Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden & Pet Third Quarter Fiscal 2023 Earnings Call. My name is Doug 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 Friederike Edelmann, Vice President, Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Chief Executive Officer; Niko Lahanas, Chief Financial Officer; J.D. Walker, President, Garden Consumer Products; and John Hanson, President, Pet Consumer Products. As usual, Tim will provide a business update, and Niko will discuss the results for our third quarter ended June 24, 2023 in more detail. After the prepared remarks, JD and John will join us for the Q&A. Our press release and related materials are available at ir.central.com, and contains the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call. Lastly, unless otherwise stated, all growth comparisons made during this call are against the same period in the prior year. Before I turn the call over to Tim, I would like to remind you that statements made during this call which are not historical facts, including earnings per share and other guidance for fiscal 2023, expectations for new capital investments, product launches and future acquisitions 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 filings with the Securities and Exchange Commission, including our annual report on Form 10-K filed on November 22, 2022. 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, Tim Cofer. Tim?

Thank you, Friederike, and good afternoon everyone. As we exit our fiscal third quarter, we're in a fundamentally improved position versus last quarter. Our main focus all year long has been on cost and cash and the strength of our third quarter performance underscores the good progress our team has made in these areas. We're pleased with our record results and the momentum we're building on our multi-year cost and simplicity program. With that, let me start the call with three key messages. First, our quarterly performance. Thanks to our financial discipline and the strong execution by Team Central. We delivered record operating income and earnings per share in Q3 while expanding gross margin, growing market share and significantly improving our cash position. I want to thank our 7,000 associates for their hard work driving this record performance. Our garden business, which had a challenging start to the season earlier in the year, improved in the third quarter with top line growth, gross margin expansion and continued market share gains. The strong garden performance coupled with the ongoing strength in pet driven by our consumables brands and our short-term actions to cut controllable costs are the key drivers of our third quarter results. Specifically, our net sales grew 1%. Our non-GAAP gross margin improved by 160 basis points and non-GAAP operating income increased by 20% to $137 million translating into a non-GAAP earnings per share of $1.75. Our operating income and EPS for the quarter are both all time highs, both on a GAAP and non-GAAP basis. And importantly, our focus to turn inventory into cash is starting to pay off as demonstrated by more than $300 million of cash on our balance sheet at quarter end. The second key message relates to the progress we're making on our cost…

Thank you, Tim. Good afternoon, everyone. Building on Kim’s remarks, I’ll share with you details of our record third quarter results for fiscal 2023. Net sales increased 1% to $1,023 million with the largest contributions coming from dog and cat, live goods and packet seeds. Non-GAAP gross profit reached $326 million, an increase of 6% and non-GAAP gross margin expanded by 160 basis points to 31.9% driven by both segments due to pricing actions and cost management initiatives offsetting commodity inflation. Non-GAAP SG&A expense was $189 million compared to $194 million in the prior year. And as a percentage of net sales decreased 60 basis points to 18.5%. In Q3, we incurred $14 million of one-time charges related to the closure of our pet bedding facility in Texas, the majority of which were non-cash. These charges include severance, liquidation of inventory and related intangibles. We expect an annual benefit of $4 million to $6 million, a cash on cash payback in less than two years, and more importantly, a material step up in operating income contribution from our streamlined pet bed operations. Non-GAAP operating income increased by 20% or $23 million to a record $137 million and a non-GAAP operating margin increased by 220 basis points to 13.4%, driven by our pricing actions, productivity efforts, and lower commercial spend. Net interest expense of $13 million, was $1 million below the prior year quarter. Non-GAAP net income increased by $18 million to $94 million. Our non-GAAP earnings per share grew $0.36 to an all-time high of a $1.75 from $1.39 in the prior year quarter. GAAP EPS was one $1.56 and adjusted EBITDA increased to $166 million, up from $141 million. Our tax rate was 24.4% compared to 23.7% in the prior year quarter, primarily due to a lower tax benefit…

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Bill Chappell with Truist Securities. Please proceed with your question.

Thanks. Good afternoon.

Hey, Bill.

Hey, Bill.

I just wanted to zero in a little bit on the exit of – part of the distribution business. Maybe I – and I just – I assume it, it will happen at fiscal year end, and so it's not in this year's numbers. Any kind of idea of – I guess I'm trying to understand how it works of – that you're still distributing for three large retailers, but I guess at different warehouses to the other ones. And then would you look to do anything like this on the pet side going forward?

Hi, Bill. It's J.D. Thanks for the question. The distribution business that that we are exiting is is the distribution business to the independent garden center channel, which – first of all, it's a big move for us. This is a business that we've been in since the – since Central was founded in 1980. So it was a – it's a business that we know well and it's near and dear to our heart, but I think this is us acknowledging that it's far too complex and this will allow us to focus on our core competencies. The independent garden channel that we're talking about here, this is your nurseries garden centers across the country, 6,000 stores altogether, 4,000, roughly 4,000 customers, 4,500 SKUs altogether, and just a complex business. And it represents 5%, less than 5% of the overall garden business. We will continue to distribute to the big three, as Tim said in his script and some other select national accounts. The SKU count to those larger customers is actually much smaller and the volume is much higher. We will continue to distribute out of those same distribution centers. We mentioned in the script also that we are exiting one of our distribution centers. We'll continue to distribute for the big three out of the existing distribution centers. So that won't change. The sale is effective immediately. So we signed that that deal this week and we will be in a transitional services agreement with the acquiring company for the next several months until they start to service and fulfill from their own distribution centers.

And Bill, this is Tim. I'll build on everything J.D. said. Look, I think this is first of all a real win-win deal for both Central and for BFG. BFG is a great partner and distributor and they've been in this space a long time. Really, this is about playing to each company's strengths, and that's what BFG is. They are a distributor, a full line distributor. That's what they do and they do it well. For us this obviously represents, Bill, another important step in our cost and simplicity program towards simplifying our company, towards shifting our portfolio to a higher margin branded consumer products. It's also an accelerant for our supply chain and network optimization program. And as you heard me say in the prepared remarks, one of the immediate consequences is we will close another facility in Portland, Oregon. So it's a nice move for us. It's also a nice move for BFG obviously. So we're quite pleased with that. And I think a strong indication of our seriousness and our commitment to continue to evolve this portfolio in favor of our strengths, which is consumer products, great brands and great margins. With regard to the second half of your question, in terms of any read across per pet, our pet distribution business is very different than the portion of garden that we sold. It's a larger business, more profitable business than the business we sold. And as we sit today with that business, we continue to be happy with it. At the same time, Bill, we're going to continue to kick the tires on our portfolio looking for opportunities for optimization in line with our long-term strategy to build value.

Got it. And then just one more on garden. I think that, well, I know Scott said this morning that they felt like POS where the category was up kind of mid single digits for the year, and they also talked about some weakness in grass seed. I just still wanted to kind of compare notes of what you were seeing and if – maybe it seemed like your grass seed business gained share and so maybe that was just the offset. But any kind of color around that would be great.

Sure. J.D. again here, Bill. You were right. Grass seed gained share for the first half of the year, and in Q3 we held share. So overall, for fiscal year 2023, we took share in the category. The – in terms of overall POS we're in the same range, mid single digits for the full year.

Great. Thank you.

Yeah.

Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Hi, good afternoon and nice, nice quarter here.

Thanks, Brad.

My first question was just going to be around the gross margin. As I go back in our model and look at the past decade the third quarter gross margin here really coming in at one of the strongest levels in history. And so hoping you could just add a little bit more context to where pricing is today versus how much of this is mixed versus some of the productivity initiatives that you have in place? And how you're thinking about gross margin going forward? Thanks.

Yes. Brad, so the majority of it was pricing. Units continue to still be down. But again, our cost savings initiatives have played out as well. If you look at – we've been laser focused on cost and cash as Tim and I have mentioned in the last few quarters. And then you hit the nail on the head. The last piece of it was favorable mix that helped our margins there. Going forward, you know, and I've said this a bit like a broken record, we're always looking to expand margins. So we are very focused on it and we're going to continue to drive that going forward. So, look for more to come.

That's great. Thanks. And then just to follow up on kind of the question, Bill's question earlier, talking about sort of volume trends. I guess, we're seeing some green shoots, if you will, in many home related areas that had tough pandemic comparisons. And I guess I was hoping you could just talk a little bit more about maybe your optimism that were through the toughest part of things and may have better growth prospects on the horizon.

Yes, Brad, look, no doubt about it. These last couple of years we saw, I'd say three dynamics, the third being on garden, meaning one, you had kind of a post-COVID consumer behavioral shift going on. Two, you had really unprecedented inflation back to back two consecutive years, which, of course, we matched with pricing in order to protect our margins and still deliver value to our consumers. And then certainly on the garden side, we've had a couple of years of less than optimal weather. And so, all that has put pressure on unit takeaway. I think as you'll start to look forward, you see that inflationary cost envelope getting more and more benign. So this year the inflation still hit us and we had to price, and we priced kind of mid single digits across the enterprise, obviously category by category differed. And we saw a corresponding decay in volume kind of mid single digits. We are now at a point where we're seeing that cost inflationary pressure begin to mitigate. And so that sets up a different dynamic next year really in all three of those variables. One is, I think, a lot of that post-COVID consumer behavior starts to roll off and we can get to a little bit more normal as opposed to an unfavorable situation versus during COVID. Two, I mean, who knows on the weather, but it's hard to think three years in a row of rough weather. And then I think you're not going to have as much price elasticity going on. The one other call out on our business is on the pet side, and it's related to durables versus consumables. Durables, as you know, are most closely aligned with pet ownership and adoption. And here we did – we are seeing, and I said at my prepared remarks, more downward pressure in the teens on the durables again think fish tanks, small animal enclosures, pet beds, et cetera. I think that probably still hangs with us through the front half of 2024 given pet ownership dynamics. But with the exception of that, I think we get to a more favorable environment on unit takeaway as we roll into 2024.

That's very helpful. Thanks so much, Tim.

Our next question comes from the line of Jim Chartier with Monness Crespi Hardt. Please proceed with your question.

Hi. Thanks for taking my question. Where do you feel like you are in terms of your inventory destocking at retail for both businesses?

Do you want to go?

Sure. I'll jump in first. It's J.D., Jim, and then I'll turn it over to John. The – we've seen significant destocking over the course of the year in a few different ways. One, they are – they – the retailers devoted less space for off shelf displays this year. They also were seeing a difference in the way they stopped the stores at the beginning of the year, their initial orders. And then also on replenishment, they moved to more of a just in time type replenishment model, which was the first for us. So we were adjusting on the fly during the course of the year, but now our units of – our in-store inventories, the units are down versus prior year down rough – high single digits, let's call it. So we feel like now that the correction has taken place and we're in a good position going into fiscal 2024. John?

Yes. For pet on the Pet side, if you go back to Q1, I would say, destocking was – did happen. As we got through Q2, I think we still saw some Q3 were normalized, I would say. So we frame really good about where retail inventories are on the Pet side, as we come out of Q3 and throughout Q3.

Yes. And I would just add our own inventories are down, total company about 2%. Garden is up 7.6, but flat in units. So we still see some inflationary pressure within our cost. And then Pet was down like 13% year-over-year. So we’re working ours down as well. And feel like it’s really headed in the right direction, Jim.

Great. And so just, so, the – seems like there’s like a 7%, 8% difference between Garden POS and your shipments, right? And so as we kind of lap that next year, do you feel like that becomes a tailwind where POS is positive? But you’re lapping shipments that we’re lower because the destocking and so is there kind of a mid-single digit tailwind to sales in those businesses next year shipments and POS are more aligned.

So Jim, I don’t have a crystal ball, so that one would be a tough to predict what the future looks like. But I will say this, you’re absolutely right. There is a – I’d call it a 6% to 7% gap between POS and shipments. So you’re right about that. We’ve seen destocking, we think we’re in good position going into next year. But in terms of projecting that as a tailwind, I’ll stop short of that.

Okay. And then just, Niko, you guys mentioned $330 million of cash on the balance sheet. How are you thinking about kind of the pace of share purchases going forward? And then what’s kind of a good interest rate to use on the cash balance?

Yes, so, we’re going to be continue to be pretty opportunistic on share repurchase. We’ll meet with our Board next week and probably discuss where and how much we want to buy. We have a matrix that we submit during the open trading period. And then as far as the cash goes, we’re earning in that 4%, 4.5% range in terms of our investments there. So I would use 4% or 4.5%.

Great. Thank you.

Yes.

Our next question comes from the line of Andrea Teixeira with JPMorgan. Please proceed with your question.

Hi. This is Shavana Chowdary [ph] on for Andrea. How are you?

Good.

Doing well.

Congrats on the good quarter. Very quickly, couple questions. Your top line trends now that we’re exiting garden season seems like you are passing on the beat in the quarter, and – but then again, it seems at the same time the Pet category has been decelerating a little bit. So if you could just give us more color on that? And secondly, I just wanted to clarify something. Your fiscal 2023 guidance now of EPS, non-GAAP EPS of $2.55, can you give us what the GAAP EPS [indiscernible] previously you’ve mentioned was $2.35 for the GAAP EPS, just to bridge the two? Thank you.

Okay. So well, I’ll start with the…

You want to do? Sure.

The $2.35 is actually non-GAAP as well.

Correct. Yes.

So that matches up with the $2.55.

$0.20 raise.

Yes, $0.20 raise. And that was largely because when you look at our first half, we were behind prior year about $0.74 and we felt it was the right thing to do to guide down because the first half of the year was a real challenge. The third quarter has ended up being a record. We’ve seen a nice extension in terms of weather and the garden season has sort of played out late because the weather stayed mild. So we had that play out well. But the $2.55 is apples to apples with the $2.35.

Thanks for clarifying that.

Yes. In Pet, the headwind that we’re facing is durables, right? And if you think about the category, it’s 75% consumables, 25% durables. The consumable business for the category was roughly flat, but durables was down double digits. If you think about Central, our business is more 80:20 think about it. We’re actually 82% in the latest quarter, but think 80:20. Our consumables were up mid-single digits, and our durables were down high single digits, right? And that’s a headwind for the category. And it ties to the overlap in Pet adoption. I think inflationary – inflation plays a little bit of a role in that as some of these items are discretionary spend. But as we look forward, it certainly is a near-term headwind, but I think, as we get through the first half, we feel much better about the category. And we also feel very good about the long-term projections for the category.

Thank you for that, and I’ll pass that on.

Our next question comes from the line of William Reuter with Bank of America. Please proceed with your question.

Hi. I just have a couple, so to make sure I understand this. The business that you’re exiting of the independent garden retailers that will be 5% of the garden sales that are going away, but essentially that wasn’t really profitable, so maybe you actually, it’s additive to your EBITDA, is that right?

Yes, that’s right. I would say it was profit challenge segment of the business that I’d say that that’s fairly accurate.

Okay. And then was with the exit of this relationship or the transition, were there proceeds from the buyer or the entity that PFG that’s taking this?

There were – and at this point, we’re not disclosing the sale price. There was a sale price. What we can say is I think a fair and good win-win proposition for both sides. And as you noted, and J.D. confirmed this was a business from a sales side, less than 5% of total garden and de-minimus on the operating margin side.

Okay. And then when you were discussing the outlook for hard goods on the Pet side, you kind of said that I think that it could be a couple more quarters of weakness. Is that more based upon weakness at POS or is it more that you think your shipments are going to be weak because inventory levels remain high in those categories?

It’s more POS and syndicated data that we get our inventory levels. We’ve made a ton of progress on the inventory levels and continue to make progress on the Pet side.

Yes, really, John said it absolutely right. What I’d point to is really the underlying consumer fundamentals supporting that unfavorable trend, right? So we have seen off the COVID highs of 2020 and 2021, we’ve seen pet ownership drop down a couple of points. And these hard goods are most correlated with that. And so you’ve just got a built-in tailwind. We’ve seen this in the past in other recessions in times where pet ownership dips. There tends to be a four to six quarter lag on or impact on the durable side. And we’re just cycling through that. So it is more of a POS thing fueled by that underlying consumer behavior. We don’t have a complete crystal ball, but I would think by the middle of next year will work through that.

Okay. But I guess inventory levels at retail in those categories of your products, they are not out of line. They’re kind of okay at this point. So you’re selling…

They’re not. That’s correct.

That’s correct.

All right. That’s all for me. Thank you.

Thanks.

Our next question comes from the line of Hale Holden with Barclays. Please proceed with your question.

Hi, afternoon. I just had two questions. The first one was related to a comment you made around some of the garden sales moving online this season, and I was wondering what categories that was? And the second one is if you could just give us sort of updated thoughts around what the M&A environment looks like.

Sure. This is J.D. I’ll take the first part of that question around e-commerce. So overall, e-commerce continues to grow in Garden. It’s growing at a faster rate than our bricks and mortar business. It’s still overall a relatively small percentage of our business, but growing 5% and growing. But quarter to quarter, that business is growing at plus 20% each quarter. So it’s one of the fastest growing segments, the fastest growing segment. You ask which SKUs, which products. It’s really across our entire portfolio. We’re finding that the consumer, especially during the pandemic, some consumers started to shop online and we’re seeing that very – become very sticky and they’re continuing to do that post pandemic. Second part of the question, Niko?

Yes. I can take that. This is Niko. Yes. As far as you know, M&A it’s been slow the last few quarters we’re seeing a little bit of a pickup, and I think it’s also reflective in the public markets, you’re starting to see a little bit more IPO activity. But it’s still much slower than what we’ve become accustomed to during the pandemic. But it’s okay, we’re going to be patient and we’re going to look for the right deals to do and we’ll just continue accumulate cash on our balance sheet to get those deals done.

The fire power’s there.

Yes, for sure.

Fire power’s there, 4.5%. I get it. Thank you very much, guys.

Thank you.

And this was our last question. Thanks everyone for joining our call today. The IR team is available for any follow-up questions you may have. Have a great rest of the day.

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.