Central Garden & Pet Company

Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden and 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. If anyone should require assistance during the call, please press star 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 with 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 Colfer, 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 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 contain the gap-to-non-gap reconciliation for the non-gap measures discussed on this call. Lastly, unless otherwise stated, all gross 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 23, 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, Frederica, 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 percent 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 and simplicity program. As we've shared on prior calls, we've embarked on a journey to simplify our business and improve our efficiency across the organization by rationalizing our footprint, streamlining our portfolio, and improving our cost structure. Today, we will update you on the successful closure of our private label pet bed facility we announced last quarter. In addition, we will share details about another important project supporting our cost and simplicity program. We just announced the sale of our independent garden center distribution business. This sale significantly simplifies our garden business and improves margins while we continue to serve our top three garden retail partners and select other national accounts. We're building a pipeline of projects to reduce costs and simplify our business, focused on a number of key areas, including procurement, logistics, manufacturing, portfolio optimization, and administrative costs. And we'll share more about our plans for fiscal 24 in our November earnings call. And finally, our guidance for the balance of the year. When we updated the market in May, we took a prudent approach to guidance, given the poor start to the garden season, driven by weather and retailer inventory dynamics. We were cautiously optimistic that Garden could improve in Q3, and indeed, our teams delivered. While favorable weather was hit and miss during the last few months, we navigated the quarter well across both segments. Taking our record Q3 performance into account, coupled with the early visibility we have into the fourth quarter, we're raising our fiscal year non-GAAP EPS guidance to $2.55 or better. This implies delivering modest Q4 EPS in what is typically a small quarter, albeit this year benefiting from the 53rd week. Now let's look at the quarter from a segment perspective, starting with PEP. Overall, we're pleased with our gross margin, operating income, and market share performance. Sales continued to grow in our pet consumables business across all categories, including dog and cat, bird, small animal, and equine. Offsetting the mid-single-digit increase in pet consumables, we saw ongoing downward pressure on pet durables, with declines versus prior years in the teens. This aligns with the softness the overall industry has experienced in enclosures and other durable supplies driven by the slowdown in pet ownership affecting most species after the COVID spike. Thanks to our continued work over the last couple of years to build capabilities around consumer insights, brand marketing, innovation, and category management, we took market share in many of our key categories, including dog toys and treats, bird, small animal, and equine. E-commerce remains the growth driver for the category at the expense of pet specialty. Our efforts to lean into online and digital are paying off as demonstrated by a double digit increase of our e-commerce sales, which now represent 25% of total pet sales. And given our investments in digital marketing excellence and the talent of our e-commerce teams, we once again grew online market share broadly across many of our categories, including dog treats and toys, equine, flea and tick, small animal, and bird. Our pet brands continue to strengthen with our brands outperforming private label, driving positive mix shift in our portfolio to generally higher margin branded products. Pet ownership data suggests that while total pet ownership is down slightly versus the COVID peak in 2020, pet parents are more engaged than ever in their pets' lives. Pet parents stated that spending on their pets is the least likely of all spend categories to be reduced over the next 12 months, underscoring the resilience of the category even in a recessionary environment. All of these dynamics contributed to POS growth in the low single digits and helped to normalize the inventory dynamics across our pet retail partners. Moving now to our garden segment. Following a challenging start to the season, we're pleased with the achievements of our garden business in the third quarter. Growing versus prior year on all key financial metrics, including net sales, gross margin, and operating income. We also continued to grow market share in wild bird and held share in grass seed and the overall garden category. Our teams executed well, and we saw strong performance, particularly in May and early June when the weather was more favorable. Live goods, packet seeds, and wild bird were the primary drivers for the sales growth. Retailers continue to reduce their inventory and are shifting to just-in-time replenishment, as demonstrated by stronger POS than net sales. In addition, certain retail partners decreased their lawn and garden off-shelf display activity for the season. Foot traffic across home centers and mass channel remains below prior year, although improving over Q2. Garden e-commerce sales are growing faster than brick and mortar as consumers shift more and more of their purchasing to online. While still small, our e-commerce business increased more than 20% and now represents over 5% of total garden sales thanks to strong improvement in our retail media efforts, expanded assortment, winning content, and enhanced ship-to-home options across our top three customers. Turning now to our cost and simplicity program. Let me briefly recap. We're on a multi-year journey to reduce cost and simplify how we operate. We have a meaningful opportunity to better leverage the scale of our business. We're building a pipeline of projects across a number of key areas, including procurement, manufacturing, logistics, portfolio optimization, and administrative costs. We expect to reduce complexity, which means fewer SKUs and fewer facilities. We seek to lower cost of goods sold through lower logistics costs and better procurement, lower administrative costs by leveraging our scale, and we plan to shift more of our focus to our branded pet and garden consumer products. We believe the result 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. In our Q2 call, we shared the first project of our cost and simplicity journey, the closure of a manufacturing and distribution facility in Athens, Texas. Our teams executed on-plan and on-budget The Athens production facility is now closed. The warehouse is empty and has been returned to the landlord. Pet bed manufacturing has ramped up and we're now shipping all customers from our Arden facilities. The entire team has done an amazing job managing the elements of this transition. We expect this project to deliver a cash on cash payback in less than two years and drive a step up in operating income. for our more streamlined pet bed business. And as I mentioned earlier, today we're pleased to share yet another example of our cost and simplicity program in action. Just yesterday, we closed the sale of our independent garden center distribution business to BFG Supply, a leading national garden distributor specializing in the independent garden channel and regional chains. The independent garden center channel is highly complex to serve. With 4,500 SKUs, 4,400 customers, and over 6,000 stores, this channel represented less than 5% of our garden net sales and was dilutive to our garden operating income margin. Going forward, BFG will distribute our branded garden products to the independent garden center channel. This partnership will allow both companies to focus on their core strengths. While we're exiting the fragmented independent garden center channel, we will retain our third-party distribution business with our largest three retail partners and select other national accounts. This is an important step to meaningfully simplify our garden business. as it enables us to accelerate our cost and simplicity program and optimize our customer service footprint. As a consequence of this sale, we also intend to close our Portland, Oregon garden distribution facility by the end of this calendar year. We are extremely proud of the men and women who have built and grown this business throughout the years and thankful for their many contributions. And we're pleased that many of them will continue to service this channel as they transition to BFG. This sale aligns to our strategy to be a more focused, higher margin, branded consumer products company, and is just one of many projects on our journey. Now, before I turn the call over to Nico, let me say a few words about our outlook for the remainder of the year. The fourth quarter is off to a good start. and we expect our focus on cost and cash to continue to yield benefits. This gives us confidence in delivering fiscal year 2023 non-GAAP EPS of $2.55 or better. So, to summarize, we remain confident in the competitive strength of Central and our Central to Home strategy. Our record Q3 results underscore our team's ability to execute and navigate in challenging times. And we remain bullish on 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 Q3 results. Nico?