Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Fiscal 2022 Second Quarter Earnings Call. My name is Chemaly, 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.

Thank you, Chemaly. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Chief Executive Officer; Niko Lahanas, Chief Financial Officer; J.D. Walker, President, Garden Consumer Products; and John Hanson, President, Pet Consumer Products. Tim will provide a business update, and Niko will discuss our financial '22 Q2 results in more detail and revisit our outlook for the full year. Following the prepared remarks, J.D. and John will join us for the Q&A. Our press release providing the results for our fiscal '22 second quarter ended March 26, 2022, and related materials are available at ir.central.com, and contain the GAAP to non-GAAP reconciliation for the non-GAAP 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. I would like to remind you that statements made 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 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 our filings with the Securities and Exchange Commission, including our annual report on Form 10-K filed on November 23, 2021. The 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?

Thanks, Friederike, and good afternoon, everyone. I want to start the call by thanking our team at Central for their continued dedication and passion to serving our consumers and customers across both the pet and garden industries. Our solid financial performance in the second quarter is a direct result of how well they are executing. Thank you, Team Central. Let me share 3 key takeaways from this quarter. First, Central delivered another solid quarter. We grew sales and operating income, and importantly, expanded gross margin in a challenging and highly inflationary environment. Second, although the garden season experienced a slow start, Weather has not been as favorable to date and other risks like heightened inflation, geopolitical impacts and supply chain disruption continue. We remain committed to our full year guidance of $3.10 or better, which represents 6% growth versus prior year non-GAAP EPS or 13% growth on a GAAP basis. And third, the fundamentals of the pet and garden industries are strong, and we expect the purposeful investments we are making now will drive long-term shareholder value. Now turning to our results. In the second quarter, Central delivered net sales growth of 2%, driven by our recent acquisitions. While organic sales declined 3.5%, it is important to note we are comping 23% sales growth in the prior year quarter. Shifting to gross margin. Like most companies, inflation has impacted all areas of our business, from commodities to packaging, labor rates, fuel costs, international ocean freight and more. Thanks to our carefully executed pricing, favorable product mix and productivity improvements, our gross margin expanded 100 basis points versus prior year. Our teams have done a good job controlling what we can control in this high inflation environment. Our operating income improved 2% and even as we continue purposeful investments in strategic…

Thank you, Tim. Good afternoon, everyone. We feel good about the solid performance of our business given the current environment, especially after record net sales growth of 33% and EPS growth of 69% in the prior year quarter. Second quarter net sales reached $954 million, the increase of 2% and was due to the $52 million contribution from our recent acquisitions. Organic net sales declined 3.5%. However, looking at the growth over a 2-year period organic sales grew at a 14% CAGR in the second quarter. Consolidated gross profit increased $14 million to $287 million. Gross margin improved 100 basis points to 30.1%, thanks primarily to our pricing actions to mitigate the significant cost inflation in commodities, freight and labor as well as favorable product mix and productivity improvements. SG&A expense rose 7% to $180 million, driven by our recent acquisitions, higher logistics costs, our purposeful investment spending in capacity expansion and automation as well as in capabilities. SG&A as a percentage of net sales increased 100 basis points to 18.9%. Operating income grew by $2 million to $107 million, and operating margin was 11.2%, in line with prior year despite continued inflation and heightened investment spending. Net interest expense was $15 million compared to $10 million a year ago. The increase was due primarily to higher debt from the $400 million of senior notes we issued last April. Net income was $70 million compared to $73 million a year ago. Diluted GAAP earnings per share was $1.27 or $0.05 lower than in the prior year quarter, and adjusted EBITDA grew $2 million or 2% to $131 million. Our tax rate was 23.4% compared to 22.7% in the prior year quarter due to increased foreign earnings and higher tax rate jurisdictions. Now I'll provide some insights into the segments, starting…

[Operator Instructions]. And our first question comes from the line of Bill Chappell with Truist Securities.

Just looking at the garden season, clearly, from what you and Scotts said, it was a late start. Is there 1 any way to quantify what impact that had on the Garden segment this quarter? And two, any kind of update on what you've been seeing as we move through April into early May?

I'll give a quick headline and turn it over to J.D., who knows it even better. I mean, no doubt this year, unlike the last 2 years, we characterized as an unfavorable weather season so far. If I had to dimensionalize it, I think we're probably 3 to 4 weeks behind where we've been in the last couple of years, good weather years. And I mean, you know well, Bill, at some point, you kind of run out of runway. May and June are great months for us and will need to be great months for us. And we're hopeful, especially after a really bad March and April, that this thing can turn. So I think about it kind of 3 to 4 weeks behind type in terms of dimensionalizing the impact of the garden season. J.D. expand on that, if you would.

Bill, it's J.D. here. I think Tim summarized it well. I'd say that it's very difficult to pinpoint exactly the impact from unfavorable weather. There are so many causal factors impacting the business. One of the more challenging business environments that I've seen everything from retailers taking a very aggressive approach last year. They took a more measured approach this year to their inventory build in the stores. Tim mentioned earlier in his script that the retailer foot traffic was down year-over-year. A lot of that due to the inflationary environment, one like we haven't seen in several decades. We're still battling with lingering supply chain challenges. We're working our way through that, and we're seeing improvement in our service metrics. But that's still a challenge. And it was noted earlier as well that we had a pull forward into Q1. So with all of this noise, it's challenging to exactly pinpoint weather. I should mention that we took some pretty sizable price increases too. I think it's too early to tell the impact from those pricing increases on elasticity. All those things said, one encouraging sign is when the weather has been good and favorable. There is pent-up demand, and we've seen strong consumption at a retail level. So that's an encouraging thing. We just need the weather to be a little more favorable going forward.

Got it. And then on the Pet side, any impacts or weighted -- 1 of impact of the kind of the China shutdowns? I can't remember how much of your business you source in terms of manufacturing from China and if that's going to have any impact over the next few months?

Bill, this is John. The global supply chain has been challenged for quite some time now. We've not seen the latest what's going on in China have a more negative impact, but our supply chain does remain challenged. We are catching up. Certainly, service in Q2 was better than it was in Q1. We've added a lot of capacity across the network, and we plan to sequentially improve service in Q3 and Q4.

Yes. And Bill, I would just add just A reminder, we do a little bit less than 8% of our cost of goods coming out of China. And then the other thing I would point out is you'll notice our inventories were up quite a bit. And so we have forward bought inventories and some of that would be the stuff coming in from China because we've learned the hard way that the supply chains are really slow moving right now.

Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets.

And off to a really good start here against some very difficult comparisons. To that end, I was hoping to talk a little bit more about the outlook for organic sales in the two categories. And maybe starting with Pet. Given that we're now past what's, I believe, not only the toughest kind of 1-year comparison but also stack comparison. I was wondering your level of optimism that perhaps the organic sales may even be able to accelerate from here, just how you're thinking about things?

Sure. I'll give a headline, and then we can go into both categories. I think to your point, Brad, when you think about this year, you can simplify it maybe into 2 halves where front half the comps a lot more challenging than back half. A slightly more precise view would really think about it as the first 7 months versus the last 5. So it's really at this point in May where we're getting into far more favorable comps year-over-year. And so you saw that in some of the commentary we've already provided on Pet. We grew sales 1%, which we feel really good about because we're lapping 21% growth this quarter a year ago. And on Garden on the organic sales line, we were down kind of high single digits, but again, lapping a 23% growth a year ago. As you look at the last 6 months, the last couple of quarters, particularly May year-to-go in our fiscal you've got more favorable comps. I think on the Pet side, we continue to feel very good about the consumer fundamentals. We feel good about the competitiveness of our franchises. We noted a number of categories where we expanded market share in the quarter. We feel good about year-to-go initiatives. We've got a number of innovations hitting the market. We've got some new marketing campaigns, and you'll hear more about that as we talk Q3 and Q4. So I think overall, on the Pet side, feeling good about organic growth, low singles type growth likely year-to-go. And then on the garden side, as J.D. said earlier in the call, we do need the mother nature to help us here and break more favorably. The comps, as you get the balance of the year are a lot easier. And with some favorable weather, we should expect that to turn.

That's really helpful, Tim. And I was wondering if in the categories you could also go into a little bit more detail about what's happening on pricing versus volume? And how much that's a factor in sales relative to the volume trend?

Pricing is definitely the biggest driver of our overall sales performance. Order of magnitude, we're pricing in the high single digits, 7%, 8% across the portfolio, that would be on both the Garden and the Pet side. So obviously, do the simple math and say, well, price is up in that high singles, and then we've quoted our total sales performance, obviously, somewhere in the volume mix, you're looking at a negative number. Now having said that, that's in aggregate. We have business units that -- and brands that are still growing volume. I mean our dog and cat business unit not only pricing, but it's growing volume. Our outdoor cushions business, not only pricing, it's growing volume, our health & wellness business is growing volumes. So we you really need to get down to the BU specifics and sometimes the SKU specifics. But the aggregate story is, I think, appropriate and very carefully executed pricing quite honestly, at a customer channel SKU level to take into account competitive dynamics, et cetera. On the backdrop of a very aggressive inflationary envelope that we're working against, I think at the beginning of the year, I shared with you, Brad and others that we are expecting a couple of hundred million of inflation on the year. We're seeing that number creep higher versus original expectations. And that's why we're responding with a little bit more pricing. So pricing is definitely impacting volume. But again, it differs BU by BU, business by business.

Our next question comes from the line of Jim Chartier with Monness, Crespi & Hardt.

I guess just Niko, what is kind of the outlook for acquisitions look like at this point as a current environment produced more opportunities for you? Just some color there would be great.

Yes. I mean we're in several negotiations on deals right now. I would say certainly, the deal flow is not what it was a year ago. I think the private markets have sort of followed the public market valuations have sort of come down. And I think folks that were thinking of selling maybe waiting a little bit until the volatility settles. So overall deal flow is a little bit muted compared to a year ago. That said, our pipeline is still pretty active, and we're in some pretty good discussions.

Great. And then you mentioned a need for price increases later in the year. What magnitude of price increases would you need to kind of offset all of the additional inflation you're seeing today?

It's the high single digits that I mentioned earlier is the plan here, so call it 7, 8 type percent in aggregate, Jim. And I think between that, as you heard both Niko and I say earlier in the prepared remarks, between our pricing agenda, our cost-out productivity agenda relying on some continued favorable mix, and part of that is acquisition-related as well, right? Some of these recent acquisitions are also favorable on a margin basis. Between all of that, we're hopeful that we can either offset or largely offset that tsunami of inflation that, as I said, is now well north of a couple of hundred million on the year.

Okay. And then just lastly, any color in terms of kind of cadence of sales and earnings for third and fourth quarter, any meaningful differences between the 2 quarters?

I mean, you know us well. Obviously, a very different magnitude Q3 versus Q4. I think you're going to see -- we're hopeful you'll see an accelerated top line relative to what we've seen in the front half show up in the back half, starting in Q3 and Q4. And you're going to see, obviously, earnings as well, right? And that's just simply doing the math to the $3.10 guide that we provided versus what we've actualized in the front half. I don't know what else you'd say, Niko on that.

No, I think if anything, you may see just looking at the late-breaking garden season, you may see some garden business maybe go into Q4 that we normally would see in Q3, assuming the weather cooperates, but that's about the only dynamic that I can see really happening other than the fact that Q3 is our biggest quarter. I don't think that's going to change.

Niko, I would add to that, that last year, we had some fairly heavy inventories at retail at the end of Q3, and the retailers sold through a lot of that inventory in Q4. So that too may lead to exactly what you said, a little bit of a shift from Q3 into Q4 somewhat.

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

My first question on the high single-digit price you mentioned and then over $200 million of inflation at this point. Are we in a dynamic such that we'll continue to see gross margin expansion in the back half of the year like we did in the second quarter?

Well, it's a great question. And we're going to continue -- the answer is, it depends, as usual. We're going to have to see how inflation behaves into Q3. And then you've got the elasticities, how they behave, and then that will depend on really how much overhead we absorbed in that period. So all those things are going to have an effect on how margins play out. The other thing I would tell you is mix. If you look at our portfolio, we've got a really wide range of margins and a favorable mix can really have a profound role on our margins. We've seen that play out really in the first half of the year where we've had very favorable mix. That happened in Q2 with our acquisitions performing well and affecting margin there. So we're planning on it, but for us to tell you this is how it's going to play out. It's going to be TBD. It's a very fluid dynamic process right now. And then also given the late breaking garden season kind of throws another wrench into it. So we're just going to have to see how the whole thing plays out.

Okay. And then secondly, I have heard such a range of consumer behavior with regard to our consumers trading down now that inflation is accelerating. Have you been seeing a mix shift in terms of your private label, which I think is about 15% to 20% of sales. Has that been either gaining or losing sales relative to your branded products?

Yes. William, we definitely monitor that closely. And as you said, I mean, 1 of the, I think, good things about our portfolio is the majority of our portfolio is definitely branded but we do have some limited exposure to private label as well. So we monitor this closely. There are many categories where we may have an offering, both on the branded and the private label side. Looking at the data, including the most recent quarter, Q2, we are not seeing a shift from branded to private label in the categories in which we compete. In fact, I would tell you, pretty consistently, we're seeing our growth trends on branded outstrip the growth trends on private label by a margin. So we're on top of it. I think as the American consumer continues to be put under pressure with rising gas prices and overall inflation. They are going to be looking at trade-offs kind of category by category. But so far, in both lawn and garden consumables and in Pet as it relates to our business, we are seeing that as an unfavorable impact.

Our next question comes from the line of Hale Holden with Barclays.

This is Mary Anne on for Hale. On the back of Jim's question, we were wondering if higher financing rates in the market have changed your outlook at all for the M&A pipeline?

No, not at all. We really are very value-focused on the deal itself. And we don't really view financing rates having a huge impact on what we do. We look for great companies, and we look to expand our portfolio. And if we make the right decision on M&A, the cost of capital is pretty much secondary.

And our next question comes from the line of Carla Casella with JPMorgan.

Paused for a moment, I apologize if this has already been asked. But have you talked about inventory at retail and your comfort level in each category with inventory at retail? And how about purchasing versus last year? Do you see and buying ahead more this year we're trying to buy ahead?

Sure. J.D., you want to start on Garden?

Sure. Carla, this is J.D. To answer your question, we see retail inventories up low double digits right now. But when you consider the pricing factor that we mentioned earlier and the fact that a year ago, we still had fairly widespread out of stocks due to demand for the product. So really, we don't consider this to be heavy in inventory at all. I mentioned earlier that retailers last year loaded their stores earlier and heavier for the season in anticipation of the season. And this year, we're seeing them take a more measured approach. So we believe that if the weather improves and consumption improves, that, that should drive replenishment type orders, right?

And maybe [indiscernible].

Just one other point. Your -- when we look at total Garden sales net revenue, and we look at total Garden POS, they're actually quite in line, which again would mean there's no kind of big overhang or dislocation for us to necessarily be worried about. They're tracking more or less in line. Is that fair, J.D.?

That's accurate. Yes.

And then on Pet...

And then just one follow-up. Sorry. Sorry.

On the pet side, I would say there is increased inventory at retail, but it's needed, right? Our service level has been challenged and has improved and is still improving, and we'll continue to improve, but there's nothing kind of out of sorts.

Okay. Great. And then just one follow-up on how far out do you negotiate freight rates? And can you just say where they stand relative to like 2019 or '20 as you're thinking of freight rate?

We do a combination of we go out, I think, as much as 6 months. We also participate in the spot market. So we like to play that trade a little bit and arbit to some extent. Sometimes you see some dislocation between the forward rate and the spot. So it's a little bit of a mixed bag. The other thing I would tell you, a large part of our business actually is FOB our dock. So it's the retailers are picking up and they're picking up that freight. In fact, we had a large customer transition to that over on the Garden side this year, which is why you kind of saw our delivery expense come down a little bit. It wasn't that freight came down. It was just a different way of operating with that customer.

[Operator Instructions]. Next question comes from the line of Karru Martinson with Jefferies.

In terms of the additional pricing actions that you have planned for this year, are those already been negotiated with your retailers? Or is this something that you need to go to them and request additional price?

Yes. It is largely as you look at our total fiscal '22 pricing envelope. It is -- the vast majority is already either landed or communicated and locked in. There is a small amount as inflation has accelerated in a few areas that we're looking for additional pricing. Order of magnitude, call it, around 15% that would fall into that bucket up, we're still in negotiation with our customer partners and 85% is largely locked in.

Okay. So it's a little flow through. And then when you look at kind of the volume declines, fully understanding that we're up against some tough comparisons, and we do have the late start to the garden season. But I think, as Bill had asked, we've heard it from many, many people of the state of the consumer, are you seeing the consumer kind of pushing back on pricing, whether it be for Pet or for Garden?

I would say broadly, no, or maybe better said, not yet at least. So when you look at -- as you say, I think when you look at our overall organic sales growth and you take into account the type of massive lapse that we've got in the 20s and 30s in the prior year. And then certainly, on the Garden side, you overlay dynamic of a late break to the season. Overall, when you look at pricing versus volume mix, I would say it's largely in line with what we planned back at when we put our plan together and guided to the market. We aren't seeing the consumer walk away at these high prices, at least not yet. And to another color, we're not seeing a shift into private label, at least not as of yet in terms of any sort of meaningful way. The last kind of proof point I would say is the fact that we have a number of businesses that even on the back of that high pricing are actually still growing volume. And I mentioned 3 or 4 earlier in this call. So touch wood, I think the American consumer is getting pushed and squeezed in a lot of areas. But so far, I think the resilience on Garden and Pet is encouraging.

And we have reached the end of the question-and-answer session. And I'll now turn the call back over to Tim Cofer for closing remarks.

Thank you. Thanks, everyone, for joining our call today and your continued interest in Central Garden & Pet. If you have further questions, please follow up with Friederike, and our Investor Relations team, and we'll look forward to speaking with you again next quarter, if not before. Have a good day.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.