Central Garden & Pet Company (CENT) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's First Quarter of Fiscal Year 2013 Financial Results Conference Call. My name is Andrew, 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, Andrew. Good afternoon, everyone. Thank you for joining us and we apologize for the delay. It's my pleasure to welcome you to today's call and to introduce our 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 Central Operating Companies; Lori Varlas, Central's Chief Financial Officer. We also have with us John Ranelli, who will be named CEO in just a few days at our Annual Shareholders Meeting. As a reminder, we issued a press release this afternoon providing results for our first quarter 2013 period ending December 29, 2012. The press release is available on our website at www.central.com. But 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, including expectations from improving Garden segment results to the new product introductions, aggressively building our brand, growing cost and achieving revenue growth and improved profitability from the company's transformation initiative are forward-looking statements that 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 Central's annual report on Form 10-K filed on December 13, 2012, and other Securities and Exchange Commission filings. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events or otherwise. Now I'll turn the call over to Bill Brown. Bill?

Thanks, Steve. Good afternoon, everyone. Before we go over the results for the quarter, I want to begin with the management and board changes that we announced last month. At our board meeting next week, John Ranelli will be named CEO. I'll be providing some color for you on John in a minute. Also, we expect that Beth Springer will be elected to the Board of Directors. Beth is a seasoned and accomplished consumer products executive who worked 21 years at Clorox. She has extensive strategic and management expertise, including brand building and marketing. Her addition to our board is in keeping with our desire to have deep consumer products experience on the board. Beth's knowledge and guidance will be invaluable to us as we move forward to a more integrated consumer products company. We're looking forward to her contributions. As John takes the helm, I'll be relinquishing my role as CEO, so this will be my last earnings call. Going forward, I will continue my responsibility as Chairman of the Board. Gus is actively helping John get up to speed on the day-to-day operations of the company. After a period of time, Gus will focus solely on the ongoing transformation initiatives and certain business development activities in support of John and his leadership. I've got to tell you, I'm excited about the direction we are headed. First and foremost, we are committed to the transformation and achieving profitable growth in the years ahead. Some of you have expressed concern that we may now be less committed to the transformation. Nothing could be further from the truth. We had been working to transform this company from 20 separate businesses into 1 integrated organization, with a structure more typical of a consumer products company. Just to remind you, we have realigned our organization, eliminated redundant costs, transformed our supply chain, reduced the number of separate ERP systems and we're creating strong marketing and shared services organizations. I'm grateful to Gus for his efforts so far. It's hard work, and it's difficult work. With Gus' leadership, we have built a strong effective team to drive this transformation forward. And Gus, along with the entire senior management team, has worked hard to get us to where we are today, a more integrated company that is beginning to utilize economies of scale to create synergies across the entire organization. On our last call, we told you we were extending the time frame of our transformation. Gus, John and I are in agreement that it's a necessary course correction. We believe that increased focus on taking care of our customers is imperative as we move forward in becoming an integrated consumer products company. Shifting to the bigger picture, I want to take this opportunity to give you a historical and broader perspective on the recent leadership changes. Our desire to bring in a CEO with strong consumer products background actually goes back several years ago. When I came back as CEO 5 years ago, my intent was to only be in the CEO role for a couple of years, maybe just up to 2. The board even started a CEO search about 3 years ago. Gus was a consultant back then and what the board, Gus and I found in that search was that there weren't any really good consumer packaged products executives available that were proficient in running a company with siloed businesses. The CEOs that really interested us were experienced in running integrated consumer product structures. When we began to look at our options, we identified the enormous cost savings opportunities available to us by moving to an integrated structure at Central. As we thought about our plans to grow for the future, we concluded that the integrated structure was a better model for achieving our goals and our future growth aspirations. So we began to think about that move, and we wondered how many of these consumer product executives could actually make the transformation. Gus and I concluded that none of them could. One day, Gus looked at me and said, "You know, Bill, I think we'll have to do the transformation and then bring in a CEO." I agreed, and so did the board. So that's what we set off to do. A few months ago, with much of the foundational core work of the transformation under our belt, the board decided, and Gus and I strongly agreed, it was time to move forward. We then embarked on the process of finding a seasoned consumer products leader while we continued forward with the transformation. As we evaluated our options, we revisited the search we had done a few years ago. At that time, we had reviewed as many as 50 candidates. The board had met with around 10. And what the board determined was that none of those candidates met the level of excellence and expertise that John Ranelli brought to the table. That same John Ranelli who's been on our board the last 2 years. John is an outstanding -- he has an outstanding experience in the consumer space and is an inspiring leader. John has led a number of consumer product companies, and he has extensive experience building brands and achieving revenue and profit growth. Some of the brands of that you may be more familiar with includes FosterGrant, Stride Rite, Timberland, Mikasa, Woolrich, Sperry Top-Sider, TEVA and others. He has the skills to both build our brands and strengthen our customer and consumer relationships. And he's highly experienced in leading transformations. These strengths are key to helping us grow our revenues and increase our profitability over the long term. In summary, I'm delighted to have John take the reins from me and become CEO of Central next week, with Gus continuing in support of John in the transformation. I see these moves as additive to our overall goals of building our brands in support of customers and completing the transformation to deliver shareholder value. Now let me turn the call over to John. He has a few things to add. John?

Thanks, Bill. It's a pleasure to be here. I certainly want to echo Bill's comments. I'm moving forward with the transformation. We will focus on meeting the needs of our customers and our consumers. I have to say that it is truly remarkable what Central has accomplished since the transformation began. It is no easy task taking 20 separate companies and integrating them into 1 larger organization. It has really taken great effort from all of the employees to get us where we are today. The challenges we have going forward are very familiar to me. I have faced them before. From the need to optimize our systems and our supply chain to the desire to reduce our SKUs and costs to the efforts to grow profitability. I am totally confident that Central is positioned to succeed in all of these areas. Now it is time to execute. I look forward to taking the reins of this dynamic organization as CEO next week. I believe we can generate significant shareholder value in the years ahead. I look forward to talking with you in the future. And with that, I'd like to turn the call over to Gus.

Thanks, John. Before I talk about the transformation within our operations, I'd like to share some thoughts with you about John. I've gotten to know John well over the last few years. He has a very collaborative and engaging style, and I believe that, that style will play particularly well here at Central. His experience and track record of building brands, developing innovation and driving cost savings will be a huge asset to the organization. John has helped lead 5 previous transformations. I know he understands the full potential of this company and the steps needed to take to unlock the significant earnings power. So I look forward to working with him to help make Central a truly integrated consumer products company that operates in a more optimal way. Turning to business. We're very excited about the upcoming garden season, especially due to the new product innovations we are rolling out in our Garden segment. These fertilizer and control products have already achieved strong sell-in and superior in-store placement. The innovations being introduced are centered around the ease-of-use, application and storage of the products. Consumers will find these new products to be very easy to use and safe. Let me spend a minute describing these patent pending innovative new products. Our Pennington fertilizer applicator utilizes a tablet that is inserted into the sprayer that attaches to the hose. It then mixes the water with the fertilizer tablet, ensuring uniform application. They can be applied across the consumer's lawn and shrubs. There are no heavy bags or messy liquids to deal with, and these tablets are easily stored, taking up very little space. We also have a line of new AMDRO products that utilizes an innovative new application system. We will be launching that in the spring. And we look forward to you seeing it at your nearest store. As I mentioned, these new products have already achieved strong sell-in from retailers and should benefit from attractive placement in the stores. We expect to begin shipping these products shortly. With recent point-of-sale figures up in the inventory levels and major retailers relatively low, we're very optimistic that the consumer takeaway on these new products will be extremely strong. In addition to rolling out new innovative products, we have continued to work on our transformation. We have been focused on stabilizing and optimizing the systems and facility consolidations we undertook in 2012. As we said on our last call, in order to meet the customer needs, this optimization is a key, key priority for us in 2013. With a busy garden season approaching, we believe we are well positioned to meet the demands of our customers during this important time of year. Our annualized run rate savings exiting Q1 2013 remained at approximately $20 million, the same as our exit rate at the end of our prior quarter. We've been working on additional transformation initiatives as we concurrently prepare for the garden season, but these actions are not yet complete. For example, we are midway through 2 additional warehouse consolidations, which we expect to be substantially completed by the end of the second quarter. As a reminder, we started with 7.5 million square feet of facility space and have reduced it by almost 460,000 square feet at the end of our 2012 fiscal year. Let me give you a little color on some of the activities we have undertaken in the transformation that have yielded the biggest results to date. One of the greater areas of savings so far has been our procurement area. As we have integrated our procurement activities, we have taken essentially 20 different purchasing silos and integrated them into 1 organization. We have analyzed most of these purchasing activities for the entire company, identified the areas of greatest opportunity for savings and are aggressively prioritizing in tapping those opportunities. Let me give you an idea of the savings that we've identified. In the packaging area, our sourcing initiatives have reduced our supply base by over 50%, and we expect the annual savings of approximately 7%. In our garden décor business, we have identified new international suppliers, focusing on what vendors can deliver in best in cost, quality, service and innovation. In the pottery and bird feeder area, we have already achieved or identified up to 25% in cost savings. These are just 2 examples of literally hundreds of savings opportunities our procurement organization has evaluated. We are prioritizing and systematically pursuing these savings. And of course, these evaluations have occurred in other areas of the company as well. We are focused on our customers, delivering innovative products and pursuing the transformational activities as a company. I now would like to clarify my role on a go-forward basis. In the near term, I'll be helping John be up to speed in his role as CEO. I will then transition to a consulting role, focusing roughly 60% of my time on the transformation and business development activities for the organization. Going forward, as Bill and I step back, John will be the voice of the company. With that, I'll turn it over to Lori.

Thanks, Gus. The details of our fourth quarter results are in the press release that we issued this afternoon, but let me spend a few minutes giving you some additional color in a few areas. We announced on our last call in December that our revenues and earnings for this quarter would be lower than the first quarter of 2012. Impacting our results was continued weakness in the Garden segment and the disruptions from Hurricane Sandy that impacted our Pet segment. For the total company, first quarter sales were down 3%. Our first quarter is typically the lowest revenue quarter of our year due to seasonality of the garden business. The prime garden seasons fell under Q2 and Q3 and consequently, the second and third fiscal quarters have historically been the highest for revenue and profits for our company. Our consolidated gross margin as a percentage of sales for the quarter was 26.3% versus 26.7% in the first quarter of 2012. The first quarter operating loss is $13.1 million, down from $11.3 million in the first quarter of 2012, reflecting our lower sales and gross margin. Let's turn to business segment results. In the Garden segment, revenue declined 5% predominately due to lower seasonal décor sales. We expect better results in the upcoming garden season based on strong initial demand for our new products with the new application innovation that Gus described earlier. Operating margin for the Garden segment improved 200 basis points. The improvement reflects better operating results for our grass seed and pottery businesses, partially offset by higher losses in our seasonal décor business. In the Pet segment, sales declined 2% on lower revenues in our Dog & Cat business and lower sales of other manufacturers' product. The equine and aquatics businesses saw strong revenue gains during the quarter. Operating margin in our Pet segment was relatively flat, reflecting improved results in equine and reduced spending. These gains were partially offset by lower margins in our Dog & Cat and distribution businesses. Consolidated SG&A expense declined $2 million. SG&A as a percentage of sales was 30.8% in Q1 2013 and 30.5% in Q1 2012. The first quarter net loss was $15.3 million or $0.32 a share. A few other data points for Q1. CapEx for the quarter was $8 million versus $9.2 million in the first quarter of 2012. And as I mentioned in our year-end call in December, we expect our capital expenditures in fiscal 2013 to be up to $40 million, similar to the amount spent in fiscal 2012. Inventories of $398 million were up from $366 million a year ago. As we discussed last quarter, we chose to build inventories ahead of the garden season ensuring we can react quickly to the customer demand. Also contributing to the increase in inventory is we built inventory for the launch of our new innovations in garden and to support the transition associated with the consolidation of 2 distribution facilities. As you may recall, last year, we have the disruptions in our business in Q2, which caused us to have lower[indiscernible] than planned. We are taking steps to ensure that there is not a recurrence of those issues by holding more inventory as a precaution. Our cash and short-term investments balance was $30 million, up from $28 million a year ago [indiscernible] from $461 million a year ago [indiscernible] approximately $52 million [indiscernible]. In summary, we had anticipated a difficult quarter due to a few of the factors that we believe were temporary. Going into the garden season, we're striving to have the right products, marketing plans and customer focus to drive a successful season. Thank you for joining us this afternoon. And we'll now take your questions. Operator, can you please open the lines.

[Operator Instructions] First question comes from Bill Chappell of SunTrust.

Just I guess 2 questions. One, maybe give me a little more understanding of the gross margin decline, and how much of that is kind of short term with some of the operational things you talked about and how much of that is just timing and mix that we're looking at for the December quarter?

Sure. Our gross profit on a consolidated basis obviously impacted by the decrease in sales year-over-year. As we look at the margin percentage, it's primarily mix-related. As we've mentioned in our Dog & Cat category, Sandy had an impact on that. And then Garden, we have reduced sales in our sales in one of our seasonal products. And so mix had a hand in that.

Okay. And would you expect to see, I mean, return to kind of gross margin expansion as we're moving through the rest of the year?

We're certainly looking towards our transformation to deliver savings. We are looking to expand those margins. You may remember last year, from a commodity perspective, prices and as commodities rose quickly and steeply, and so we took pricing increases across last year to help mitigate the impact of that. And so we should see benefits of that in this year as well, which should help with our margin expansion.

And Bill, during the last call if you remember, we talked about how we viewed literally every SKU of every product and evaluated what our cost basis were, what the opportunities for our price increases were, and we hope that some of these things will kick in during the year.

Okay. And just if you don't mind, I mean, is there any way we could look at the Pet and Garden segment to kind of get an idea this quarter what the underlying segment growth was? I mean did you -- were you pretty much in line or with the SKU reduction, were you below? Or did you gain market share?

The SKU reduction really didn't have an impact on the gross margin percentage. When we started -- we started with those SKUs that were marginal at best, sometimes had few quantities and exercise to really make us more efficient, and we're continuing to down that path. As you may recall, we exited 2012 with a SKU reduction about 16%. We've increased that side amount in the first quarter. So the SKU isn't really impacting -- SKU reduction isn't really impacting gross margins. It's really much more about mix as we look at the Garden and Pet segments and they both had their margins impacted this quarter.

Yes, I'm sorry. I was just talking -- actually, going back probably at the top line, were the top line that the Pet and Garden segment down in the quarter just kind of a category growth?

No, they were not. The top line was not down compared to others. We were in line with category growth, and we expect to take market share with some of our product innovation in the future.

Okay. So do you expect those categories to grow this year?

Yes.

Okay. And then just one last one and you might have mentioned it. The other income kind of the bigger-than-normal loss, can you remind me of what that was?

Sure. In our other income expense, our accounting for hedging activities, any unrealized or realized gains or losses recorded in that line and so that's what you're seeing this quarter as a combination.

It's currency hedge? Is that right?

No, commodity.

The next question comes from Joe Altobello of Oppenheimer. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: Just a couple of questions on pricing. I guess first, you mentioned earlier that you did take pricing. I know one of your -- obviously, your big competitor in garden earlier this week said they had not seen any competitive pricing action as of yet on the garden side. So are you guys taking pricing or line pricing up in garden this year?

We were a bit puzzled when we saw that because we have been taking pricing consistently, and we've taken pricing again this year. And as I mentioned, as we look at a SKU-by-SKU item, we had some selected price increases because we wanted to be equal to what we should be selling those particular products from what value -- what our value proposition was. So we were puzzled by that statement, but we don't really run our business by what's going anywhere else and what somebody else thinks. We did take price, and we are continuing to take price. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: Okay. And just secondly on shelf space, can you give us a sense for how you guys felt coming in line reviews regarding the upcoming garden season. You mentioned you've got a couple of new products coming out. Sounds like you're excited about them. So I'm just curious where you stand this year on shelf space versus where you were last year coming into the garden season?

Yes. We're really excited about the shelf space because it's not just our sell-in, which has been quite good and we're excited about, but also, the positioning. It's the locations in the store that are a lot of times the key, and we have been granted some favorable locations, which clearly will impact sales, we feel. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: Okay. But overall, is your shelf space up this year?

Yes.

Next question comes from David Mann of Johnson Rice. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: Gus, in the press release, you called up the Garden business, but not necessarily the outlook for the Pet business this year. So maybe you can talk about a couple of things. First of all, flea and tick obviously was very strong last year. Can you talk about your ability to sort of anniversary that?

Well, we don't talk specifically. We do expect the flea and tick business to continue in a very positive manner. We -- if you noticed, we did run award just a few couple of months ago. We do expect the business to increase. And whether or not we anniversary, it will be something that we'll see, but that is one area where we're very, very positive on. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: And in terms of the overall Pet business, would expect that to be positive? And can you clarify any thoughts of how much Hurricane Sandy hurt the business in terms of percentage growth?

Percentage, we haven't given out, but I can tell you that it did impact it because frankly, it was the Eastern quarter and the Northeastern, in particular, which is one of our highest-selling areas. And with that many people still not being in their homes and also the damage that Sandy caused were substantial. In addition to that, we lost some opportunities to ship because a lot of dog products that we have facilities in those locations. So we were impacted in a couple of different ways, both in how we shipped and in how we sold because of Hurricane Sandy and that was substantial. We've not given the percentages because it's really hard to pinpoint exactly how much it was, but we could see that in that part of the world, we were impacted substantially. And when you lose production, you can't ship. Sometimes, you don't make those up. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: Got you. Last question on this, I've noticed in the couple of the national pet retailers that a couple of your brands seem to be coming off the shelf, Avoderm and PetSmart and maybe Pinnacle and Petco. Can you just comment what's going on there?

With PetSmart, yes. With Petco, that's news to me. That's not anything that we've been notified. But yes, so even though we had substantial growth under ordinary circumstances, that is an area that is just on fire with calculating growth in the 40% range. And our range is in the 25% to 28% didn't seem to be adequate.

[Operator Instructions] The next question comes from Gregg Hillman of First Wilshire Securities.

I was wondering if you could talk of about, number one, in the positioning of Miracle-Gro grow versus Pennington kind of in general and then specifically the positioning of your tablet product that you think in conjunction with a garden hose versus what the offering is of Miracle-Gro in the same area.

We don't really talk about -- each one has its own niche. All we can talk about on the Pennington side is I want to reiterate that we feel the tablets are unique. It's a uniform spread. It's -- the storage space is small. And there are no mixing or anything else. So we just try to position it in terms of what our product can produce as opposed to compare it to something else. Miracle-Gro has its own positioning, but we feel that our products are pretty well positioned for the consumer as in storage space, ease-of-use and the consideration of not having to mix anything.

So the ease of usage, just be easier to put one of those things on your garden hose to spray your lawn rather than going around with a spreader or something like that, that would be easier for the consumer to do. Is that correct?

In a particular container that fits at the end of the hose, you insert the tablet and it uniformly delivers the product to your shrubs or whatever you're going to using fertilizer. So it's a delivery system that we feel is superior to most products in the market. We feel very good about it. More importantly, our retail partners feel that way, and that's a cause for optimism for us.

Okay. That's great. And then, I also had a question about the kind of the ERP systems in general. I just wanted to ask you about the integration for the systems for the 20 companies that you alluded to earlier. Is there ERP systems basically feed into gap indirectly to allow you to create GAAP income statements for all of your subsidiaries?

Sure. Let me take that question. As you mentioned, really, the last part of the year, we've been working diligently to retire legacy systems in various businesses and move to SAP, one standard system that facilitates efficiency and standard processes. As it relates to those businesses, we still have legacy systems. We have software that allows that information to roll out in a very disciplined and coordinated fashion to allow us to report on a consolidated basis. So there's software that allows us to do that.

Okay, great. But eventually, you're going to be on one ERP system for the entire company. Is that correct?

We are working diligently to get to -- off the SAP. We did solve that down. We talked in our year-end call that we did a number of implementations last year, where I'm working to optimize that implementation, use the system that is best meant to be used while moving forward throughout implementation. So it can take us a little longer than we originally had anticipated by simply doing the right thing to make sure we get the value for our investment.

Okay. And one last question. Just in terms of -- it's kind of a general question, but just in terms of investing in innovation across the board for your various units, how do you go about determining how much investment you need to make in innovation? And have you lagged in investing in innovation in the past?

As far as investment and innovation, we haven't necessarily quantified from a dollar's perspective the innovation, but we have talked as to how that's an area of focus and have stepped-up investment as a company along with brand building. And we think in order to deliver top line growth, we actually deliver innovation for our customers and the consumer, and that's certainly an area of focus for us.

As a key takeaway on that item is that where we have invested in products, you need the positioning, innovation or marketing because we can't do it literally across the board because it's very expensive. We've been extremely successful, and I've been very happy with -- and we have as a company been very happy with the results.

[Operator Instructions] The next question comes from David Mann of Johnson Rice. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: In terms of the SG&A expenses and the transformation, obviously, it's a great sign that you have -- your SG&A was down year-over-year in the first quarter. Is that something that we should expect as we go through the year? Or is potentially, let's say, the second quarter going to see higher investments in marketing that might not allow that to happen?

David, this is Lori. So from an SG&A perspective, you're right, we're down a couple of million dollars on our total spend and roughly in line with as a percentage of sales. We will have investments, increased investments, in brand building, marketing, support, our product and our product launch, but we continue to build and watch our spend there ensuring that our SG&A from an overall basis on the long term, we want to obviously make that more optimized. But we do plan, I think, definitely investing on it in the coming quarters to support our products in the product launch. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: Okay. That's helpful. And then in terms of the consolidation of facilities, I guess today, you've shared with us that there are a couple of more that have been identified. Is that the extent of what you would plan to consolidate this year or should we expect more than that? And if so, can you give some -- shed some light on that?

David, we are going to shut those down. But as I mentioned during the last call, we have to -- one of the reasons that we've extended our transformation is primarily to ensure that if we are shutting facilities and doing a lot of the transformation in an orderly manner. And so while we don't have anything identified completely, we do have in essence the next one that would be coming up. And as we go through and we evaluate where our capabilities are, then we will act on it. And of course, we will let you know during that time. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: But is it likely because of the seasonality of the business that beyond these first 2 that any other consolidations will not happen until much later in the calendar year?

I don't know that we're prepared to say one way or another. It would be a 50-50 proposition if we were analyzing it.

This concludes our question-and-answer session. I would like to turn the conference back over to Bill Brown, Central's Chairman and Chief Executive Officer, for any closing remarks.

I wanted to -- this is Gus Halas, and I wanted to explain something because it's been a discussion, and I don't know if it's completely clear. And also, there's been questions about where I am and how long I will be with the company in the future. If you've seen the 8-K that was identified, I plan on being with the company for a long, long time in one capacity or another. As I mentioned during the call, there's going to be a first step, which I'll be here as long as John needs me in order to take him through the learning process of turning the company over to him. And then there's a multiyear agreement that I'm going to participate at one level or another for anything that John and the organization needs. So I wanted to explain that because that's been -- we've had a lot of questions about it, and we've had a lot of different views. So I just want to make sure that it's clearly understood as to where I'm going to be and how I'm going to be involved in the future.

Thank you, Gus. We all appreciate you and we appreciate your commitment, and we're enthused to go forward together to complete all of the good work we have ahead of us. And John, I'll be looking forward to the annual meeting. Thank you all for joining us on the call today.

Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line.