Central Garden & Pet Company

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

Thank you, John. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Colfer, Chief Executive Officer, Nicola Hannas, Chief Financial Officer, J.D. Walker, President, Garden Consumer Products, and John Hanson, President, Pet Consumer Products. Tim will provide a business update, and Nico will discuss our third quarter results and our outlook for the full year in more detail. After the prepared remarks, J.D. and John will join us for the Q&A. Our press release that posted earlier today and related materials are available at ir.central.com and contain the gap reconciliation for the non-gap measures discussed on this call. All growth comparisons made during this call are against the same period in the prior year and as otherwise stated. Please note that statements 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 different 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 23rd, 2021. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events, or otherwise. With that, I will turn it over to Tim Cofer. Tim?

Thank you, Frederica, and good afternoon, everyone. Let me begin by thanking the more than 7,000 dedicated and passionate Central employees who are serving our consumers and customers across the pet and garden industries in these challenging times. Thanks to their hard work, Central is now listed as number 785 in the Fortune 1000 company rankings. We've climbed over 200 spots since our debut. in 2018. Thank you, Team Central. Let me highlight three key messages from this quarter. First, as you've seen in our press release, we expect to deliver full year EPS at or above prior year. And in Q3, we delivered EPS two cents above the prior year quarter. This is despite a muted garden season primarily due to unfavorable weather. That, coupled with reduced foot traffic and changing retailer inventory expectations, led to softness across most of our garden portfolio. Second, there is no doubt that we are currently in a difficult operating environment, and that means our team is focused on controlling what we can control. More precisely, we are tightly managing our spending, more aggressively pursuing productivity opportunities, adjusting our inventories, and building a plan to successfully steer central through this difficult environment. The external landscape has changed materially over the last year. Like many other companies, we are faced with high inflation across commodities, freight, and labor. a disrupted and elongated supply chain, evolving consumer behavior coming off the early pandemic years and adjusting to higher prices as they prepare for a potential recession. And our retail partners are experiencing reductions in foot traffic and realigning on inventory expectations. All of this impacts the consumer, and unsurprisingly, we have seen category participation rates moderate. albeit still above pre-COVID levels, and unit volumes decline in response to the high inflation and pricing. And the third key message, while we acknowledge this difficult near-term operating environment, the fundamentals of the pet and garden industries remain strong. We continue to be bullish on the long-term growth potential of our industries. Both pet and garden are driven by multiple macro consumer trends that can support attractive growth rates. We expect the purposeful investments we are making in strategic areas today, together with our strong balance sheet and M&A agenda, will allow us to capture opportunities and generate long-term shareholder value. Now, turning to our third quarter results. Net sales were down 2% versus prior year, driven primarily by the garden segment. Maintaining our gross margins has been a focus of our team all year long. To offset inflation and commodities, labor, and freight, we thoughtfully executed our pricing agenda. Together with recent margin accretive acquisitions and net productivity efforts, this resulted in year-to-date gross margin expansion of 50 basis points, While in the quarter, gross margin was down due to lower sales, higher inflation, and unfavorable product mix, we expect to expand full-year gross margin versus prior year. Operating income grew 1%. Even as we made purposeful investments in strategic areas, including capacity expansion and automation, consumer insights, brand buildings, innovation, and e-commerce to drive profitable long-term growth. And finally, EPS came in two cents above prior year. Now let me share some color on the trends we are seeing across our customers and consumers in our two segments, starting with pet. After an unprecedented increase in pet adoption and pet supplies category penetration in the pandemic years, This year, driven by increasing inflation and lifestyle changes, we have seen a modest decline in pet ownership and penetration rates, yet both are above 2019 levels. Net sales and POS in our pet segment were largely in line with last year, on top of 10% growth in the prior year quarter. We held or gained market share in several categories including dog treats and equine. And most of our central pet brands continue to outperform private label, reflecting the investments we are making in building and growing brands. We've significantly improved customer service levels, and as new capacity expansion and automation projects are completed across key businesses, we expect to reach pre-pandemic fill rates by year end. Last but not least, our investments in digital capabilities continue to pay off. E-commerce grew 14% and now represent approximately 22% of our pet-branded sales, an increase of 200 basis points versus prior year. Now, shifting to garden. Unfavorable weather combined with broad inflation, both at the macro and garden level, resulted in lawn and garden consumers shopping less frequently this year. In addition, activities such as personal travel, entertainment, and dining out are competing with time gardeners spend in their outdoor spaces, impacting near-term household penetration and consumption rates. These factors drove net sales in our garden segment down 4% and organic garden sales down 8% versus prior year. While these near-term dynamics are very real, we believe long-term trends such as rural revitalization, homesteading, and sustainability can support lawn and garden business vitality for years to come. In Q3, we experienced softness in most of our garden businesses in both organic sales and POS, However, there were a few bright spots to call out. First, we saw continued strength in our wild bird business with solid sales growth, new distribution, and market share gains. Next, you will recall over the last couple of years, we were challenged in our grass seed business. In our Q1 call, I referenced the launch of Pennington SmartPatch. Our team and our customers have been pleased with this innovation, and we have gained market share in the overall grass seed category, and most notably in patch and repair segment, reversing the share loss trend over the last few years. We're keeping a close eye on consumer behavior, especially related to price sensitivity and the potential migration to value segments and private labels. In Q3, we saw our brands continue to outperform private label in almost all of the lawn and garden categories, confirming that strong brands still matter. Doubling its share of wallet in the last two years, e-commerce is becoming more relevant to consumers and to our garden business. However, brick and mortar still dominates the garden channel landscape. Our e-commerce business grew 15%. and now represents mid-single digits of garden-branded sales. Customer service levels in our garden business have further improved, now consistently in the mid-90s, and we expect to be back at historic rates by end of year, thanks to our investments in capacity expansion and automation. Now, I'd like to provide some updates on our central-to-home strategy in action. starting with the consumer pillar. As we discussed previously, we're committed to making investments to build and grow distinctive brands consumers love. A great recent example is our All for the Small campaign, launched for KT, starring actor and comedian Rainn Wilson. This campaign included a first-of-its-kind digital short film featuring Rainn himself, attempting to register his guinea pig, Kenneth, in the prestigious Westminster Dog Show. Over 16 million households currently care for small animals and pet birds. This campaign demonstrated that these pets are just as worthy of recognition as dogs and cats, while also positioning our KT brand as the champion for small animal well-being. The campaign was very well received by consumers and garnered over 420 million earned impressions and a 500% amplification of our total media spend. If you haven't seen it yet, I urge you to check it out on YouTube or Instagram. Let's now turn to the customer pillar. As we've said in prior earnings calls, we are investing in digital capabilities and e-commerce. our fastest-growing channel across both segments. We're starting to see these investments bear fruit. We improved e-commerce fill rates, optimized digital investment levels, and created more engaging content. These efforts led to higher return on ad spend, market share growth, and mid-teen sales growth in both the pet and garden e-commerce segments. On to the cost pillars. which is focused on reducing costs to improve margins and fuel growth. Let me share a few noteworthy examples of our recent capital investments. Expansion of our controls manufacturing plant in Greenfield, Missouri, which enabled us to insource the production of ironite and Amdro from outside suppliers, as well as provide capacity for future growth. As a result, we expect to considerably improve gross margins and our controls business. Our bird feed warehouse in Madison, Georgia ran out of space given the strong growth of wild bird in the last few years. The expansion set us up for future demand and allowed us to consolidate a nearby rented facility, eliminating the rental and the cost to shuttle goods between locations, thereby improving margins. We expanded our KT paper bedding plant in Chilton, Wisconsin, which was outgrowing its capacity. In addition to improving gross margin, the project enabled sales growth of more than 30% versus prior year and allows for future innovation. And our Nylabone dog treat and toy business has been one of our most capacity constrained brands in the last two years. Thanks to recent expansion of both extrusion and injection molding capacity, We not only significantly improved our service levels, but are now able to fulfill additional orders and better keep up with the continued high demand. Lastly, on our culture pillar. This summer, our 150 top leaders from across all business units and functions came together for the first Central Leadership Council Summit. Over the course of the summit, we reaffirmed our conviction and ownership of the Central to Home strategy, shared best practices, celebrated accomplishments, and strengthened our winning culture. I certainly came away from that leadership summit inspired by the energy and talent of our top leaders and how we can take Central into its next chapter of growth. In summary, We're pleased with the progress we've made in the first nine months of the fiscal year. For the remainder, we're clear on our priorities. Given the evolving operating environment, we are pivoting our near-term priorities while not losing sight of our long-term targets. First, managing through this inflationary period with a heightened focus on cost control, pricing, and margin management. Second, developing a robust, 2023 operating plan that reflects the current realities of the external environment and positions central to leverage our strengths in these challenging times. Third, driving meaningful progress on our long-term strategy by making purposeful investments in key capabilities, our brands, and innovation agenda while staying active and agile as we consider further potential acquisition opportunities. And importantly, maintaining a focus on our people by enhancing a winning culture and continuing to recruit, retain, and develop the top talent in our industries. In closing, I'm confident in the ability of Team Central to successfully navigate in these challenging times. With that, let me turn it over to Nico. who will share more details of the Q3 results and our outlook for fiscal 22. Nico?