Central Garden & Pet Co (CENT) 2014 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Central Garden & Pet's first quarter 2014 financial results conference call.

My name is George, 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 Q&A session, and instructions will be given at that time.

(Operator Instructions).

As a reminder this conference call is being recorded.

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

Please go ahead.

Thank you George.

Good afternoon everyone, thank you for joining us.

With me on the call today are John Ranelli, Central's President and Chief Executive Officer, and Lori Varlas, Central's Chief Financial Officer.

As a reminder our press release provided results for our first quarter 2014 and December 28, 2013 available on our website at www.central.com.

Before I turn the call over to John I would like to remind you that statements made during this conference call which are not historical facts, including expectations for inventory reduction, new product introduction, cost reduction and improved profitability are forward-looking statements, subject to risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements.

These risks are described in our SEC filings.

We undertake no obligation to public lay update forward-looking statements to reflect new information, subsequent events, or otherwise.

Now I will turn the call over to John Ranelli.

John.

Thank you Steve.

This year my first as CEO has been very eventful.

We accomplished a great deal.

We are re-focused on the customer.

We increased the profits in our Pet segment, and are now beginning to focus on Garden.

We established a balanced approach of servicing our customers with excellence, while at the same time seeking to drive growth in sales, reduce expenses, and increase profits.

We made management and organizational changes.

We fostered an environment of accountability to emphasize the performance throughout the organization.

The foundation is now being laid to enable us to realize our ultimate objectives of substantially increased earnings and a higher stock price.

However, we still have much work to do to get our operating and financial performance where it should be.

We focused first and have made the most progress in our Pet segment, during the past year we raised prices and reduced expenses, while improving customer service, and enhancing our product innovation process.

Most importantly, we implemented new operating philosophies and principles throughout the Pet segment.

These changes have led to improved performance, stronger relationships with our customers, and more effective planning for the future.

They have also facilitated more effective cross-functional communication, better coordination, and greater accountability throughout the Pet organization.

We are beginning to see tangible results in the form of better execution in the Pet segment, for example, we increased profits in both the fourth quarter of last year and first quarter of this year.

We increased gross margins and reduced our SG&A resulting in higher operating margins in both periods.

We improved customer fill rates significantly, and we took positive steps to improve our cash flow and reduce our inventory levels.

We are confident that the steps we have taken to-date are the right ones for our Pet business.

However, we expect that it will take time for the full impact to show up in our financial statements.

Notwithstanding our recent improvements our Pet sales remained below prior year levels, as we wait for the changes we are making in mature service and innovation to translate into increased shelf space and consumer takeaway.

With respect to our Garden segment we are taking the operating philosophies and principles we instituted in our Pet segment, and are beginning to deploy them in Garden.

Our Garden strategy will be the same as Pet, a balanced approach focusing on sales growth and profitability improvement, with continuing emphasis on expense reductions and disciplined pricing.

We will focus as we are in Pet on executing better and more consistently.

We will develop a steady supply of meaningful new products that appeal to the consumer and provide superior customer service.

We will scrutinize all of our spending to ensure we are getting a proper return on our investment.

We recently made key management changes to better structure our Garden segment for success in the years ahead.

JD Walker will lead our Garden-branded products commercial organization, Dan Pennington will lead our wild bird and private-label garden businesses.

These changes are part of our efforts to put our customer first, and to place experienced and successful business leaders in positions to improve our results.

Both JD and Dan have a wealth of experience in the garden industry, and by increasing their responsibilities we will be able to leverage their knowledge and expertise.

We have made changes to position us to work more closely with our customers by removing a layer of management just as we did in Pet.

Mike Reed, our Executive Vice President, who previously ran Garden for five years, and has held other senior leadership positions within the Company, will have oversight responsibility for the Garden segment.

We are engaged in putting in place a whole new forward way of thinking throughout the entire organization,defining the future and making it a reality, through a disciplined approach that we did not previously have.

This includes introducing new and innovative products which is key to our organic growth.

These efforts take time, and we believe it will be another year to two before we will be firing on all cylinders.

This doesn't mean that we do not expect improvement sooner.

Just that the improvement will not be linear, and will not be as dramatic or consistent as we expect it to be in the future.

We are executing our balanced strategies in a consistent and methodical way.

These efforts are starting to show results confirming we are going in the right direction.

I am confident that the solid progress which we are making will be more visible as time goes on.

I am very optimistic about the future.

And now let me turn it over to Lori.

Thank you John.

You have likely seen the press release we put out earlier today, but I will give you some more color in a few areas.

On a consolidated basis sales for the quarter were relatively flat to last year, but our growth in operating margins improved.

A decline in Pet revenues was largely offset by revenue gains in our Garden segment, resulting in a sales decrease of 1%.

Our consolidated growth margin improved 110 basis points in Q1 from 26.3% last year to 27.4% this year.

We delivered improvements in our gross margin in both our Garden and our Pet segment, with the lion's share of the improvement coming from Pet.

Our first quarter operating loss was $8.4 million, improved from a loss of $13.1 million in the first quarter of 2013.

Our consolidated operating margin was negative 2.9%, a 160 basis point improvement from last year, reflecting the higher gross margin improvements in SG&A as a percentage of sales.

Let's move onto the segment results, starting with Garden.

As a reminder the majority of the Garden season spans our second and third fiscal quarters which have historically been the highest for revenues and profit for our Company.

Our first quarter is typically the lowest revenue quarter, due to the seasonality of the garden business.

In the first quarter the Garden segment revenues increased 9%, predominantly due to higher seasonal decor, wild bird seed and professional fertilizer sales.

All three benefited from increased distribution this year.

Grass seed sales declined due in large part to lower export sales, and the timing of orders from certain customers.

The Garden segment's gross margin improved, operating margins showed an even larger gain of 290 basis points.

The operating margin improvement was due in large part to better results in the seasonal decor and wild bird feed businesses.

To expand on that, the seasonal decor business was negatively impacted last year by sales returns and expenses that did not recur this year.

While bird seed margins reflect the benefits of lower raw material costs versus a year ago.

Going forward bird seed revenues and input costs may be impacted by market changes as commodity costs have recently come down.

Partially offsetting the improvement in the seasonal decor and wild bird seed margins were lower grass seed margins which were negatively impacted by higher raw material costs, and a mix shift to lower margin products in the first quarter.

In the Pet segment sales declined 5% on lower revenues in our aquatics, wild bird seed, and small animal businesses.

Sales in the aquatics industry as a whole have softened, and we lost distribution of certain aquatics SKUs to one of our customers in the summer of last year.

While bird seed sales were down due in part to customers shifting their buying until after scheduled price decreases were implemented.

Our operating margin in our Pet segment increased 260 basis points, primarily due to improved gross margins as well as reduced headcount from a year ago.

The areas of greatest margin improvement was in our Dog and Cat businesses.

Pet margins in general benefited from pricing, favorable mix, the discontinuation of marginally profitable SKUs, and manufacturing and distribution efficiencies.

Moving back to our consolidated results, in addition to improved gross margins in both Pet and Garden, consolidated SG&A expenses as a percentage of sales continued their positive trend for the fourth quarter in a row, excluding the goodwill charge in the fourth quarter of 2013.

SG&A expense as a percentage of sales improved 50 basis points to 30.3%, due principally to improved selling and delivery expense.

Net interest expense increased $2 million to $12.2 million in the first quarter.

Interest expense included a noncash charge of $1.7 million for unamortized deferred financing costs associated with our former revolving credit facility.

As you may recall we replaced the previous line with our new ABL in December of 2013.

Our first quarter net loss was $12.7 million, or a loss of $0.26 a share, including the $1.7 million noncash charge I just mentioned.

Our first quarter loss last year was $15.3 million for a loss of $0.32 a share.

Turning to cash flow and the balance sheet, our cash flow from operations improved $58 million from a year ago.

The improvement in cash flow from operations was largely driven by reduced spending on inventory during the quarter.

Inventories of $427 million, or $29 million higher than a year ago.

We increased our inventories in fiscal 2013 in response to supply chain disruptions in the prior year, and began to reduce the inventory balance in the back half of last year to more normalized levels.

While we are currently building for the upcoming garden season, we are focused on bringing our investment in inventory down over time when compared to comparable quarters.

We have made progress in our inventory reductions while balancing these actions with maintaining our fill rates.

CapEx for the quarter was $5.4 million, versus $8 million in the first quarter of 2013.

Depreciation and amortization for the quarter was $8.3 million relatively flat to last year.

Our cash and short-term investment balance was $31 million, and net debt was $419 million, both relatively unchanged from the first quarter of 2013.

During the quarter we paid off our previous revolver.

We had no borrowings outstanding on our current facility at the end of the first quarter.

During the quarter we did not buy back any of our outstanding shares.

Approximately $50 million remains available for repurchases under our Board authorized share repurchase program.

In summary while our consolidated sales were relatively unchanged, we reduced our first quarter loss as a result of higher gross margins and lower SG&A expense as a percentage of sales, while also improving our operating cash flow.

Thank you for joining us this afternoon.

We will be happy to take your questions.

George, would you please open the line?

Absolutely.

(Operator Instructions).

Our first question is from the line of Joe Altobello with Oppenheimer.

Please go ahead.

Hey guys.

Good afternoon.

Hi Joe.

I guess first question, for you, John, it seems like in terms of the tone, it is pretty noticeable that the same thing compared to last quarter it is very much improved, and I am just curious obviously the number is a little bit better than we saw in the last quarter, but did it just take some time for those cost savings initiatives and the pricing initiatives you just talked about in Pet to really kind of take hold, or did something else happen the last three months that has sort of changed the organization?

Well, I believe it is a whole series of things, including the two items that you mentioned.

I think our operating philosophies and our operating disciplines that we are putting into place is starting to work.

I believe our relationships with our customers are improving.

I believe our fill rates are improving.

I believe our innovation is improving.

So we have a lot of good things going in our favor.

Unfortunately, it is just going to take time for them to take hold, and for us to be able to see the potential of our Company on the financial statements.

Okay.

You did mention that obviously you have taken some steps on the Pet side, and you are seeing it in the margins, you want to kind of do the same thing to Garden.

How much of what you did in Pet is transferable to Garden, or is Garden a little bit different?

And what is the opportunity to size it for us, in terms of potential cost saves you see across the organization in the next 12 to 18 months?

Thanks.

With regard to the transferability of the operating principles that we are putting in, obviously no two businesses are exactly the same, but from a business perspective and an operations perspective are very similar.

So the concepts that we are putting into Pet definitely apply, and having started the process I am more convinced just about every day.

With regard to future potential, we are right now so focused on improving our earnings, and improving our relationships with our customers, improving our fill rates, et cetera, developing our new innovative products that while we are doing this, it is taking up most of our time, most of our energy.

We are looking at what the potential is, but we are learning what that potential is every day, so as soon as we have a better feel for our potential, and we would then be happy to communicate how we feel, and what the potential is about the business.

So right now we are just focused on increasing earnings.

Okay.

Just one last one if I could.

The last time you guys really took an ax to cost savings.

It sort of caught up to you with regard to customer service, and we are now heading into the heart of the garden season.

Are you concerned at all or worried at all that you are not prepared for the garden season, or do you feel like you are in a good spot at this point?

No.

I think we are in a very good spot for the season.

I think there are really two aspects to your question.

First is the operations side and the cost reductions.

The cost reductions have been done very surgically on more of a continuous improvement basis, so I don't see any major change in the cost reductions that would result in any impairment of service.

In fact, we made sure that as we put the changes in that they would not impact service.

The second aspect I believe of what you are asking about was inventory.

And as we are reducing our inventories, we are monitoring and have set a priority for our fill rates not to be impacted, and that is why we are taking a much more measured approach to reducing inventories, so that we do not impact our fill rates or our service levels in any way, shape or form as part of our inventory reduction.

Great.

Thanks John.

You are welcome.

Thank you.

And our next question is from the line of Kevin Ziets with Citi.

Please go ahead.

Hi.

Good afternoon.

Hi Kevin.

My question is on the Pet side of the business.

If you take-away the aquatics business that you lost last summer, would the business be up, or could you talk about sort of what is going on at POS versus in your sales?

The decrease in sales came really from a myriad of impacts on our various businesses.

We had weaknesses in certain of our categories.

We lost distribution in certain of our categories, and we had some reduction in sales as a result of some anticipation of price reductions in certain of our businesses.

So as you can see from that group, there is no one factor, but we also had some positive aspects.

First, we eliminated some unprofitable SKUs which impacted our financial statements primarily our revenues, and also we eliminated some promotions that we weren't as profitable on, and timed and reduced the timing of those promotions, and on top of that we introduced pricing which improved our margins.

So all-in-all there was a myriad of impacts on several different businesses.

It is very hard to just say it was one thing.

Okay.

And then as I guess as pricing comes down on the bird feed business, do you think you can hold the same level of profitability that you have had over the last several quarters?

That is what we are trying to do.

That is our objective.

Okay.

And then as you look at the Garden business, and making changes on that side of business, should we expect that you are looking to, that you may look to get out of businesses, or get out of products in the same way that you did on the Pet side that weren't meeting your profitability thresholds, or is there a different focus on that?

One of the principles that we have, if we have any unprofitable business we will always be looking at it, so as time goes on and we further develop our analysis and review and put in the operational changes in the Garden businesses, obviously if there are unprofitable products we would look at it, and make adjustments appropriately.

Okay.

And then the higher inventory levels that you have right now, is that and indication of better shelf space or distribution going into this garden season, or is it all sort of an abundance of caution to make sure your fill rates stay very high?

Alright.

So back in 2013 we deliberately raised our inventory rates because we had some fill rate issues the prior year, and so the back half of 2013, we started bringing those down and taking time, obviously on the Garden side we have to get to the garden season to take advantage of moving some of the seasonal products, so while we raised it last year for fill rates we think we are in good shape there, and have been very disciplined, very focused on bringing those inventory levels down over time, but it will take some time.

I guess I was just seeing that they are higher year-over-year at the same time of year, so is it continuing to be for fill rate perfection, or is there something that should tell us about how your placement stands for this garden season?

I think inventories are still high as kind of a carryover from last year, because we went through the season, we exited the season in June with our inventories very high, and so it is part of the carryover for that.

Okay.

I appreciate that.

And then just you mentioned you didn't buy back any stock.

Can you say where the, you haven't filed the credit treatment yet.

Can you say where the RP basket stands on the credit agreement and the indenture?

With respect to all our debt covenants, we are fully in compliance.

When we changed facilities from our previous revolver to our current revolver as it relates to the various covenants, there is one primary covenant, which only kicks in when we borrow up to 85% of the amount outstanding, and we had no borrowings on the line at the end of the quarter.

Okay.

And there are no restricted payments beyond that restriction?

We only have one fixed charge covenant ratio with the new ABL.

Okay.

Thank you.

Okay.

Thank you.

Our next question is from the line of Carla Casella with JPMorgan.

Please go ahead.

One question just for clarification.

You talked about a bit about inventory.

Did you say inventory in the channel doesn't go into the current quarter, how is it shaping up on the [side-inaudible] channel, meaning versus mass versus other channels, and is it very dramatically by Pet versus Garden?

From the channel perspective I think obviously as we approach the garden season there is a seasonality to both our inventories and the retailers inventories building for that garden season.

I don't think we are seeing anything that us abnormal in the channels.

It sounds like you said there is still some holdover from last year?

Oh, as far as our inventory.

The inventory we hold on our balance sheet.

Again our inventory levels are still too high, we are working on bringing them down, so as work through the garden season, we will be working our inventory levels down.

Okay.

And then any talks on refinancing the notes that are now are almost callable?

As we look at our capital structure we constantly evaluate that.

We have two pieces, one we have our bonds and we have our revolver.

As we look at the bonds, those carry obviously a higher interest rate.

The ABL gives us additional flexibility, and our first and primary use for that is in operations, as we build through the garden season, what we do is we borrow against that line, and then we build inventories appropriately, and then pay it down as we collect unreceivables resulting from the garden season.

We will continue to look at our capital structure, and make appropriate adjustments as we deem appropriate.

We are always balancing the potential P&L benefits versus our flexibility to achieve the appropriate balance.

Okay.

Are you committed to draw from your revolver to pay down notes?

The answer is very similar there.

Again, we look at our capital structure constantly, and try and balance between the potential P&L benefits of one scenario versus another, but we also want to make sure we have got the right flexibility for our operations for potential changes we want to make in the business.

Okay.

Thank you.

Okay.

(Operator Instructions).

Our next question is from the line of Alan Weber with Robotti & Company.

Please go ahead.

Good afternoon.

You took out new and innovative products, and like that.

I guess two questions.

One is, can you talk in any specific areas or segments that you are focused on, and then also is there any kind of data that you can share with us regarding the percent of current of next year of new products, relative to what it was a year or two ago, just so we can see and quantify improvements there?

Very good questions.

First, I think from a confidentiality standpoint it is a little difficult for us to talk about the types of products that we will be going into, but the approach to product innovation, or as we call it product, product, and product, which are our three strategies to improve our shelf space and our sell-through, and including our market share is really across the board.

We want to be innovative in each and every line of business, historically we have been known for being the most innovative competitor in our industry, and that is our objective again, so there is no weight or balance to any one individual business.

On the [size-inaudible] of the improvement, I would like to say that what we will be delivering in the future, and you probably as we have said, won't be able to see much of the difference, it really won't be in percentages, but I think it will be in more in multiples of what we have been delivering over the last year or two.

I guess looking at it in a different way, there are obviously expenses for product development, and there were revenues from new products.

Can you realize that you are not going to give those kind of numbers in detail, but is that kind of equation turn now at least heading in the right direction, or is it just that relationship has stopped declining?

No.

In fact, I believe that what we are doing is we are putting more resources behind our product development process than we have in the past, that may or may not be reflected in costs directly on the balance sheet or income statement, but we are also looking at what each and every project that we have, and we are identifying the lowest hanging fruit that we possibly can, and putting our resources more efficiently towards the highest revenue and profit producing products.

Okay.

I guess my last question with regards to when you talked about shelf space.

Are you seeing again, if you take away products that you are discontinuing excluding those kind of products, are you seeing actual signs of improved shelf space at this point, or heading into the season, or how do you stand?

I think it is too early for us to tell, and we will be taking reads as we go.

Okay.

Great.

Thank you very much.

You are welcome.

Thank you.

(Operator Instructions).

Our next question is from the line of [Robby Devisetti, Niti] Capital.

Please go ahead.

Good afternoon.

John, question I have is, I know you guys are making lot of progress on Pet segment, and you are trying to make the same on Garden segment, but historically Garden segment is a much tougher business than Pet segment, do you think you have the scale necessary to turnaround the Garden segment, and approximately you said it will take probably up to two years to turn it around, and if things don't turn around, would you make any strategic motions to remove that part of your segment?

First, we truly believe that the Garden segment is an attractive opportunity there.

We have strong brands in that marketplace, and we have a significant expertise.

Our retailers believe that our brands have a significant place on the shelf and in the consumer's mind, so we feel very comfortable with the Garden business, and its growth trends and our position in the marketplace.

With regard to potentially selling it, right now we have absolutely no plans to do that, and truly believe in the potential of the Garden business.

Thank you.

Thank you.

I am showing no further questions.

I will turn the call back to John Ranelli for closing comments.

Well, thank you for your questions, and for joining us on the call today.

We look forward to talking to you again in the very near future.

Ladies and gentlemen, this concludes our conference.

Thank you for your participation.

You may now disconnect.