Central Garden & Pet Company (CENT) Q3 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Third Quarter Fiscal Year 2016 Financial Results Conference Call. My name is Claudia and I will be your conference operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. 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, 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 Machek, Senior Vice President, Finance and Chief Accounting Officer; J.D. Walker, Executive Vice President and GM, Garden Brands and Nicholas Lahanas, Senior Vice President, Finance Operations and Management Reporting. Our press release provided results for our third quarter ended June 25, 2016, is available on our website at 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 filing, 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've 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, the 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 up34% and 26% respectively versus year ago on revenue growth of 12%. We feel great our results and the 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 am working closely with our employees and business leaders and getting valuable feedback from our customers. These session have helped me better understand our operations and our strength and opportunity 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 yearend. However, I can tell you that we won't be making any major right hand turns. We'll continue to be focused on the three pillars that we have been executing over the last few years; our customer first orientation, increasing our innovation output and success rate and lowering our cost to reinvest in growth. But we have demonstrated much progress in these areas, I can signal that we will be more aggressive going forward. This one include accelerating the depth and pace of our innovation efforts, increasing demand-building activities and driving even more systematic cost reduction efforts, all with the goal of driving sustainable growth over the long-term. I am personally engaging in 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 site to deliver on our growth objective. We believe that there is significant opportunity on both the cost reduction and innovation front 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 cost. On the innovation front, recent examples of growth-oriented innovation include two new behavior modification products for our dog and cat businesses for dog and cats under our Comfort Zone brand. Comfort Zone products dispense pheromones to calm dogs and cats, and has shown great growth this year albeit from a relatively modest pace. Another recent launch in our Garden segment was an expansion 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 in new product introduction in this line in 2017. Driving the pace, quality and quantity of our innovation and cost reduction efforts is 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 am actively engaged in assessing our portfolio to more clearly define the role of each of our current businesses, but also seeking attractive acquisition 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, what we believe that we can continue to be a strong growth contributor as evidenced by our recent DMC and IMS acquisition. 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 and in the mean time we will stay focus on executing our current plans with excellence and finalizing our plans for fiscal year '17. 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 result was a $2.4 million gain on the sale of a manufacturing plan. 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 décor 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 sales. 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 décor business, lower raw material cost 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 manufactures 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 manufactures products and increased wild bird feed revenues were the largest contributors to the sales increase and more than offset a reduction of $7.7 million due to our exit from the seasonal décor 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 we’re dealing part to the exit from the seasonal décor business, which was not profitable as well as lower raw materials 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 a fixed rate fixed debt as a result of d 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 sales gain was $0.48. Regarding our balance sheet and cash flows, for the quarter, cash flow provided by operations was approximately a $140 million compared to $155 million in the third quarter a year ago. The company’s inventory balance rose $22 million from a year ago and reflects the increase from our recent acquisitions, partially offset by the businesses as 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 remain relatively unchanged. Two, at quarter end we are $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 out adjusted EPS guidance to $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 have continued 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 yearend call later in the year. Now, I'll turn it back over to George

Thank you, Howard. 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 at Central can accomplish. Now we would all be happy to answer any of your questions. And Operator, please open the line for questions. Question-and-Answer Session Operator Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] The first question comes from Bill Chappell with SunTrust. Please go ahead.

Thanks. Good afternoon.

Hi, Bill.

Hey, Bill

Quick question I guess on the Garden segment with various reports about weather especially in May in the Northeast. Can you trigger us how it was for your business and was this a fairly normal season that evened out, or was it where you hit by weather as well and could have been even better?

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. 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 timeframe 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 that exit of 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's rebounded in Q3. So they have both the top line and bottom line growth. In Q3, we feel very good about that performance.

Okay. That helps. Thanks. And then turning to both businesses that you talked about other manufactured products 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 effect your gross margin by those growing faster than your core brand?

Hey, Bill. This is Nicholas. On the Pet side we had fairly good double -- not double-digit but high single digit growth on the vendor partner side and that was really the -- it was due to the gain that pick up of some food business as well as increased distribution, where our 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 dilutive effect on our margin.

On the Garden, was there anything that was leaning on the pet side?

It was on the Garden as well, Bill. On the Garden side I'll echo lot of Nicholas' comments that it's a lower margin business for us. That business was a business that was challenged a few years ago, one 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 through 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 as a value added service that we provide to them. And for us it gives us more critical mass with those retailers. So the answer to your question it wasn’t a specific brand, it was a number of brands. It was a number of retailers and we're pleased with that business. It continues to grow very rapidly, but we're also being very choosy in who we partner with and taking them to market.

Perfect and last question for me, so which should be the normalized DNA rate going forward?

Our -- if you notice our DNA 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 the $3 million. Perfect. Thanks so much.

The next question comes from Jason Gere with KeyBanc. Please proceed with your question.

Okay. Good afternoon, guys. Congratulations on the quarter. I've two questions that are a little bit more longer term and some of this maybe work in progress and we'll talk here later, but I was just trying to get your thought. 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 like count that as three year pipe. So I was just wondering where it stands now -- what could go into this in order to drive some of the larger or maybe bigger innovation. So clearly I know some of this has come from the Clorox model, but I was just wondering like where Central Garden & Pet stands right now and the innovation front, how deep it is and what would you need to get to that kind of runway of growth.

So the first thing I would say is I'll go back to strategically and innovation is going to be more critical on some businesses and others and each business will have its role once we've completed our strategies, but innovation will then somewhat be a driver to the top line. As I look at Central today, innovation pipelines are there. Some are healthier than others and I think when you look at some of our recent launches that I mentioned in the script around our comfort zone, the heavy modification products and things we've recently done on NYLABONE and our aquatics, across the company there is good innovation entering the marketplace and I think our organic results reflect that. Ongoing I think we're going to try and increase the depth and pace of that and the way to do that is as I've talked about, you heard before, we're systematically for it, but really looking three years out at the depth of the pipelines and I'll you there are stronger cultures farther 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 and innovation, particularly on some of our key growth businesses. So we're in this spot, we're going well, but I think it's kind of we 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.

Okay. That’s great. That’s very good. I appreciate that. The other thing I guess just trying to look at obviously the margin and certainly people who have looked, see the margins and see the opportunity there, probably both I think SG&A but a lot more on maybe on the gross margin side. So I know you talked a little bit about some of the manufacturing efficiency improvement. Can you just talk a little bit about maybe the number of plans and facilities that you have across the U.S. and from maybe a capacity utilization standpoint or just looking at it and where -- are there clear lines for improvement there whether or not buildings state of the art plans to kind of -- 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.

So I've never seen businesses -- even mature businesses that didn’t have significant cost savings opportunities over time and from my prior life we're able to generate 1% to 2% of the total cost every single year and I don’t think it should be any different care at Central. Now I can't give you item for item the number of facilities and where exactly all the essential opportunities are, I can't point to something like what we're doing on the dog and cat business, but we recently invested significant amount of capital to Class 7 facilities to reduce the number of touch points that were touching the product making operating layouts more efficient. I can tell you having visited the number of facilities and talked to the teams, there is a number of opportunities like that across the company and I'll just say more to come on that front.

Okay. Great. Thank you and congrats again guys.

Thanks.

The next question comes from Brian Nagel with Oppenheimer. Please proceed with your question.

Hi, good afternoon congrats on the nice quarter. Couple of questions. I wanted to bounce back to the first question whether and it's understandable given the cooler temperatures in April and particularly in May as others have discussed you lost some sales. My is that now as we're getting a decent look at the next quarter, you think that you're going to capture some of those sales back because the weather has and we've seen it 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. If you miss some of the spring planting season you may not get that back until the fall or 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 put -- or to plan certain applications to your yard. So, there may be some lost sales as a result of that. However there is lawn damage this summer and you could pick that up again this fall, difficult to project.

Got it. That’s helpful, and the second question I had. I know you discussed this in the past, but with respect to the outlook for the business you mentioned and you expected a moderating trend in the pet side. I know I understand would allow you some product introductions from the last year but what else is behind that thought. Is there a -- you see evidence of our slowing consumer in the pet business or is there something else to play there.

This is Nicho, yeah we actually have seen a little bit of a slowing part of Nielson numbers. Now keep in mind that doesn’t include Amazon, it doesn’t include a lot of the club channel, but there has been a bit of softening across, broad base real softening across the pet categories. So, we’re following that lead and tempering expectation.

Can you attribute that either in your business, do you see any reasons behind that softening?

Great question. I think I don’t know, is it consumer, is it a cyclical thing we haven’t been able to put our finger on it. Again we’re trying to read the TV, if you're looking through the Neilson data, but I think what one of the things to get our arms around is you’ve got a lot more to state to get your arms around these days, whereas before you could get a better handle on things from Neilson. Now you got big chunks of the business that don’t really report through Nielson. So we have to keep our eyes really all over the place with respect to club online. There is just a lot more going on.

The other thing I would add is if you look at the overall Neilson line for the categories in aggregate, we’re not talking a major deceleration. We're talking roughly a point or point and half the thing at which point in time you look. So it's really tough to tease out what exactly is causing that type of change. The other thing to add to is if you recall our pet businesses had really been outperforming each category by dramatic amount. So I think would be a bit unrealistic to expect that to continue in perpetuity. So I think tempering it a little bit is prudent.

Okay. Thank you all. Thank you very much. Congrats.

Thank you.

Thanks Brian.

[Operator Instructions] The next question comes from Kevin Ziets with Citi. Please go ahead sir.

Hi, thank you for taking my questions. First one is on -- you mentioned the innovation pipeline, do you -- is your goal to solely just stay within the product lines that you are in now or do you think, you can develop innovation or adjacent categories in-house or would you seek to do that, their M&A?

So I can’t answer that all the above. So, I go back to our strategy, in some cases innovation will be a bigger driver on a business particularly business someone might grow faster in the company average. A lot of pet business is for example of pit pet boat. I would tell you in term of trying to go large vessel on market you absolutely have to look adjacencies and when you actively do that in fact I give a garden example, we looked at Hydroponics and we’re doing a small acquisition there. So what I would say is we are going to look adjacencies, so there is one way we're going to drive innovation faster growth. We'll look at whether it make more sense to develop those internally or make acquisitions if we can get them at the right price and right timing.

Okay, great. I guess along those lines do you have any products that would benefits from concerns about Zika and I know a lot of controls business but not as a large of our other POS business could you maybe talk about the opportunities there?

Sure this is Nico. What you see out in the marketplace right now are the repellants being the biggest beneficiaries of the Zika phenomenon. Our repellant business is on the professional side and we rely on municipalities for business. We haven’t seen really the Federal funds trickled down in those municipalities and have not seen it manifests itself in orders as if yet. That said we’re certainly prepared to do our best and we are on standby to help any city, county or any rebasing district if recall upon.

And this is J.D. on the garden side of the business you are exactly. So the controls business would have some products that could help in the control of mosquitoes broad spectrum, multi-purpose insecticide, but we don’t compete in the area of personal repellent business.

Okay. And 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?

No, we're not going to shy away from private label in any census where we're the low cost producer and particular we have excess capacity, we’ll pursue private label. We particular like private label in instances where we can work in partnership with the customers and develop a better product and 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 partner. So private label is something that we will continue to pursue and again we're the low cost producer and we have capacity leverage that we can use.

Okay. Great. And then 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 the integration and how the recent acquisitions are performing? I would appreciate that 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 have mentioned earlier in the call that we were consolidating seven facilities into two in our dog and cat, food entry business. That IMS is one of those businesses that we are consolidating. So that’s well underway. 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 are going to see more of that as '17 develops that we’ll begin to integrate that as well. There is 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. So if I could squeeze one more in just on leverage target has it changed at all from three to four times?

No, it hasn’t. We would like to stay in that three to four times range and like we’ve said before, we could live at the upper end to that range for a period of time for the right acquisition, so all the same.

Got it. Thank you, guys.

The next question comes from Stefan Mykytiuk with ACK Asset Management. Please proceed with your question.

Hi, good evening. I wanted to just touch on Pet in a couple areas. I guess first George you mentioned, where you talked about investing in innovation and growth at NYLABONE and I am just curious, are you referring specifically to the cost around bringing those seven facilities down to two and ramping up capacity or is there another layer of investment that’s going to go 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 the dog & cat business related to what I'll call complex cost savings projects, which are fueling providing the funds to drive innovation and innovation I would talk way beyond dog & cat 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 that role and others, and across all those business 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. And then secondly on pet, still on pet, when you were referring to the strength in professional is that in the fight control or the farm animals and the protein industries or was it -- is it something else that was -- that you were referring to?

Yes, that was within our pro business that was the start 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 all more resources behind it since what we're doing right now is working well.

Okay. And then lastly on the distribution side, you were saying you won some more business with existing accounts and then I think you were saying there were some other aspects of what's driving that outsized growth of distribution, can you just elaborate on that?

Yes, we have 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 and 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 and we feel good about our progress and our future and appreciate you spend the time with us today. So thanks.

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