are getting favorable feedback from our customers on the level of service they are receiving from our unified teams.
We have expanded our marketing talent base, and they are aligned and fully focused on promoting our strong portfolio of products as we move into the spring selling season.
Rather than silos we employed in the past, we have organized our back-office teams by function to better drive synergies and standardize our internal processes.
We have organized our supply chain operations into one consolidated organization, including manufacturing, warehousing, procurement, inventory management and distribution.
This important part of our business is now aligned to deliver savings and synergies.
This area is fundamental to driving efficiencies and meeting our customers' needs.
In addition to our organizational realignment, we are continuing to execute against the cost savings plan derived from our thorough and detailed enterprise-wide evaluation in mid-2011.
One of the targets we shared on the last call is that we believe we can take out at least $120 million in annual costs over the next two to three years with savings from supply-chain initiatives and SG&A.
Another target we shared was our expectation of achieving a run rate of $30 million of cost savings by the end of this calendar year.
We believe we are on track to meet both of these targets.
Let me give you a few more specifics from the initial stages of our transformation.
Since the beginning of our fiscal year through today's call, we have closed two warehouse facilities.
We expect to achieve our target of closing a total of six facilities by the first half of this fiscal year.
In an effort to enhance efficiency and standardize our processes, we have accelerated our SAP implementation.
We have reduced the number of legacy ERP systems by two since we last spoke.
We are underway on the SKU rationalization process and in several product lines we have already begun to eliminate unprofitable or low-volume SKUs and are reducing the associated excess inventories.
We are in the early stages of this effort and believe there is ample opportunity in this area.
Much of our purchasing has now been consolidated, with more to come.
This will help us achieve better pricing through volume discounts and sharing of cost information across the enterprise.
On the manufacturing side, our lean Six Sigma review of our operations is in process, and we have found significant opportunities for operating efficiencies that we are beginning to execute on.
We continue to believe we can reduce inventories by $60 million to $70 million by the end of this fiscal year with a goal of doubling that amount over the next two to three years.
This quarter inventories actually rose compared with the first and fourth quarters of 2011.
As you may recall, the fiscal first quarter is typically when we build significant inventory for our spring garden season.
In addition, a trend we have seen recently is that certain retailers desire to hold less inventory themselves.
This may temporarily cause our inventory levels to be higher than historical levels in order to meet customer demand for quicker turnarounds.
And, finally, the cost of raw materials included in inventory is higher than the prior year.
Nevertheless, despite this rise in the first quarter, we expect to see the inventory levels drop meaningfully later in the year.
As our efforts to reduce our SKU count pick up steam and we see results from reducing our working capital investment in inventory.
From a headcount perspective, from the beginning of Q1 2012 through mid-January, we reduced our core headcount, which we project will translate to an annualized savings of $4.5 million.
We will hire seasonal workers to assist during the peak garden season, as we always have, but this will only be a temporary increase.
Further identified efficiency gains and right-sizing of our operational footprint is expected to yield additional savings in future quarters.
It's really too early in the transformation to report any significant cost savings in the first quarter, although many initiatives are in place.
However, we continue to believe strongly that many of our actions we are now taking will result in significant savings in future quarters.
We expect calendar 2012 savings to be back-end loaded, benefiting results later in the year and beyond.
So in summary, we believe we are on track to meet transformation targets were laid out in November.
We continue to progress toward our objectives to come out of the transformation two or three years from now with sustainable top-line growth of 10% or more and EBIT margin of at least 10%.
If we really are firing on all cylinders and achieving optimal mix of products and distribution, we think EBIT margins can get as high as 15%.
I hope you can see from the examples I have described that we are pleased with the early progress we have made.
We have much work ahead of us and are focused on profitable growth and pleasing our customers.
With that, I will turn it over to Lori.
Lori?
Lori Varlas - SVP, CFO, Secretary
Thanks, Gus.
The details on our first quarter results are in the press release that we issued this afternoon, so let me highlight a few key metrics we have seen.
Though the significant proportion of management's time and attention continue to be devoted to our transformation, we delivered, as Gus said, our fifth consecutive quarter sales growth with first quarter revenues increasing 7% year-over-year.
And importantly, we delivered growth in both the Pet and Garden Products segments with sales up 7% and 8%, respectively.
Keep in mind that this is typically the lowest quarter -- revenue quarter of the year due to seasonality of the Garden Products business.
The second and third fiscal quarters have historically been the highest for revenues and profits for our Company.
Our gross margin as a percentage of sales in the quarter was 26.7% versus 29.5% in the first quarter of 2011.
Products mix was a factor in both the Garden and Pet Products segments as change of timing of some of our larger customers' purchases tightened their inventory control practices were a factor in mix changes to our sales compared to last year.
Also, commodity costs continue to drag on our profit.
In the Garden Products segment, revenue growth was led in large part by higher sales of bird seed, built by higher pricing and increased volume.
While revenues increased, margins for the Garden Products segment were lower than the first quarter of 2011 as high raw material costs continued to affect bird seed margins.
Our margins were down year-over-year, it's worth noting that growth in operating margins for bird seed during the quarter were stabilized over the fourth quarter of last year, helped by recent price increases.
As I mentioned earlier, product mix was also a factor as we filled more bird seed and experienced greater sales of lower-margin chemical and controls products.
In the Pet Products segment, the strength in sales was widespread with our small animal and dog and cat category particularly strong.
Our small animal category, which includes aquatics, pet bird and other small animal businesses, has benefited from innovative new products and increased distribution while our dog and cat products benefited by the timing of customer buying patterns.
Margins in our Pet Products segment declined primarily due to product mix, higher raw material input costs and higher trade and consumer promotional expenditures.
Product mix reflected lower sales in areas such as equine, which typically carries higher margins, and higher sales in our dog and cat category where margins are not as high.
Also during the quarter our flea and tick products were subject to discounts as older product was moved out to accommodate a launch of new innovation in flea and tick this spring.
As you might recall, or profitability in flea and tick in the second half of last year was negatively impacted by the availability of generic Firponil and unfavorable weather.
However, we have several customers who are either new to carrying our flea and tick products or who have expanded their relationship with us this year.
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SG&A expenses decreased to 30.5% of sales from 31.8% in the first quarter of 2011, which benefited with the growth in our revenues.
The first quarter operating loss was $11.3 million, reflecting our lower gross margin.
Our first-quarter net loss was $13.1 million or $0.27 a share.
A few final data points for Q1 -- during the quarter, we repurchased approximately 2.6 million shares of our common and nonvoting Class A common stock for a total of $20.9 million.
As of December 24, 2011, approximately $52 million remained available for future share repurchases under our current $100 million repurchase program authorized by the Board in June of 2011.
CapEx for the quarter was $9.2 million versus $5.3 million in the first quarter of 2011.
As we mentioned on our year-end call in November, we expect our CapEx to be higher in fiscal 2012, approximately $40 million versus the roughly $25 million to $30 million we have typically spent over the last couple of years.
This summer we posted our fifth consecutive quarter of revenue growth with total Company revenues up 7%.
Our Q1 results reflect growth in our top line in both segments of the business and a seasonally slow period for lawn and the garden category.
Our margins reflect continued high material input costs and changes in product sales mix.
As a management team, we continue to focus on both operating the business and servicing our customers while successfully implementing significant changes to our business for the long-term growth and profitability of the Company.
We are looking forward to providing additional information on the progress of transforming the Company into an integrated multibrand company as we move through the year.
Thank you for joining us this afternoon.
Now Bill, Gus and I would like to take your questions.
Mike, would you please open the call to Q&A?
Operator
Bill Chappell, SunTrust.
Bill Chappell - Analyst
First, I wanted to dig into my understanding of the cost savings, both $30 million for this year and $120 million.
That's obviously $0.30 this year and over $1 over the next three years.
How much, how quickly does it fall to the bottom line, and where would be the focus of what's not falling to the bottom line?
Is it more R&D, is it more sales and marketing?
How should we look at that?
Bill Brown - Chairman, CEO
Bill, I would like to make an opening comment, and then perhaps Gus or Lori can fill it in a bit.
There must be a misunderstanding of what we communicated because I believe what we communicated is by the end of the year we would be at a run rate of $30 million (multiple speakers) in 2013, we would see $30 million on the run rate plus any additional savings we created in 2013.
In this year many of these savings won't start until we have made a lot of the changes that Gus discussed as he was speaking.
And there will be some one-time costs that go through the P&L that will offset that.
So the effect for this year will be quite modest.
Bill Chappell - Analyst
I'm sorry; for 2013, how should we look at it?
Bill Brown - Chairman, CEO
Well, 2013 we should see $30 million of savings, plus whatever we generate during the year net of cost.
(multiple speakers) stated it correctly?
Gus Halas - President & CEO of Central Operating Companies
Yes, that's the key, is that it is the total run rate.
And as I said, it was what we were committing to.
But it is at a run rate, and during my call, I mentioned that it's going to be mostly back-end loaded into fourth quarter and beyond, not necessarily we're going to be able to achieve all those results right away.
Bill Chappell - Analyst
Sure.
No; I guess I was just trying to understand as we move forward and looking, it's a pretty sizable impact to EPS, and if it was to all fall to the bottom line, should we expect that to eventually fall to the bottom line?
Or are you reinvesting a half or three quarters of it, or how should I look at that?
Gus Halas - President & CEO of Central Operating Companies
I think that's going to be fundamentally based on what we need.
We are committed to our branding strategy and to growing our products in the marketplace.
So that's going to be predicated on what we see as a need rather than a deliberate effort for this year because this is pretty much in 2013.
The best way to look at it is we're going to $30 million in 2013, and that will be part of our operating plan that will dictate how much we apply towards brands or other investment versus dropping straight to the bottom line.
Bill Chappell - Analyst
Okay, and then in terms of the commodity environment, I guess I'm just trying to understand how that also impact sales, just in terms of both grass and bird.
I understand you're getting the benefit in the second half of lower commodity costs, but usually in the past you've also seen prices having to be pulled down with that, that somewhat offsets that.
How should we look at that over the next six to nine months?
Lori Varlas - SVP, CFO, Secretary
If you think about the first quarter, our price of our -- the weighted cost of our key materials for bird seed Q1 this year versus Q1 last year are up more than 50%.
As we've talked about in previous calls, we took pricing throughout fiscal year 2011.
We will have more pricing coming into play here in the Q1 we just completed as well as Q2.
So there's a bit of a lag effect.
And while, if you look at the marketplace, commodity costs have come down slightly.
They still remain higher than prior year, and so that certainly factors into our gross margin.
If you look at in terms of our Garden segment, bird seed was quite strong.
We saw benefit from both pricing and from volume.
So definitely from a short-term perspective.
Is it relates to the back half of the year, I don't think we are really counting on any windfall.
We are continuing to operate not knowing where commodity prices are going, but keeping a very, very close to eye on our margins looking to our customers to cover our costs.
So the pricing we have taken historically is starting to take effect.
There's still more pricing to come, given the steep and high rise of commodity costs over the last year.
Bill Chappell - Analyst
Then one last one -- I know you don't talk about individual deals, but one of your competitors made both an acquisition in the pet and in the garden over the past three months.
Are you still open to acquisitions or should we think of it more of an internal focus of fixing everything over the next few quarters?
Bill Brown - Chairman, CEO
We have an active search and exploration of acquisitions going.
And I think it's reasonably broad and robust.
But we have always been disciplined buyers, and some of the numbers and things that we have seen don't look so attractive.
Bill Chappell - Analyst
Got it, thanks so much for the color.
Operator
Joe Altobello, Oppenheimer.
Joe Altobello - Analyst
First question -- I just wanted to go back to something you guys mentioned earlier about the one-time costs this year.
Roughly speaking, how much do you expect to spend on a one-time basis this year?
And then how much does that number increase or decrease in 2013?
Lori Varlas - SVP, CFO, Secretary
So we talked a little bit about this in our last call.
As it relates to fiscal year 2012, we anticipate we will incur costs in the neighborhood of $10 million.
As it relates to the next two or three years, probably $30 million to $40 million investment as we transform the Company.
Joe Altobello - Analyst
Okay, so that $10 million is going to run through the P&L; right, Lori?
Lori Varlas - SVP, CFO, Secretary
Yes.
Joe Altobello - Analyst
And then I'm sorry you said the next two to three years, $30 million to $40 million?
Lori Varlas - SVP, CFO, Secretary
Yes.
Joe Altobello - Analyst
Got you, okay.
And then in terms of the retailers taking inventory later in the season, it sounds like, or at least later in the quarter, could you help us quantify that and maybe how much that might have impacted sales in the quarter?
Lori Varlas - SVP, CFO, Secretary
I'm sorry; can you repeat that?
Joe Altobello - Analyst
Yes, sure.
In terms of retailers taking inventory later in the quarter, could you quantify how much that might have impacted sales?
Lori Varlas - SVP, CFO, Secretary
Yes.
It's quite interesting.
I think we are seeing a trend along with other companies providing products to the retail market.
The inventory levels at our retailers are trying to keep those relatively low, and so in some areas of our business it benefited as sales from Q4 to Q1.
In other areas, sales moved from Q1 to Q2 and further out.
So I think it's can't necessarily quantify that, but we have seen a trend where retailers just on average are trying to keep those inventories low, requiring us to make sure we can service them in a more rapid fashion.
Joe Altobello - Analyst
Okay, so it's possibly a wash where you are benefiting from some sales getting pushed back and some sales being pulled forward, essentially?
Lori Varlas - SVP, CFO, Secretary
Well, I think the other piece of that is mix.
So it sort of depends on what gets deferred on the inventory levels on what gets booked quarter to quarter, so sometimes it could impact us from a mix perspective which impacts profitability as well.
Joe Altobello - Analyst
Just one last one in terms of SKU rationalization.
I think you guys have talked about reducing the number of SKUs by about 30% or 35%.
Obviously it's early, but where do you see that number by the end of fiscal 2012, let's call it?
Gus Halas - President & CEO of Central Operating Companies
That key area that we are looking for and we are hoping we are going to be able to achieve most of that by calendar 2012.
But a lot is going to depend on the marketplace and how important each of those SKUs are to our customers because we want to make sure that we continue down the path of profitable and satisfying customer needs.
So as an overall, overarching target, that's our target.
But that doesn't necessarily mean that we are going to get there, predicated on what happens with our customer base.
Joe Altobello - Analyst
Understood, okay, thank you.
Operator
(Operator instructions) Karru Martinson, Deutsche Bank.
Karru Martinson - Analyst
Just for a point of clarification on the $120 million of cost savings, we are essentially getting a very minimal amount here in 2012.
We'll have the run rate of $30 million, well, we will exit with a run rate of $30 million and we'll get the $30 million in 2013, plus any additional.
But that would imply that in year three of this program that we are looking at a $90 million potential savings in one year.
What is that kind of back-end loaded savings opportunity that we should be focused on?
Gus Halas - President & CEO of Central Operating Companies
Let me see if I can suggest a better way to look at it.
The savings sort of starts to be rather small because you have to deploy resources, take a lot of action necessary in order to be able to do that.
And as momentum builds you have more and more opportunities.
As the policy deployment, the lean Six Sigma starts to take place, you have a residual effect that starts to build up throughout the years.
So it's not as though it's going to be so linear in the process.
If you can imagine, it's almost like a geographic line that starts going up over a period of time.
And it becomes cumulative to that effect.
And I hope I'm not getting too outside the area of what I want to talk, but it just sort of starts slow and starts to build momentum.
And that's why we are committing between two to three years because we want to make sure we are going to get the savings over a certain period of time.
It's not necessarily that we are going to get them on the third year or the second year; it's just going to be how we have our policy deployment and how we get our organization to focus on those particular goals.
Karru Martinson - Analyst
If I look back over the last couple of years, and when I say the last couple of years I'm thinking more of, let's say, the last decade, it is kind of been this ebb and flow over the years of where you have brought in costs and then a couple years later we find that costs have kind of grown again and then we kind of restructure.
And there has been this kind of ebb and flow.
What are we doing different this year to kind of lock in the savings that we don't face this in, say, let's say four or five years down the road, again having to kind of reinvent the wheel?
Bill Brown - Chairman, CEO
Well, I think in the simplest sense we are a completely different company.
We used to have siloed, separate businesses and all the actions were taken within them.
And we didn't even get many of the savings that we are getting now from sharing facilities, doing Company-wide buying.
It's as simple as butane for the fork trucks.
We used to buy it from 27 different suppliers across the country.
We had no buying power when it came to mobile phones, it was spread all over, business by business.
This is a completely different thing, and what Gus brings to us is a skill set and an experience in building these things, locking them in over the long-term structurally so that it's quite different.
The only thing that I can see that would tend to potentially be variable in the future are the prices associated with input commodity costs.
In there, we are putting in a very concerted effort to much more tightly manage those, to look at any forward contracts, to lock up positions and to be able to negotiate with our retailers these step-ups so that we don't take all that risk.
Those would be things I would answer in a broader context.
Gus Halas - President & CEO of Central Operating Companies
Just as a corollary to that, the whole issue is what cost savings do you develop in order to make sure that you institutionalize a lot of the savings and a lot of the steps that you take in acquiring or anything else and, frankly, limiting the number of resources, the number of options where people can go to purchase.
We have approximately 50 suppliers of pallets, if you will.
We plan on having them on a regional basis that there are no more than five or six.
So once you develop those kind of relationships and once you implement them that they only have those particular sources to buy from, then it becomes a little more restrictive and it's a lot clearer in terms of understanding.
So it's a matter of policy deployment and making sure that we do the right things and develop the processes to ensure that we don't backslide or lose the savings.
Karru Martinson - Analyst
Just on those input costs, the bird feed costs were up, I think was you guys said 41% or so on the last call.
When you just go to the retailers and you lay out the facts of the input costs that you're getting or that you are seeing, what is the pushback on raising prices that you're seeing from the retailers and, I guess, from your competitive peers out there as well?
Gus Halas - President & CEO of Central Operating Companies
Well, for the most part, it's discretionary.
It's a discretionary buy.
So our retailers are concerned about what the elasticity is on that kind of product and what impact it's going to have on revenue.
So far, we have not had severe drop-offs because of elasticity issues.
But in the future, who knows?
So the resistance is maintaining the profitability and us along with them, and being concerned about how it's going to affect the revenue on the price/volume basis.
Karru Martinson - Analyst
Thank you very much, guys, I appreciate it.
Operator
(Operator instructions) Kevin Leary, Spitfire Capital.
Kevin Leary - Analyst
Just a couple of questions.
In the press release you mentioned that leverage ratio on the quarter at 3.9.
Could you remind us what the covenant is on that leverage ratio?
Lori Varlas - SVP, CFO, Secretary
I was (inaudible) at the overall covenants -- we typically have a range we like to be in, in the 3 to 3.5 range; we're at 3.9.
The actual ratio itself has to do with debt and EBITDA, and I'm just looking here at the actual covenant.
Bill Brown - Chairman, CEO
I don't think we have an overall leverage covenant.
We have a covenant that deals just with the senior portion and not an overall leverage covenant.
Kevin Leary - Analyst
Got it, thanks.
While we are on debt, I also noticed that net debt increased about $125 million year-over-year.
I was just wondering if you could expand for a minute on how you think about managing your net debt levels and potentially paying that down.
Lori Varlas - SVP, CFO, Secretary
So our debt's comprised of a couple of pieces.
We have the $400 million with the fixed debt, fixed interest rate, as well as our revolving line of credit.
The revolver was about $60 million at the end of the quarter, which was up over the prior year.
As we think about the seasonality of the business, as we go into Q2 we are clearly building inventory for that peak garden season and so we'll draw on that line.
As that inventory converts through sales, through receivables, we collect those dollars, we typically pay that down.
So there's a seasonality to our debt levels as well with the higher debt levels in the second to third quarter, third quarter with it being paid out.
So that's the seasonality we look at.
Kevin Leary - Analyst
Got it, thanks.
And then just last question -- were there any restructuring expenses in the quarter?
Lori Varlas - SVP, CFO, Secretary
It was minimal.
I think over the course of the year we expect it to be somewhere in the neighborhood of $10 million as we look at optimizing our facilities, our operations, investing in the business with it growing.
And so we will see that spread across the year, but the first quarter was relatively minor.
Kevin Leary - Analyst
Got it, that's all I've got, thanks.
Operator
(Operator instructions).
Well, it appears that we have no further questions at this time.
Bill Brown - Chairman, CEO
Thank you for joining us on the call and we look forward to being with you again next quarter as we make our transformational journey.
Bye, everyone.
Operator
Thank you, sir, and thank you to the rest of management for your time.
The conference call is now included.
We thank you all for attending today's presentation.
At this time, you may disconnect your lines.