Central Garden & Pet Company (NASDAQ:CENTA) Q1 2018 Earnings Conference Call February 7, 2017 4:30 PM ET
Steven Zenker - Vice President, Investor Relations, FP&A Communications
George Roeth - President & Chief Executive Officer
Niko Lahanas - Chief Financial Officer
J. D. Walker - President, Garden Branded Business
Rodolfo Spielmann - President, Pet Consumer Products
Jason Gere - KeyBanc Capital Markets
Brian Nagel - Oppenheimer
Bill Chappell - SunTrust Robinson Humphrey
Jim Chartier - Monness Crespi Hardt
Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's First Quarter Fiscal Year 2018 Financial Results Conference Call. My name is Darin [ph] 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 Steven Zenker, Vice President of Investor Relations, FP&A Communications. Please go ahead.
Thank you, Darin [ph]. Good afternoon, everyone. Thank you for joining us. With me on the call today are George Roeth, Central's President and Chief Executive Officer; Niko Lahanas, Chief Financial Officer; Howard Machek, Senior Vice President-Finance and Chief Accounting Officer; J.D. Walker, President, Garden Branded Business; Rodolfo Spielmann, President Pet Consumer Products. Our press release providing results for our first quarter ended December 30, 2017 is available on our website at www.central.com and contains the GAAP to non-GAAP reconciliation for the non-GAAP measures discussed on this call.
Before, I turn the call over to George, I would like to remind you that statements made during this conference call, which are not historical facts, including adjusted EPS guidance for 2018, expectations for new product introductions, future acquisitions and future revenue and profitability as well as the expected impact of the recent tax reform 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 filings, including our Annual Report on Form 10-K filed on November 29, 2017. 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, George Roeth. George?
Thank you, Steve. Good afternoon, everybody. The bottom line is that we're on track for the fiscal year in our long-term plans. Additionally, we expect to benefit from continued M&A related activity and changes to our cat situation. These catalysts give us even greater optimism going forward. Both the Central's Garden and Pet segments continue to perform in line with expectations in the first quarter and are executing well against our growth objectives. Together our Garden and Pet segments grew revenues by 5% in the first quarter with organic growth of 1% despite difficult year ago comps in an unfavorable shipping calendar.
Acquisitions K&H and one month Segrest headed another 4 percentage points of growth. As you may recall in the first quarter of last year we grew 7% organically. And the way the calendar fell was more favorable for the first quarter last year than it was this year. So we continue to grow organically despite those challenging comps and we certainly wouldn't 1% growth rate to be normative for the year. Additionally our growth investments were funded by our aggressive cost reduction program was contributed to 100 basis point increase in gross margin in Q1.
Our Pet segment during the quarter was led by strong growth in several of our businesses including dog and cat treats, chews and toys where we recently invested in increased capacity to handle the expected growth in the years ahead. In addition, Central continued to keep pace with changes in consumer purchasing behavior in the pet industry by increasing our capabilities and focus on e-commerce channel where rapid sales and sheer growth is more than offsetting decline in the [indiscernible] track channels.
In our Garden business we continue to grow share and capture incremental shelf space by rolling out new products including a collaboration between Garden and Pet segments to market mosquito control products for the consumer market. Central has a long history in the professional mosquito control and we're excited to be ramping up activity in the consumer markets with these new products under our AMDRO Quick Kill brand. We are optimistic about the upcoming garden season and believe we're well positioned for success in the month ahead.
January has already started [indiscernible] and our analysis indicates retail inventories and where they should be at this time of the year. Having said that though, the Garden season is still very much ahead of us. Going forward for the total company organic growth of the year is expected to be driven in large part by the continued rapid growth in e-commerce channel, increased innovation, expanded distribution of both branded and private label products across all channels as well as continued rollout of the store [indiscernible] store concept in our pet distribution business at our major grocery retailer.
In terms of e-commerce we're going to share at Amazon and the majority of our categories. On the innovation front, we're launching an array of products across our segments and Pet's has include the new line of CADET dog treats and the expansion of our NYLABONE nubz [ph] to the mass market after success from the club channel. In Garden, new products include reformulation of our successful SEVIN pesticide line where SEVIN's product improvements include increased efficacy and longer last benefits. And last but not least, we're continuing to expand our offerings across in array of private label products from both our Garden and Pest segments.
Beyond the strong operating earnings growth 13% in the first quarter there were number of other items that impacted the bottom line. These included a seasonal loss in a JV investment. Higher interest cost due to the $300 million [indiscernible] issued in December that are intended to fund acquisitions. A favorable change to our Federal statutory tax rate and a tax benefit related to the remeasurement of our deferred tax assets and liabilities. So putting it all together, we earned $0.50 a share for the quarter versus $0.15 a year ago on a GAAP basis.
Adjusting for non-recurring items, non-GAAP earnings were $0.19 a share versus $0.12 a year ago, an increase of 58%. Niko will explain the non-GAAP items and their impact in detail in just a few minutes. However, before I turn it over Niko I want to talk a little bit how Central's business is evolving as we move forward, that gives us even greater confidence in optimism regarding our future. We have been very clear that Central's first and foremost is focused on growing its revenue and profitability organically. This means we're spending more support demand creation funded by cost savings of almost 2% controllable cost a year. We've seen the favorable impact of those savings both sustained organic growth and improved margins. We're then using the cash flow generated by our core business to help fund value creating M&A.
Recent events tailwinds if you may have increased our confidence and capability to drive additional sales and profit growth and ultimately shareholder value. M&A is one such area. To our recent note offering where we raised $300 million at a very attractive rate. We're well positioned to continue to make thoughtful, impactful and strategic acquisitions and investments to drive growth in the years ahead. But we never can predict specific transactions I can't say we have an active and healthy pipeline and are optimistic about our opportunities quick funds to use towards accretive acquisitions going forward.
Additionally the changes on tax law that lower our tax rates are significant tailwinds. Niko will explain the various changes. But suffice to say we will be paying a much lower rate and has been the case historically. This enables higher cash flow that can be utilized in a number of ways including reinvesting into the business and its employees and increasing profitability all driving significant gains and shareholder value in the years ahead.
Now I will turn it over to Niko to go deep on the quarterly financials.
Thank you, George. Good afternoon, everyone. We issued our first quarter press release of our financial results earlier today. I'd like to now give you more detail on the results. As George mentioned earlier, Central's EPS on a GAAP basis was $0.50 for our first quarter up from $0.15 over the same period a year ago. Fiscal 2018 reflects $16 million impact of the revaluation of our deferred tax accounts necessitated by the change in Federal tax law. Fiscal 2017 includes $2 million sale of the distribution facility in the first quarter of last year.
On a non-GAAP basis, it's excluding those two items. EPS was $0.19 versus $0.12 a year ago. There were numerous factors in play during the quarter that impacted the results. So I'll take you through them and give you some color and what transpired. Our first quarter sales rose 5% versus prior year to $442 million principally driven by acquisitions, our K&H business as well as the one remaining non-organic month of Segrest. Organic growth was 1% in both our Garden and Pet businesses.
As George mentioned earlier, we were up against some organic comps versus a year ago. Keep in mind that the first quarter is typically our lowest in terms of sales and well on plan, we do not expect the 1% organic growth to be indicative of what we expect for the year. Consolidated gross profit rose $11 million and our gross margin increased 100 basis points to 29.8% aided by cost savings and a positive impact from our K&H and Segrest acquisition. SG&A expense for the quarter increased 9% or $9 million versus a year ago and as a percent of sale increased 70 basis points, it's 24.7%, excluding the $2 million sale of the Garden distribution facility last year. SG&A as a percent of sales increased 20 basis points.
Operating income for the quarter increased 13% to $23 million on higher revenue and gross margin expansion. On a non-GAAP basis the increase was 26%. Operating margin of 5.1% was up 30 basis points or up 80 basis points on a non-GAAP basis benefiting from the higher gross margin.
Turning now to the Pet segment. Pet segment sales for the quarter increased 7% or $21 million to $325 million. The company's latest acquisition Segrest and K&H made up the majority of the game. Organic sales increased 1% with higher sales of other manufacturers products and behind the strength in our animal health, small animal and dog and cat businesses. Offsetting weaker wild bird feed and aquatics results. The other manufacturers pet distribution gains can be contributed to the continued rollout of its enhanced business model of running a store within a store concept at one large retailer and by strong sales in the e-commerce channel.
We also saw sizable increases in e-commerce sales in several of our other pet businesses. Wild bird was negatively impacted by warmer and less severe weather in the first quarter versus a year ago, while aquatics has been impacted by the weaker sales in the pet speciality channel. Pet segment operating income increased $3 million or 8% compared to prior year. Strength in animal health and dog and cat was largely offset by weakness in aquatics and wild bird. Pet operating margin increased 10 basis points to 11.1% as an increase in gross margin was partially offset by facilities and warehouse cost incurred in ramping up our pet distribution business to service the large retailed I mentioned earlier.
Now turning to Garden. For the quarter, Garden segment sales increased 1% or $1 million to $117 million. All of which was organic. Controls in fertilizer products exhibited strength versus a year ago benefiting impart from shipments of new products and expanded distribution while wild bird feed declined due impart to unfavorable weather. Garden's operating income declined slightly to $2 million from $3 million in the first quarter of last year, due to the facility sale a year ago. Excluding the facility sale Garden operating income increased $2 million. Operating margin was down 30 basis points but rose 150 basis points from the prior year excluding the facility sales. Higher gross margin across all categories except wild bird drove the increase benefiting from our cost savings initiatives.
Moving back to our consolidated results. In the first quarter other expense increased to $3 million from $1 million a year ago. We've mentioned in previous earnings calls that the results from this line may vary significantly quarter-to-quarter impart due to the seasonal nature of our largest JV investment. Net interest expense increased $383,000 to $7 million primarily due to incremental interest expense on our new notes that we issued in December, 2017. We raised $300 million from the issuance of tenured notes at an interest rate of five of an eighth [ph]. We were happy to secure the funds at a very attractive cost of capital and be able to stagger our debt maturities across multiple years. We expect to utilize the funds for M&A opportunities.
The tax rate for our first quarter was positively impacted by the revaluation of our deferred tax accounts which were impacted significantly by the recent reduction in federal corporate tax rate. The revaluation resulted in a negative GAAP tax rate for this quarter which certainly is not indicative of what we believe our tax rate will be going forward. On a non-GAAP basis, the rate for the quarter was 17.3%. This adjusted tax rate includes the reduction and the federal tax rate and the impact from the changes in the recent accounting standards around non-cash equity compensation expense.
The impact of the latter is likely to vary quarter-to-quarter depending among other things, the market price of our stock and employee option exercise activity. So for fiscal year 2018 we expect our effective tax rate to be 25% or less on a non-GAAP basis which excludes the impact of the deferred tax liabilities and accounts for three-fourths [ph] of the year at the new lower federal tax raise.
Now looking at our balance sheet and cash flow statement. Cash at the end of the first quarter was $283 million up from $7 million at the end of the first quarter last year. The increase reflects the proceeds of the debt offering I mentioned earlier. Debt offering also increased our total debt to $691 million from $395 million a year earlier. Our leverage ratio at the end of the quarter was 3.3 times compared to 2.1 a year ago. Well within our target range. We also had $330 million of availability on our credit line at the end of the quarter.
For the quarter cash flow used by operations was $24 million up from $13 million in the first quarter a year ago due primarily to changes in working capital and after taking into account the increase in our net income for the quarter which was offset by the non-cash effects of the impact of the Tax Reform Act. CapEx was $8 million versus $13 million in the first quarter of 2017 the decrease is part declining versus a year ago and we still expect CapEx to be somewhere around $40 million for the year.
Depreciation and amortization for the quarter was $11 million up from $10 million a year ago primarily due to recent acquisitions. During the quarter we did not repurchase any of our outstanding stock and approximately $35 million remains available under the board approved stock repurchased program. Now I'll turn it back over to George.
Thank you. I'll accept to take all the complexities of the changes this year and incorporate them in our thoughts on guidance for the year. We're revising our guidance up for fiscal year 2018 reflecting a number of factors that were not present in our previous guidance for the $1.62 or higher provided last quarter. The largest factor in the revision is the change in the company's tax expense. We currently estimate our effective tax rate will be no higher than 25% for fiscal year 2018. This excludes the impact of the revaluation of our deferred tax accounts that very favorably impacted our tax rate in the first quarter.
Additionally the guidance reflects higher interest cost from $300 million fixed rate notes that we issued in December 2017. Taking all these factors into consideration in addition to the current results of our operations coming in line with our expectations we're increasing our guidance for EPS for fiscal 2018 to $1.85 or higher. The gain won't be evenly spread across all quarters reflecting the lumpiness of growth versus the prior year we've been for shadowing. Having said all, we feel great about our start for the fiscal year. The added tailwinds and we have confidence in the $1.85 or higher guidance we put forth.
Now we'll open up the lines for questions.
[Operator Instructions] our first question comes from Jason Gere of KeyBanc Capital Markets. Please proceed with your question.
I guess the first question if you could just talk the organic sales and honestly, I mean I understand that it will build out as the year progresses. On a two-year stack rate your organic sales actually improved versus the fourth quarter. So I thought maybe you could a little bit or just about the categories maybe from - I guess from a destocking perspective at brick and mortar, the e-com what you saw that was maybe better than expected and also if you could talk a little bit planograms resets and how you're thinking about 2018 that's a little bit more specific I think to the Garden business.
That's a mouthful. But we'll try. I'll have J.D. snippet on Garden and then we'll have Rodolfo talk to Pets. So J.D.?
Sure. First of all with regard to organic sales Jason. Our two largest categories historically in Q1 are our wild bird feed and our grass feed categories. Typically they account for over 50% of our PoS in that quarter. Niko mentioned in his piece earlier. The weather really wasn't conducive for either one of those categories in Q1. So we saw some softness in those categories that impacted our organic growth rate. That plus the fact that, we had a shift in a week that was also shift in the quarter by one week. So lost a week on the front end of that quarter moving from a 53-week year to a 52-week year and fixed it up on the back end of the quarter and net-net what that means is, we lost the last week of September and picked up the last week in December that week between Christmas and New Year's which isn't a great week from a retail standpoint. Both retailers not very interested in lawn and garden products at that time. So all of that had an impact on our quarter net-net we still had a 1% organic increase year-over-year. So we felt good about that all things considered.
Moving to 2018, you mentioned that we feel good about planograms right now, the stores are being set. The retailers are taking from what we can see what they're telling us an aggressive approach to the season, so that they're ready for the season. They're building inventories as we would expect them to. We feel very good about - on our side about execution of the season. So our products are ready to go and our people are setting the stores working closely with the retailers and we feel like, we have the level of support in store to ensure success for 2018. And I'll pass it over to Rodolfo.
Perfect. Hi, Jason. In the case of Pets. As we've mentioned in the past. I will not over emphasize this on quarter-over-quarter [indiscernible] growth .we have over the last several quarter we've been most [indiscernible] 3%, we have posted organic growth over three years. So [indiscernible] account so Q1 is come to negative 6.1% growth a year ago. As I said all that, I'm going back to your question on e-commerce and how we're driving the share. We're growing share in all channels, as a total.
With e-commerce more than picking up is like that, that's coming down from speciality. In the case of e-commerce while the Segrest and [indiscernible] share is not something I would like to disclose in the call. Now what we can tell you that is that we've been working on that for well over a year, now we have run many test in different categories and we now work, we now know what works and what doesn't. We have been executing more and more on that and the growth has come.
Okay, great. Thank you and I guess my second question before passing it off. And thank you for the color on the proceeds from the tax benefit that comes through. I mean really beyond the free cash flow that you guys do and the new debt offering. M&A obviously is at the top of the list, a priority. But can you talk about maybe as we look at SG&A for this year. Are you also using that tax benefit as a way to kind of increase some of your investments or capabilities to kind of drive longer term kind of organic opportunities for you? So if that's more an e-commerce or other areas. So I was just wondering how we should think about SG&A as a percentage of sales this year. Are we going to see more of a set up this year because of the tax benefit as that comes through?
Well first Jason I'd say, when you look at our SG&A. it doesn't break it out granularity for you non-working versus working I'll call it. So a lot of that, we're talking about is working investment to drive growth. We didn't wait for any tax savings to do that. So we're looking to drive that number up in the absolute as a percent of sales I'll call the working portion of SG&A to drive growth. Having said that, there is additional cash flow from the tax savings that's all very recent and I'll just say that we're looking at opportunities to invest both in the business and our people to drive long-term sustainable growth and news to follow. I'll tell you our forecast sets aside money to do that, we find the right opportunity but no specifics yet.
Okay, great. Thank you guys. I'll pass onto the next caller.
Our next question comes from Brian Nagel of Oppenheimer. Please proceed with your question.
So maybe I guess some - maybe some bigger picture questions, George. In the Pet category it seems you're talking more about weakness in the pet specialty channel. The first question I had there is, are you seeing another sort of weight down is in that channel, but then the second question is when you think about online. You know at the same time, if you're talking more about pushing online in your success of doing so, so far. Will there will be side - is the Central model prepared for that? Or is there a tweaking that needs to happen overtime to allow you to even better perform online? Thanks.
I heard two things and the first one was actually quite [indiscernible]. So we didn't get the first part of your question.
I'm sorry. Let me ask that again, just in the pet specialty channel. Is the weakness you're seeing, has there been another lag of weakness there or is it more [indiscernible]?
Is it more of weakness? I would say that, if I'm answering your question right. Things have gotten worse in the pet specialty channel. I would say.
I'm afraid, Brian. This is Rodolfo. The answer is yes. If you compare the growth in speciality channels this year against a year ago or against two years. The answer is yes. The main pet specialist retailers are having worse comps this year than what we're used to do. Now well do we have exposure to pet speciality? We have - again we have seen this coming for a long time and you asked about us tweaking our model for e-commerce. We have been doing that for e-commerce for mass, for class [ph] and also for pet speciality. Figuring out ways of working with customer to drive traffic. All those processes are enabling us to continue the organic growth besides the pet specialty channel issues.
Yes and the only other thing I'll add if I heard your question, right. Are we having to tweak our model to drive online? I would say everybody has. So the types of marketing things that we think about today like replication management, search engine optimization are different for sure than what I did 10 years ago. We're getting smarter about that every day and the interesting things about online I'm sure you heard this from a lot of manufacturers is, what you know today and what's working today may not relevant 18 months from now and that's very different. So what drives online sales? I would argue as a continuous learning process and our company has put in place mechanisms to drive that continuous learning and day-to-day change which is new for us.
There is probably issues also around the supply chain to increase the efficiency of delivery to online customers and I would say, that's work in progress.
Thank you very much.
Our next question comes from Bill Chappell of SunTrust Robinson Humphrey. Please proceed with your question.
I guess three specific questions. One on gross margin. I was looking back this is the highest first quarter gross margin that you've had in seven years and so just trying to understand if that's mix related or if there were some projects that they've done over the past year, that have really driven that and how sustainable not obviously this type of improvement but sustainable kind of the gross margin improvement is this year.
I'll answer it from a corporate standpoint and then I'll let J.D. and Rodolfo comment on their respect segments. I would tell you there are some mix there because as the weather factors that we outlined, so this quarter does have a little bit of different mix. The other part I would tell you it's really a testament to a lot of our low cost producer savings project that we got in terms of our long-term cost savings initiatives that we're seeing coming to fruition and so it's just an ongoing continuous improvement that we have here at the company and then the other piece again I would just say it's mix, but I'll J.D. and Rodolfo give more color.
Sure. So just building off what Niko said, the low cost producer initiatives that's something we use to describe anything that lowers out cost of goods, improves of operator efficiency, improves plant utilization, reduces the complexity or simplifies our business model and each one of our business units literally each one has not just a robust pipeline but a three-year line of sight on initiatives that they're currently working on to drive cost out, we have plenty of opportunities. I'm often asked is that going run dry at some point, we see a lot of runway in front of us, but what you're seeing is the fruits of labor over the last couple of years against these low cost producer initiatives.
And Bill I think you heard me talk about this before but the cost savings is an important growth driver for the company, so got to do three things. Help us avoid taking pricing our competition is not taking, invest back to growth so I talked I think when Brian asked this question around growth spending that we're taking up and it also needs to expand margin. So I would expect our margin to expand overtime as we continue to drive cost.
Just a little bit from the pet side. The margins are coming as expected and the drivers are not short-term. It's all coming from this low cost producer. I can tell you that even the mix for the pet business was not positive for margins in the first quarter. So despite - there [indiscernible] perfect mix with an increased margin.
Got it, that helps. Second maybe a little more color on the store within a store concept. Number of doors maybe that you're doing this, can this expand to other places. And also in the quarter did you get a revenue benefit from that, from the sell in or is it just incurred some costs as you set that up.
Okay, so [indiscernible]. The stores - the number of doors is in thousands, but this is over a year long process to get those, to those hundreds and more than thousand stores. Revenue in the quarter, yes would it get some pick up? Not major. Remember we set up division-by-division. But in terms of expansion from this the model is a model that have worked for the customer. We've tested with this customer for years and it drove growth for them, growth for us and margin expansion for both.
The way I think about Bill is it's a phase rollout over the year, we have upfront spending to set that up that's right now is more significant than the cost and you'll see that slipped toward the end of the year.
Okay and then last one from me just on your EPS guidance just by my math it looks like the debt raised in the near term well assuming you don't do anything with the cash is about $0.14 hit to EPS this year just kind of $3 million to $4 million of interest expense per quarter and then the tax benefit is $0.27 so I'm just trying to couple that with your at least EPS guidance raise.
I can't walk you through all the reconciliation. The way I would think about it, is we're giving a $1.62 or higher and our business performed as expected in the first quarter I wouldn't have expected to revise our guidance based on the first quarter we almost never do as you know and then when we look at the multiple tax benefits, it might have get a little bit confusing because you have the federal statutory rate, you have the impact from the stock accounting and then you also have the interest expense that hits three off the four quarters, you come up with $1.85 or higher.
But I remember seeing - interest should be negative $0.14, is that the right range?
It's a good ballpark yes.
No, it makes sense. It's all positive. I just wanted to double check. Thanks so much.
[Operator Instructions] our next question comes from Jim Chartier of Monness Crespi Hardt. Please proceed with your question.
So I just wanted to ask about the facilities in New Jersey where you consolidated those last year for the dog and cat business. How is new facility running? What kind of benefits did you see from the sales and margin perspective in this quarter?
So I would say simply those facilities are up and running and running well. We're seeing already drive lower cost and improved margins and it's given us the capacity to meet a growing demand in some of those businesses, where one of the contributors to the pet flows in the first quarter.
The lower tax rate have you made any changes to your thinking in terms of capital deployment. You have $300 million from the debt raise to do M&A and now you got some additional tax savings. Your thoughts on maybe share repurchases.
As it right now we still like our - the M&A opportunities as well as our internal cost savings and cost opportunity both internally and externally. So I would say repurchase would be a distant third right now, we feel we can put all that money to work at a much higher IRR, with the things I just outlined.
Great. Thank you.
[Operator Instructions] there are no further questions. I would like to turn the call back to George Roeth for closing comments.
Thanks everybody for joining us today and have a great day.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.