Central Garden & Pet Company

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden and Pets Fiscal 2022 Second Quarter Earnings Call. My name is Shamali, 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. If anyone should require assistance during the call, please press star followed by zero on your touchtone phone. As a reminder, this conference call is being recorded. I would now like to turn the call over to Frederic Edelman, Vice President, Investor Relations. Please go ahead.

Thank you, Shamali. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Chief Executive Officer, Nico Lahana, Chief Financial Officer, J.D. Walker, President, Garden Consumer Products, and John Hansen, President, Pet Consumer Products. Tim will provide a business update, and Nico will discuss our financial 2022 Q2 results in more detail and revisit our outlook for the full year. Following the prepared remarks, JD and John will join us for the Q&A. Our press release providing the results for our fiscal 2022 second quarter ended March 26, 2022, and related materials are available at ir.central.com. and contain the gap to non-gap reconciliation for the non-gap 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. I would like to remind you that statements made during this call, which are not historical facts, including the potential impact of COVID-19 on our business, earnings per share, and other guidance for fiscal 22, Expectations for new capital investments, product launches, and future acquisitions are forward-looking statements subject to risk and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements. These risks and others are described in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, filed on November 23, 2021. 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?

Thanks, Frederica, and good afternoon, everyone. I want to start the call by thanking our team at Central for their continued dedication and passion to serving our consumers and customers across both the pet and garden industries. Our solid financial performance in the second quarter is a direct result of how well they are executing. Thank you, Team Central. Let me share three key takeaways from this quarter. First, Central delivered another solid quarter. We grew sales and operating income and, importantly, expanded gross margin in a challenging and highly inflationary environment. Second, although the garden season experienced a slow start, weather has not been as favorable to date, and other risks like heightened inflation, geopolitical impacts, and supply chain disruption continue, we remain committed to our full-year guidance of $3.10 or better, which represents 6% growth versus prior year non-GAAP EPS, or 13% growth on a gap basis. And third, the fundamentals of the pet and garden industries are strong, and we expect the purposeful investments we are making now will drive long-term shareholder value. Now, turning to our results. In the second quarter, Central delivered net sales growth of 2%, driven by our recent acquisitions. While organic sales declined 3.5%, it is important to note we are comping 23% sales growth in the prior year quarter. Shifting to gross margin. Like most companies, inflation has impacted all areas of our business, from commodities to packaging, labor rates, fuel costs, international ocean freight, and more. Thanks to our carefully executed pricing, favorable product mix, and productivity improvements, our gross margin expanded 100 basis points versus prior year. Our teams have done a good job controlling what we can control in this high inflation environment. Our operating income improved 2%, even as we continue purposeful investments in strategic areas, including capacity expansion and automation, innovation, brand building, consumer insights, and e-commerce to drive long-term growth. And finally, as we indicated in our last earnings call, we expected second quarter EPS to be below prior year. EPS came in at $1.27 or five cents below Q2 of 21. Now let me provide you some color on the trends we're seeing across our customers and consumers in our two segments, starting with pet. Today, more than half of all U.S. households own at least one pet, and that number has risen significantly during the pandemic years. Since 2019, an incremental 4 million households added pets to their families. Not surprisingly, household penetration in almost all of the pet supply categories also improved. as our furry, feathery, and scaly friends benefit from the new normal. In addition to penetration gains, annual spend per household in the pet category continues to increase with significant gains in 2020 versus 2019 and steady growth in 2021. Consumers are buying more often and spending more per trip compared to pre-pandemic levels. In line with these trends, Our pet segment enjoyed sustained consumer demand across most pet supplies categories, on top of a record second quarter in the prior year. Notable contributions came from our dog and cat, outdoor cushions, professional and distribution businesses, offsetting softness in pet beds. Our point of sale, or POS, was down slightly as we are lapping 30% POS growth in the prior year quarter. We've made progress improving fill rates in every pet business, and as new capacity expansion projects are commissioned across our key businesses, we are working towards our goal of getting back to pre-pandemic service levels by year end. We gain market share in several categories, including health and wellness, dog toys and treats, as well as equine, And last but not least, our investments in digital capabilities are beginning to pay off. E-commerce grew almost 10% and now represents approximately 22% of our pet-branded sales. Shifting to garden. In 2021, garden household penetration grew slightly, with about 1 million households entering the garden category, on top of the even larger increase seen in 2020. The segments with the largest gains were live plants and wild bird as consumers continue to beautify their outdoor spaces and enjoy their new or renewed passion for gardening and caring for wild birds. Net sales growth in the garden segment was driven by our recent acquisitions, all of which continue to perform well. Garden organic sales were below the prior year quarter, Three factors drove the organic sales decline. First, the garden season is off to a slower start, and foot traffic across our key retailers has been down versus prior year. March saw cold temperatures and snow in many states, and inflation, including rising gas prices, has led consumers to consolidate their trips to stores. Second, as we mentioned in our last earnings call, we experienced a bit of a pull forward of sales in the Q1. And finally, it is important to remember that we're lapping a robust 23% organic growth rate in the prior year quarter. As a result, strength in wild bird was more than offset by softness in chemicals and fertilizer, distribution, branded controls, and grass seed for both organic sales and POS. While brick and mortar still dominate the garden channel landscape, e-commerce continues to become more relevant to consumers and our business. In Q2, our garden e-commerce business grew by more than 20%, representing low single digits of total garden sales. Service levels in our garden businesses have improved over prior year, and our teams are working hard to get fill rates back to historic levels by year end. Now I'd like to take a few minutes to provide an update on our progress against our central-to-home strategy. Starting with the consumer pillar, where we seek to build and grow distinctive brands consumers love, we continue to elevate our capabilities, including significant new hires, new external partnerships, and a fresh focus on consumer insights to build our brands to new heights and create disruptive innovation platforms. This is inspiring new thinking and reinforcing a growth mindset. A critical goal for us is to step up product innovation to drive incremental growth, expand margins, and enhance the distinctiveness of our brands. Here are some recent examples. While dogs and cats continue to reign supreme, the growth of the other pet space cannot be denied. In fact, pets other than dog and cat although fewer in number, recently experienced the greatest surge in ownership, with the number of households increasing 12% versus prior year. KT, our leading brand for small animals, is well positioned to take advantage of this growth trend, providing premium products, including food and treats, hay, bedding, accessories, and enclosures for pet birds, rabbits, guinea pigs, and more. KT recently launched its NutriSoft line, which provides optimal nutrition for picky feathered eaters. Unlike almost all other bird food, which is hard, KT NutriSoft pairs a distinctive soft texture with naturally sweet flavors and no artificial colors to mimic the fresh fruits and vegetables found in a pet bird's native habitat. We're excited about this disruptive food form and our strong marketing support behind it. To build and grow brands consumers love, we remain committed to invest in demand creation to accelerate organic growth. One example of our work is the recent Flip the Turf campaign. So in February, just in time for Super Bowl, our Pennington brand launched a bold campaign, rallying together players, fans, athlete advocates, and those fighting for a greener future to call upon the NFL to make a change for the better. While we've been keenly aware of the benefits of natural grass over turf when it comes to sustainability, Pennington also realized the safety issues turf presents to athletes. Thanks to our efforts, thousands of consumers signed our change.org petition and the movement caught fire. Half of the NFL teams currently play on artificial turf, and we made a pledge that if they put safety and sustainability first and flip the turf to grass, we will provide our winning Pennington grass seed. The results of this campaign were impressive. Pennington had the highest social media engagement rate across every category of any brand that did not run a Super Bowl ad. This was an important step in building our brand purpose and recognition. Now let's turn to the customer pillar, where we focus on strengthening the relationships with our customers and building a leading e-commerce platform. We're proud that Central has been recognized once again as Petco's companion animal vendor of the year. We're pleased to receive this prestigious award for our continued commitment to championing the health and well-being of companion animals and expanding category sales. In our efforts to build a leading e-commerce platform, we recently completed the implementation of Do My Own's Pick, Pack, and Ship solution for online fulfillment in our largest Arden cushion plant. This investment will increase Arden's e-commerce fulfillment capacity by 40% and provide a runway for growth for years to come in the fastest growing channel. So, to summarize my remarks, we feel good about the progress in both the second quarter and the first half of our fiscal year, and we're excited about the opportunities ahead of us. Nevertheless, fiscal Q3 is typically the largest quarter for Central, and unfavorable weather has caused a late start to the garden season. We expect continued inflation in commodities, freight, and labor, and we're monitoring consumer behavior and spending patterns as we execute further pricing actions across our pet and garden portfolios. We are also monitoring the impact of the Russia-Ukraine war on the global economy, including prices for certain grains and seeds, fertilizer, and energy on an already challenged global supply chain. For the remainder of fiscal 22, we remain focused on our top priorities that we laid out last quarter. First, successfully adding capacity and automation to restore customer service to historic levels. Next, managing through this inflationary period with a focus on pricing actions and cost control efforts. Third, making meaningful progress against our long-term strategy by investing in our capabilities, our brands, and our innovation agenda. And finally, continuing to recruit, retain, and develop the top talent in our industries. Despite the continued headwinds, I'm confident in our team's ability to navigate in these challenging times. With that, let me turn it over to Nico, who will share more details of our Q2 results and the outlook for the fiscal year. Nico.

Thank you, Tim. Good afternoon, everyone. We feel good about the solid performance of our business given the current environment, especially after record net sales growth of 33% and EPS growth of 69% in the prior year quarter. Second quarter net sales reached 954 million. The increase of 2% was due to the 52 million contribution from our recent acquisitions. Organic net sales declined 3.5%. However, looking at the growth over a two-year period, organic sales grew at a 14% CAGR in the second quarter. Consolidated gross profit increased 14 million to 287 million. Gross margin improved 100 basis points to 30.1 percent, thanks primarily to our pricing actions to mitigate the significant cost inflation in commodities, freight and labor, as well as favorable product mix and productivity improvements. SG&A expense rose 7 percent to $180 million, driven by our recent acquisitions, higher logistics costs, our purposeful investment spending in capacity expansion and automation, as well as in capabilities. SG&A, as a percentage of net sales, increased 100 basis points to 18.9 percent. Operating income grew by 2 million to 107 million, and operating margin was 11.2 percent, in line with prior year, despite continued inflation and heightened investment spending. Net interest expense was 15 million compared to 10 million a year ago. The increase was due primarily to higher debt from the 400 million of senior notes we issued last April. Net income was $70 million compared to $73 million a year ago. Diluted gap earnings per share was $1.27 or $0.05 lower than in the prior year quarter. And adjusted EBITDA grew $2 million or 2% to $131 million. Our tax rate was 23.4% compared to 22.7% in the prior year quarter due to increased foreign earnings in higher tax rate jurisdictions. Now I'll provide some insights into the segments, starting with pet. Pet segment sales increased 1% to $498 million, driven by dog and cat, outdoor cushions, professional and distribution, offsetting lower sales in pet beds due to intentional skew rationalization. Pet is up against strong comparables in the second quarter a year ago, and when looking at the growth over a two-year period, organic pet sales increased at a 12% CAGR. Pet segment operating income was $61 million, a decline of 2% compared to prior year. An operating margin declined 40 basis points to 12.2% due to inflationary headwinds in commodities, freight and labor, as well as purposeful investments in our growth initiatives to drive long-term growth. Pet segment adjusted EBITDA decreased $1 million, or 1%, to $70 million. Turning now to GARDEN. garden segment sales grew 3%, or 13 million, to 457 million. Excluding the contribution from acquisitions, organic sales decreased 9% as growth in wild bird was more than offset by declines in chemicals and fertilizer, distribution, branded controls, and grass seed. As Tim mentioned, the decline was driven by three factors. First, unfavorable weather across the country, causing a late start to the garden season, more than offsetting pricing action taken to cover inflation. Second, some pull forward into Q1. Third, our garden segment is comping extraordinary growth in the prior year, and when looking at the growth over a two-year period, organic garden sales increased at a 17% CAGR. Garden segment operating income grew 7% to $71 million. Garden segment operating margin increased 50 basis points to 15.4%, primarily driven by the benefits of our pricing actions and the contribution from acquisitions exceeding inflationary headwinds and our heightened investment spending. Garden segment adjusted EBITDA increased 3 million, or 5%, to 78 million. Now moving to the balance sheet and cash flows. Cash and cash equivalents at the end of the second quarter were 54 million, compared to 40 million a year ago. Given our liquidity position, we remain on the lookout for high growth companies with accretive margins in both pet and garden to build scale in our core categories, enter adjacent categories, and add capabilities around e-commerce. Net cash used by operations was 180 compared to 84 million a year ago. The increase was mainly driven by working capital requirements, in particular, an increase in inventory resulting from an intentional buildup in inventory due to the increased demand for our products amid the continued global supply chain issues, as well as higher input costs. CapEx was $51 million as we continue to lean in on capacity expansion and automation. Some examples of investments made in the quarter are new lines of production in dog and cat, relocating Do My Own to a larger, more efficient, state-of-the-art facility and enhancing our manufacturing footprint and capabilities for branded controls in Missouri. Total debt was $1.2 billion, up from $1 billion at the same time last year. Our leverage ratio of 2.9 times at the end of the quarter compared to 2.5 times a year ago, well within our target range. We had no borrowings under our credit facility at the end of the second quarter. Depreciation and amortization for the quarter was $18 million, compared to $19 million the prior year quarter. During the quarter, we repurchased approximately 227,000 shares, or $9.4 million of our stock. There remains $100 million under the Board's previously authorized share repurchase program, as well as additional shares under the Board's equity dilution authorization. And finally, turning to our fiscal 22 outlook, we are certainly pleased with our solid results in the second quarter and the first half of fiscal 22. We are now lapping two years of extraordinary growth, and while improving, our supply chain remains stressed with outstripped capacity. We continue to experience labor shortages across many of our businesses, and driven by the current geopolitical factors, we expect costs for raw materials and freight to increase further. While we have taken and plan to seek additional pricing where necessary, we may not be able to offset all the impact this fiscal year through pricing. We continue to pursue our productivity cost agenda and drive favorable mix to mitigate the gap. We are monitoring customer dynamics and consumer spending as they adapt to this inflationary environment. Despite all of this, we are executing against our long-term strategy and continue to lean in with purposeful investment spending to drive profitable, sustainable growth. Considering all the above, We are maintaining our guidance of fiscal 22 GAAP EPS of $3.10 or better. Please keep in mind that this outlook excludes any impact from potential acquisitions that may be undertaken during the year. And with that, we would like to open the line for questions.

Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. and confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. And 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. Hey, just looking at the garden season, clearly from what you, Scott, said, it was a late start. Is there, one, any way to quantify what impact that had on the garden segment this quarter? And two, any kind of update of what you've been seeing as we move through April into early May?

I'll give a quick headline and turn over to JD, who knows it even better. I mean, no doubt this year, unlike the last two years, we characterized as an unfavorable weather season so far. If I had to dimensionalize it, I think we're probably three to four weeks behind where we've been in the last couple of years, good weather years. And, I mean, you know well, Bill, you know, at some point you kind of run out of runway. May and June are great months for us and will need to be great months for us. And, you know, we're hopeful, especially after a really bad March and April, that this thing can turn. So, you know, I think about it kind of, you know, three to four weeks behind type in terms of dimensionalizing the impact of the garden season. JD, expand on that if you would.

Hi Bill, it's JD here. I think Tim summarized it well. I'd say that it's very difficult to pinpoint exactly the impact from unfavorable weather. There's so many causal factors impacting the business. One of the more challenging business environments that I've seen, you know, everything from retailers taking a very aggressive approach last year. They took a more measured approach this year to their inventory build in the stores. Tim mentioned earlier in his script that the retailer foot traffic was down year over year, a lot of that due to the inflationary environment, one like we haven't seen in several decades. We're still battling with lingering supply chain challenges. We're working our way through that, and we're seeing improvement in our service metrics, but that's still a challenge. And it was noted earlier as well that we had to pull forward into Q1. So With all of this noise, it's challenging to exactly pinpoint weather. I should mention that we took some pretty sizable price increases, too. I think it's too early to tell the impact from those price increases on elasticity. All those things said, one encouraging sign is when the weather's been good and favorable, there is pent-up demand, and we've seen strong... consumption at a retail level. So that's the encouraging thing. We just need the weather to be a little more favorable going forward.

Got it. Thank you. And then on the pet side, any impacts or way to quantify impacts of the kind of the China shutdowns? I can't remember how much of your business you source in terms of manufacturing from China and if that's going to have any impact over the next few months.

So this is John. You know, the global supply chain has been, you know, challenged for quite some time now. We've not seen, you know, the latest, you know, what's going on in China have a more negative impact, but our supply chain does remain challenged. We are catching up. You know, certainly service in Q2 is better than it was in Q1. We've added a lot of capacity across the network. And we, you know, plan to sequentially improve service in Q3 and Q4.

Yeah, and Bill, I would just add just a reminder, we do a little bit less than 8% of our cost of goods coming out of China. And then the other thing I would point out is you'll notice our inventories were up quite a bit. And so we have forward bought inventories and some of that would be the stuff coming in from China. because we've learned the hard way that these supply chains are really slow moving right now.

Great. Thanks for the call.

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

Hi. Good afternoon. Thanks for taking my question. And, you know, off to a really good start here against some very difficult comparisons. You know, to that end, I was hoping to talk a little bit more about the outlook for organic sales in the two categories. And maybe starting with PET, you know, given that we're now past what's, I believe, not only the toughest kind of one-year comparison, but also stacked comparison, I was wondering your level of optimism that perhaps the organic sales may even be able to accelerate from here, just how you're thinking about things.

Sure, I'll give a headline and then we can go into both categories. I think to your point, Brad, you know, when you think about this year, you can simplify it maybe into two halves where front half, the comp's a lot more challenging than back half. A slightly more precise view would really think about it as the first seven months versus the last five. So, you know, it's really at this point in May where we're getting into far more favorable comps year over year. And so you saw that in some of the commentary we've already provided. You know, on pets, we grew sales 1%, which we feel really good about because we're lapping 21% growth this quarter year ago. And on garden, on the organic sales line, we were down, you know, kind of high single digits, but again, lapping a 23% growth Bill Meyer, As you look at the last six months, these last couple of quarters, particularly May year to go on our fiscal, you've got more favorable comps. I think on the pet side, we continue to feel very good about the consumer fundamentals. We feel good about the competitiveness of our franchises. You know, we noted a number of categories where we expanded market share in the quarter. We feel good about year-to-go initiatives. We've got a number of innovations hitting the market. We've got some new marketing campaigns, and you'll hear more about that as we talk Q3 and Q4. So I think overall on the pet side, feeling good about organic growth, you know, low singles-type growth. likely year to go. And then on the garden side, as J.D. said earlier in the call, we do need Mother Nature to help us here and break more favorably. The comps, as you get the balance of the year a lot easier and with some favorable weather, we should expect that to turn.

That's really helpful, Tim. And I was wondering if in the categories you could also go into a little bit more detail about What's happening on pricing versus volume and how much that's a factor in sales relative to the volume trend?

You know, pricing is definitely the biggest driver of our overall sales performance. Order of magnitude, you know, we're pricing in the high single digits, you know, 7%, 8% across the portfolio. That would be on both the garden and the pet side. So, obviously, you know, do the simple math and say, well, price is up in that high singles, and then we've quoted our total sales performance. Obviously, somewhere in the volume mix, you're looking at a negative number. Now, having said that, that's an aggregate. We have business units and brands that are still growing volume. I mean, our dog and cat business unit is not only pricing, but it's growing volume. Our outdoor cushions business, not only pricing, it's growing volume. our health and wellness business is growing volumes. So we, you know, you really need to get down to the BU specifics and sometimes the SKU specifics. But the aggregate story is, I think, appropriate and very carefully executed pricing, quite honestly, at a customer channel SKU level, you know, to take into account competitive dynamics, etc., On the backdrop of a very aggressive inflationary envelope that we're working against, I think at the beginning of the year I shared with you, Brad, and others that we were expecting a couple hundred million of inflation on the year. We're seeing that number creep higher versus original expectations, and that's why we're responding with a little bit more pricing. So pricing is definitely impacting volume, but, again, it differs BU by BU, business by business.

That's very helpful. Thank you, Tim.

Our next question comes from the line of Jim Chartier with Modest Crespi and Heart. Please proceed with your question.

Good afternoon. Thanks for taking my questions. I guess just, you know, Nico, you know, what does kind of the outlook for acquisitions look like at this point as a current environment, you know, produced more opportunities for you? Just some color there would be great. Thanks.

Yeah, I mean, we're in several, you know, negotiations on deals right now. I would say, you know, certainly the deal flow is not what it was, you know, a year ago. You know, I think the private markets have sort of followed the public market. Valuations have sort of come down. And I think folks that were thinking of selling may be, you know, waiting a little bit until the volatility settles. So overall, deal flow is a little bit muted you know, compared to a year ago. That said, you know, our pipeline is still pretty active and we're in, you know, some pretty good discussions.

Great. You know, and then you mentioned the need for price increases later in the year. You know, what magnitude of price increases would you need to kind of offset all of the additional inflation you're seeing today?

You know, it's the high single digits that I mentioned earlier is the plan here. So, you know, call it 7, 8 type percent in aggregate, Jim. And I think between that, as you heard both Nico and I say earlier in the prepared remarks, between our pricing agenda, our cost-out productivity agenda, relying on some continued favorable mix, and part of that's acquisition-related as well, right? Some of these recent acquisitions are also favorable on a margin basis. Between all of that, we're hopeful that we can either offset or largely offset that tsunami of inflation that, as I said, is now well north of a couple hundred million on the year.

Okay. And then just lastly, any color in terms of kind of cadence of sales and earnings for third and fourth quarter, any meaningful differences between the two quarters?

I mean, you know, you know as well, obviously a very different magnitude Q3 versus Q4. I think you're going to see – We're hopeful you'll see an accelerated top line relative to what we've seen in the front half show up in the back half, starting in Q3 and Q4. And you're going to see, obviously, earnings as well, right? And that's just simply doing the math to the 310 guide that we provided versus what we've actualized in the front half. I don't know what else you'd say, Nico, on that.

No, I think, you know, if anything, you know, you may see just looking at the late breaking garden season, you may see some garden business maybe go into a Q4 that we normally would see in Q3, assuming the weather cooperates. But that's about the only, you know, dynamic that I can see really happening other than the fact that, you know, Q3 is our biggest quarter. I don't think that's going to change. Yeah.

Nico, I would add to that that last year we had some fairly heavy inventories at retail at the end of Q3, and the retailer sold through a lot of that inventory in Q4. So that, too, may lead to exactly what you said, a little bit of a shift from Q3 into Q4 somewhat.

That's helpful. Thanks, and best of luck.

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

Good afternoon. My first question on the high single-digit price you mentioned and then over $200 million of inflation at this point, are we in a dynamic such that we'll continue to see gross margin expansion in the back half of the year like we did in the second quarter?

Well, it's a great question, and, you know, We're going to continue, you know, the answer is it depends, as usual. We're going to have to see how inflation behaves into Q3, and then you've got the elasticities, you know, how they behave, and then that will depend on really how much overhead we absorb in that period. So all those things are going to have an effect on how margins play out. The other thing I would tell you is mix. You know, if you look at our portfolio, we've got a really wide range of margins, and a favorable mix can really have a profound role on our margins. We've seen that play out really in the first half of the year where we've had very favorable mix. That happened in Q2 with our acquisitions performing well and affecting margin there. We're planning on it, but for us to tell you this is how it's going to play out, it's going to be TBD. It's a very fluid, dynamic process right now. And then also given the late breaking garden season kind of throws another wrench into it. So we're just going to have to see how the whole thing plays out.

Okay. And then secondarily, I have heard such a range of consumer behavior with regard to Are consumers trading down now that inflation is accelerating? Have you been seeing a mixed shift in terms of your private label, which I think is about 15% to 20% of sales? Has that been either gaining or losing sales relative to your branded products?

Yeah, William, we definitely monitor that closely. And as you said, I mean, one of the, I think, good things about our portfolio is the majority of our portfolio is definitely branded products. but we do have some limited exposure to private label as well. So, you know, we monitor this closely. There are many categories where we may have an offering both on the branded and the private label side. Looking at the data, including the most recent quarter, Q2, we are not seeing a shift from branded to private label in the categories in which we compete. In fact, you know, I would tell you pretty consistently we're seeing our growth trends unbranded outstrip the growth trends on private label, you know, by a margin. So we're on top of it. I think as the American consumer continues to be put under pressure with rising gas prices and overall inflation, they are going to be looking at tradeoffs kind of category by category. But so far in both lawn and garden consumables and in pet, as it relates to our business, we are seeing that as an unfavorable impact.

Good color. Thanks a lot.

Thank you.

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

Hi, this is Marianne on for Hale. Thank you for taking our question. On the back of Jim's question, we were wondering if higher financing rates in the market have changed your outlook at all for the M&A pipeline?

No, not at all. We really are very, you know, value focused on the deal itself. And, you know, we don't really view, you know, financing rates having a huge impact on what we do. We look for great companies and we look to expand our portfolio. And, you know, If we make the right decision on M&A, the cost of capital is pretty much secondary.

Okay, great. Thank you. Our next question comes from the line of Carla Casella with J.P. Morgan. Please proceed with your questions.

For a moment, I apologize if this has already been asked, but have you talked about inventory at retail and your comfort level in each category with inventory at retail and how they're purchasing versus last year. Do you see them buying ahead more this year or trying to buy ahead?

Sure. J.D., you want to start on garden?

Sure. Hi, Carla. This is J.D. To answer your question, we see retail inventories up low double digits right now. But when you consider the pricing factor that we mentioned earlier, And the fact that a year ago, we still had fairly widespread out of stocks due to demand for the product. So really, we don't consider this to be heavy in inventory at all. I mentioned earlier that retailers last year loaded their stores earlier and heavier for the season in anticipation of the season. And this year, we're seeing them take a more measured approach. So we believe that, you know, as the weather improves and consumption improves, that that should drive replenishment type orders.

And maybe, J.D., just one other point. Go ahead. You know, when we look at total garden sales, net revenue, and we look at total garden POS, they're actually quite in line, which again would mean, you know, there's no kind of big overhang or dislocation for us to necessarily be worried about. They're tracking more or less in line. Is that fair, J.D.? ? That's accurate, yes.

Oh, sorry, sorry.

On the PEP side, I would say there is, you know, increased inventory at retail, but it's needed, right? You know, our service level has been challenged and it's improving and will continue to improve, but there's no, you know, nothing kind of out of sorts

Okay, great. And then just one follow-up. How far out do you negotiate freight rates? And can you just say where they stand relative to like a 2019 or 20, as you're thinking of freight rates?

We do, you know, a combination of we go out, I think, as much as six months. We also participate in the spot market. So We like to play that trade a little bit and arbit to some extent. Sometimes you see some dislocation between the forward rate and the spot. So it's a little bit of a mixed bag. The other thing I would tell you, a large part of our business actually is FOBR dock. So the retailers are picking up and they're picking up that freight. In fact, we had a large customer transition to that over on the garden side this year, which is why you kind of saw our delivery expense come down a little bit. It wasn't that freight came down. It was just a different way of operating with that customer.

Great. That's super helpful. Thanks.

And just as a reminder, if anyone has any questions, you may press star 1 on your telephone keypad to join the question and answer queue. Our next question comes from the line of Tyrone Martinson with Jefferies. Please proceed with your question.

Good afternoon. In terms of the additional pricing actions that you have planned for this year, are those already been negotiated with your retailers, or is this something that you need to go to them and request additional price?

Yeah, it is largely, as you look at our total fiscal 22 pricing envelope, it is the vast majority is already negotiated. either landed or communicated and locked in. There is a small amount, as inflation has accelerated in a few areas, that we're looking for additional pricing. Order of magnitude, call it around 15%, that would fall into that bucket of we're still in negotiation with our customer partners. And 85% is largely locked in.

Okay, so this will flow through. And then when you look at kind of the volume declines, you know, fully understanding that we're up against some tough comparisons and we do have the late start to the garden season. But, you know, I think as Bill had asked, you know, we've heard it from many, many people about the state of the consumer. You know, are you seeing the consumer kind of pushing back on pricing, whether it be for pet or for gardens?

You know, I would say broadly, no, or, you know, maybe better said, not yet, at least. So, you know, when you look at, as you say, I think when you look at our overall organic sales growth and you take into account the type of, you know, massive lapse that we've got in the 20s and 30s in the prior year, and then certainly on the garden side, you overlay a true dynamic of a late break to the season. Overall, when you look at pricing versus volume mix, I would say it's largely in line with what we planned, you know, back at when we put our plan together and guide it to the market. We aren't seeing the consumer walk away at these high prices, at least not yet. And to another caller, you know, we're not seeing a shift into private label, at least not as of yet in terms of any sort of meaningful way. The last kind of proof point, I would say, is the fact that we have a number of businesses that even on the back of that high pricing are actually still growing volume. And I mentioned three or four earlier in this call. So, you know, touch wood. I think the American consumer is getting pushed and squeezed in a lot of areas. But so far, I think the resilience on garden and pet is encouraging.

Thank you very much. Appreciate it.

And we have reached the end of the question and answer session. And I'll now turn the call back over to Tim Cofer for closing remarks.

Thank you. Thanks, everyone, for joining our call today and your continued interest in Central Garden and Pet. If you have further questions, please follow up with Frederica and our investor relations team, and we'll look forward to speaking with you again next quarter, if not before. Have a good day.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.