Central Garden & Pet Company

Ladies and gentlemen, thank you for standing by. Welcome to Central Garden and Pets 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. If anyone should require operator assistance during the call, please press star followed by zero on your touchtone phone. As a reminder, this conference call is being recorded. I would now like to turn the call over to Frederic Edelman, 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, Nico Lajanas, Chief Financial Officer, J.D. Walker, President, Garden Consumer Products, and John Hansen, President, Pet Consumer Products. Tim will provide a business update, and Nico 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 in June 26th. 2021 and related materials are available on our website at ir.central.com and contain the gap to non-gap reconciliation for the non-gap 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 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 Koch. Tim?

Thank you, Frederica, 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, Nico 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 are 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 are bringing our central to home strategy to life. First, as shared in our investor day last year, we've outlined a new commitment to put the consumer at the center of our business. We want to build and grow strong brands that consumers love. We're investing in consumer insights, strengthening our brand foundations, and developing multi-year innovation pipelines across our key brands. In our dog and cat business, we've launched some exciting innovation, including new Nylabone puppy kits, new flavor and format extensions of Nylabone Nubs dog treats, and new rawhide offerings from our Cadet brand. Another example of recent innovation success is our Aquion Aquatics brand. This year we launched a patented aquarium kit with SmartClean technology. It combines the easy-to-clean function fish keepers need with the styling and design they want. The SmartClean technology allows consumers to perform water changes in less than two minutes and improves the water quality for a happy and healthy fish. It's easy to use and suitable for first-timers and experienced fish keepers of all ages. Each of these innovations are exceeding our high expectations, and they're over-indexing in our Q3 total pet branded sales growth of 11% versus prior year. Next, to our customer strategy. where our goal is to win with winning customers and channels. We've started to tap into the digital direct-to-consumer capabilities of one of our newest acquisitions, Do My Own, as part of our efforts to build a leading e-commerce platform. We are working to integrate Do My Own's customizable technology into the central network, which should allow some of our business units to operate at an even higher level of efficiency when it comes to e-commerce. We've just kicked off our first integration project, and we'll share more details in the future. Our third strategic pillar focuses on strengthening our company's portfolio, and a key element here is our M&A agenda. As you may have seen, just last month, we announced the acquisition of the D&D bird feed business. This latest addition to our family will allow Central to continue to build scale in a core category and leverage the D&D premium brand portfolio. Since the outbreak of the pandemic, the wild bird food category has experienced incredible demand. In fact, an estimated 34 million households participated in the category in 2020, an increase of 11% over the prior year. and we're seeing new and younger consumers continue to join the category throughout 2021. With the addition of D&D, we will now have more capacity and portfolio breadth to meet our customers' and consumers' needs. This is our fourth acquisition in the last eight months, and we feel good about our integration progress. We continue to prioritize growth both organically and by our M&A agenda, and we are actively looking for additional attractive assets in both pet and garden. We look forward to keeping you posted on what's to come. The fourth pillar in our strategy, cost, is focused on reducing costs to improve margins and fuel growth across the enterprise. An example of work underway in this area is a project involving our pet bedding business and Arden. our industry-leading outdoor cushion business. These two businesses use the same raw materials, utilize suppliers with the same skill sets, and have some of the same large retail customers in common. Our teams are excited to collaborate with each other as they capture scale benefits, realize synergies, and fuel growth through strategic sourcing and the implementation of technology and automation. We expect benefits in both efficiency and effectiveness as we pursue the synergistic opportunities across these two businesses. And finally, our culture pillar, which is dedicated to our greatest asset, the 7,000 employees here at Central. As mentioned last quarter, we're very focused on creating training programs centered around capability building, and we're seeing high engagement and early results from those efforts. In Q3, we rolled out a new online learning platform that allows us to provide thousands of on-demand training courses and develop learning paths for critical skills ranging from e-commerce to gross margin management for all of our employees across the company. Lastly, for the first time in the company's history, Central was named one of America's best midsize employers by Forbes. Inclusion in this list is especially meaningful because it's compiled from data provided by our employees. And this recognition is a direct reflection of the efforts and achievements of our entire team. Our world-class team members are at the heart of our company. and we're very proud to be included on this list. Now, to provide some color on our Q3 performance, net sales increased 24% driven by our three recent acquisitions, as well as organic growth in both segments. Gross margin decreased 50 basis points to 30.9%, largely due to initial inventory-related purchase accounting adjustments from our recent acquisitions. and to a lesser extent, from cost inflation headwinds, which were only partially offset by our pricing and net productivity efforts. Operating margin of 11 percent declined 170 basis points, driven by gross margin compression, rising logistics cost, and purposeful heightened investment spending. Importantly, our strong growth led to EPS expansion of 8% over the prior year. Given this performance, we are raising our outlook for fiscal 2021, and Nico will share more details in his remarks. Now, turning to our two segments. While we've recently seen consumers' personal travel, entertainment, and dining pick up, and many of us are returning to the office at least part-time, Long-term trends such as rural revitalization, homesteading, pet humanization, health and wellness, and sustainability continue to bring new consumers, especially millennials, into both the garden and pet industries. Sales in our pet segment increased 10% versus prior year, driven in particular by our dog and cat business, live animals, pet distribution, and our aquatics business. We gained share in dog treats with our Nylabone and Cadet brands, in pet bird with our KT brand, in cat calming with our Comfort Zone brand, and we maintained share in most of our other pet categories. E-commerce continues to be an important part of our pet business. In Q3, we lapped almost 50% growth in the prior year quarter as consumers shifted to online purchasing and avoided traditional brick and mortar channels due to COVID concerns. This quarter, e-commerce represents a meaningful part of our business at approximately 20% of pet-branded sales and will play a critical role in our future growth algorithm. Shifting to garden. You will recall last year was an excellent weather year for lawn and garden, and the industry experienced unprecedented growth given consumers staying at home and beautifying their outdoor spaces. While we saw some declines in foot traffic in the quarter across many of our leading retail partners and our POS consumption has slowed, we still delivered organic growth of 5% versus prior year. We believe most of the new gardeners gained during the pandemic will continue to be engaged with our brands as we settle into the new normal. Our live plants business, garden distribution, and wild bird feed drove the organic growth. And in particular, we gained share in wild bird feed. In addition to our legacy garden business, our three new acquisitions from earlier this year added $137 million in net sales. And they are delivering consistent with our business propositions. As you know, D&D closed just after quarter end and will be included as of the fourth quarter. While we're certainly pleased with our strong results, the ongoing elevated demand for our pet and garden brands continues to put pressure on our manufacturing capacity. And while our service levels have improved, we can still do better. As you recall, we are investing in capacity expansion and automation to meet the continuing strong demand. We are on track to double our capital expenditures in fiscal 2021 versus historic levels, with most of the spending aimed at increasing manufacturing capacity. Additionally, we continue to face the inflationary pressures stemming from the COVID-19 operating environment, including notable increases in costs for key commodities, labor, and logistic costs, both domestic transportation and ocean freight. As such, we remain focused on our net productivity agenda, leveraging our scale across the enterprise and pricing to offset these inflationary pressures. Let me wrap with a view towards our priorities for the fourth quarter. we are making important investments to drive future profitable growth. These include investments in brand building, consumer insights, innovation, and e-commerce. Second, we are focused on integrating our four recent acquisitions with excellence, ensuring they deliver on our investment thesis, and we capture any smart synergies along the way. And finally, We are addressing the challenging supply chain environment through significant capacity expansion to improve our service levels and pursue cost out opportunities and pricing to help offset cost inflation headwinds. With that, let me turn it over to Nico, who will share more details of the Q3 results and our revised outlook for the fiscal year.