Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet’s First Quarter Fiscal 2023 Earnings Call. My name is Shamali 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] As a reminder, this conference call is being recorded. I would now like to turn the call over to Friederike Edelmann, Vice President of Investor Relations. Please go ahead.

Thank you, Shamali. 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. As usual Tim will provide a business update, and Niko will discuss results for our first quarter ended December 24, 2022 in more detail. After the prepared remarks, J.D. and John will join us for the Q&A. Our press release and related materials are available at ir.central.com, and contains 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. 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 the potential impact of COVID-19 on our business, earnings per share and other guidance for fiscal 2023, 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 over the call to our CEO, Tim Cofer. Tim?

Thank you, Friederike, and good afternoon everyone. Let me begin by extending a sincere thank you to Team Central for their perseverance and execution in yet another challenging quarter. Three key messages for today’s call. First, our quarterly results. We delivered Q1 in line with the guidance we provided in November, which anticipated near-term challenges. These included unfavorable cost overhang from last year’s poor garden season, higher inventories at our retail partners, and a more sluggish demand environment compared with the strong growth quarter a year ago. As expected, these challenges put downward pressure on our key financial metrics. Net sales were $628 million, gross margin was 27.4%, and operating income was $400,000. We had a loss per share of $0.16 in line with our guidance. Second, our outlook for the year. Our fiscal first quarter is traditionally our smallest quarter. As such, we don’t usually draw any major conclusions from Q1, especially since the 2023 garden season is still in front of us. For the remainder of the year, we assume a normal weather garden season and that inventory dynamics will stabilize and we expect our pricing actions and cost control measures to largely offset inflation. As such, we are maintaining our EPS guidance of $2.60 to $2.80 for the year. And third, our long-term outlook remains favorable. Both Pet and Garden are dynamic growth categories with numerous consumer trends that underpin sustainable growth potential for years to come. We remain confident in the competitive strength of Central and our Central to Home strategy as the roadmap to create value for our customers and shareholders. Now let’s take a look at our two segments starting with Pet. Sales in the Pet segment were 5% below prior year largely due to our decision to discontinue low-profit private-label product lines, especially…

Thank you, Tim. Good afternoon, everyone. Building on Tim’s remarks, I’ll share with you details of our first quarter results for fiscal 2023. Net sales were $628 million, a decline of 5% as we are comping strong growth in the prior year first quarter. Consolidated gross profit was $172 million, a decrease of 13%. Gross margin of 27.4% was down 260 basis points, largely driven by our Garden segment due to further cost inflation and commodities and much lighter sales volumes, resulting in unabsorbed overhead, which were partially offset by our pricing actions. SG&A expense of $171 million was in line with prior year. However, SG&A as a percentage of net sales increased 130 basis points to 27.3% due to lower sales. Operating income declined by $26 million to $406,000 and operating margin decreased 390 basis points to 0.1%. The decline was largely driven by our Garden segment, which saw continued cost inflation and unabsorbed overhead due to lower sales, which were partially offset by lower commercial spent. Net interest expense of $14 million was in line with the prior year quarter. We had a net loss of $8 million compared to net income of $9 million a year ago. Our loss per share was $0.16 compared to earnings per share of $0.16 in the prior year quarter. And adjusted EBITDA was $29 million compared to $52 million in the prior year. Our tax rate was 24.2% compared to 20.7% in the prior year quarter, due to a lower benefit from stock-based compensation. Now provide some insights in the segments, starting with Pet. Pet segment sales of $416 million declined by 5%, driven by our decision to discontinue some low profit private label pet bedding product lines and SKU rationalization. Lower demand and durables especially in aquatics, strength in dog…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Bill Chappell with Truist Securities. Please proceed with your question.

Thanks. Good afternoon.

Hey, Bill.

Hey, Bill.

Hey, just want to talk a little bit more about kind of the POS numbers in the quarter and try to break that down between price and volume. I mean, I would expect that you had at least kind of a 5 point – 5 percentage point tailwind from pricing into this quarter. And so I didn’t know if you’re seeing volume still up on a year-over-year basis in Pet and Garden and as you look forward, will you lap that pricing where we could see things turn downward on POS or do you have enough pricing to carry sales growth into 2023?

Sure. Thanks, Bill. Look, our pricing continues to be an important part of the overall algorithm in this inflationary environment. And as you look at Q1, we priced again in the high singles. That’s a good chunk of that is carry over on pricing actions that we took in the last fiscal and then some select new pricing actions in the first quarter. As it relates the volume impact of that, we monitor that closely on a regular basis business by business. We continue to see an elasticity around one, meaning, we’re seeing that upper single digit volume decay off that upper single digit pricing. And that’s more or less our expectation. Obviously the mileage varies, we have some views that are more elastic, some businesses and brands than others, but in aggregate that’s what you see. As you go to the balance of the year, we still have a new pricing. We’ve got some pricing in this quarter meaning now we’re in the second quarter as you know, our fiscal second quarter that’s landed. Our overall pricing envelope when you look at it in aggregate around a couple hundred million bucks, it is north of 90% landed with our customers. So we feel good that it will come through. Again, the wildcard, if there is one, is any sort of changes in elasticity versus our assumptions. And I think when you look at that pricing envelope for the balance of the year, and you compare that to our view on the inflationary envelope, we feel pretty good as I said in my prepared remarks, that we’ll be able to between pricing and our cost control efforts largely cover that inflation. POS finally is, as you heard, remains strong and in positive territory. So while net sales was down in both Pet and Garden for the reasons that you heard on the prepared remark call. POS is up and it’s up mid single digits on Pet and it’s up single digits on Garden. So that we feel good about.

Great. And then on gross margin, it was obviously down year-over-year, but still a little bit better than I was anticipating. Is that driven in part by just the mix shift in Pet of more consumables versus durables and is that something that continues or was that not that significant?

Yes, I mean that played a role, the other piece too is we also got out of some private label bedding, which is lower margins. So some of that was also intentional on the Pet side and – but yes, a lot of it is the shift to consumables from the durable area. And Bill, the good news on Pet is gross margin on the quarter was basically flat. The gross margin degradation at a company level was Garden driven as Niko said on the call. And that’s for the reasons that I think Niko shared and we certainly can elaborate on further. But overall, I’d say on gross margin, feeling pretty good about being able to hold on the water line on Pet and a little bit challenged in the first quarter on Garden as we anticipated. We also had some of our higher margin businesses outperform in the quarter on the Pet side as well. So that helped margin.

Got it. And last one for me. Just kind of early read in terms of how the retailers are thinking on the garden season. This is obviously the season hasn’t really kicked off with the weather. But yes, I may imagine you have a pretty good idea whether they’re all in, half in, not really sure if they’re in for the season. Thinking of last year, trying to figure out whether it was more – last year’s weakness was more weather related or more return to normal consumer patterns related. So what are you hearing or seeing from your retail partners right now in terms of how they’re set up for 2023?

Hi, Bill, it’s JD. I’ll take that question. I’d say the feedback we’re getting from our retailers is overall very bullish. They do think that last year was mainly a weather driven challenge more than anything else. This year what they’ve done is take a more measured approach to flowing the goods to stores to set the stores at the beginning of the season. But we’ve seen some nice pickup in POS. In fact, POS and shipments have both rebounded very nicely after the end of the quarter in early January here. So in my conversations with the retailers they’re saying that they’re going to take an aggressive approach once the season starts to break. The good news is we’re up against some pretty weak comps for the next couple of months. And I think if the retailers see that it’s going to embolden them to be more – even more bullish on the season, I think most of our season is going to – our consumption is going to take place between March and mid-June. And I think by then, first of all, we feel very good about our off shelf activity, our promotional activity, but the retailers seem to be remain engaged. And when we’ve had decent weather, doesn’t have to be stellar, but when we’ve had just decent weather, the consumer’s very active in our company. I think once all that comes together, we are cautiously optimistic, but the retailers are very much engaged and bullish.

Great. Thanks so much.

Our next question comes from the line of Stefanos Crist with CJS Securities. Please proceed with your question.

Hi. Thanks for taking my questions. First just on inventory just the timing of converting that. Is that expected to happen in the next quarter or is that maybe more of a starting in the back half of the year?

No. The way our business is, you see the working cap build kind of through the tail end of Q1 and then it peaks out sort of mid-Q2 and then starts to come down. A couple comments in inventory. In absolute dollars, it was obviously up about $180 million. Couple things I want to point out, we mentioned are focused on cost and cash. If you look at the quarter itself the inventories were actually down. We – a year ago in Q1, we came up about $160 million. And if you flip through the cash flow, you’ll see that. And then this quarter, this last quarter, we are only up $85 million. And then that’s reflected in cash used from operations, which was only $63 million versus $92 million a year ago. So you can kind of see the early sort of fruits of our labor. We were very serious when we said we were going to focus on cost and cash, and I think we’re starting to see the early stages of that with a lot more to come as the year plays out.

That’s great color. Thank you. And then this thing about acquisitions, just talk about what you’re seeing in the M&A pipeline and maybe deal flow versus what you saw 12 months ago.

Yes. I mean, we’ve sort of said this on a couple of past calls. The deal flow has definitely slowed down. I think as we look at the volatility in the public markets, the private market tends to follow that. So, clearly deal flow has slowed, the pipeline is not quite what it was 12, 18 months ago. But we’re still out there. And we still have a number of deals that are in play and discussions that are going on. So it’s not going to deter us. For us, it’s all about finding the right fit, the right company, management team and the right margin profile for us. So we’re still going full speed ahead.

Great. Thank you.

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

All right. This is Taylor Zick on for Brad Thomas. Thanks for taking my question. I’m curious on some of the factors. If you touch on some of the factors that have been impacting the business from an inflation standpoint, and kind of how you’re thinking about those for the rest of the year. And then additionally, if you can kind of just talk about maybe what your customers were saying in terms of pricing as you kind of continue to push these prices through? Thanks.

Yes, I mean, as far as inflation goes, last year was unprecedented. We’re still seeing some continued inflation into 2023, but it’s certainly moderating in our opinion. Everyone has seen labor has sort of flattened out. Delivery certainly has moderated, especially ocean freight. Fortunately we can’t take full advantage of a lot of like the ocean freight, because we do have heavy inventory, so we’re not bringing in as much product right now. We need to sell through what we’ve got. But I would say overall the trend, there’s a moderation going on. That said, we’re still at historically very, very high levels. So, we’re still combating that.

Yes. And the build on Niko’s comments, I think you said it well, Taylor, look, we’re still in an inflationary environment and our total cost envelope is going up year-over-year. It is unfavorable. And you ask for a little bit, some of the details, I mean, certain of our commodities around grains, grass inputs, wheat and potato starch for dog treats, et cetera. These are still year-over-year and unfavorable cost input into our total envelope. And so and that’s why we’re pricing as we price, because we have that pressure and we are seeking to do our best to maintain if not expand margin. But the order of magnitude of the increase is definitely diminished 2023 versus 2022 compared to 2022 versus 2021, as Niko said.

Got it. Thank you. And then if I could just squeeze one last one. How did that pet to stocking kind of turn out this quarter relative to what you had expected for the last quarter?

Yes for Q1, as Tim mentioned, our POS was 6% and our shipments weren’t close to that, right? So, you can see customers continue to tighten their inventories. Our expectation is that we’ll continue to impact us in Q2, and then it will normalize mid-year.

Great. Thank you.

Our next question comes from the line of Andrea Teixeira with JPMorgan. Please proceed with your question.

Thank you, and good afternoon. I have two clarifications please. On the exit of the private label contract. I understand that it started last quarter, so you’re through the first half of it. So I want to just clarify that, and then you’re going to lap in the fourth quarter. So what is the magnitude of that impact? And on the EPS guide, of course, I understand this is like a small quarter, but can you talk about like cadence if we should expect basically inflection in the second quarter and how to think about it? And lastly, if you can talk about market share trends? Thank you.

I’ll do that one. All right. Well have John Hanson take the pet bedding, Niko will take EPS, I’ll take market share. John?

Yeah. So on pet bedding; we have a meaningful private label pet bed business. In Q1 of 2022, we proactively rationalized skews. And then in the back half, we decided to exit some low margin product lines to improve margins profitability. We started laughing that in the back half of fiscal 2023. We’ll see that throughout 2023. In this business and other businesses, we’re going to continue to critically assess our cost competitiveness to improve margin and improve profitability. So it’ll be a – it’s an ongoing effort from us and to a degree, normal part of our business.

And just speaking EPS, Andrea, so next quarter Q2, we’re still expecting EPS to come in a little bit lower than a year ago. As I mentioned in my prepared remarks, it’s really a back half story for us here as more pricing kicks in. We see a little bit more normalization in terms of retail inventories throughout the year. And then, we’re assuming a more normal sort of weather pattern as we go through that. And then all along we’re going to be controlling costs and cash. So it’s going to be a Q3, Q4 story as we head to the $2.60 to $2.80 guide.

And then Andrea, on your third question on market share, I will say that we feel good that our market share performance is definitely a bright spot on the quarter. It continues a trend that started in the back half of last year. If I break it out across garden and pet, starting first with pet, we had broad market share gains across pet supplies. In my prepared remarks, I mentioned many of them. We grew market share in dog treats, dog toys, small animal, pet bird, aquatics, equine, feel good that we are outpacing those supply categories in which we compete. Notably as well, if I drill into e-commerce, as you would know, Andrea e-commerce remains the fastest growing channel by far relative to the brick and mortar footprint out there in the channel landscape. And on e-commerce and in particular of the largest pure play player whom you know, we expanded market share there as well. And that’s the fast growing channel. So I’d say, sales on the quarter, they are – what they are, they were down 6% in pet. But you kind of peel that back and say, as per your first question, part of – a big part of it was a purposeful decision to exit lower margin private label pet bed. That’ll still continue in the next quarter or two as John said. But you look at POS, POS up 6% and then you look at market share Nielsen syndicated data and you feel good about our performance relative to competition. Shifting to garden, garden was more muted in the quarter for the reasons we stated. But we gained market share in two of our biggest and most important categories. First in Wild Bird, this is our third consecutive year of market share expansion primarily behind brand Pennington and Wild Bird. And we continue to grow market share in grass seed, a very important category for us. And one, we turn the corner on grass seed market share mid last year with some of the launch of new innovation that we’ve talked about Smart Patch, as well as a new fully digital marketing campaign. And we saw that positive share performance continue in the first quarter of this fiscal.

Very helpful. Thank you. I was confusing the first part of my question on the EPS because when you said the first half, I didn’t know if you’re adding back the losses and could – the losses in the second quarter? Could it still be higher or not? But it seems that it’s on isolation. The quarter is also going to be down from last year. Appreciate the clarification.

Yes.

Thanks.

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

Great, thank you. How much of your overall business in Pet & Garden is private label? You mentioned you’ve got a sizable pet business, but can you just give us a little bit more color on how you see private label?

Sure. I mean, in aggregate a private label is approximately 10% of our sales. Little noise in the – on the line. But private label is about 10% of our sales. The vast majority of our sales are our own branded products that we manufacture and bring to market; that’s two thirds of our portfolio. And then the balance of the portfolio would be our distribution business where we are a distributor on both the Pet & Garden side for select third party brands.

Okay, great. And then on the business that you exited, did you say how much sales you had done in that business in the fourth quarter in the first quarter last year?

No, we didn’t give that. We didn’t give that out.

No.

Okay. Okay, great. And then how much supply chain savings are built into your guide for 2023? Any kind of a ballpark that you can give us there?

Okay. We haven’t given that out either. A lot of the supply chain savings are early stage and timing of it is going to be a little bit tricky. So we were a little remiss in our November call to give firm numbers for the year. That said we’ve got a number of work streams in progress right now. And building on Niko’s comments, I mean, generally look we’ve got a – we’ve got a continuous improvement, net productivity cost out mindset in the company. I think ideally we’d like to look at around 1% of cost that we can impact and try to take out each year. That’s at a high level, but we don’t as Niko said, we didn’t guide to a given number.

Okay, great. Thanks so much.

All right. Next question comes from the line of Hale Holden with Barclays. Please proceed with your question.

Thanks, afternoon. I just – I had one question. I was wondering, how you were thinking about the guidance you provided in November versus today relative to what you’re seeing in the consumer. So things have changed and I was wondering if you – if you were feeling that the consumer was tracking to where your guidance was potentially better or potentially worse?

I would say broadly we feel the same. We guided at the end of November, so we’re only a couple of months on since our last guide. There’s no doubt that the consumer’s under pressure and I think our crystal ball like many others would suggest that that’s not going away anytime soon. Having said that, looking at things like point of sale trends as you heard the consumer is still boarding with his or her dollars in our categories, and they’re spending more than prior year. And that is true on both pet, which was low-single-digit POS growth, lapping a 14% POS growth in the prior Q1. And then pat in the mid-single-digits, I think we quoted 6%. So there’s the ultimate test. Now a big part of that is the pricing, right? Our goods as well as competitive goods are more expensive. So on a unit basis; you’d see a slight down tick as a result of that. But overall, I think that the consumer remains highly engaged in both of these categories. Certainly when you look at recessionary environments over the last, call it 30 years both of these categories are resilient. We like to say here, they’re not recession proof, but they’re recession resilient. And consumers continue to love to spend time with their pets in treating them and aiding their health and wellness and then spend time, beautifying. It’s a small cost outlay to beautify your backyard and improve things in your lawn and garden. So, I’d say in general, back to the core of your question, nothing has – we have seen nothing in the last 90 days that gives us a very different view on state of consumer as it relates Pet and Garden.

Great. Thank you so much. And fingers crossed for good weather pattern.

Thank you.

Thank you. Yes.

And our next question comes from the line of Karru Martinson with Jefferies. Please proceed with your question.

Good afternoon. Just on the Pet side and the consumer behavior, certainly it sounds like dog and cat, you’re seeing that resilience. The pet is a family member, but on the aquatic side, is it that the consumer is not shelling out for the durable goods or not getting involved in a new category or perhaps not replacing the fish when it dies?

Yes, on the aquatics, which we did call out, that’s a durable product, right? And we have seen, live animal sales slowing and a bit of a decline. And that does impact durable purchases. When somebody does buy that live fish, they often buy a fish tank, right? When somebody does buy the guinea pig, they often buy a small animal enclosure. So that, certainly has had an impact

Okay. And then just lastly, when you look at M&A, you mentioned it had slowed. Is it just that the financing is not there or is it that folks have kind of pulled down, pulled back and hunkered down and saying, I’m not going to sell into this environment?

Yes, I think, it’s more the latter, especially for us because, our balance sheet is in good shape. So we are, a great buyer from the standpoint of financing and whatever we can’t finance from the balance sheet, we can get, on the outside. So it’s really more the latter. We’re not seeing the volume of deals out there that we saw 12 months, 18 months ago. And again, I think just looking at the public markets and the volatility that’s there, I think, a lot of folks are scratching their heads in terms of, what’s deemed a fair valuation in this day and age. And then especially in our categories, that got such a great lift during COVID and for the most part, they’re starting to flatten out. And so if you’re a seller, you may opt to wait and see how things play out, so just the overall volume is a little more muted.

Got it. Thank you very much guys. Appreciate it.

Thank you.

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

Thanks everyone for your continued interest at Central Garden & Pet. We wish everyone a good week.

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