Central Garden & Pet Company

Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden and Pet second quarter fiscal 2023 earnings call. My name is Camilla 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. 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, Camilla. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Chief Executive Officer, Nicola Hannas, 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 Nico will discuss the results for our fiscal 23 second quarter end of March 25 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 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. Before I turn the call over to Tim, I would like to remind you that statements made during this call, which are not hysterical facts, including the potential impact of COVID-19 on our business, earnings per share, and other guidance for fiscal 23, 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 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 over the call to our CEO, Tim Cofer. Tim?

Thank you, Frederica, and good afternoon, everyone. I assume most of you saw our earnings pre-announcement last month. It was a challenging second quarter for our garden business. But since we ended the quarter, trends have improved, and we've taken additional action that builds confidence in our year-to-go outlook. So there's a lot to share on today's call. Let me get straight to what I think are the three most important messages for this call. First, our quarterly performance. While the pet segment largely met our expectations and we outperformed the pet supplies market as evidenced by our expanded share, it was our garden segment that significantly underdelivered. Garden was unfavorably impacted by poor early spring weather including severe storms in the southeast, heavy rain and snow in the west, and an unseasonably cold late March. As a result, total company performance fell short of both prior year and our expectations, with net sales of $909 million, gross margin of 28.6%, and operating income of $78 million. This translated to earnings per share of 90 cents. Second, our cost and simplicity program. As we've shared on prior calls, in fiscal 2023, we have a sharper focus on the cost pillar of our central-to-home strategy. In addition to the short-term actions we've taken in recent quarters, we are advancing our plans to more significantly simplify our business and improve our efficiency across the organization by rationalizing our footprint, streamlining our portfolio, and improving our cost structure. Our focus is on a number of key areas, including procurement, logistics, manufacturing, portfolio optimization, and administrative costs. Today, we will share the first of many restructuring efforts with more to come in the quarters and years ahead. And the third key message is our outlook for the year. For the remainder of the year, we are purposefully taking a prudent approach. We know that our Q2 fell short of expectations, driven by the poor start to the garden season. While we're cautiously optimistic that the garden season will normalize and inventory dynamics will stabilize, particularly given the encouraging signs we're seeing in April, we are unlikely to make up the losses from the early part of the garden season. Hence, our fiscal 23 guidance takes a prudent view. And importantly, it underscores our expectation that we will grow operating income and earnings per share in the second half. Now, let's look at the quarter from a segment perspective, starting with PET. In line with our expectations, sales in the pet segment were below prior year, largely due to the overall industry softness in durable pet supplies and our decision to discontinue certain low-profit private label product lines, especially in pet beds. In contrast, we saw continued solid growth across our consumables business, including dog and cat treats and toys, small animal, pet bird, aquatics, and reptile. Durable pet products, such as fish tanks and small animal enclosures, continue to be on a decline as new pet adoptions slowed, lapping the strong COVID bump. We expect durables to continue to be a headwind through the balance of the year. In contrast, consumables are still growing. Our business is skewed to consumables, which generally have higher margin. We're pleased that the investments we've made over the past couple of years to build capabilities around consumer insights, brand marketing, innovation, and category management continue to show results. as evidenced by broad-based market share gains in many of our key categories, including dog treats, dog toys, aquatics, small animal, and equine. Our POS once again outperformed our net sales, continuing the trend of retailer inventory destocking that we experienced the past few quarters. As said in our Q1 call, we expect that to normalize in the second half of the year. Shifting to online, our e-commerce business continues to outperform brick and mortar, and e-commerce represents 23% of total pet sales. Stronger programming, enhanced content, and improved customer service levels further increased our return on investments in digital and drove e-commerce share growth across our categories. As we consider the challenging economic conditions and the health of the pet parent consumer, we carefully monitor their behavior and sentiment. We know from prior recessions that pet is a resilient industry, even in difficult times. Recent data from package facts show that pet products and services are at the bottom of the list of household spending cutbacks. second only to human medicine and healthcare. In most of the categories we compete in, branded products continue to outperform private label. However, in some of the categories, for example, dog treats, we've seen some consumers trade down to lower price products, including private label. Given our wide dog treat portfolio across all price tiers, including some select private label offerings, we can weather these shifts and still grow market share. Overall, pet supplies household penetration remains in line with prior year, and online shopping trips have increased, even as consumers are making fewer trips to brick and mortar retailers. We believe 2024 will likely be a gradual return to normalcy in terms of pet category dynamics, and trends like work at home, premiumization, humanization, health, wellness, and sustainability, and all things digital, including e-commerce, should continue to support long-term pet industry growth. Turning now to our garden segment. As mentioned, we experienced broad-based softness across our garden portfolio, primarily due to unfavorable weather leading to a later start to the garden season. While we hate to talk about the weather, it plays a meaningful role in the annual garden season performance Let me share some facts to reinforce this point. Through mid-March, our garden POS was up almost 10% versus prior year. But then came the last two weeks of the quarter. These are the two most important weeks of the quarter for garden as we're ramping up for the season. The third week of March was the coldest in 38 years. a full 18 degrees colder than last year on average across the country. Then the fourth week was one of the wettest and snowiest in decades. So after a strong start to the quarter, our POS came in flat versus prior year. That's a huge swing in just a couple of weeks. Adding to the challenge, our top customers saw lower foot traffic than in prior years. And we saw a change in pre-season ordering patterns as retailers recalibrated their inventory expectations relative to historic behavior. With that as backdrop, our garden sales declined 5% versus prior year. The volume decline also had a material impact on our gross margins. The lower volume impacted fixed cost absorption, and we cycled through some higher price inventory that we expect to normalize in the back half. And while there's no doubt it was a disappointing quarter for our garden business, I'd like to call out four bright spots. First, our Pennington wild bird business continued its multi-year trend of growing sales and market share. Second, our Ferry Morris packet seed business showed solid growth and we're pleased with the sales, profitability, leadership, and synergies associated with this acquisition we made in 2021. Next, our Pennington grass seed business significantly expanded market share again in both brick and mortar and online. And our garden e-commerce performance was very strong, growing sales high teens, supported by improvements in retail media return on ad spend, or ROAS, and an expanded assortment. Before leaving the garden segment, let me give you an update on the development of the season. We now have good visibility into April sales, and we see that when Mother Nature cooperates, there's strong consumer engagement and growing POS. This is an encouraging sign for Q3. Now let's shift to our cost and simplicity program. As we've shared in prior calls, we're on a multi-year journey to reduce cost and simplify how we operate. It's increasingly clear that we have a meaningful opportunity to better leverage the scale of our $3.3 billion pet and garden platform. We've identified a series of projects across a number of key areas, including procurement, manufacturing, logistics, portfolio optimization, and administrative costs. In procurement, we want to better leverage the combined purchasing power to reduce input costs and build margin. In manufacturing, we seek to insource third-party production, reduce redundancies, improve manufacturing excellence, and drive efficiencies and synergies across the network. In logistics, we plan to lower the number of distribution points and drive scale benefits across transportation and warehousing. In terms of portfolio, we want to simplify our portfolio and focus on our higher margin, branded consumer products business. And last but not least, in administrative, we plan to align our admin costs to a lean, agile, and entrepreneurial growth culture. The outcomes we seek are clear. We expect to reduce complexity, which means fewer SKUs, fewer plants, and fewer distribution centers. We further expect lower cost of goods sold through lower logistics costs and better procurement, lower administrative costs through scale leverage and efficiency, and a gradual shift in focus to our higher margin, higher potential branded pet and garden consumer products. We believe the results of these efforts will drive higher margins and generate more fuel to invest in organic growth and advantageous M&A, supporting our long-term financial algorithm. Today, I will share a current example of our cost and simplicity program in action. You will recall in the last few quarters, we talked about the purposeful exit of low margin private label pet fed product lines and our efforts to achieve a simpler, more efficient manufacturing and distribution network, leveraging the supply chain synergies with our ardent cushion facilities. Last Friday, we announced the closure of a manufacturing and distribution facility in Athens, Texas. This decision comes with one-time charges of approximately $15 million in Q3, the majority of which is non-cash. We expect this to deliver a cash-on-cash payback in less than two years and drive a meaningful step up in operating income for our more streamlined pet bed business. This is one example of actions we're taking today, and yet we have so much more opportunity in the coming quarters and years ahead. Our management team has a vision and conviction, and we will prioritize executional excellence. This will be an evolution, not a revolution, with benefits impacting fiscal 24, 25, and beyond. Going forward, we will provide further updates on our plans to deliver sustainable, improved performance. While cost and cash are the priorities this year, We've not taken our eye off the opportunity to strengthen our brands and to drive organic growth for the future. Three growth spotlights for this quarter. First, we've embarked on a comprehensive Pennington master brand renovation. The goal of our work is to modernize and strengthen the Pennington brand, expand the portfolio into adjacencies, and simplify lawn and garden care for our consumers The brand team conducted extensive research to understand how millennials and Gen Zers approach lawn and garden. Encouragingly, a shared mindset was uncovered across age groups that should drive the category forward for years to come. The brand is now united under a new purpose to nurture the roots you put down and has a new brand architecture and package design that reflects a more contemporary, vibrant, and sustainable lawn and garden expertise. This spring, we extended the brand into new gardening categories, such as soils, organic packet seeds, and plant food. This is in addition to our brand anchors in grass seed and wild bird feed. Some of our new products have already been launched and are in store now, but the full brand migration will be a multi-year journey. Our retail partners are excited about the ambition, and we look forward to bringing it to life in store and helping to drive both attachment rates and basket size across total lawn and garden consumables. Second, our Ferry Morris direct-to-consumer e-commerce site, FerryMorris.com, has introduced a suite of innovative capabilities to help gardeners be successful. The Garden Matchmaker tool pairs the gardener's interest, skill level, and growing location with a personalized selection of seeds, plants, and guidance that match their needs. In March, we launched Ask Our Gardening Community, a digital Q&A center featuring real-time advice from Ferry Morris brand ambassadors. Consumers can access the live Q&A chat function from home, their gardens, or while shopping. at their local garden center to get answers right when help is needed. And once our garden enthusiasts have the tips they need as inspiration, our farrymorris.com site and our retail partners have all the fruit, veggies, herbs, and flower packet seeds, live plantlings, and seed starter kits to make them as successful as the pros. Third, our thriving dog treat and toy business launched new Nylabone innovation including novelty chew toy shapes inspired by everyday objects with a fun twist. We launched a new line of healthy edibles, meaty center chew treats that are packed with flavor while using limited ingredients. And a new patent-pending sneaky snacker refillable treat toy that combines a durable chew toy with dog's favorite healthy edible treats. And our leading cadet brand is launching a patent pending line of all natural highly palatable and digestible long lasting choose called bully hide that offers all the satisfaction for your dog at a more affordable price. Now, before I turn the call over to Nico, let me say a few words about our outlook for the year. As I previously mentioned, given the garden performance in the second quarter, we're taking a prudent approach to our fiscal 23 outlook. As the year progresses, we're cautiously optimistic that the garden season will normalize and retailer inventory dynamics will stabilize. We expect operating income and earnings per share to grow in the second half. The visibility we have into April builds our confidence that the season is improving. And as we communicated last month, we're expecting fiscal year EPS of $2.35 or better. This outlook excludes any impact from potential acquisitions or restructuring activities undertaken during the year. So to summarize, we remain confident in the competitive strength of Central and our Central to Home strategy. Our team's ability to navigate the current challenges and the fundamental trends that support long-term pet and garden industry growth. And with that, let me turn it over to Nico, who will share more details of our Q2 results. Nico?