Central Garden & Pet Company (NASDAQ:CENT) Q4 2023 Earnings Call Transcript

Central Garden & Pet Company (NASDAQ:CENT) Q4 2023 Earnings Call Transcript November 20, 2023

Central Garden & Pet Company misses on earnings expectations. Reported EPS is $0.05 EPS, expectations were $0.08.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden & Pet Fourth Quarter and Fiscal 2023 Earnings Call. My name is Shamali and I will be your conference operator for today. [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.

Friederike Edelmann: Good afternoon, everyone. Thank you for joining Central’s fourth quarter and fiscal year 2023 earnings call. With me on the call today are Beth Springer, Interim Chief Executive Officer and Lead Director; Niko Lahanas, Chief Financial Officer; J.D. Walker, President, Garden Consumer Products; and John Hanson, President, Pet Consumer Products. In a moment, Beth will provide our key takeaways from the fiscal year and Niko will discuss our financial results, our Cost and Simplicity Program, as well as our outlook in more detail. After the prepared remarks, J.D. and John will join us for the Q&A. Before they begin, I would like to remind you that all forward-looking statements made during this call are subject to risks and uncertainties that could cause our actual results to differ materially from what we share today.

We describe the range of risk factors in our Annual Report filed with the Securities and Exchange Commission. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events, or otherwise. Our press release and related materials are available at ir.central.com and contain the GAAP reconciliation for the non-GAAP measures discussed on this call. Lastly, all growth comparisons made during this call are against the same period in the prior year unless otherwise stated. For further discussion after the call, please reach out to me. And with that, I will turn it over to Beth.

Beth Springer: Thanks, Friederike, and good afternoon, everyone. It’s a pleasure to be here and thank you for joining our call today. Let’s start with the three themes I’d like you to take away from this call. First, our fiscal year 2023 achievements. We are proud of what Team Central was able to achieve in light of a challenging environment, an environment characterized by unfavorable consumer behavior, unfavorable retail dynamics, high inflation, and some extreme weather. Most notably, we delivered fiscal year 2023 non-GAAP EPS within our revised guidance, generated record cash flow, and grew market shares broadly across Pet and Garden. We’re grateful to our 6,700 associates for their hard work driving these results. Second, I want to speak to the strides 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 efficiency across our organization. We are doing this by rationalizing our footprint, optimizing our portfolio, and improving our cost structure. Today, we’ll share some of the proof points we’ve accomplished in fiscal year ’23, including the closure of our dog bed manufacturing and distribution facility in Texas as a result of exiting certain low-margin private label pet bed product lines. And the successful sale of our distribution business to the fragmented independent garden center channel, a complex channel to serve that was dilutive to our Garden operating margin. We will also provide more color around our recently announced acquisition of TDBBS, a provider of premium natural dog chews and treats.

The TDBBS acquisition adds scale and e-commerce capabilities to our fast-growing dog and cat platform. And third, fiscal year ’24 guidance. We remain committed to our long-term Central to Home strategy. We are intensely focused on executing our cost and cash agenda and making thoughtful investments to fortify our foundation and to drive growth. We expect to continue to face a challenging external environment in fiscal year ’24 and guide to non-GAAP EPS of $2.50 or better. Importantly, we remain confident in the health of our business and our categories and are particularly encouraged by data showing younger households spending more money on their pets and enjoying their time gardening. Before I turn it over to Niko, I want to reiterate that our FY ’23 achievements underscore our ability to execute in challenging times and the fundamental strength of Central Garden & Pet.

And with that, I’ll now turn it over to Niko.

Niko Lahanas: Thank you, Beth. Good afternoon, everyone. Building on Beth’s remarks, I’m pleased to walk you through our financial results and share details on our Cost and Simplicity program, as well as our outlook for fiscal ’24. Let me start with our fiscal ’23 results. Net sales were $3.3 billion, in line with prior year. As a reminder, this year we benefited from an additional 53rd week. Non-GAAP gross profit for the year was $957 million compared to $992 million, and our non-GAAP gross margin was 28.9% compared to 29.7%. The decrease was due to inflation and lower volumes resulting in an unfavorable overhead absorption, partially offset by improved pricing and productivity efforts throughout the year. While commodity costs have continued to moderate, the benefit of the lower cost takes more time to be realized as we continue to work through older higher-cost inventory.

Non-GAAP SG&A was $729 million compared to $732 million a year ago and was 22% as a percentage of net sales versus 21.9%. Non-GAAP one-time charges were approximately $17 million for the year, which are net of a gain of approximately $6 million on the sale of our distribution business into the independent garden center channel and related facility closures, the majority of which are part of our Cost and Simplicity program. Non-GAAP operating income for the year was $227 million compared to $260 million in the prior year. And non-GAAP operating margin was 6.9% compared to 7.8%. The decrease was due to inflation and lower volumes resulting in unfavorable overhead absorption which was only partially offset by improved pricing and productivity efforts.

Other income and expense was income of $1.5 million compared to expense of $3.6 million in the prior year. Net interest expense was $50 million compared to $58 million a year ago, driven by higher cash balance, and interest income. Non-GAAP net income was $138 million compared to $152 million a year ago. And non-GAAP EPS came in at $2.59, in line with our revised guidance. GAAP EPS was $2.35. Adjusted EBITDA for the year decreased 7% to $343 million. Our tax rate for the year decreased by 80 basis points to 22.4% due to the impact of a lower blended state tax rate. Now, turning to the consolidated financials for the quarter. Fourth quarter net sales were $750 million, up 6%, primarily benefiting from the additional week this year. Non-GAAP gross profit for the quarter was $199 million, essentially in line with a year ago.

And non-GAAP gross margin was 26.6% versus 28.2%, as the favorable impact of our pricing actions and productivity efforts was more than offset by inflation and unfavorable overhead absorption due to lower unit volumes. Non-GAAP SG&A expense for the quarter was $187 million, in line with prior year. And as a percentage of net sales, was 25% compared to 26.4% as we benefited from the additional week of sales while managing commercial spend, and administrative expense. Non-GAAP operating income for the quarter was $12 million compared to $13 million and non-GAAP operating margin was 1.6% compared to 1.8% in the prior year. Net interest expense was $8 million compared to $14 million a year ago. Non-GAAP income for the quarter was $5 million compared to a loss of $2 million in the prior year and non-GAAP earnings per share was $0.10 compared to a loss per share of $0.04 a year ago.

GAAP EPS was $0.05. Weighted diluted shares outstanding decreased to 53.4 million from 54.4 million in the prior year. We bought back approximately 65,000 shares for roughly $2.4 million. Now, I’ll provide some insights into the fourth quarter of our two segments, starting with Pet. Pet net sales for the fourth quarter increased 10% to $483 million, thanks to the extra week and strong consumer demand. Our POS growth was in the high single-digits, and coupled with improved service levels, resulted in share gains in a number of categories. Sales continue to grow in our pet consumables business across all categories including dog and cat, which had a record quarter. Pet distribution, animal health, small animal, bird, and aquatics, all experienced growth versus prior year.

Pet durables continued to decline in high single-digits. Sales of our pet brands increased low double-digits, outperforming private label sales, which were negatively impacted by the purposeful exit of low-profit private label product lines and SKU rationalization. Driven by our efforts over the last couple of years to build capabilities around consumer insights, innovation, and category management, we gained or held market share in most of our categories, including dog toys and treats, small animal, bird, aquatics, and equine, reflecting the overall health of our brands. We gained mid-single-digits in total distribution points or TDPs. E-commerce continues to drive growth for the segment at the expense of brick-and-mortar. Thanks to our investments into online and digital, our e-commerce sales increased low double-digits, and now represent approximately 25% of total Pet sales.

Moreover, we grew online market share broadly across many of our categories, including dog toys, equine, and animal health, small animal, and bird. Non-GAAP operating income for Pet was $48 million compared to $40 million, and non-GAAP operating margin was 9.9% versus 9.2% a year ago. The increase was driven by productivity efforts and improved pricing, partially offset by unfavorable overhead absorption. Pet adjusted EBITDA increased 15% to $58 million. Moving on to Garden. In the fourth quarter, Garden net sales were $267 million, in line with the prior year due to softness across most of the Garden portfolio except for Garden controls & fertilizer, live goods, and grass seed. We continue to grow market share in grass seed and wild bird, two important anchor categories in our Garden business We saw retailers continue to manage their inventory closely, shifting to just-in-time replenishment.

This coupled with the declining foot traffic in home centers, and mass channel as well as extreme weather for the second year in a row, resulted in another challenging quarter for the Garden segment. Garden e-commerce sales continue to grow faster than brick-and-mortar as consumers shift more and more of their purchasing to online. Our e-commerce business, while still small, now represents approximately 6% of total Garden sales, thanks to our investments in digital and e-commerce capabilities. Non-GAAP operating loss for Garden was $5 million compared to operating profit of $2 million, and non-GAAP operating margin was negative 2% compared to 0.7% a year ago. The decrease was due to inflation, partially offset by improved pricing and productivity efforts.

Garden adjusted EBITDA was $6 million compared to $12 million in the prior year. Now turning to the balance sheet and cash flows. Cash provided by operations was $382 million in fiscal ’23 versus cash used by operations of $34 million in the prior year. I’m extremely proud of our team’s focus on converting inventories into cash. Inventories at year-end were $100 million below prior year and inventory value is down for total Central and across both segments. CapEx for the year was $54 million, about half of what we invested in the prior year. In the quarter, we invested in automation and expansion of pet and wild bird, aquatics, live plants, and controls & fertilizer. Depreciation and amortization was $88 million compared to $81 million a year ago.

Thanks to our focus on turning inventories into cash, we had a record cash flow year. Cash and equivalents including short-term investments were $489 million at year-end compared to $177 million in the prior year. Total debt was $1.2 billion, in line with prior year. We ended the quarter with a leverage ratio of 3.1 times compared to 2.9 times a year ago, well in line with our target range of 3 to 3.5 times. We had no borrowings under our $750 million credit facility at the end of the year. Given our financial strength, and in addition to our recent pet consumables acquisition, we continue to be on the lookout for high-growth companies with accretive margins in both Pet and Garden, to build scale in core categories, enter adjacent categories, and add key capabilities.

Let me now touch on our Cost and Simplicity program. As previously communicated, we’re in a multi-year journey to reduce cost and simplify how we operate. We have meaningful opportunity to better leverage the scale of our business across a number of areas, including procurement, manufacturing, logistics, portfolio optimization, and administrative costs. We expect to reduce complexity, which means fewer SKUs, increased manufacturing warehouse efficiency, as well as fewer facilities. We seek to lower costs through improved logistics costs, better procurement, and lower administrative costs. This will be done by leveraging our scale and capabilities across the Company. We believe this program will drive higher margins and generate more fuel to invest in organic growth and accretive M&A in both Pet and Garden.

Now turning to the progress we’ve made so far in the different areas. First, in manufacturing. We continue to pursue a continuous improvement mindset by measuring cost and productivity by manufacturing line, by facility, which resulted in major improvements in cost per unit. In Q4, we announced the closure of an outdoor cushion manufacturing warehousing facility in Amarillo, Texas, moving all manufacturing to a centrally located consolidated facility. Second, logistics. We’re aligning for scale in logistics by expanding our corporate transportation management system and centralizing load planning. In addition, we are standardizing how we operate our warehouses by reapplying internal best practices across BUs, deploying technology solutions to reduce waste, and implementing voice direct picking in multiple facilities.

Moreover, we are closing three smaller Pet distribution facilities in Kansas and one in Illinois. Third, portfolio optimization. To become a more focused higher margin consumer products Company. As a result of the purposeful exit of low-margin private label pet bed product lines, we closed a smaller distribution facility in Corsicana, Texas in December of ’22, followed by the closing of our pet bedding manufacturing and distribution facility in Athens, Texas in April of ’23. We sold our independent garden center distribution business. As you recall, this channel represents less than 5% of our Garden net sales and was dilutive to our Garden operating income margin. As a result of the sale, we plan to close our Portland, Oregon Garden distribution facility.

Fortifying the Central portfolio, two weeks ago, we acquired premium natural chews and treats company, TDBBS. Adding their established brands and digital capabilities solidifies our position in this large and growing category, strengthens our footprint with key customers, and enhances our e-commerce and digital capabilities. We remain committed on this multi-year journey to reduce cost and simplify our business. We have a pipeline of projects to leverage our scale and deploy our capabilities across the Company. We’ll continue to provide regular progress updates on a quarterly basis. As always, our priority will be on business continuity and minimizing disruption to our operations. As a Company that has grown through acquisition, and that has the intention of continuing on that path, there is no shortage of opportunity ahead of us.

Now turning to our fiscal ’24 outlook. We currently expect non-GAAP EPS for the year to be $2.50 or better. Let me provide some color around our assumptions. We expect a challenging retail environment with customers continuing to manage their inventories closely, and consumers faced with high prices and interest rates reining in their spending. While our team has done a great job managing inventories, higher-value inventory is going to put pressure on margins for some part of the fiscal year. The benefit of the lower cost is taking more time to realize as we continue to work through existing high-cost inventory. Our Pet segment continues to perform well, especially in the consumables business such as dog treats and chews, small animal, and bird.

Conversely, in line with the softer pet ownership, durables continue to present a challenge for the industry and Central. In addition, we remain cautious about the ’24 Garden season after two years of unfavorable weather and continued declines in foot traffic at retail. As we look at CapEx, we’re planning to invest approximately $70 million, most of which is required maintenance, and productivity initiatives across both our segments. While the near-term external environment remains challenging, we remain committed to our Central to Home Strategy as it relates to our consumer growth agenda and we continue to selectively invest in our digital marketing, brand building, and innovation, to drive profitable long-term organic growth, as well as investments to enable future Cost and Simplicity savings.

Our guidance reflects our belief in the long-term health of our business, our team’s execution, and the long-term trends that support the Pet and Garden industries. Fiscal ’24 it’s back to 52 weeks, whereas fiscal ’23 benefited from an additional week. As always, our outlook excludes any impact from acquisitions, divestitures, or restructuring activities that may occur during fiscal ’24, including any such project under the Cost and Simplicity program. It also excludes the impact of our recent pet consumables acquisition as we’re still in the early stages of the integration process. We expect the acquisition to be accretive over time. However, it will have a minimal impact on fiscal ’24. Now, as we look forward to the first quarter of fiscal ’24, I want to remind you that Q1 is typically one of our smallest quarters and not indicative of the full year.

We expect Q1 non-GAAP loss per share to be in the range of $0.15 to $0.20 for the quarter. To summarize, ’23 was a challenging year for our industries and Central. Nevertheless, we delivered fiscal ’23 non-GAAP EPS within our revised guidance, turned inventories into cash, generated record cash flow, and grew market share broadly across Pet and Garden. We continue to believe in the fundamental trends that support long-term growth in the Pet and Garden industries. Our Company remains strong, well-capitalized, and well-positioned to grow both organically, and through acquisitions in the coming years. And with that, I’d like to open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Brad Thomas: Hi, good afternoon, and thanks for taking the question. Wanted to ask, Niko, a couple of questions, as we think about the fiscal year ahead of you, and maybe starting first with margins. I was hoping you could talk a little bit about, you know, some of the puts and takes, some of the opportunities, and headwinds that you have as you think about margins for this year.

Niko Lahanas: Sure, Brad. You know, I’ve said this almost every year, we go into every year planning to expand margin. I mean that’s our goal. That’s how our financial algorithm works. I think, you know, this year is going to be unlike the last three years, in that I think we’re heading into a little bit of a deflationary environment. So, I think we’re going to benefit from some commodity downdraft, however, I think it’s going to be a much more, you know, promotional environment as well. The other piece of this is what we, you know, discussed in the prepared remarks that we do still have some higher-cost inventory to roll through. So, that’s going to create a little bit of pressure. The question will be, you know, how promotional does it get, you know, what our product mix is, because the margins there are kind of all over the map, and that becomes a wild card as well.

So, that’s sort of how we’re thinking about it, but we are going into the year expecting to expand margin.

Brad Thomas: That’s helpful. And I understand this is such a challenging environment to forecast sales, can you help us think in broad strokes what you’re starting to plan for in terms of organic trends in the segments and what level of growth or potentially maybe modest decline you might be able to go through and still have flat or up operating margins?

Niko Lahanas: Yes. I mean if we, you know, the way we’re looking at it is, you know, keep in mind we had a 53rd week. So, if I look at in absolute terms, we’re going to be down year-over-year because of the 53rd week. We also sold off the Garden distribution business, which also will drag down. Now, the upside is, we bought TDBBS. So, that’s going to help on the top-line. If I look at it apples to apples, we think that, you know, flattish to modestly up. In absolute terms, I think we’ll be down. But again, we have to see how it all plays out because the deflationary environment, you know, could put pressure on the top-line. I think that’s going to be a real wild card and, you know, I think it’s going to be a very competitive environment in ’24 as well.

Brad Thomas: That makes sense. Certainly what we’re hearing out there as well. Great. Thanks so much, Niko. Appreciate it.

Niko Lahanas: Sure.

Operator: Our next question comes from the line of Bill Chappell with Truist Securities. Please proceed with your question.

Bill Chappell: Yes, thanks. Good afternoon.

Niko Lahanas: Hi Bill.

Bill Chappell: I guess first, any update on the CEO search at this stage?

Beth Springer: Hi Bill. It’s Beth Springer. Nice to hear your voice again.

Bill Chappell: Hello Beth.

Beth Springer: Hi. Before we talk about that, I do want to take a moment to reiterate that we have a really experienced leadership team, an engaged Board, and a clear direction in our Central to Home Strategy. So, we’re very focused on continuing to execute that. As we look ahead to new leadership, our Board is committed to finding the best possible successor. And our goal specifically is to recruit a world-class leader who can champion Central’s culture of entrepreneurship, collaboration, and partnership, and drive our Company’s positive trajectory. Obviously, Bill, we’d like to finish that sooner rather than later, but the most important thing is to find the right long-term leader. So, when we have an update, we’ll provide it to you.

Bill Chappell: Got it. Thank you. And then Niko, I guess, is there any way you could just for modeling, I’m just trying to understand kind of what the almost the pro formas were for 2023 in terms of Pet and Garden taking out, you know, the business exits, taking out the distribution as stuff like that because it’s tough to handicap unless we kind of understand what you’ve exited.

Niko Lahanas: Yes. What I would say is, like I said, I think, you know, overall top-line is going to be down if you look at it apples to apples. The TDBBS business and the exit of distribution are sort of a wash. But then you got – you have the extra week, so that, you know, in absolute terms would cause us to be down year-over-year.

Bill Chappell: Got it. But then I’m just trying to quantify the distribution exit in terms of revenue in terms – and the Pet bed exit in terms of revenue, maybe little more specific?

Niko Lahanas: Yes. We haven’t given that out, Bill, and I don’t think we will going forward.

Bill Chappell: Okay. And then just trying to understand, you know, I – the Garden outlook in particular, I mean I understand it’s November and you want to be conservative, but it seems that there was, you know, certainly from your pre-announcement back in early April, it was a much more impactful on the negative side for the business than normal, and so are you just assuming that the abnormal happens again this year or do you expect some recovery because I think that was, yes, $0.20, $0.30 out your guidance that doesn’t appear to be coming back.