Central Garden & Pet Co (CENT) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden & Pet third-quarter FY16 financial results conference call. My name is Claudia and I will be your conference operator for today.

(Operator Instructions)

As a reminder this conference call is being recorded.

I would now like to turn the conference over to Steven Zenker, Vice President of Investor Relations and Communications. Please go ahead.

Thank you, Claudia. Good afternoon, everyone, thank you for joining us. With me on the call today are George Roeth, Central's new President and Chief Executive Officer; Howard Macheck, Senior Vice President, Finance and Chief Accounting Officer; J.D. Walker, Executive Vice President and GM, Garden Brand; and Niko Lahanas, Senior Vice President, Finance Operations and Management Reporting.

Our press release provided results for our third quarter ending June 25, 2016, is available on our website www.Central.com. Also on the website is the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call.

Before I turn the call over to George, I would like to remind you that statements made during this conference call which are not historical facts, including adjusted EPS guidance for 2016, expectations for new product introductions, future acquisitions, and improved revenue and 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 and others are described in Central's Securities and Exchange Commission filings, including our Annual Report on Form 10-K filed on December 10, 2015. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events, or otherwise.

Now I will turn the call over to our new CEO George Roeth, who joined us on June 1. George?

Thank you, Steve. Good afternoon, everyone. It's a pleasure to be with you today. I have now been in the CEO seat for a few months and I continue to be impressed by the quality of the Central team's execution, their dedication to our customers, and their commitment to and passion for the business. I think this is reflected in our results for the quarter and for the last couple of years. I thank the Central team for the recent success and frankly making my entry into the CEO role a smooth one.

I'll leave most of the numbers for Howard, but I did want to highlight the $0.51 in GAAP EPS and $0.48 in adjusted EPS that we earned for the quarter, were up 34% and 26% respectively versus year ago, on revenue growth of 12%. We feel great about our results and momentum of the businesses.

As the Company continues to operate in the near-term business well, I've been able to focus on a number of initial priorities including look, listening, and learning. I'm working closely with our employees and business leaders and getting valuable feedback from our customers. These sessions have helped me better understand our operations and our strength and opportunities as a company.

I've also been working with key leaders in the Company on evolving Central's longer term strategy. We'll be in a better position to discuss this with you in detail after our fiscal year end. However, I can tell you that we won't be making any major right-hand turns. We will continue to be focused on the three pillars that we have been executing over the last few years: a customer-first orientation, increasing our innovation output and success rate, and lowering our costs to reinvest in growth.

While we have demonstrated much progress in these areas, I can signal that we will be more aggressive going forward. This will include accelerating the depth and pace of our innovation efforts, increasing demand building activities, and driving even more systematic cost reduction efforts, all with a goal of driving sustainable growth over the long term.

I am personally engaged in a deep dive on our innovation and cost reduction pipeline, with the objective of building a robust, ongoing three-year pipeline of initiatives in order to ensure that we have a clear line of sight to deliver on our growth objectives. We believe that there is significant opportunity on both the cost reduction and innovation fronts, with the former funding the latter.

One of the more complex cost reduction efforts that I would like to highlight, which will result in some additional near-term costs, is in our dog and cat business. This is one of our fastest growing business units where we have recently deployed additional capital to add capacity, consolidate various supply chain facilities, while improving operating efficiencies to lower costs.

On the innovation front, recent examples of growth oriented innovation include two new behavior modification products for our dog and cat business -- for dogs and cats, under our Comfort Zone brand. Comfort Zone products dispense pheromones to calm dogs or cats and has shown great growth this year albeit from a relatively modest base.

Another recent launch in our Garden segment was an extension of our AMDRO product line, AMDRO Quick Kill that debuted this spring. Those products are performing well above our expectations, and you will see expanded distribution and new product introductions in this line in 2017.

Driving the pace, quality, and quantity of our innovation cost reduction efforts was a significant focus for the organization. These efforts will take some time because of the associated lead times, but we are confident that we can make progress on this front over time.

Finally, I'm actively engaged in assessing our portfolio to more clearly define the role of each of our current businesses, while also seeking attractive acquisitions that are strong fits with our current capabilities and are consistent with our future growth strategy. To be clear, our plans will not be dependent on M&A because much of that is out of our control. But we believe it can continue to be a strong growth contributor, as evidenced by our recent DMC and IMS acquisitions. These both are performing well and making valuable contributions to both our top- and bottom-line growth.

As I indicated, we will be able to talk more definitively about our strategies and plans later this calendar year. In the meantime, we will stay focused on executing our current plans with excellence and finalizing our plans for FY17.

With that, I will now turn the call over to Howard to go more in depth on the financials for the current quarter.

Thank you, George. Good afternoon, everyone. We issued a press release earlier today outlining our third-quarter financial results. I'd like to give you some color around those results.

For the third quarter, the Company recorded GAAP earnings of $0.51 per diluted share, up 34% over the same period last year. Included in those results was a $2.4 million gain on the sale of a manufacturing plant. Excluding the sale, earnings were $0.48 per diluted share, a gain of 26% over the prior year.

Consolidated sales for the quarter increased 12% versus the prior year to $515 million, aided by recent acquisitions. Organic revenue growth, excluding the impact of acquisitions over the prior 12 months and our exit from the seasonal decor business earlier this fiscal year, totaled 5%. Consolidated gross profit rose 15%, and our gross margin increased 90 basis points to 31.8%.

SG&A expense for the quarter increased 12% or $13 million versus a year ago. And as a percent of sales increased by 10 basis points to 22.5%. Included in our SG&A is the $2.4 million benefit from the manufacturing plant sale.

Operating income for the quarter rose to $48 million compared to $39 million a year ago. Our operating margin of 9.4% was up 90 basis points due to the absence of the seasonal decor business, lower raw material costs, and manufacturing efficiency improvements.

Turning now to the Pet segment. Pet segment sales for the quarter increased 21%, or $49 million, to $287 million. $39 million of the increase was from two recently acquired businesses, IMS and DMC. Our organic revenue growth was driven by sales of other manufacturer's products and our professional and wild bird feed businesses. Pet segment operating income increased $6 million, or 18%, compared to the prior year, and includes $2.4 million from the manufacturing plant sale. Pet operating margin declined 30 basis points to 13.5%.

Moving to Garden. For the quarter, Garden segment sales increased 3%, or $6 million, to $227 million. Higher sales of other manufacturer's products and increased wild bird feed revenues were the largest contributors for the sales increase and more than offset a reduction of $7.7 million due to our exit from the seasonal decor business. Garden's operating income improved 13% to $26 million, and operating margin increased 100 basis points to 11.6%. The improvement in both operating profit and margin were due in part to the exit from the seasonal decor business, which was not profitable, as well as lower raw material costs and manufacturing efficiency improvements.

Moving back to our consolidated results, net interest expense decreased from $9 million to $7 million. The $2 million decrease was due primarily to a lower rate on our fixed-rate debt as a result of the refinancing we completed in the first quarter of the fiscal year. Our net income for the quarter was $26 million, and diluted earnings per share were $0.51, compared to $19 million or $0.38 in the third quarter of 2015. Adjusted earnings per share excluding the manufacturing plant sale gain was $0.48.

Regarding our balance sheet and cash flows. For the quarter, cash flow provided by operations was approximately $140 million, compared to $155 million in the third quarter a year ago. The Company's inventories balance rose $22 million from a year ago and reflects the increase from a recent acquisitions, partially offset by the businesses we are exiting. CapEx was $7 million in the third quarter of 2016 and 2015.

Depreciation and amortization for the quarter were $11 million, up from $8 million a year ago. The primary drivers of the increase were, one, we wrote down or accelerated the depreciation on some assets we don't intend to use going forward; and two, the impact of the additional amounts related to our recent acquisitions.

Cash and equivalents including short term investments decreased to $40 million, from $44 million a year ago. And our total debt decreased to $395 million, from $397 million a year earlier. The takeaway from this is that after spending approximately $90 million on acquisitions in the last 12 months, one, our cash balance and debt balances remained relatively unchanged; two, at quarter end we have $400 million available under our asset backed credit facility; and three, our leverage ratio at quarter end was 2.5 times, down from 2.9 times a year ago. In other words we have plenty of resources at our disposal to execute on our strategies and goals.

During the quarter we did not repurchase any of our outstanding stock and approximately $35 million remains available under the Board approved stock repurchase program.

As far as guidance for the fiscal year, we are revising our adjusted EPS guidance to a $1.18 per share or higher, reflecting our strong results this quarter and year to date. As we mentioned last quarter, we continue to expect, one, a slowing of organic revenue growth for the Pet segment, compared to the high single digit increase experienced year to date through the end of the third quarter. This rate of increase is unsustainable as industry growth appears to be slowing. In addition, our comps will become more difficult as we anniversary some sizable new product launches and distribution gains we achieved over the past 12 months.

Two, we also continue to expect our SG&A expenses as a percent of sales for the fourth quarter to be above the prior-year level, as we spend to invest on initiatives to drive future sustainable growth. As George mentioned earlier, we will give more details on what to expect in 2017 on our year-end call later in the year.

Now I'll turn it back over to George.

Thank you, Howard. So to summarize, we continue to be pleased by our performance, and we'll stay focused on executing well and exhibiting financial discipline. Additionally, we are refining and putting meat on the bones of our strategies and plans in order to ensure that Central delivers sustainable top-line and bottom-line growth over the long term. One quarter into my tenure as CEO, I continue to be very optimistic about what the great people here Central can accomplish.

Now we would all be happy to answer any of your questions. Operator, please open the line for questions.

(Operator Instructions)

Bill Chappell, SunTrust.

Thanks. Good afternoon. Just a quick question on the Garden segment, with various reports about weather, especially in May in the Northeast, can you characterize how it was for your business? Was this a fairly normal season that evened out, or where you hit by weather as well and it could have been even better?

Hi, Bill, this is J.D. Walker, I'll take that question. It's a good question. When you say fairly normal weather I'm not sure what normal weather is like anymore. In the last couple of years, we've had some challenging years. This season was an interesting one in that it broke very early, so the February/March time frame was extremely strong. April and May we saw softness in consumption across the business and that was pretty widely reported by other lawn and garden companies, by retailers as well. So we indeed did see the weather impact, particularly in northern markets, the Northeast in general was pretty soft.

Having said that, we feel pretty good about our performance here. We came into the season knowing that we were going to have some headwinds due to the exit of a couple of businesses. We also had just come out of Q2 where our wild bird business had not been very stellar, had not kicked in yet, but it rebounded in Q3. So to have it both the top-line and bottom-line growth in Q3, we feel very good about that performance.

Okay. That helps. Thanks. Turning to (inaudible) in both businesses, you talked about other manufactured products that driving the growth. Was there any specific segment that was doing that, or specific brands, or is it just -- and how much did that mix maybe affect your gross margins by those growing faster than your core brand?

Hey, Bill, this is Niko. On the Pet side we had fairly good double -- not double digit, but high single digit growth on the vendor partner side. That was really the -- it was due to the gains and pick up of some food business as well as increased distribution -- new customers as well as more doors at existing customers. That business typically is a little bit lower margin as everyone has come to understand. So it does have a bit of a dilutive effect on our margin.

On the Garden, was there anything, or it was mainly on the Pet side?

It was on the Garden as well, Bill. On the Garden side I will echo a lot of Niko's comments. It's a lower margin business for us. That business was a business that was challenged a few years ago. We weren't in a very good operating rhythm, so we've reset that business. It's now profitable for us; it's now growing very nicely.

We have people coming to us all the time that want us to distribute their products, both to the independent channel and also to try to gain distribution in some of the larger retailers. Some of the larger retailers, national retailers, view this is a value-added service that we provide to them. And for us, it gives us more critical mass with those retailers.

So to answer your question, it wasn't a specific brand, it was a number of brands. It was a number of retailers. We are pleased with that business. It continues to grow very rapidly, but we're also being very choosy in who we partner with in taking them to market.

Perfect. Last question for me, so what should be the normalized D&A rate going forward?

Our -- if you noticed our D&A rate was just a little bit higher this quarter. I would put more in the norm of what we experienced earlier in the year than the additional $3 million we had coming through this quarter.

Okay, so just $3 million. Perfect. Thanks so much.

Jason Gere, KeyBanc.

Good afternoon, guys, congratulations on the quarter.

Thanks, Jason.

I have two questions that are a little bit more longer term. Some of this might be work in progress and we'll probably here later, but I was just trying to get your thoughts. So you were talking about the innovation pipeline and that's one -- George, I think that's one of your areas of focus, trying to get that three-year [pipe]. I was just wondering where it stands now? What could go into this in order to drive some of the larger or maybe bigger innovations? Clearly, I know some of this has come from the Clorox kind of model. I was just wondering where Central Garden & Pet stands right now on the innovation front, how deep it is? What would you need to get to that runway of growth?

The first thing I would say is -- I go back to strategically -- innovation is going to be more critical in some businesses than others. Each business will have its role, once we've completed our strategies. But innovation will definitely be a driver to the top line.

As I look at Central today, the innovation pipelines are there. Some are healthier than others. I think when you look at some of our recent launches that I mentioned in the script around our Comfort Zone behavior modification products and things we've recently done on Nylabone and our aquatics. Across the Company there's good innovation entering the marketplace, and I think our organic results reflect that.

Ongoing, I think we're going to try increase the depth and pace of that. And the way to do that is -- as I've talked about I think hear before, is systematically planning for it. So really looking three years out at the depth of the pipelines, and I will tell you they're stronger closer in than further out. But we do have things further out. It's going to be more of a funnel than a pipe, so let's make sure we have more in terms of ideas. We're not worried about every idea having to be successful because it usually doesn't work out that way.

And you are going to see some incremental investment around consumer insights, making sure that the depth and breadth of our insights are, I would say, informing our innovation even more strongly than they do today. And probably some increases in the number of people, both in capability of people on innovation, particularly on some of our key growth businesses.

We're in a good spot. We're growing well, but I think it's going to even have to be broader and deeper to get the kind of growth rates we're going to want longer term, I'll call consistently. Does that make sense?

That's great. No, that's very good. I appreciate that. The other thing just trying to look at -- obviously, the margin and certainly people who looked at your name see the margins and see the opportunity there, probably both I think SG&A but a lot more maybe on the gross margin side. So I know you talked a little bit about some of the manufacturing efficiency improvements. Can you just talk a little bit about maybe the number of plants and facilities that you have across the US? And from a capacity utilization standpoint, or just looking at it, and where -- are there clear lines for improvement there, whether or not building state of the art plants to supplant a few of them?

I know this is more forward thinking, and I know you're not at the point where you're going to talk about what's happening, but I know that this is probably something that you've talked internally a lot about. So I was just wondering if you could provide some context for investors out there who are looking at it and looking at what the gross margin potential could be?

I've never seen businesses, even mature businesses, that didn't have significant cost savings opportunities over time. And from my prior life we were able to generate 1% to 2% of controllable costs every single year, and I don't think it should be any different here at Central. Now I can't give you item per item the number of facilities and where exactly all the essential opportunities are.

I can point to something like what we're doing on our dog and cat business, where we recently invested a significant amount of capital to collapse seven facilities in to two, to reduce the number of touch points that were touching the product, making operating layouts more efficient. I can tell you having visited a number of facilities and talked to the teams, there's a number of opportunities like that across the Company. And I will just say more to come on that front.

Okay. Great. Thank you. And congrats again, guys.

Thanks.

Brian Nagel, Oppenheimer.

Good afternoon. Congrats on a nice quarter.

Thanks, Brian.

Couple of questions. First, I wanted to bounce back to, I think, the first question had to do with weather. But it's understandable given the cooler temperatures in April in particular May as others have discussed, you lost some sales. My question is now as we're getting a decent look at this next quarter, do think that you're going to capture some of those sales back because the weather has, at least somewhat, normalized, or were they lost in the period?

Difficult to answer that completely, Brian. I would say this, we saw some rebound in our business in June and the early part of July remained very strong as well. Now if you missed some of the spring planting season, you may not get that back until the fall, or it may be next spring before you see it again. I don't think that -- we may not capture that in this current fiscal year, let's put it that way. It's too hot now in many markets to plant grass seed or to apply certain applications to your yard, so there may be some lost sales as a result of that. However, if there's lawn damage this summer, you could pick that up again this fall. Difficult to project.

Got it. That's helpful. The second question had -- I know you've discussed this in the past. With respect to the outlook for the business you mentioned and expecting a moderating trend in the Pet side. I understand we're lapping some product introductions from last year, but what else is behind that thought? Is there a -- do you see evidence of a slowing consumer in the Pet business, or is there something else at play there?

This is Niko. Yes, we actually have seen a little bit of a slowing per the Nielsen numbers. Now keep in mind that doesn't include Amazon; it doesn't include a lot of the club channels. But there has been a bit of a softening across -- broad base, real softening across the Pet categories. So we're sort of following that lead and tempering expectations.

Can you attribute that, either in the [work] that you are -- in your business? Do you see any reasons behind that softening?

Great question. I think -- I don't know. Is it the consumer; is it a cyclical thing? We haven't been able to put our finger on it. Again, we're trying to read the tea leaves here, looking through the Nielsen data. But I think -- one of the things to get our arms around is you've got a lot more data to get your arms around these days. Whereas before you could get a better handle on things through Nielsen, now you've got big chunks of the business that don't really report through Nielsen. So we have to keep our eyes really all over the place with respect to clubs online; there's just a lot more going on.

The other thing I would add is, if you look at the overall Nielsen line for the categories in aggregate, we're not talking a major deceleration. We're talking roughly a point or point and a half, the thing (inaudible). So it's really tough to tease out what exactly is causing that type of change.

The other thing to add too is, if you recall, our Pet businesses had really been outperforming each category by a dramatic amount. So I think it would be a bit unrealistic to expect that to continue in perpetuity. So I think tempering it a little bit is prudent.

Thank you all very much. Appreciate it. Again, congrats.

Thank you.

(Operator Instructions)

Kevin Ziets, Citi.

Thank you for taking my questions. The first one is on -- you mentioned the innovation pipeline. Do you -- is your goal to solely to stay within the product lines that you're in now, or do you think you can develop innovation -- or adjacent categories in house, or would you seek to do that through M&A?

I can answer that, all of the above. So I go back to our strategy. In some cases innovation will be a bigger driver on a business, and particularly businesses that we want to grow faster than the Company average. A lot of pet businesses, for example, fit that boat. I will tell you in terms of trying to grow more aggressively than market, you absolutely have to look at adjacencies, and we actively do that. Matter of fact I give a garden example, we've looked at hydroponics and we made a small acquisition there.

So what I would say is, we are going to look at adjacencies. It is one way we're going to drive innovation and faster growth. We'll look at whether it makes more sense to develop those internally or make acquisitions if we can get them at the right price and the right timing.

Great. I guess along those lines, do you have any products that would benefit from concerns about Zika? And I know you're a large controls business, but not as large of repellents business. Could you maybe talk about the opportunities there?

Sure, this is Niko. What you see on the marketplace right now are the repellents being the biggest beneficiaries of the Zika phenomenon. Our repellent business is on the professional side, and we rely on municipalities for business. We haven't seen really the federal funds trickle down to those municipalities and have not seen it manifest itself in orders as of yet. That said, we're certainly prepared to do our best, and we're on standby to help any city, county, or any of the abatement districts if we're called upon.

And this is J.D. On the Garden side of the business, you're exactly right. So the controls business would have some products that could help in the control of mosquitoes, broad-spectrum multipurpose insecticides, but we don't compete in the area of personal repellent business.

Okay. Then maybe just generally given -- George, given your background coming from Clorox and more of a branded focus. I know private label has been a relative success story for the company in recent quarters. Is your focus going to be away from that or would you continue to look for those opportunities?

We're not going to shy away from private label. In instances where we're the low cost producer, in particular where we have excess capacity, we'll pursue private label. We particularly like private label in instances where we can work in partnership with the customers to develop a better product and some claims -- in many cases working with them on the claims on packaging, actual packaging graphics, so very much almost acting like a branded partner for our retail partners. So private label is something that we'll continue to pursue, and again we're the low cost producer and we have capacity leverage that we can use.

Okay. Great. My last question was just on the recent acquisitions. I think there was an initiative to bring some of the manufacturing in house. Could you just talk about the status of the integration and how the recent acquisitions are performing? I'd appreciate it, and thank you.

Sure. So the IMS acquisition, which was the rawhide business, is a little bit further along. One of the top initiatives is to -- I think we mentioned earlier in the call that we were consolidating seven facilities into two in our dog and cat toy and treat business. That -- IMS is one of those businesses that we're consolidating. So that's well under way. That will be happening during 2017.

The second one, DMC, which is the bedding business is a little bit behind IMS as far as that integration process. And I think we're going to see more of that as 2017 develops, that we will begin to integrate that as well. There's also a lot of manufacturing synergies and expenses that we can take out of that business as well, so we're eagerly waiting to get into that on a more meaningful level.

Okay. Great. Sorry, if I could squeeze one more in? Just on leverage target, is it changed at all from the 3 to 4 times?

No, it hasn't. We like to stay in that 3 to 4 times range. And like we've said before we could live at the upper end of that range for a period of time for the right acquisitions. So all the same.

Got it. Thank you, guys.

Stefan Mykytiuk, ACK Asset Management.

Hi. Good evening. I want to just touch on the Pet in a couple of areas. First, George, you mentioned -- or you talked about investing in innovation and growth at Nylabone. I'm just curious, are you referring specifically to the costs around bringing those seven facilities down to two and ramping up capacity, or is there another layer of investment that's going to go on around product developments or marketing or R&D, things like that?

I didn't mean for that to be the takeaway. The example I gave that the dog and cat business is related to what I'll call complex cost savings projects, which are fueling -- providing the funds to drive innovation. In innovation I would talk way beyond dog and cats, frankly across the entire Company. We're looking at all the businesses that we want to drive top-line growth on, and some will have more of that role than others. And across all those businesses we'll be doing exactly what I was talking about in terms of taking a look at our pipelines, improving the depth of our consumer insights, and investing in people and capabilities to drive even stronger innovation.

Okay. So but it's putting SG&A dollars to work in order to drive future revenue growth.

It is.

Okay. Secondly on Pet -- still on Pet, when you were referring to the strength in professional, is that in fly control for the farm animals in the protein industries, or is it something else that you were referring to?

Yes, that was -- within our pro business that was the star of the group and has been the last few quarters. About a year ago we had added some sales folks to that team and it's done quite well. We couldn't be happier with the results.

Okay. And what is penetration, what kind of penetration do you have now, or how much opportunity to drive future growth is there left?

There's plenty of opportunity there. As far as penetration, we don't give that sort of guidance in a business that size, but we certainly are not opposed to hiring more sales folks and putting a little more resource behind it since what we're doing right now is working quite well.

Okay. Lastly, on the distribution side you were saying you won some more business with existing accounts, and then I think you were saying there was some other aspect of what was driving that outsized growth in distribution. Can you just elaborate on that?

Yes, we've picked up a large food and treat manufacturer and we continue to roll out the distribution there. We've also won some business at some large retailers. Again that -- we initially start that in a given territory, and then that starts to roll out across all of our territories. So we're starting to see that really take hold and that's really what's driving a lot of the growth.

Perfect. Thanks very much.

(Operator Instructions)

Mr. Roeth, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Great, everybody, thank you for spending the time with us. We had a terrific quarter. We feel good about our progress and our future and appreciate you spending the time with us today, so thanks.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.