Ladies and gentlemen, thank you for standing by. Welcome to the Central Garden & Pet Second Quarter Fiscal 2023 Earnings Call. My name is Camilla and I will be your conference operator for today. At this time, all participants are in a listen-only mode. Later we will conduct the 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 Friedderike Edelmann, Vice President, Investor Relations. Please go ahead.

Thank you, Camilla. 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 the results for our fiscal '23 second quarter ended March 25 in more detail. After the prepared remarks, JD and John will join us for the Q&A. Our press release and related materials are available at ir.central.com, and 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 '23, expectations for new capital investments, product launches and future acquisitions are forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements. These risks and others are described in Central's filings with the Securities and Exchange Commission, including our annual report on Form 10-K filed on November 22, 2022. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events or otherwise. Now I will turn over the call to our CEO, Tim Cofer. Tim?

Thank you, Friedrike, and good afternoon, everyone. I assume most of you saw our earnings pre-announcement last month. It was a challenging second quarter for our Garden business. But since we ended the quarter trends have improved, and we've taken additional action that builds confidence in our year-to-go outlook. So there's a lot to share on today's call. Let me get straight to what I think are the three most important messages for this call. First, our quarterly performance. While the pet segment largely met our expectations and we outperformed the pet supplies market as evidenced by our expanded share, it was our Garden segment that's significantly under delivered. Garden was unfavorably impacted by poor early spring weather, including severe storms in the Southeast, heavy rain and snow in the West and an unseasonably cold late March. As a result, total company performance fell short of both prior year and our expectations with net sales of $909 million gross margin of 28.6% and operating income of $78 million. This translated to earnings per share of $0.90. Second, our cost and simplicity program. As we've shared on prior calls, in fiscal 2023, we have a sharper focus on the cost pillar of our Central to Home strategy. In addition to the short-term actions we've taken in recent quarters, we are advancing our plans to more significantly simplify our business and improve our efficiency across the organization by rationalizing our footprint, streamlining our portfolio and improving our cost structure. Our focus is on a number of key areas, including procurement, logistics manufacturing, portfolio optimization and administrative costs. Today, we will share the first of many restructuring efforts with more to come in the quarters and years ahead. And the third key message is our outlook for the year. For the remainder of…

Thank you, Tim. Good afternoon, everyone. Building on Tim's remarks, I'll share with you details of our second quarter results for fiscal '23. Net sales declined 5% to $909 million, as poor early season weather, lower foot traffic and changes in retailer buying patterns impacted the garden category. While our Pet segment performed largely as planned and grew share in a number of categories, our durable pet products continue to be challenged. Consolidated gross profit was $260 million, a decrease of 9%. Gross margin of 28.6% was down 150 basis points driven by the Garden segment due to overhead absorption pressures in key garden businesses such as grass seed and live plants, initial start-up costs associated with the live goods facility we acquired a year ago in Paris, Kentucky, and input cost inflation, all of which were partially offset by our pricing actions. SG&A expense of $182 million was generally in line with prior year, However, SG&A as a percentage of net sales increased 110 basis points to 20% due to lower sales. Operating income declined by $29 million to $78 million and operating margin decreased 260 basis points to 8.6%. The decrease was largely driven by our Garden segment, largely due to unabsorbed overhead due to lower sales and input cost inflation, partially offset by lower commercial spend. Net interest expense of $15 million was in line with the prior year quarter. Net income was $48 million compared to $70 million a year ago. Our earnings per share was $0.90 compared to $1.27 in the prior year quarter, and adjusted EBITDA was $107 million compared to $131 million in the prior year. Our tax rate was 23.9% compared to 23.4% in the prior year quarter, primarily due to a lower tax benefit from stock-based compensation and a higher impact…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. And our first question is from Bill Chappell with Truist Securities. Please proceed with your question.

Thanks, good afternoon.

Hey, Bill. Just any plans for more color kind of dollar amount cost savings, stuff like that on the restructuring program? Or is that -- will we see that in the coming months? Just trying to understand when we would see the kind of meaningful improvements or dividends from this kind of program? I understand it's a multiyear program. Just trying to -- anything more you can put around it just so we can kind of start to think about it from a margin standpoint and a cost standpoint?

Yeah. Thanks, Bill. As you heard, we've really advanced our work on what we're calling our cost and simplicity program. And as we've discussed with you, among others, in the past, we think there's a significant opportunity here. It's pretty broad ranging in terms of its scope, and I outlined those areas from manufacturing through procurement, logistics, some work we're doing on portfolio simplification and admin costs. And the outcomes that we're looking for are clear as well. I think we are a complex platform and there's opportunities to streamline it. And when we do, we think there's money to be saved and margin to be built and fuel to be created to put back in our growth agenda. And so in the end, that's going to be less SKUs and less facilities. Today, we gave that first tangible step Bill, to your question. I know you're looking for some hard figures and further direction. But I think it's a great example of stuff you will see going forward. Niko shared the numbers in the prepared remarks, closing a facility, a onetime cost that's reasonable and a very quick payback. We're lining up projects that can follow in the quarters and years ahead. And at this point in terms of dollars and cents, we can only talk to you about the one we announced last Friday. But the expectation should be you're going to hear more from us in the quarter, quarters ahead and in our annual guide as we turn the corner to '24.

Got it. And then just a follow-up, maybe talk a little bit about inventory at retail. And I know we're coming off last year where retailers were tightening inventory, cutting inventory -- have you seen that in both Pet and Garden continue as we moved into calendar '23 and do you expect that to continue for the next couple of quarters? Thanks.

Sure, Bill. It's JD. I'll start, and then I'll turn it over to John to speak to inventories. In Garden, we've certainly seen the inventories -- or the retailers continue to take inventory out of their system. Some of that was a destocking that's been widely reported. And then in addition to that, we saw a change in buying patterns this year versus historical standards. Typically, the retailers would ship a lot of inventory in at the beginning of January to set the stores for the upcoming season. What we've seen this year is a more measured approach with a shift more toward just-in-time ordering. So that's pushed inventory back into the -- into our barns waiting for the season to break. I do believe -- and we did not load the channel at the end of the quarter. So we feel like we're in a very good position. They've taken inventory out -- but I think what we'll see, and we said all along, we thought second half would be stronger. And I think that will play out. Our inventories are much better position than they were a year ago. And as we see consumption in Q3s and 4, we should see replenishment that follows. I'll turn it over to John.

Yeah. Bill, on the Pet side, we talked a little bit about it last quarter. We certainly saw it in Q1, and it continued a bit in Q2 we certainly -- as our POS in Q1 and Q2 was stronger than our shipments. We expect the inventory levels in pet to stabilize in the back half. We're seeing a little bit of that in Q2 and expect it to more so stabilize in the back half.

Great, thanks.

Thank you. Our next question is from Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Hi, good afternoon. Thanks for taking my question. Just a follow-up on the pet line, a question here before. Hoping you could talk a little bit more just about the outlook for demand at the POS level and how you're thinking about that? And then maybe if you can give us a little more color on how much some of the product exits that you've done, how much mathematically that's impacting growth here for the category? Thanks.

Yeah, Brad, I'll start. This is Tim. Look, overall, we've -- as I said in the comments, we feel good about our performance on pet. It is a bit of a tale of two cities, Brad, for us and pet supplies between consumables and durables, I think that is more than an important nuance to understand in durables continue to see headwind, saw durables decline in the quarter, both at a category level and central pet level. In contrast, saw consumables grow. And the good news is our business does skew consumables and pretty heavily kind of 75% to 80% consumables to durables but the headwinds on durables continue, and we'd expect through the year to do that. Remember that durables are more closely associated with new pet adoption. And so as we rolled off all that COVID spike, you did see things like fish tanks, small animal enclosures, pet beds, et cetera, take more of a hit than the everyday consumables like food, treats and supplies. So as you roll into the back half of the year, we're feeling good. We're feeling good about our growth prospects. Quarter-after-quarter that durables impact will begin to moderate. And on the consumables side, we feel very good about our competitive position and growth but also reinforce that as we look at it through syndicated data, Nielsen as well as online data, we expanded market share in aggregate across eight or 10 of our key categories, from dog treats to small animals, aquatics, reptile, equine, et cetera. And I think the last thing to say is on the back half, we are lapping slightly softer comps on the pet side year-over-year from a sales side. So for all those reasons, feel good about current competitiveness and outlook on Pet.

That's really helpful. And if I could ask a follow-up to Niko on the gross margin outlook. Obviously, in the current quarter and Elements deleverage that you were dealing with. But can you talk a little bit more about the outlook as you think about some of the tailwinds you have from pricing, coupled with what you're seeing on the input cost side?

Yeah, sure. Yeah. So as Tim mentioned, the back half is a little bit of an easier comp for us. And we've got sort of 90% of our pricing is set, which is another tailwind for us. So as we look into the back half of the year, we are expecting some margin expansion going into the back half. So we feel pretty good about that. Pretty encouraged by April and looking forward to a strong second half.

Really helpful. Thanks so much.

Thank you. Our next question is from Andrea Teixeira with JPMorgan. Please proceed.

Thanks, Camilla and good afternoon Jim, Nick. JD, Jon, Friederike. I appreciate the comment about the weather impact. And JD, you said that obviously, as you exited, you gave a little bit of color on the March numbers, especially the last two weeks, which are crucial. So I was hoping to see -- and I know you updated the outlook even before today, but I was just hoping to see what is in more detail embedded in there. In the case of Patch, Jon had said that he expects at least for consumables, things to be pretty much inventory kind of mimicking or selling sell-out mimicking consumption. In the case of gardening -- Garden, it's probably a little bit more complicated from what I can understand. So I was hoping if you can -- if you can explain to us that point of traffic and all of that, as we said, obviously, if you miss a crucial times of the gardening folks may not engage in gardening at all. So I was hoping to see if you're embedding some of the conservatives in there in their -- in your outlook.

Hi, Andrea, it's JD. So yeah, I'll speak to that. I'd say, first of all, we still are very optimistic. A lot of the season still lies in front of us. Over 50% of the business still is in Q3s and 4 and when we have reasonably decent weather, we're having great consumption. The consumer is still very engaged in our categories, which is -- we feel incredibly positive about. As I said earlier, the inventory levels are at a point right now where any consumption is going to drive replenishment. So they've taken quite a bit of the inventory out of the system. We're not sitting on heavy inventories at retail. We think that's a tailwind for us as well. All things considered, I think if you look at syndicated data, we're also taking share in the key categories in which we compete from grass seed to branded controls to wild bird feed. We also know from talking to our customers that we're taking share in packet seed as well. So we feel good about our key categories. We know that the consumer is engaged we just need some decent weather and the forward-looking forecast, at least in the near term looks very favorable. So we are, I'd say, cautiously optimistic because the single biggest causal factor is still out of our control, but we feel good about those controllables and that we're in a good position there.

Very helpful.

And the last thing, Andrea, to build on JD's point, he made this earlier, I think, to Bill's question, is our inventory is in a good position, right? So I think that JD mentioned earlier, we didn't load retail at the end of our fiscal Q2. So that means once we get the additional POS going, which we have visibility now into this quarter, those replenishment orders are going to flow through, and there's nothing stopping it from a retail inventory standpoint. So that's encouraging. And you mentioned that earlier, JD.

I did. Yeah.

Thank you. Thank you, both.

Thank you. Our next question comes from Hale Holden with Barclays. Please proceed with your question.

Hi, good afternoon. I just -- sneaky snacker might have been the best pet food name, treatment and I've heard in a long time, made me laugh a lot. So thank you. Two questions. The first one, just as a clarification. When you talk about margin expansion in the second half, that's on a year-over-year basis, not on a sequential versus first half basis. I just want to make sure I got that correct.

Yeah, it should be both actually.

Okay. And then the second one on some of the pet durable weakness. Are you seeing that evenly across all your channel partners? Or is it more weighted to mass or pet specialty or online. I was wondering if there's any differentiation there.

Yeah. We're seeing it pretty even across brick-and-mortar, we see online being a little bit stronger, honestly. But it's pretty even across brick-and-mortar.

Okay. Thank you very much. I appreciate it.

Thank you.

Thank you. Our next question comes from Carla Casella with JPMorgan. Please proceed with your question.

Hi, thank you. You mentioned you're in a good inventory position. And I know last year, this time from third -- second and to third quarter inventory stayed about the same -- but that's -- I don't think that's typical. Can you just say whether you see -- should we get some working capital released in third quarter as you work through inventory? Or is there some reason it should stay kind of at the current level?

No, Carla, we -- we're going to continue to work through it. I mean if you look at -- we saw some already this quarter even though the first half of the year, we were users of cash. We were users of much less cash in this quarter. So in the prepared remarks, we used like $34 million of cash and a year ago, we were using $180 million. So that's a nice sort of change up in the quarter. And then the graph -- the garden season, excuse me, is still kind of ahead of us -- so you -- most of the inventory is on the garden side. I'll just share this with you, our pet inventory year-over-year is down. And so we expect more of that into Q3 and 4. So we are very, very focused on working capital inventories.

Okay. Great. And did you say how much your guidance or what you think the working capital could be as a source for the year?

No, we didn't share that.

Okay -- how about cash taxes? Are there any unusual tax items with some of the restructuring you're taking?

No.

Okay. So just assuming the P&L taxes or your cash taxes?

Yes.

Okay. And then just one thing. As the marketing plans, as you said, SG&A was about flat this quarter versus last year. How flexible is your SG&A, meaning if we see weather weaknesses we get through further into the season? How quickly can you pull back on any of that? Or should we expect to -- that -- that stays relatively stable?

Yeah. No, it is flexible. Certainly, when we talk SG&A, if you go to the commercial expenditure side, marketing, sales, merchandising, et cetera, that is flexible. And indeed, when I look at the two gentlemen that Run Garden and Pet here next to me, I mean, these guys are -- stay very nimble and very agile particularly on the garden side, to your question, Carla, if for whatever reason, mother nature doesn't cooperate for an extended period of time, J.D. and his team have that contingency and that flexibility to pull back to match the type of demand environment we're in.

Okay. And then just one on housekeeping. Did you -- can you just remind us when you exited the private label business for the pet beds that you did. Was that -- have we cycled that fully now?

Yeah. We -- this is John. It's been a process over the last 12 months, maybe even a little bit longer. And it's been a continual process. So it's not fully cycled to answer your question.

Okay. Okay, great. Thanks for all the questions your answer.

Thank you. Our next question comes from the line of Karru Martinson with Jefferies. Please proceed.

Good afternoon. With 90% of your pricing set, I was wondering what are you seeing on input costs here in the second half and going forward?

Yeah. So as we looked at input costs, they're still historically pretty high. Now they're not quite as high as they were a year ago. So we saw inflation this year of approximately half of what it was a year ago. And it's not as broad based, right? So for instance, containers coming in from China are much lower. I would say delivery expenses are lower. But we have pockets of inflation like we had some graph fee varieties that were up things like potato starch, some actives in our life science business like PBO and pyrethrins. So there are still some pockets there, but it's not nearly what it was a year ago is the way to think about it.

And the feeling, given the margin expansion here you in the second half is the feeling is the pricing that you have set covers those costs, correct?

Yeah. Yes, that's correct.

Okay. And just interesting to hear you still on the M&A trial. Kind of what are we looking for in terms of tuck-ins or favoring one side of the business or another or you want a third leg to that stool?

Great question. Yes, we still are on the prao. So we are actively looking. The pipeline has slowed, I would tell you. I think with the public markets being as volatile as they are, I think there's less assets out there, less folks wanting exposure to -- well, actually to expose themselves to this market. So it's just the pipeline has definitely slowed, but we are still looking. And again, we view each deal sort of based on its own merit. We have done a number of garden deals. So it would be great to get a pet deal here shortly. But we'll see. We have to see. They all tend to take -- have a life of their own, and we'll have to see, but we continue to look.

Thank you very, guys. Appreciate it.

Thank you. There are no further questions at this time. I would like to turn the floor back over to CEO, Tim Cofer for closing comments.

Thanks, everyone, for joining today's call and your continued interest in Central Garden and Pet. We're happy to follow up with you with any questions, contact Friedrike. Thanks. Have a good day.

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