Welcome to Central Garden & Pet's first quarter fiscal year 2016 financial results conference call. My name is Matt 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. [Operator Instructions]. Also as a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Steven Zenker, Vice President of Investor Relations and Communications. Please go ahead.

Thank you, Matt. Good afternoon, everyone. Thank you for joining us today. With me on the call today are John Ranelli, Central's President and Chief Executive Officer, David Chichester, Central's Acting Chief Financial Officer and a member of the Board of Directors; J.D. Walker, Executive Vice President and General Manager, Garden Brands; Nicholas Lahanas, Senior Vice President, Finance Operations and Management Reporting; and Howard Machek, Senior Vice President, Finance and Chief Accounting Officer. Our press release provided results for our first quarter ended December 26, 2015, is available on our website at www.central.com. Also on the website is the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call. Before I turn the call over to John, I would like to remind you that statements made during this conference call, which are not historical facts, including adjusted EPS guidance for 2016, expectations for new product introductions, future acquisitions and improved revenue and profitability 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 Securities and Exchange Commission filing, including our Annual Report on Form 10-K filed on December 10, 2015. 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 John Ranelli. John?

Thank you, Steve. Good afternoon, everyone. Thank you for joining us today. After a very strong year in 2015, in which we grew our adjusted earnings per share by over 100%, we have hit the ground running in the first fiscal quarter of 2016. Both our garden and pet businesses outperformed on the topline and in operating profits for the quarter. Revenue grew 17%, approximately half organic and half from acquisitions. We earned an adjusted $0.01 per share for the quarter versus a loss of $0.12 per share in last year's first quarter. It was the first time in 10 years that consolidated earnings for the first fiscal quarter on an adjusted basis were positive. This was above our expectation and was our eighth consecutive quarter of year-over-year adjusted earnings growth. Our results indicate that our strategy and plan are right and working. We are well along in achieving three key objectives. First, we are starting to demonstrate the potential of Central's operating leverage by increasing gross profit significantly more than SG&A. Second, we are growing organically and demonstrating Central's organic growth potential. And third, we have shown our willingness and ability to manage and improve our portfolio by making accretive acquisitions and divesting nonstrategic assets. The Central of today is very different than three years ago. Our plan when I joined in February 2013 as CEO was to focus on our customers, get our operations in order, reduce costs, increase earnings and then shift to topline growth. Our organic growth and acquisitions along with our lower-cost structure have helped us produce adjusted profits in our latest fourth and first quarters. This compares to losses we had incurred in those quarters over the last several years. The progress we have made operationally over the last few years has enabled Central…

Thank you, John. Good afternoon, everyone. We issued a press release earlier today outlining our first quarter financial results. I would like to spend some time giving you some additional details around those results. As John mentioned earlier, the company recorded adjusted earnings of $0.01 per diluted share for the first quarter. The adjusted numbers exclude the impact of $14.3 million in charges related to the refinancing of our fixed rate debt in November 2015. I will go into the details of those charges a little bit later. As a reminder, the majority of our garden season spans our second and third fiscal quarters, which has historically been the highest quarters for revenues and profits for our company. Our first quarter is typically the lowest revenue quarter due to the seasonality of the garden business. Consolidated sales for the quarter increased 17% versus the prior year to $359.8 million, due in part to strong organic growth and recent acquisitions, especially in the pet business. Consolidated gross profit dollars rose 13% and our gross margin decreased 90 basis points to 27.7%. SG&A for the quarter increased 5% or $4.2 million versus a year ago, but as a percent of sales declined by 300 basis points versus the prior year to 25.3% We benefited from greater utilization of our fixed resources due to the higher sales volume during the quarter. Operating income for the quarter rose to $8.8 million compared to the $1.1 million a year ago. Our operating margin of 2.4% was up 200 basis points compared to the same period last year. Turning now to the pet segment. Pet segment sales for the quarter increased nearly 25% or $49 million to $249 million. The inclusion of three months of our IMS division and one month of our DMC division accounted…

Thank you, Howard. To summarize, we feel very good about our performance, where Central is today and where it is going. We are seeing better than expected success in growing revenues and profits organically as well as through acquisitions. The progress on our strategy is on track. Results this quarter exceeded our expectations. Please keep in mind that the first quarter is typically our smallest. We have our largest two quarters ahead of us with all the vagaries of weather, including whatever El Niño might bring. Still, we are off to a great start and feel very positive about 2016. We are now more comfortable with our projections for the year and are increasing our guidance for adjusted EPS to $1 or higher, representing at least a 35% increase over the prior year. Now we would be happy to answer any of your questions. With Howard and me on the call today are David Chichester, Nicholas Lahanas, Senior Vice President of Finance and Operations and Reporting and J.D. Walker, EVP and General Manager of our Garden Brands. Operator, please open the line for questions.

[Operator Instructions]. Our first question comes from the line of Brian Nagel from Oppenheimer. Please proceed with your question.

Good afternoon.

Hello Brian.

Congratulations on a really nice quarter.

Thank you.

A couple of questions. First off, just on weather. We have all talked the weather a lot lately. You called out in your comments that the garden segment benefited somewhat from weather. So I guess the question there is, is there a way to quantify, recognizing this is small quarter for garden, but how much garden did benefit? And then a follow-up to that is, if given the warmer temperatures we had for a while in the northeast, which you benefited from, are those sales completely incremental? Or could they potentially pull sales in from future periods, the next couple quarters or so? Then I will ask another question.

Hi Brian. This is J.D. Walker. I will be glad to address that question. So I am assuming you are speaking to Q1 of this year and our portfolio, if you look at our portfolio, some segments of the portfolio are going to benefit from the milder than normal temperatures in Q1. So our controls business and our grass seed business certainly benefited in Q1. And we exited Q1 with lower than normal inventories at retail. So we feel like the sales were incremental sales and won't subtract from our upcoming season. At the same time, though Brian, you have to look at our full portfolio. So we have got wild bird food business that actually benefits from a harsher winter condition. So while it benefited some certain segments of our business, there were other businesses that, like wild bird, where the POS was actually negatively impacted.

Got it. That's really helpful. And then the second question I have also on the garden segment. Looking at your press release and there was a comment, I think John you were quoting there as saying you made significant progress, but there is still a lot of work to do, particularly in the garden segment. Is there something specific you are referencing there? Is that some specific picture you are thinking about that we could start looking towards for that segment of the business?

Brian, this is J.D., again. So I can't share any specifics with you, but I would say this in general. When John started the resetting process three years ago and turning our businesses around, he started first with pet and he spent the first year working with pet. I would say they are further along the continuum than the garden segment of our business. Now we have made great strides on the garden side of the business and I think our results speak for themselves. Last year was our second most profitable year, but we have spent time in getting our operating rhythm, improving our operating rhythm and focusing on operating profit. So that's what we have done over the -- and I would say that our house isn't fully in order. We have more work to be down there. We are working through that and as we continue to make progress then we’ll shift our attention to growth initiatives.

Got it. Thank you.

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

Hi. This is Janani on for Bill today. Thanks for taking my question. Could you perhaps elaborate on what caused the decline in both the garden and pet segment's gross margins and the extent of the decline in each business?

Sure. This is Howard speaking. I will lead off. Just the last two fiscal years, remember our gross margin had improved. Also, this quarter, absent the impact of our acquisitions, our gross margin year-over-year was relatively flat. So our recent acquisitions have a different profile than our historical business. As such, they have a lower gross margin but they also have a lower SG&A as a percentage of sales. They are still kicking off good operating profit. So gross margin is just one of the indicators. We are focused on gross profit dollars and constantly try to find that proper balance between gross margin and gross profit dollars.

Okay. Thanks. And then you also mentioned, that shrink in the pet segment was partially driven by organic growth in the dog, cat and aquatic categories. Could you perhaps talk about what drove that strength in the quarter?

Sure. This is Niko Lahanas. What drove the strength in that category were the two acquisitions. They were both in dog and cat. But then also our treats business where we had uptick in sales across a number of channels, pet specialty, the club channels [indiscernible] across the board, really good quarter for our treats business. The aquatics business, really same thing. Very strong in the pet specialty channel due to our dollar a gallon promotion that continued on. Also had strength in the other channels as well. So a lot of good breadth as far as growth within those two categories.

Great. Thank you. And then last one for me. On the last call you mentioned you were willing to temporarily take leverage to the top of three to four times range for a few months for the right acquisition. Has this leverage target changed at all?

No. Our leverage targets have not changed. We feel very comfortable about where we are and we feel very comfortable about what our targets are for the future to provide the maximum out of our earnings given the leverage ratio.

Okay. Thanks so much.

Our next question comes from the line of Bill Chappell from SunTrust. Please proceed with your question.

Hi. This is actually Stephanie on for Bill. Looking at it, your organic growth certainly outperformed this quarter. So any kind of gauge on what your outlook for organic growth is for the rest of the year? Maybe not necessarily in percentage terms, but just how sustainable these levels are going forward?

So Stephanie, I will speak for garden first and I will turn it over to Niko. In terms of growth for the rest of the year, typically that's not something we disclose at a meeting. I will say this though, we do anticipate some headwinds on the garden side of the business. We mentioned that we exited our seasonal decor business. We also decided not to renew a private label contract where we were producing professional fertilizers for a customer. Neither of those businesses were profitable. So while we anticipate some headwinds on the topline, it will have little to no effect on our bottom line, which keeps us on strategy of looking at our portfolio, exiting unprofitable SKUs or businesses and focusing on operating profits.

This is Niko. On the pet side, we go into every year thinking we are going to really grow organically. So the first quarter, we really knocked the cover off the balls. So we feel very good about that. Is that kind of growth sustainable? We don't know yet. We are going to have to look and really monitor POS, things like that to see if that's really sustainable. Our intent would be to keep pushing the business and keep growing. We feel very optimistic about the year. We love where we are right now and just looking forward to really producing a very, very strong year.

Got it. No, that's definitely really helpful. And then also just quickly coming back to garden, Scotts reported earlier today stronger topline growth. So wondering if you guys lost any share there during the quarter?

Stephanie, this is J.D., again. So I will speak to that. So their announcement, without making a lot of comments about the competition, I will say that it is difficult for us to get to an organic number there, because I believe that they had a change in the timing of their quarter, six additional days and there was some acquisitions that were included in there as well. But even if we can get past that to try to normalize that, it's still comparing, it's not apples-to-apples. We compete in a couple of categories like wild bird feed and decor and we have a distribution businesses and Scotts competes in the soils and mulch categories where we don't compete. So we don't match up head-to-head. But what I will say is, in those areas where we do overlap, grass seed, fertilizers and controls, we are confident that we held or took share in each of those categories.

Got it. No, that's very helpful. Thanks so much.

Our next question comes from the line of Karru Martinson from Deutsche Bank. Please proceed with your question.

Good afternoon. When you guys look at the Dallas Manufacturing Company, DMC, what was the penetration of their product? Is there a lot of opportunity for you guys to quickly expand the distribution? Or is this going to be kind of a multistep process to grow the business?

Yes. This is Niko. Great question. When we bought the business, they got a fair amount of concentration in their top, call it, A customers. With our distribution business, we see a fair amount of opportunity to take the product and penetrate independent channel. We also see growth happening in the existing customer base as well, which is what made the business really attractive to us when we started to look at it. So kind of have a two-pronged approach going on there.

Okay. And just when you look at the customer base on the pet side, two of the large big-box guys now in private equity hands, is nay thing changing on that market? You guys called out growth on the online business. But is that industry still stable and is still having the kind the growth characteristics that you guys you have seen in the past?

Yes. If I were to comment on it, I would say it is stable. There is always challenges and there is always change going on. You have got Amazon coming into the fray. Walmart's doing their thing. And you have got the P's. You are seeing more private label. So all of that kind of is that work. We have to find ways to work with and navigate that environment. But we feel like we are doing all it fairly well right now by participating in private labels as well as building our brands. We are seeing our e-commerce business grow. And we seeing raising our business grow within the PetSmart and Petco franchise.

Okay. And just lastly, as you guys invest in the brand, certainly getting a return on that investment but when you look at that investment versus share buybacks, how should we think about it going forward? Is there a point in time where one outweighs the other? Or what are some of the metrics we should look at there?

Could you repeat your question again?

When we think about investing in the brands versus share buybacks, you guys have held off on buying back shares. How do you make that decision? How much more investment do you guys need before you return to buying back shares?

Well, our whole strategy is to invest in growth. And so buying, repurchasing shares is not our priority right now. What we are doing with our capital is we are investing in the working capital necessary to grow not only our brands, but our private label business. So I feel very comfortable that that is growing. We are also in investing in the SG&A and gross to net site and getting increased turns, primarily by investing in the store which we hadn't done as much as we had before. And thirdly, we are investing our capital expenditures in our low-cost producer program. And that program is little bit of a misnomer because the whole concept behind low-cost producer is that we want to own the markets that we believe are important to us and to be able to defend them. And the way to do that is to be able to come up with the lowest possible cost that we can manufacture so we can invest in product development, invest in additional promotions, invest in additional space, displays, invest in better packaging, et cetera. So essentially, that's where our organic growth money is being spent. As well as you can see and Howard outlined, we invested a significant amount in acquisitions over the last six months. Those acquisitions are very important to our growth strategy and the expansion of our company into adjacent categories. We feel very comfortable with the acquisitions that we made and I am very happy that they are essentially going to be accretive in the first year. So all-in-all, that's where we are directing our money. Again, growth is our key objective, both organic and acquisition.

Thank you very much, guys. I appreciate it.

Our next question comes from the line of Gregg Hillman from First Wilshire Securities Management. Please proceed with your question.

Afternoon, gentlemen. Great quarter. My first question concerns the goal for the operating margin in the pet area. I know just when Smucker bough Big Heart in March of last year, it was doing like 18.4$ EBITDA margin and I think you were 10%, 10.5% on the quarter you just reported for pet. Do you think the midpoint between those two numbers is a good goal for pet margin, operating margin?

This is Niko. As far as the goal, we don't really have a stated goal on operating margin. I think we just try to get as high as we can in a given year. The area where we are always little bit and I hate to use the word, hamstrung but we have a distribution business that sits within pet and it does a fair amount of revenue and the margins there are south of 5%, typical distribution margins. We have strategic reasons for keeping that business within pet but that typically tends to dilute the margin percent in pet. So it's a little bit of apple and orange comparison.

Okay. And then moving on to Nylabone. I noticed you seem to increase your shelf space in Nylabone. That seems to be doing really good. Can you talk about that? And how well it help that? And also whether you are coming out with any innovative products in Nylabone that will help improve dog cleaning or teeth and bad breath in dogs?

Yes. Nylabone is, without a doubt, our strongest brands in pet. It continues to take shelf space in a number of channels. The Nylabone management team is one of our strongest teams that we have within pet. And the thing they do really well is innovate. So you can always look for continuous innovation, new products coming out of there. As far as our overall pet products pipeline, usually it's Nylabone that dominates the amount of new products out there.

Okay. Great. And then finally, can you comment online sales of pet items like, for pet items in the United States, what percentage is online right now? And is there any limits in terms of what you can sell in that channel? Or is sky the limit on there?

Well, there are certain products that have a better online profile because typically the online products get shipped, get picked and packed, as each and get shipped to an individual home. So typically the higher dollar volume, lower-Q type products tend to do better for an online type of purchase. The heavy bulky high-Q low value items would be a little tougher to do. So we have a little bit of both. If you look at one of our better selling online items is our Comfort Zone behavior modification product that does extremely well online. That is a high ticket item type product. I think that there are a lot of things to consider in terms of when you are growing online. I just outlined a bunch, but the other piece of it is the frustration free packaging and all the other stuff that goes along with shipping things through the mail.

Right. Do you have a number right now? What percentage of the pet industry is online right now? Actually it's less than 10%.

We don't disclose our sales picture.

Well, total retail --

I don't mean for the industry.

Yes. I don't have that number handy right now as far as the pet industry, how much is online.

Right. Okay. Well, thanks for your comments.

Our next question comes from the line of Grant Jordan from Wells Fargo. Please proceed with your question.

Thanks for taking the questions. I just have two follow-ups. One, I think there was a reference to some headwinds in the garden segment. So just wanted to make sure, is that related to some of the programs you are discontinuing? Or is that something else?

Grant, this is J.D. So that is related exactly to the programs that we are discontinuing. So it's the seasonal decor business that we are exiting and it's this hard decision not to renew a contract on a private label business, professional fertilizer. It was just not profitable any longer. So to be clear, it's topline headwinds only. We see no impact to our bottom line.

And this is all part of our portfolio management strategy to improve our profits in the long haul.

Okay. That's kind of what I thought. I just wanted to confirm. So that's helpful. And then second, I know you have talked a little bit about the succession plan and management search, is there any sort of timeline you guys are working with?

The time table that we outlined in our last call is continuous. We feel very comfortable with the timeline.

Okay. Thank you.

[Operator Instructions]. And our question comes from the line of Hale Holden from Barclays. Please proceed with your question.

Thank you for taking the call. I appreciate it. I just had three quick ones. In terms of the portfolio rationalization, is that something we should consider as just sort of exiting underperforming business lines like seasonal and private label fertilizer? Or is it potentially something we consider having off more significant assets?

I think it's just our commitment to looking at our portfolio and nay underperforming segments of our portfolio to make sure that we are fully optimizing the portfolio. I think that's a direction we moved in. It's the first time we have made a move like this is some period of time.

We believe that the allocation of our portfolio and the structure of our portfolio is probably just as in your personal portfolio, the biggest factor or the biggest driver towards your return. So we are taking an active approach in looking at our portfolio, adding growing businesses such as DMC or IMS and also Hydro Organics. So we feel comfortable that our whole strategy is to turn our portfolio into higher performing assets so that we can increase our company sales and returns over the future.

And to John's point, we have spent an awful lot of time trying to turn some of those businesses around. Now it's time for us to focus our time and energy and our capital on our core assets, our core businesses to grow those.

I would add that, it is always our first choice to spend or invest our capital in growing our current businesses because that's the most immediate return. So I don't want people to think that we are challenging every business in our portfolio. We are not. We are just essentially evaluating our portfolio on our growth plans and looking at them strategically going forward. Our first goal is to improve all of our current business and then our second goal is to add other businesses to our portfolio that are growing.

Understood. And as a follow-up to Grant's question on the management timeline, I just want to make sure I understood the sequence, is the Board trying to fill the CEO and then let the new CEO pick the CFO? Or is this of being one coterminous?

I would change the words a little bit. Obviously, our top priority is to find the best CEO to continue our plans that we believe are working well and that will fit into our operating philosophies and to our culture. And we would like to have him be able to participate in the selection of a CFO. So I think that is more along the timelines we were referring.

Yes. I was fairly inarticulate on that. So thank you for the follow-up for clarity. And then the final question is, a lot of discussion about weather and I was wondering if you were seeing any change in order patterns for sort of spring orders or shelf that's from your retail partners? Or is it sort of normal ordering and then we will just see what the weather brings? I didn't know if the last couple of months changed some of your customer's perception of where the spring might set?

I think that in general, our customers are still very bullish on the upcoming season and they are setting their stores for the upcoming long-garden season. Not whole three of the big three depot, Walmart had a fiscal year that ended at the end of January. So you see a little bit slower, but this is annually, we see just a little bit slower ordering patterns in January and it picks significantly in February. So we have reason to believe that all three of the big three and our independent channel, our national accounts, everyone is looking forward to the season and will set their stores accordingly. So they will be ready for business when the season breaks.

Great. Thank you very much for the time. I appreciate it.

Our next question comes from the line of Carla Casella from JPMorgan. Please proceed with your question.

Hi. On the categories you exited, should we see a cash flow in this current quarter from any inventory liquidation? Or is there any asset sales proceeds from it?

I think most of the cash flow as we were reducing our inventory levels probably came in the first quarter of the year. The actual transaction took place in the second quarter of the year, but the majority of the cash flow came in the first quarter.

Okay. Great. All of my other questions have been answered.

Thank you.

[Operator Instructions]. And our nest question comes from the line of Kevin Ziets from Citigroup. Please proceed with your question.

Hi. Thanks for taking my question. Just on the pet bedding business, you mentioned it was the number one market share leading business in the U.S. I am curious what the competitive set looks like. Are there other large players in the U.S.? Or how does the market share sit relative to maybe international companies? Just curious.

Sure. This is Niko. Yes, there are two other fairly large players in the bedding business as well as us now. Internationally, I am not aware of any huge player out there, but here domestically, which is where all of our sales are taking place anyway, it's pretty much a three horse race as far as the bedding business goes.

Okay. And does share shift very often? Or have you been growing share overtime?

Yes. The business has been growing share very aggressively. That was again, as I mentioned earlier, one of the reasons it was so attractive to us was the growth rate there. The category overall is growing as well, believe it or not. It's seen more as a consumer category because you have folks now that own multiple beds in a house. A lot of people have a bed upstairs, downstairs, in multiple rooms. And we are seeing --

My dog has more beds than any of us.

So we are seeing the purchases, the frequency increase as well. So it's becoming very much a consumer business, which again was what made it so attractive to us.

Okay. Great. And then my second question was about the private label fertilizer business you walked away from. I know you have talked about private label being important to you in terms of your holistic relationship improving with the retailers and so I am just trying to square that with walking away from what might be a somewhat unprofitable program, but how do you square that against your broader business with those retailers? Or maybe this is less significant retailer that you walked away from?

It's a great question. The business that we decided to exit was a professional fertilizer program. It wasn't with one of our core retailers. So we still very much the same ways that you outlined with regard to private label still important to us. On the garden side of the business, we have private label business and bird feed and controls and fertilizer and grass seed. And for all the reason that you are articulating gives us more critical, a bigger share of the shelf. It drives manufacturing efficiencies which benefits our branded business as well. So we are still very bullish on private label in general. It's just that one piece of private label for a specific customer that was no longer profitable and we decided to exit.

Okay. That makes sense. Thanks again for taking my questions. And good luck for the spring.

Thank you.

There are no further questions at this time. Mr. Ranelli, would you like to make any closing remarks?

No. Thank you very much for attending our call today. We look forward to our next earnings call at the end of our next quarter. Thanks again. Good bye.

This concludes today's conference. Thank you. You may disconnect your lines at this time.