Central Garden & Pet Company (CENT) Q1 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet’s First Quarter Fiscal Year 2017 Financial Results Conference Call. My name is Darren 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 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 Darren. Good afternoon, everyone. Thank you for joining us. With me on the call today are George Roeth, Central’s President and Chief Executive Officer; Howard Machek, SVP, Finance and Chief Accounting Officer; J. D. Walker, President, Garden Branded Business; and Nicholas Lahanas, SVP, Finance Operations and Management Reporting. Our press release provided results for our first quarter ended December 24, 2016, is available on our website at www.central.com. It contains 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 2017, 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 the 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 2, 2016. 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 CEO, George Roeth. George?

Thank you, Steve. Good afternoon, everyone. Since we reported our year-end results just two months ago, I’m going to keep my comments relatively brief today. For fiscal year first quarter started out on track, delivering earnings of $0.15 per share, or $0.12 if we exclude the sale of a distribution facility during the quarter. It’s important to note that over half of the non-GAAP gain of $0.11 was due to acquisitions, favorable timing of revenues and expenses was also a factor. All-in sales were up 17%. Importantly, organic sales growth was a strong 7% behind a favorable off-season Garden corner and share gains across much of our Pet business. I do want to caution you that our first quarter is typically our smallest of the year and that we still have a full Garden season ahead of us, as well as more difficult comps in the three remaining quarters of our fiscal year. For those reasons, we’re keeping our non-GAAP earnings per share estimates for the year at $1.34 or higher. Having said all that, we’re pleased with where we’re at. We’re making significant strides on all of the change vectors I spoke to you about on the last earnings call. First, we continue to work diligently on accelerating our portfolio momentum. For example, in our AVODERM and PINNACLE dog food business, an area that has been challenging for us in the last few years, we’re in reset mode. We recently made strategic decisions around which channels and geographies to emphasize in order to improve our focus and drive sustainable profit growth. In addition, we have secured and are seeking partnerships to drive growth and scale. This business is already in a better place than it was just six months ago and we’re encouraged by our progress. Beyond the makeup of our current portfolio, we continue to dial up our efforts on evaluating M&A opportunity and have built a solid pipeline of targets. Our strong cash flow generation and low leverage ratio gives us the ability to continue to make meaningful acquisitions. We have closed deals totaling over $150 million over the last 18 months, and in each case, they have been accretive by the end of year one. Another change vector I mentioned in our last earnings call was increasing our innovation output and success rates. We feel great about our progress in our upcoming product launch. For example, in Garden, we’re introducing two product enhancements that utilize technological advances to improve the growing process, while meeting once more our Pennington Smart Seed grass products will be utilizing a coding with a biostimulus to help the seeds establish quickly, while continuing to acquire 30% less water than regular grass seed. Our reformulated Ultragreen fertilizer product now under our PENNINGTON brand will be utilizing a patented technology that also reduces watering needs and maintain more nutrients in the soil. This helps to grow deeper roots and grow bigger plants with more blooms and greener leaves. In our Pet business, our new product efforts continue to target the treats and chews categories, which is one of the better performing categories in the Pet industry of late. We’re adding to our successful line of treats and chews under our NYLABONE and CADET brands. For example, in our NYLABONE business, we’ll be adding to our successful healthy edibles line in 2017 with new healthy edibles Lidl with unique alternative proteins like bison, venison and turkey. These are just a few examples across our Garden & Pet business of what we believe is a robust pipeline of new product launch slated for this fiscal year. The third strategic change vector has been around the efforts we’re making to address cost savings and productivity improvements to fuel growth. Our program here is on track and we continue to target cost savings at 1% to 2% of controllable cost per year in an effort to reinvest and generating organic growth, while also enhancing our margins. For example, in our Garden controls business, we have brought some additional product manufacturing in-house what we believe will be more economical. A great example of strategic cost savings on the Pet side of the business within our small animal bedding unit, which we began producing our own preparatory product in-house, sales have increased dramatically and we have rolled out a better product at lower cost. Finally, we have talked at length about our network reorganization in our dog and cat business, designed to increase capacity and lower cost. Suffice to say, we’re making good progress and are on track to meet our goals. However, the timing for some elements have been slightly delayed as we work to ensure that we can execute with excellence and the pace of rapid growth and demand for our products in those business. Now, there are costs implementing our strategies and these expenditures as well as their timing will be factors in this year’s results versus a year ago. However, to be clear, that the market share gains that we have achieved and the organic growth we expect, we continue to believe that we will show good earnings growth overall this year consistent with our $1.34 or higher estimate. All in all, I’m very pleased with how the company is executing and I’m looking forward to another strong year in 2017. Now, I’ll turn it over to Howard to give you some more details on the quarter.

Thank you, George. Good afternoon, everyone. Earlier today, we issued our press release with our first quarter financial results. I’d like to discuss these results with you and then we’ll open it up for questions. For the first quarter, the company recorded GAAP earnings of $0.15 per diluted share, up from a loss of $0.18 over the same period last year. Included in this year’s results is a $2 million gain on the sale of a distribution facility. Included in last year’s first quarter, there was incremental interest expense of $14 million related to our note refinancing. Excluding the distribution facility sale in Q1 2017 and the note refinancing in Q1 2016, earnings for our first fiscal quarter for this year were $0.12 per diluted share, compared to $0.01 per diluted share in the first quarter of last year. As George mentioned earlier, this quarter’s results benefited from the conclusion of our new acquisition Segrest and DMC, as well as favorable revenue and expense timing. Consolidated sales for the quarter increased 17% versus the prior year to $419 million aided by recent acquisitions, as well as organic growth in both our Pet and Garden businesses. Our quarterly organic growth was 7%. Consolidated gross profit rose 21% and our gross margin increased 110 basis points to 28.8%, due in part to favorable mix and lower input costs. SG&A expense for the quarter increased 11%, or $10 million versus a year ago. Included in the SG&A numbers is the $2 million gain from the sale of the distribution facility. Excluding that facility sale, SG&A increased $12 million and as a percent of sales was 24.5%, declining 80 basis points. Operating income for the quarter rose to $20 million compared to $9 million a year ago. Our operating margin of 4.8%, was up 240 basis points due in part to the facility sale, additional volume leveraging fixed operational costs and sales mix changes compared to a year ago. Excluding the facility sale, operating margin of 4.3%, was up 190 basis points. Turning now to the Pet segment. Pet segment sales for the quarter increased 22%, or $55 million to $304 million. The quarter sale included two months from our newest acquisition, Segrest, and a full quarter of DMC. In comparison, we had only one month from DMC last year, and organic revenue growth was 6% and reflects widespread increases across the Pet segment, was benefited from shift and timing of orders into Q1. With more difficult comps later in the year, we would expect our Pet organic growth to be less robust than it was in our first quarter. Pet segment operating income increased $7 million, or 28% compared to the prior year. Net operating margin increased 50 basis points to a 11%. The operating margin benefited from a favorable mix of sales during the quarter versus the prior year, as well as higher profitability from DMC, which had repressed margins a year ago due to the impact of purchase price accounting adjustments. The impact from these gains more than offset the unfavorable margin impact from the company’s recent acquisition of Segrest and the increased spending on facility, as we transitioned several dog & cat businesses to a new location. Those activities are expected to continue in the future quarters. Moving to Garden. For the quarter, Garden segment sales increased 4%, or $4 million to $115 million. Higher sales of other manufacturers’ products, as well as increased grass seed and wild bird feed revenues contributed to the sales increase. The first quarter of last year included $5 million in revenues from the holiday decor business we exited in January of 2016. Garden’s operating income improved to $3 million from a loss of $3 million in the first quarter of last year and the operating margin was 2.3%. The improvement in both operating profit and margin was due in part to the sale of other distribution facility, as well as additional volume leveraging the fixed operational costs and lower input costs. Moving back to our consolidated results, other expense doubled to a $1 million, reflecting our interest in partnerships to drive future growth. We expect expenses to be slightly higher in this line item in the fiscal year at our normal run rate. Net interest expense decreased from $22 million to $7 million. The $15 million decrease was due primarily to the absence of $14 million and incremental interest expense we incurred in the first quarter of the prior fiscal year, in conjunction with the refinancing of our fixed rate debt. Our net income for the quarter was $8 million and diluted earnings per share were $0.15, compared to a loss of $9 million, or $0.18 in the first quarter of 2016. Adjusted earnings per share was $0.12 compared to $0.01 in Q1 in fiscal 2016. Turning to our balance sheet and cash flow statement. For the quarter, cash flow used by operations increased approximately $13 million from the first quarter a year ago. CapEx was $13 million versus $5 million in the first quarter of 2016. The increase was predominantly driven by investments in expanding and consolidating our facilities. Depreciation and amortization for the quarter was $10 million, up from $9 million a year ago. The primary driver of the increase was the new businesses we acquired. Our total debt decreased to $395 million from $436 million a year earlier. So we made an acquisition for $60 million just a few months ago and yet our debt level is still down $41 million year-over-year and our leverage ratio was 2.1 compared to 2.9 a year ago. We also had $329 million of availability on our credit line as of the end of the quarter. During the quarter, we did not repurchase any of our outstanding stocks at approximately $35 million remains available under the Board approved stock repurchase program. Now, I’ll turn it back over to George.

Thank you, Howard. So to summarize, we’re off to a good start in the fiscal year. We’re driving share consumption gains. We are successfully integrating our acquisitions and we’re on track executing our strategic initiatives. So with that said, operator, can you please open the line for questions.

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Bill Chappell of SunTrust. Please proceed with your question.

Thanks. Just…

Hi, Bill.

Hey, how are you? Just starting off on figures, maybe you can give us a little more color now on kind of the revenue run rate, or if we should look at this is kind of a normal quarter, I don’t know if there’s much of seasonality, or kind of also what you think in terms of impact on margins going forward?

There’s not a lot of seasonality on the business. We don’t have a full quarter, but I’ll tell you during the integration, the sales have been as to expectation. So it’s doing quite nicely and we expected to be roughly around the company margins in Pet going forward.

Okay. And then in terms of – you alluded to, or you spoke to on the call, you gained some share in Pet, but you don’t expect Pet growth to be as robust on the organic side for the rest of the year. So can you help me a couple those two comments and then maybe give some more color on where you’ve gained share in Pet?

This is Niko, Bill. So, yes, in looking at the consumption data via Nielsen, we gained share in a lot of categories. So dog and cat, aquatics, hard goods, small animal, avian. So it was pretty broad-based, feel really good about that. Going forward, as we look into the – as we look later into the year, we’re obviously lapping tougher comps. We also had a lot of promotional activity last year. We’ll have promotional activity again this year, hard to say at this stage, whether it will be as successful. So that’s why we’re tempering the outlook a little bit.

Okay. And then just last one for me on Garden. Any idea kind of, I mean, how much of an impact the longer season, Scott’s also talked about, it was a pretty good fall season. What you’re expecting Garden to grow and maybe what it would end up doing and how much weather helped?

For Q1, you’re talking about, Bill?

Exactly?

Yes. So this is J. D., I’ll speak to that. Similar to what has been reported by others, the favorable weather, the milder temperatures in the fall favorably impacted our business. So we saw strong consumption really across the board in all of our businesses, probably the strongest performers were grass in our branded controls. Our distribution of business also was very strong during the quarter. So we talked previously about our traditional Lawn and Garden categories versus our Wild Bird Food categories. So our Wild Bird didn’t farewell as well because of the milder temperatures, so we have a little bit more of a balanced portfolio. Having said that, very strong forward for us. We exceeded expectations and over delivered for the quarter and we feel good about that.

It sounds good. I’ll turn it over. Thanks a lot.

Thanks.

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

Congratulations on a nice quarter. So maybe [indiscernible] With respect to weather, and I know that’s been a topic [indiscernible]. So is it fair to assume that as temperatures cooled in – later in the – in your fiscal Q1, in the month of December, did sales moderate, or was there more of a big shift in there to some other colder weather type products?

The only other perspective I would jump in with is, Q1 is a very small quarter in the overall Garden season.

It is.

And weather has a way of reverting to the mean, so there’s a lot out in front of us.

So as I understand it – the other question is on the [indiscernible]. A lot of rain this year on the West Coast, it’s interesting there was a talk of flood condition – I’m sorry, drought conditions for so many years and with the rain, I think that the drought may be over, close to being over. How should we think about that within the context your Garden business, not just in Q1, but maybe as a factor going through with the year?

But we’ve gone into seasons before anticipating, strong markets and things have gone in the other direction on us, so it’s difficult. What I tend to talk about is, what is controllable and what’s uncontrollable. The controllable causal factors in our business going forward, distribution, secondary locations, promotional support, we feel great about all of that. If the weather is favorable, we’ll capitalize on that, but that is a big – single biggest causal factor out of our control.

All right. Then – the one final question, and I know this is longer-term, it’s quite difficult to ask at this point. But I’m getting a lot of questions across my coverage universe on potential for a border adjusted tax. How – is that something, and again recognize kind of no entry for dog on this. But is that something that you begin to contemplate within your discussions and maybe some initial thoughts there for your business?

Well, it’s obviously something we have to think about. First thing I’ll tell you, there’s a lot of unknowns, where, when, and what, from where? We do produce the majority of our production in U.S. although we do have material imports, so it’s something we have to keep our eye on. The way we think about it, competition is going to face the same pressures. So if there’s pricing pressure, they will face the same things and then market will likely move in lock step, and we’re a very nimble company on this front. We shift our sourcing to optimize the cost and our low-cost producer program, I think, I talked earlier about controls, we moved some production in-house versus things we had done with co-packers, and in other cases co-packers who are in other countries which this would actually impact. So we’re confident in our ability to adapt to any situation as it unfolds.

Great. Okay. Well, thank you, and again congratulations.

Thanks.

Thank you.

Our next question comes from William Reuter of Bank of America Merrill Lynch. Please proceed with your question.

Good afternoon. You guys talked a little bit about a shift and timing from the second quarter into the first quarter. Can you disclose what’s the dollar value of shipments that you think shifted from the second quarter to the first would be?

We’re not going to get into the puts and takes. First, I want to be clear, we didn’t say it was from – necessarily from the second quarter into the first quarter and we’re not going to put a dollar value on it. There’s a number of things that impacted timing. One of them I talked to in my opening comments was around our investment timing around our dog and cat facilities project. Demand on that business has been quite strong. We want to execute for our customers and the change with excellence. Therefore, some of the timing of that has been pushed out in the fiscal year. There has been some promotional shifts that impacted the business as well. So I wouldn’t lam on strictly from Q2 to Q1 and we’re not going to give an exact dollar number.

Okay. You guys are exiting a handful of facilities this year. Do you guys have a ballpark range for what you guys might receive in proceeds? I can’t remember exactly how many of them you own that you guys are exiting?

As far as the – if you’re referring to the dog and cat facility transition, or the one we transitioned from, we mentioned on the opening comments that we had a $2 million gain from the sale of a distribution facility. So I’m not sure if you’re harkening back to that or to something else?

Well, everything else.

Yes. We had a facility. We exited last year on the Pet side and then this year was on the Garden side.

Sure. So, I mean, we are always evaluating our footprint and trying to optimize it, and just recently we came across those as part of our optimization process. It doesn’t mean, there won’t be any in the future, but right now that’s – don’t have anything on the horizon.

You mentioned it was a $2 million gain, what were the proceeds from the sale of that facility?

Oh, I think it might have been around $5 million, I don’t recall specifically.

Okay. And then just lastly for me, in your prepared remarks when you guys were talking about acquisition, it sounded like maybe the pipeline was more robust, or maybe you guys were going to be more active than you had been recently. I guess, was I reading your body language correctly that – it seems like there’s more opportunities than maybe there had been for sometime?

I will say that M&A is going to be a key growth lever for us and we’ll continue to be active in the market. We bought three properties – three significant properties in the last 18 months. We hope to at least continue that pace. And as we look out and have been putting diligence again, building the pipeline, we feel the pipeline is as strong as it’s ever been.

Okay. I’ll pass it to others. Thank you.

[Operator Instructions] Our next question comes from Bill Baker of GARP Research. Please proceed with your question.

Hi, thanks it was a fantastic quarter. I’m trying to understand the organic growth that was really excellent on the Pet side and you do a nice style of breaking out Segrest. And knowing what I think I know about DMC, is that a very -- are these very low sales months for DMC, because if I’m trying to adjust for that, I’m not sure I can get to a similar organic growth number unless I assume DMC doesn’t really saw many dog beds in November and December. And could you just also just tell us where, what pieces of Pet might have been stronger than the 6% organic growth and which might have been lower, highlight one or two areas if you haven’t already?

Sure, this is Niko, Bill. As far as DMC goes, we have the October, November, December timeframe is a strong sales timeframe for that business. So there is some seasonality in that business and that’s what was strongest. As far as Pets strength, the dog and cat category was very strong, particularly the treats category treats and toys. I would tell you our Small Animal, Avian category did extremely well in Q1, and then aquatics was also good. Underperformers would be our reptile category where we continue to retrench there.

Thanks. Wasn’t there anything you did in Small Avian that might have led to that good growth or was it just the market?

No, I think we’ve got excellent operators in that business. They do a tremendous job every quarter. I’ll tell you that our small animal bedding project is doing extremely well, that product is well received by both the customer and the consumer. So we’re aggressively going after that market and it’s just a function having great operators to be honest with you.

Great, thanks Niko, this was a super quarter. So thanks, keep up the good work.

Thank you very much, Bill.

Our next question comes from Kevin Ziets with Citi. Please proceed with your question.

Hi, thanks for taking my questions. Just quickly on commodities, I guess I’ve heard your competitor and others talk about a spike in urea costs, I know you picked up some private label and in the fertilizer space. And I was just wondering if you could talk about your outlook for the year and how you’re managing through that?

Kevin, it’s J. D. here, I will comment on that. Typically that’s not something we make comments on or divulge any information there. I did hear the same comment from our competitor. And in terms of the commodities, it affects three of our businesses our wild bird business, our fertilizer business and our grass business. And what we have seen having been in these markets, in these categories for a long time is quarter-to-quarter, year-to-year we see some fluctuations in those. There were some slightly favorable commodity impact from last year, however, I’ve said on prior calls I wouldn’t take that necessarily as a headwind or a tailwind for us, because typically we work pretty closer with our customers. Our customers are tracking these costs as well. So usually there’s a pass-through to the customer and retail price and ultimately to the consumer.

Okay. Great and then did you reiterate the CapEx guidance, I think last quarter you had said $40 million to $45 million?

Yeah, we’re not changing that guidance at this point as well.

Okay, great. And then just thinking about the new products that you highlighted, the sort of less water needed products. I guess how do you think about those being situated in an environment or maybe we’re in a less drought focused?

So, Kevin it’s J. D. again, I’ll comment on that. Maybe this year the focus isn’t as much on drought, but from time to time that’s usually the biggest concern, particularly around grass seeds. So, whether it’s this year or next year, we think it’s the claim to go after and it’s more sustainable, which -- and the consumers at the store I think will give -- we launched a number of new products this year, we’re expanding our AMDRO Quick Kill that we talked about in previous calls. A new launch of -- and enhanced PENNINGTON Smart Seed this year and that’s the one that cuts along established, quicker and uses less water. We’re also launching PENNINGTON Ultra Green fertilizers with that additive that holds the nutrients in the ground longer, so better results from that. We’re also re-launching with two major customers, a private label line. So we feel very good about the new products that we’ll bring in the market this year and the new distribution that’s resulting from that.

Okay. And then do you think what’s the heightened innovation that we should expect advertising to be higher this year or at least marketing expenses?

George, you want to comment on it.

I’ll just say as a companywide I would say marketing spending is up nominally. That’s an area we’ll be investing more and over time. Right now with our new products we’re supporting was scoring well, particularly on the PENNINGTON Grass Seed line. Another case was the economics of the business are a little bit more challenging, for example doing in like TV advertising, so we did more economical demand creation around digital activities, search engine optimization, for example, which we’re investing significantly buying. So you will see our marketing spending up, you will see it up in the absolute, I would say, it’s up nominally as a percent of sales and you’ll see that grow over time as our consumer insights grow, as our idea generation grows, and as we invest even more around new products.

And then George I would add to that, in addition to our marketing spend, its trade spend that we’re investing with our customers to in secondary locations and the store being very promotional. Kevin, we believe we had fantastic progress and our goal is to drive five of those products with the customers so you will see increased spend there as well.

And I think about Central, as you can see our demand creations show up in a lot of different lines. On some businesses it’s a selling trend, so we get feet on the street selling to cattlemen, for example, on life sciences businesses. In other cases, it’s digital and you’ll see some of that in class of the marketing. Other bases were more off the shelf and you’ll see more around trade promotion spending to drive trial in-store. So you’ll see it number of areas, not just one.

That’s really helpful. And then I guess lastly maybe moving away from the stores, if you could talk about your positioning with e-commerce pure plays, particularly I guess in the Pet space?

Yes, we have a fantastic business digitally, I’m very proud of it, it’s growing very nicely. We continue to partner with the number of e-commerce partners and it’s performing quite well. We think it’s a great area for us to grow.

Do you think your share is similar I guess in e-commerce platforms as it is in bricks and motor or is there more opportunity to grow there?

And so it’s a difficult question to answer, in fact I don’t know the answer to that right now of how our share compares. If I look at total retail and I look at e-commerce as a percent of total retail, I would say that yes, we certainly have opportunity to grow, to reach those costs. But yes, we are very, very excited about e-commerce.

Okay. Thank you guys, good luck this year.

Thank you, Kevin.

[Operator Instructions] If there are no further questions at this time, I would like to turn the call over to George Roeth for closing remarks.

I just want to simply thank everybody for being on the call today. And we’re looking forward to a terrific 2017 for Central Garden & Pet. So thanks everybody.

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