Prepared remarks
Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Fiscal 2025 Third Quarter Earnings Call. My name is Julian Bell, and I'll be your conference operator for today. As a reminder, this conference call is being recorded. I will now turn the call over to Friederike Edelmann, Vice President, Investor Relations. Thank you. Please proceed.
Good afternoon, everyone, and thank you for joining Central's third quarter fiscal 2025 earnings call. Joining me today are Niko Lahanas, Chief Executive Officer; Brad Smith, Chief Financial Officer; John Hanson, President of Pet Consumer Products; and J.D. Walker, President of Garden Consumer Products. Niko will start by sharing today's key takeaways, followed by Brad, who will provide a more in-depth discussion of our results. After their prepared remarks, J.D. and John will join us for the Q&A session. Before we begin, I would like to remind everyone that all forward-looking statements made during this call are subject to risks and uncertainties that could cause our actual results to differ materially from what those forward-looking statements expressed or implied today. A detailed description of Central's risk factors can be found in our Annual Report filed with the SEC. Please note that Central undertakes no obligation to publicly update forward-looking statements to reflect new information, future events, or other developments. Our press release and related materials, including GAAP reconciliation for the non-GAAP measures discussed on this call are available at ir.central.com. Last, but not least, unless otherwise specified, all comparisons discussed during this call are made against the same period in the prior year. If you have any questions after the call, or at any time during the quarter, please don't hesitate to contact me directly. And with that, let's get started. Niko?
Thank you, Friederike, and good afternoon, everyone. Let me begin by sharing three key takeaways from today's call. First, we delivered a solid third quarter, driven by strong cross-functional collaboration, disciplined execution, and the unwavering dedication of team Central across all business units. We advanced our operational optimization efforts, consolidating our footprint, refining our portfolio, and improving our cost structure, setting the stage for long-term growth. Second, we remain confident in our full-year outlook, even as we navigate a complex and fluid macroeconomic environment. Now, let me expand on these points. Our third quarter achievements were significant. Our team's strong execution led to record Q3 and year-to-date GAAP and non-GAAP earnings per share, significant margin expansion, and a major improvement in workplace safety performance within the company. We achieved these results despite extended cool and rainy weather that negatively impacted the garden season, as well as top-line pressure from the recent loss of two product lines in our third-party garden distribution business and ongoing assortment rationalization and soft demand in pet durables. These outcomes reflect the dedication, teamwork, and cross-business collaboration across our more than 6,000 employees. Their collective efforts continue to drive our success and pave the way for an even stronger future. Second, progress in our Cost and Simplicity program continues to deliver measurable impact. Highlights from the third quarter include e-commerce expansion. We are excited about our progress in consolidating two outdated distribution centers into a new modern direct-to-consumer-enabled facility in Salt Lake City, Utah, which is scheduled to start shipping next month. Streamlining operations has also been a focus. With the consolidation of 20 outdated locations and the creation of five efficient DTC-enabled hubs, we've reached a major milestone in our simplification and e-commerce expansion efforts. As part of our commitment, we're proud to highlight a recent collaboration between several of our business units and teams to support animal welfare organizations, assisting communities impacted by the flooding in Kirk County, Texas. Our contributions included essential pet supplies, such as dog beds, training pads, and treats, as well as a cash donation to Greater Good Charities and the Hill Country Humane Society. Third, confidence in our outlook for the fiscal year remains strong. We posted record third quarter and year-to-date results, outpacing the prior year. As we look to the fourth quarter, recent tariff developments and escalated geopolitical tensions have heightened macroeconomic uncertainty and put additional pressure on consumer confidence. We continue to anticipate increased consumer value consciousness, heightened promotional activity across retail channels, and ongoing pressure in the pet specialty brick-and-mortar space. Nevertheless, we are reaffirming our fiscal 2025 non-GAAP EPS guidance of approximately $2.60. This outlook excludes potential impacts from acquisitions, divestitures, or restructuring initiatives that may arise in Q4. We remain confident that our Central to Home strategy is not only the right one, but the foundation for long-term success. We see our unique opportunity and responsibility of blending the agility of a start-up with the scale of a large enterprise. Looking ahead, we remain focused on disciplined cost and cash management, while making targeted investments to drive organic growth, especially in e-commerce, digital technology, and innovation. While innovation is still an emerging capability for us, we're encouraged by the early momentum we're seeing from several recent launches. These include Zilla Turtle Sticks made with black soldier fly larvae and shrimp meal, free from artificial colors and preservatives, and Adams Botanicals Spray, a plant-based solution proven to kill fleas and ticks. We also introduced Aqueon SMART LED Lights with app control and Aqueon SmartClean filtration system, which makes water changes faster and easier. Lastly, our KT brand launched the All About the Little Things campaign, celebrating the importance of everyday care for small animals and pet birds. With that, I'll turn it over to Brad.
Thank you, Niko. Expanding on Niko's key takeaways, I'll share an overview of our third quarter results, including the performance of our two segments. Net sales were $961 million, a decline of 4%. Gross profit of $332 million increased 5%, while gross margin expanded by 280 basis points to 34.6%. Margin improvement was driven primarily by the successful execution of our Cost and Simplicity program. The impact of tariffs on our third quarter results was relatively limited, thanks to adequate pre-tariff inventory levels. SG&A expense of $197 million was 2% below the prior year, reflecting continued cost discipline across our businesses. However, given the lower sales, SG&A as a percentage of net sales increased by 30 basis points to 24.5%. Non-GAAP operating income increased 9% to $139 million, and non-GAAP operating margin expanded by 170 basis points to 14.5%. Non-GAAP adjustments in the Garden segment are related to the consolidation of two older distribution facilities in Ontario, California and Salt Lake City, Utah into a larger modern facility in Salt Lake City, incurring a charge of $2.2 million, most of which is in SG&A. In the Pet segment, non-GAAP adjustments are related to the strategic wind down of our U.K. operations and moving to a direct export-only model, a Cost and Simplicity initiative we launched in the second quarter, incurring an additional charge of $1.7 million, again, most of which was in SG&A. Below the line, net interest expense was $9 million compared to $10 million in the prior year, driven by higher interest income from larger cash balances. Other income was $1.1 million compared to $225,000 a year ago. Non-GAAP net income totaled $98 million, an increase of 11%. We delivered GAAP earnings per share of $1.52, an increase of 28%. Non-GAAP EPS rose 18% to $1.56. These record third quarter results underscore the strength of our operations and the positive momentum we are maintaining across the business. Adjusted EBITDA was $167 million, an increase of $11 million. Our tax rate for the quarter was 25.1%. Now, I'll provide highlights from our two segments, starting with Pet. Net sales for the Pet segment totaled $493 million, down 3%. This was primarily due to our strategic decision to exit lower margin durable products and customers. Overall point of sale trends were in line with shipments. Importantly, consumables now represent 82% of total Pet sales, up from 79% a year ago, underscoring our success in building out a higher margin, more resilient consumables portfolio while thoughtfully reducing our exposure to durables. E-commerce remained an important part of our channel mix, accounting for 27% of total Pet sales. Non-GAAP operating income for the segment came in at $78 million, down 6% compared to a record third quarter last year. Non-GAAP operating margin contracted by 60 basis points to 15.8%, largely due to lower volume. Lastly, Pet segment adjusted EBITDA totaled $88 million, reflecting a $6 million decline year-over-year. Now, moving to Garden. Net sales for the Garden segment were $468 million, representing a 4% decline. This was primarily driven by the exit of two product lines in our Garden third-party distribution business following ownership changes. These headwinds were partially offset by continued momentum in our Wild Bird, Fertilizer, and Packet Seeds businesses, each delivering strong broad-based performance across channels. Non-GAAP operating income for Garden rose to $85 million, up $12 million. Non-GAAP operating margin expanded by 310 basis points to 18.2%, reflecting solid productivity gains. Adjusted EBITDA for the segment was $96 million, an improvement of $11 million year-over-year. During the quarter, we repurchased approximately 1.7 million shares or $55 million of our stock. As of the quarter end, $46 million remained authorized under the share repurchase program. Cash and cash equivalents at the end of the third quarter were $713 million, an increase of $143 million. Total debt of $1.2 billion was in line with the prior year. We ended the quarter with a gross leverage ratio of 2.9x. We continue to have no borrowings under our $750 million credit facility. We're reaffirming our guidance for non-GAAP EPS of approximately $2.60 a share for the full fiscal year. And with that, we'd like to open the line for questions.
Questions and answers
Our first question comes from Brad Thomas with KeyBanc Capital Markets.
Niko, my first question for you was around the strong profitability and the momentum that you've had in the Cost and Simplicity program. And I was wondering how investors should think about the opportunity to keep improving margins in what's been a difficult environment should that persist? And then if we think about a recovery, where you think perhaps margins might be able to go for the company?
Sure. Well, what I would say is the company has done just an excellent job around Cost and Simplicity. We've been at this for some time. And I think it's really been ingrained here, and everyone is on board looking for ways to take cost out. I think there's also the simplification piece of this, which we think about every day, how do we simplify the company? But with that comes complexity. So, we're constantly looking to simplify the business, both from logistics, from procurement in a lot of different areas. So, that's ongoing. I think, we've made a lot of progress. We feel great about our distribution centers. I think there's other areas where we can continue to improve margins, and that's around portfolio optimization, SKU rationalization. We're going to continue to take cost out. We still have a ways to go there. And then there's also innovation, which we touched on as well, where we can really start ramping up that innovation muscle, similar to what we've done with Cost and Simplicity. And of course, you always want to innovate with, first of all, great products, but you want them to be margin accretive. So, we feel like we can influence margin in a lot of different ways. Lastly, you're going to be disappointed with the answer, but we don't give a target. We keep it open-ended on margin, and we just come at it from a continuous improvement mindset.
Niko, one thing I'd add to that, you said that we've made great progress on Cost and Simplicity, and we have. But we still have a lot of runway still in front of us. There's still a lot of opportunity for further consolidation, simplification, which should lead to margin enhancement.
Yes. And the work is really never done here, because we do intend to acquire more businesses, and those will have to be integrated.
That's really helpful. Well, knowing that you're probably not going to give us too many numbers behind all this, just to ask maybe a more near-term question on margins and thinking about the tariff implications. Brad, I think you mentioned this quarter benefit from having inventory that had not been exposed to tariffs. Wondering if you could just share with us a little bit more about how to think about the timing of incremental inventory flowing through, what the implications for margins might be and how much you've needed to push through in price to customers?
We anticipate that the main impacts will become apparent in the fourth quarter. Currently, we are implementing pricing actions; however, the market remains challenging, which may lead to some volatility in our pricing strategy. We plan to adjust prices where we cannot fully offset cost increases through other means. While we're not disclosing specific figures regarding pricing impact, it's worth noting that we expect to see significant benefits from our initiatives related to sourcing changes and SKU rationalization in the upcoming year. For instance, we've seen a nearly 50% reduction in purchases from China year-over-year in the third quarter, which is a noteworthy achievement since China was our largest source for tariffable imports. We have made considerable progress in reducing our exposure to China by sourcing elsewhere and rationalizing SKUs. Considering the remaining pre-tariff inventory and the delay in pricing benefits until next year, we estimate a total tariff impact of around $10 million this year, with most of that effect occurring in the fourth quarter.
And our next question comes from the line of Bill Chappell with Truist Securities.
This is David Holcomb speaking for Bill Chappell. I would like to know if you could provide some insights on pet trends, both for the overall category and your business, as we approach the end of the year. Are things unfolding as you had anticipated?
Yes, I can take that. This is John. We certainly have a challenged consumer out there, and we have a challenged customer base with Pet Specialty relative to traffic. Now, the good news is we're seeing pet ownership stabilizing in our Live Animal business, which we've got a Live Animal business, and that is stabilizing as well. That said, our Consumable business at Central, we were lapping a record top and bottom line Q3 a year ago. Our Consumable business is flat, and our Durable business really is declining. Brad mentioned double digits. We're still seeing durables kind of in those mid to high single-digit declines. But as tariffs come into play here, it's something we have to continue to look at.
Yes. And our consumables also tend to be higher margin. So that's had an effect on our margins as well as that durable piece shrinks. It's actually accretive to our business.
Appreciate the color there. And could you maybe elaborate a little bit on if there were any particular categories for Garden that drove EPS upside?
Yes. This is J.D. I would say that the categories that have driven our business overall this year in what was a challenging year from a weather standpoint. We had certain categories, certain business units that delivered extremely well. And I'd say that Wild Bird food has been a driver this year for us, along with our Fertilizer business, which is primarily private label contracts that we picked up this year as well as Grass Seed, very strong consumption for the Grass Seed category and our Packet Seeds business. Those categories would be the strongest producers for us this year.
I would add to what J.D. said. We talked about the live goods business, which was really challenged a year ago. The team there has just done an incredible job of improving the operational efficiency there, taking cost out, SKU rationalization. The weather was actually probably worse this year for live goods during that sort of contracted season.
And our next question comes from the line of Jim Chartier with Monness, Crespi & Hardt.
Could you quantify the impact of the exited product lines on third quarter and year-to-date sales for both Pet and Garden?
I don't think we've got those numbers in front of us.
I don't think we do.
I mean with
What I would say on the Pet side, it was significant, right? So, the assortment rationalization we did on Pet, we said that was a big driver and the categories are soft in durables. The assortment rationalization was a bigger impact than the category decline.
I mean on the Pet side, durables were substantially all of the decline.
Yes, all of the decline.
A lot of that was in aquatics.
It's hard to quantify on the Garden side as well. We exited some unprofitable markets, some unprofitable SKUs, but again, I can't quantify it at this point in time.
And then the vendor partner.
Those two were.
What everyone is summing up here, though, what I would say is we're not losing high margin businesses here. These are very intentional moves.
And I think you can see that in the P&L, right? Top line pressure but gross margin has improved nicely, and it's flowing through to operating margin as well.
When we enter Q4, it will be the first quarter in which Enerpet, the business that we sold, will no longer affect our results. Therefore, there will be no revenues coming from that business. This will have a significant impact on Q4, but it will be primarily from a revenue perspective.
Okay. I'm just trying to understand if the underlying trend for sales is closer to flat for the company if you exclude kind of the intentional exits?
I don't know if it's flat. We'd have to get back to you on that.
I don't think we have those numbers in front of us.
I don't know if it's incremental in any way. It gives us a greater amount of flexibility, improves our service levels, simplifies our logistics footprint. So, I think the way we think about it is it's really more of a cost-out initiative as opposed to incrementality. But a lot of times, when you become more efficient and fill rates go up, it could lead to a little bit of a lift in sales.
I think from a service standpoint, we'll be covering over 95% of the country in less than two days. So, from that standpoint, I think it will be a benefit.
And our next question comes from the line of Bob Labick with CJS Securities.
On the Garden side, I believe you won some private label business here. I was just hoping you could give us a sense of how much of an impact from that win was this year? Should that carry over and drive incremental sales next year? Or is it fully into this year?
Bob, it's J.D. I'll speak to that. So, first of all, on the private label gains that we picked up at two major retailers. We saw some of the benefit this year, and we'll see benefit next year as well. They had to work through existing inventories of the previous supplier. So, we saw some of the benefit and then there'll be carryover. And then we picked up some additional stores with one of those two retailers for next year as well. So, we'll see that benefit.
Yes. And the work is really never done here, because we do intend to acquire more businesses, and those will have to be integrated.
Yes. Most of that will stop shipping those products this year, but we will have a challenging comparison carrying into next year.
We start to lap that loss of the two product lines this quarter, Q4.
Yes, yes.
By the way, the reason we were awarded more stores is because of great execution.
Fantastic execution. It's a beautiful business. We were glad to pick that up, and it's our in-store execution, the team there is doing a phenomenal job and gaining market share in this category. The retailer recognized that and awarded us additional business.
That's great. Well, congratulations on that. And you spoke to this a little bit, but I guess, again, thinking about next year in general, how much longer do you expect to see kind of a top line, I guess, self-imposed headwind from the SKU rationalization? Is that a full year, next year as well? Or when will you lap that?
We don't know yet. We still need to put the plans together for next year and really understand what the top line will look like. We also have to consider the estimates on innovation and other initiatives we are pursuing.
And that's not unusual. Typically, the line review process, we don't know until late August, sometime September, what line review listings will look like for the following year.
Yes.
Okay. Great. My last question is, considering the current status of the tariff exemption, if tariffs were reintroduced on all incoming goods, would that have any impact on you? And regarding the Pet segment, are you observing any effects from that? Or since durable goods represent such a small portion of your portfolio, is it not something you are closely monitoring?
Yes. We are watching it. It's hard to get good data on it, but we aren't seeing any meaningful impact at this point related to it.
No, we're not. I think there's potentially that it could be a tailwind.
And this quarter has started off good from a ship perspective and POS perspective.
And our next question comes from the line of Brian McNamara with Canaccord Genuity.
This is Madison Callinan on for Brian. What will it take for Garden to return to a consistent modest growth? Understanding weather is a factor with industry participants saying that the consumer is engaged. Can you give a little more color on why it isn't showing up in results?
Madison, this is J.D. Weather is a factor, as you said, it's the largest factor that usually impacts the Garden business. So, we need some favorable weather. We play in lawn and garden consumables. Our retailers are very engaged. And I think that some of the metrics on the Garden P&L look very favorable. But we still feel very optimistic about this. We'll work through the losses of these vendor partner businesses. And I am encouraged by the fact that our manufactured products, our branded business is growing nicely.
Well, I would say too that J.D. is being modest, but on the Garden side of our business, the relationships with the larger customers have never been better. And I think you see that with us picking up private label business.
It has. Yes. Our retailers have remained engaged. They haven't given up on the season by any means. So, we think there's still runway in this year as well.
And our next question comes from the line of William Reuter with Bank of America.
Just a couple. The first, you mentioned that the aggregate amount of tariffs in the fourth quarter would be $10 million. Is that right?
That's full year. That's full year.
Got it. I guess if we think about what the run rate implies for next year, I guess, if the fourth quarter was $7 million, most of this is Pet, does that kind of imply that we'd be at a run rate of maybe something like $30 million for next year on an unmitigated basis?
Not really. I think we need to come back to you after year-end and talk about it in a bit more detail because the situation is very fluid.
Yes, we're trying everything we can to mitigate tariffs or concessions, moving country of origin and SKU rationalization.
So, kind of similar to when we gave the answer on top line, we've got a lot of work to do as far as our '26 plan, and we'll be back to everybody with more guidance.
Got it. And then multiple times, you've mentioned private label and how your strong relationships with some of your customers have allowed you to pick up share. Are they changing the percentage of their floor space allocation to private label versus branded? Or are you picking up private label that was being produced by competition?
It's a combination of both. We are picking up private label that was produced by competition. At the same time, I mentioned our field team, our retail merchandising team, and they execute with excellence in the stores, which gets more off-shelf activity for private label. So, it's a combination of us picking up the product from that was previously manufactured by others and then better execution in store.
Got it. And then my last question, do you have a kind of long-term growth rate expectation for Pet consumables? There are numbers that a lot of different participants in this category throw out there for their expectations. And I was wondering if there was something that you guys had kind of tried to center your planning around?
Well, the good news is that we're seeing pet ownership stabilizing, and we're actually seeing our Live Animal business stabilizing as well. Long-term, we believe this category can grow low to mid-single digits. And it has historically, and there's no reason to think it won't in the future.
This was our last question. Thanks, everyone, for joining our call today. The IR team is available for any questions that may arise after this call. Thank you.
Thank you. And with that, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time.