Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Fiscal 2021 Third Quarter Earnings Call. My name is Victor, 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. As a reminder, this conference call is being recorded. I would now like to turn the call over to Friederike Edelmann, Vice President, Investor Relations. Please go ahead.

Thank you, Victor. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Chief Executive Officer; Niko Lahanas, Chief Financial Officer; J.D Walker, President, Garden Consumer Products; and John Hanson, President, Pet Consumer Products. Tim will provide a business update, and Niko will discuss our Q3 results and our outlook for fiscal 2021 in more detail. J.D. and John will join us after the prepared remarks for Q&A. Our press release providing the results for our third quarter ended June 26, 2021, and related materials are available on our website 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, EPS and other guidance for fiscal 2021, expectations for new capital investments, product launches and future acquisitions are forward-looking statements subject to risk 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 24. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events or otherwise. Now, I will turn the call over to our CEO, Tim Cofer. Tim?

Thank you, Friederike, and good afternoon, everyone. Welcome to Central's Q3 earnings call. I hope you, your friends and family remain well, as we continue to navigate the still unchartered waters of this pandemic. I'm pleased to report that our business continues to grow as consumers embark on this next chapter of their lives. While many things will look different in the months ahead, we remain committed and confident in the garden and pet industries and Central's ability to perform well despite a challenging and uncertain environment. Today, Niko and I will discuss our third quarter results, our revised outlook for the fiscal year and provide recent examples of our Central to Home strategy in action. First and foremost, I'm thankful that our workforce continues to remain healthy and diligent. We're carefully monitoring the status of the Delta variant and the CDC guidelines. We remain committed to encouraging and educating our teams about the benefits of the vaccine to ensure we keep our employees and customers safe. All of our manufacturing facilities, greenhouses and distribution centers remain open and fully operational. Thanks to our dedicated workforce, I'm pleased to share that Central has delivered strong growth across both segments in our fiscal third quarter. We're encouraged by our continued record results, especially when you consider we are lapping extraordinary growth in the prior year third quarter. These results reflect the quality of our teams, our progress against our long-term strategy and importantly, our ability to stay agile as we react to a highly dynamic and shifting consumer and cost landscape fueled by COVID. As we did last quarter, I'd like to share some noteworthy examples of how we were bringing our Central to Home strategy to life. First, as shared in our Investor Day last year, we've outlined a new…

Thank you, Tim. Good afternoon, everyone. We are once again extremely pleased with the performance of our business, especially in light of the extraordinary results in the prior year quarter. Third quarter net sales broke the $1 billion mark for the first time in the company's history, reaching $1,037 million. The increase of 24%, or $204 million was driven by $137 million of inorganic contribution from our three recent acquisitions as well as organic sales increasing 9% or $67 million. Consolidated gross profit increased $58 million to $320 million. However, gross margin decreased 50 basis points to 30.9% due to the impact of initial purchase accounting related to our three recent acquisitions, cost inflation in key commodities such as milo, millet and sunflower as well as in labor and freight, most notably ocean freight. SG&A expense increased 32% to $207 million, driven by inorganic increases in the garden segment related to our recent acquisitions, higher commercial investment and increased logistics costs resulting from volume growth and inflation. SG&A as a percentage of net sales increased 110 basis points to 20%. Operating income increased $9 million to $113 million, while operating margin decreased 170 basis points to 10.9% due to gross margin compression, rising logistics costs, especially ocean freight and heightened investment spending into capacity expansion, brand building, consumer insights and e-commerce. Adjusted EBITDA increased $16 million or 14% to $134 million. Turning now to our garden segment. Garden segment sales increased 42% or $157 million to $529 million. Excluding the contribution from acquisitions, organic sales increased 5%, with the most notable growth coming from our Bell live plant business, garden distribution and wild bird feed, driven by our Pennington brand. Garden segment operating income was $67 million, an increase of 3%. Garden segment operating margin declined by 480 basis points…

Ladies and gentlemen, we will now have our question-and-answer session. Our first question comes from Andrea Teixeira with J.P. Morgan. Please proceed with your question.

Hey. Good afternoon, everyone. It's on for Andrea. So, thanks for taking the question.

Good afternoon.

Just at a high level -- good afternoon. So we've heard from quite a few companies recently around retail customer's kind of readjusting their inventory positions sort of given the increased foot traffic in physical retail and maybe a little bit less shopping kind of from an e-commerce standpoint. So just at a high level, have you observed any of these adjustments so far with your retail partners? And has this had any impact on orders? And then, if we can just add one more. I guess, are you guys -- you mentioned kind of elevated demand and its stress on your service levels. So, can you just comment again on just the level of disruption across your supply chain, if there is any, just given the elevated demand? And I guess how confident are you, as we kind of look ahead to service this elevated demand across both divisions? Thanks a lot.

So, just at a high level have you observed any of these adjustments, so far with your retail partners and has had any impact on orders. And then if I just add one more I guess are you guys you mentioned kind of elevated demand and stress on your service levels. So can you just comment again on just the level of disruption across your supply chain, if there is any just given the elevated demand? And I guess, how confident are you as we kind of look ahead to service is elevated demand across both divisions. Thanks a lot.

Sure. Well, I'll start and certainly invite J.D. and John to comment on some specifics in their respective garden and Pet businesses. I think on your first question, we are seeing that shift from a channel standpoint on a year-over-year basis. So in other words, if you think about Q3 of '20, we were in the kind of early lockdown period. And from a consumer and shopper behavior standpoint, you saw a massive migration to online that really favored e-commerce channel, particularly in pet, but also in garden relative to traditional brick-and-mortar. There were also, at that time, prior year, some restrictions that certain retailers had, particularly as it relates to garden center offerings. So, then as you look at this year, on the year-over-year comparison, when you're lapping those, call it, on the pet side, 50% increase last year in our e-commerce channel. On the garden side, triple-digit increases on the e-commerce channel. What you're seeing this year is on a year-over-year basis, a more muted e-commerce growth and a more -- on a relative basis, an accelerated brick-and-mortar growth. And those dynamics then add up to the numbers that we shared, which on both pet, which was a 10% growth on the quarter and on garden, which was, call it, a mid-single-digit organic growth, obviously, with the acquisitions much higher. That's how you see that dynamic shake out. As it relates to inventory and kind of sales versus consumption, very much in line on the pet side, so sales growth of around 10%. We saw POS growth also around the 10% range. So, don't see any real issues there. On garden, you see a slight difference on POS versus sales. But I'd say overall, again, last year, we had inventory levels that were lower at garden retailers. And this year, retailers were prepared for that season and did a better job. So I don't know, J.D., any other color you want to talk about garden inventories related to his question?

Tim, I think you touched on the major points there with regards to shifting from e-commerce back to more traditional modes of shopping. A year ago, many of our retailers still had their garden centers locked, and consumers couldn't gain access to outside garden. So this year, we're seeing less buy online pick up in store, less curb side pickup and more people venturing out and shopping lawn and garden consumables the way they traditionally have. And I think what you said of wrapped inventory levels, it's absolutely accurate. I'm not alarmed by the inflated inventories at retail. The retailers don't appear to be either. They came into this year very aggressive on inventory. And as we've gotten into the summer months, we're now comping a period last year where they had widespread out of stock. So it's a little bit of a difficult comparison, if you will. Year-over-year, you would expect inventory to be up somewhat and they remain very bullish on the year. So, I think that we haven't had any difficult conversations with customers around inventories, inventory balancing or anything like that, but we are somewhat inflated versus prior year. And John, I'll turn it over to you.

Yes. No, I'll just echo what Tim said. I think he described it well. Foot traffic in brick-and-mortar is definitely up, and we lapped significant growth in e-commerce prior year. And our POS, for the most part, matches our shipments.

Yes, that's right; so not an issue there. And then, the second part of your question was related to service levels. And indeed, as we've shared in the last couple of quarters and again in the call today, really it's a situation where we've experienced two consecutive years of unprecedented increase in demand in both pet and garden industries, significant expansion in household penetration and in buy rate and category participation. And that has left us in a situation where on a number of our businesses, demand has exceeded supply. On top of that, we all know across the -- industries across the world, the global supply chain is tighter. And that impacts everything in terms of raw materials, components, ocean freight, domestic transportation and labor. And so that has all culminated in a service level that, quite honestly, is not up to our historic standards and one that we're working very aggressively to improve with our retail partners. Accordingly, that's why you've seen a doubling of our CapEx expenditure year-over-year. I think Niko and I have shared earlier a $70 million to $80 million figure of CapEx. We put that at the high end of that range at this point, which is about double of what we spent last year and in the prior years. The vast majority of that CapEx is being spent on adding capacity on a number of our businesses. This would include a dog and cat on our dog treats and dog toys business. This would include wild bird, aquatics, grass seed, controls. Each of these businesses, we are adding incremental capacity. And then in terms of, okay, when does all this come on? Obviously, BU, business unit by business unit, the answer differs. But in aggregate, I think certainly by the middle of next year, we're going to be in good shape in terms of these capacity expansions and back to service levels that we're proud of and that our customers expect.

Great. Thank you so much. Good luck.

Thank you. Our next question comes from Bradley Thomas with KeyBanc Capital Markets. Please proceed with your question.

Good afternoon, everyone. This is Andrew on for Brad. Thanks for taking our questions here. I was wondering if we could start by talking a little bit more about weather. We've heard from many others in the industry that weather was unfavorable, particularly in May and June. Could you talk about what you saw from a weather perspective during the quarter and how you thought that impacted your own results and POS sales in the quarter?

Hi, Andrew. It's J.D. Sure, I'll be glad to take that. Yes, I'll keep it very general. But I would say that we saw some extreme weather in the quarter. And for lack of a better explanation, I think the eastern part of the US saw too much rain and the western part of the US saw not enough, so drought conditions and extreme heat. And that affected many of our markets. It's also affecting some of the crops that we would be dependent on for grains and things like that and for our grass seed business as well. So, we saw some extreme. We saw two extremes, I should say, with regard to weather in different parts of the country and it has definitely impacted consumption. And we could see that on a week-to-week basis as we compare versus prior year. Particularly in markets, when we're looking at markets where they had a strong comp last year and we're looking at a weekend where it rained the entire weekend in the eastern market, we could see it in the POS consumption. So, we've referenced that many times that last year was near-perfect and this year has been anything but that. And I know our competitors talked about that earlier today as well. And I would concur with regard to that.

Thank you, that's very helpful. And you mentioned that the impact of acquisitions would be accretive to the year by the range of $0.11 to $0.16 on a EPS basis. Could you share how much of that was realized this quarter and how much we should expect to be realized next quarter? And then how does your recent acquisition of D&D provide upside to this?

This is Niko. So last quarter, we called out $0.07 accretion on the acquisitions. Well, I will tell you this quarter will be -- was higher than that. We're not going to give out specifics at this time. And then, I think as we look at Q4, that will turn negative. The bulk of those acquisitions are very seasonal and will not be contributing to EPS in Q4. So that's kind of the color there.

Understood. And so the guidance you've given for 2021 has been pretty helpful here. But as we think about fiscal '22, are there any high-level thoughts or guardrails you think we should keep in mind for our models?

Look, I'd say, first, we're actually in the process in the next couple of weeks of putting together our fiscal '22 operating plan. In addition, we are in very productive discussions right now with our customers, both on the garden and on the pet side in range reviews and agreeing on product listings and early promotional calendars. So it is a little premature to talk fiscal '22. Obviously, we will do that and expect to give guidance in our next quarterly call here in about 90 days. What I would tell you broadly is, obviously, starting at the top line, I mean, we've had two extraordinary years of growth on the organic side. And I think on the pet side, we would expect, given the significant increase in pet adoptions that some level of returning to normative growth levels on pet is probably likely. On the garden side, it's a situation where two incredible years, weather is always the wildcard and we'll need a little bit more time to make a determination on that. On top of that, we will have the benefit of our four new acquisitions. A lot of that year-over-year will prove to be favorable going into fiscal 2022, both top and importantly, bottom line. So at this stage, that's about all we'll share. We're keeping a keen eye on the cost envelope. Obviously, this year has been a very inflationary year across key commodities, across our labor and across transportation domestic and ocean freight. And we'll have a better visibility on fiscal '22 when we talk to you again here in a few weeks.

Understood. Thank you. That's all from me.

Thank you. Our next question comes from William Reuter with Bank of America. Please proceed with your question.

Hi. I just have one, but I guess a couple of parts to it. But once again you're in a situation where you have a lot of cash on the balance sheet. You have a lot of acquisitions that you're still continuing to integrate. I guess, can you talk a little bit about what the pipeline looks at this point? Where -- in which segment you're seeing more opportunities? And then, I guess how valuations are in the market generally? Thanks.

Sure. Yes, all of it's true and all of it's quite intentional. So M&A being one of the cornerstones to our growth initiatives, we always want to make sure that we've got the appropriate liquidity on the balance sheet. So as we've acquired, we've also replenished that cash on the balance sheet. I would say the integration is going extremely well. We're really pleased with the acquisitions. We've inherited some great businesses and some great management team, so very, very pleased there. I would say the pipeline is still robust and we meet monthly, weekly, on looking at deals. So, we're seeing a lot of deals still come across our desk. I would say it's largely balanced between pet and garden, so not more one than the other, and valuations are still a bit on the frothy side. And again, you've got to look at, lot of times the larger ones tend to command sort of the higher multiples. So, we're still remaining disciplined. We're looking at a lot of deals and we're going to continue to do what we do irrespective of the market. We're always going to look for value growth investments, if you will. Really, that's what we look for.

Great. Thank you.

Thank you. Our next question comes from Jim Chartier with Monness, Crespi and Hardt. Please proceed with your question.

Hi, thanks for taking my questions. I was hoping you could provide some color on fourth quarter. Looks like a big swing from positive $0.25 EPS last year to negative, maybe $0.25 or so cents this year. And wanted to know if you could give us some color in terms of, is it freight costs and input costs and cost pressure, that's the primary factor you continue to invest in SG&A? I think some color there would be helpful. Thanks.

Sure, Jim. This is Niko. The way I would kind of characterize Q4, I think you've got to take a step back and look at Q4 a year ago. And we were in an incredible environment between the weather and garden, the lockdown. Things were just hitting on all cylinders. So to say, we're lapping a tough comp would be a massive understatement. So, I would kind of start there and then look at the environment we're in now, where you've got some commodities really taking off. You know, we're trying to manage that. The other thing I would point out is the acquisitions that we've done, which I alluded to earlier. They're going to go negative in Q4. Probably two to three, actually two of the four now, if I include D&D. So, they probably will not be accretive to earnings. So, we kind of have that headwind as well. And then looking at ocean freight and logistics costs, we don't know what's going to go on there, as well as our investments. So, we feel really bullish about the business. We feel like now is the time to invest and so we're going to take that opportunity now. And that's obviously going to contribute to a little bit of movement there on the bottom line.

Okay. And then, can you talk about your latest adoption trends that you're seeing for dogs, cats, and small animals? Is that still continuing to grow, or is that kind of flattened out?

Sure. We continue to feel very good about what we're seeing on the pet ownership standpoint. The data that we see suggest that in 2020, there was that huge initial spike with the COVID lockdown, growth somewhere in the mid-single digits. We saw household penetration of dog up 8%, cats were up 5%, other pets everything from small animal to bird, to reptile in aggregate, up double digits. We also saw a third of existing pet households adding another pet. And we saw a disproportionate relative to existing consumer cohorts, a disproportionate increase came from younger generations. When we look at year-to-date data this year, we see that growth rate continuing, albeit at a more muted level. And I think what all that suggests is the pet industry and the ability to throw off a consistent low to mid-single-digit type growth is the type of opportunity we've got in front of us for the next few years.

Great. And then, on the capacity expansion projects, you talked about potentially having some of those come on in the second half of this year. Is that happening? Or have they kind of been delayed and then pushed out into next year?

Quite honestly a bit of both, Jim. So in a couple of cases, we've had both, some weather delays on some major expansions in facilities, consistent with what J.D. said around significant rain in some of our Midwest and Southeast locations, as well as quite honestly, given the tight global supply chain, some equipment delays, some ocean freight delay. So that's been a bit of the story in some. In others, we are ramping up the new capacity as we speak here in late, what was late Q3 and into fourth quarter. But if you look at all of them and I think earlier in the call, I listed six or seven of our major business units where we've added some of that capacity, all of that's going to be online by mid '22, really starting from the last month or so through mid-fiscal '22.

Great, thanks. And best of luck for the fourth quarter.

Thank you.

Thank you. Our next question comes from Carla Casella with J.P. Morgan. Please proceed with your question.

Hi. I'm wondering if you have any comments in terms of how you are comfortable taking leverage in the event of M&A?

Sure. So, we've been pretty consistent. Our optimal structure would be in that 3 times to 3.5 times range. For the right deal, we'd be willing to lever up into the low-4s and then quickly delever back down to that 3 times to 3.5 times range.

Okay, great. And then, just given that retailers have better inventory today and not chasing as much, are you starting to see any pickup in the promotional environment?

J.D., you want to comment on garden?

Sure. Hi, Carla. It's J.D. here. We're seeing some pickup in promotional activity versus prior year. But I would say that we're not back to pre-pandemic levels of promotion. So if last year -- I mean last year, it went to practically zero. And this year, I'd say that in a range less than 50% of where they were in 2019 and before. So, we're not back to that level yet. And I do think that, that has a pretty profound impact on our business model. Our business model is a trade that consumers want in the store. We rely on promotions and off-shelf activity. And I think that that has hurt us somewhat over the last year or year plus. So, we look forward to next year and beyond when it returns to normal levels.

Yes. And I'd say, on the Pet side, very consistent. We're seeing a pickup in promotional activity, but it's nowhere near where it was pre-pandemic. And we look forward to accelerated activity in our Q1.

Okay, great.

Thank you. Our next question comes from Oliver Grossman with Jefferies. Please proceed with your question.

Good afternoon. I was wondering if you could provide any color on how you plan on offsetting inflationary pressures. Would you say it's more pricing or more cost reduction initiatives? And then how are retailers responding to those price increases, if that's present?

Sure. Yes. I mean it's definitely a combination of what you said. I mean, we have not been shy about pricing in this fiscal year and that's both on the garden and on the pet side. If you look at the total cost pressure envelope that's hitting us and it's hitting us on all fronts, right? It's hitting us on key commodities. It's hitting us on higher labor costs. It's hitting us on domestic transportation, logistics, as well as ocean freight. Pricing to offset that has been the biggest lever this year. The second has been what is a growing discipline around cost-out and what we call our net productivity agenda. If you add the pricing efforts and our productivity efforts, we will come up shy of matching that inflationary pressure. But we will cover the majority, not all of it, but the majority. As we look to fiscal '22, we would expect some additional pricing, particularly as we're talking about line reviews and going into season on the garden and the pet side. To the end of your question, that's obviously right now part of the dialogue, discussion and negotiation with our customers. Pricing is never a welcome discussion with our customer, partners. But at the same time, they realize that we're not alone that these increased costs are fairly common across the industry, and they're seeing it pretty well broad-based. So both J.D.'s team and John's team are doing a good job of providing the right rationale. And we're in this for the win-win with our retail partners. We want them to make a reasonable margin. We need to make a reasonable margin and we need to continue to pass on good value to our end consumers.

Great. Thanks very much.

I think we have time, operator, for one more question if there is one.

There are no further questions at this time. So, I'd like to turn the floor back to Tim Cofer for any closing remarks.

Thank you. I want to thank, everyone, for joining today's Q3 earnings call. We appreciate your interest in Central Garden & Pet. We wish you a good week. And we'll talk again soon. Thank you.

Ladies and gentlemen, this concludes today's webcast. You may now disconnect your lines at this time. Thank you for your participation and have a great day.