Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Third Quarter Fiscal 2020 Financial Results Conference Call. My name is Devin, and I will be your conference operator 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. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Howard Machek. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us. With me on the call today are Tim Cofer, Central's Chief Executive Officer; Niko Lahanas, Chief Financial Officer; J.D. Walker, President, Garden Branded business; and John Hanson, President, Pet Consumer Products. Our press release providing results for our third quarter ended June 27, 2020, 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 Tim, I would like to remind you that statements made during this conference call which are not historical facts, including the potential impact of COVID-19 on our business, expectations for new product introductions, long-term organic growth goals, future acquisitions and future revenue, margin expansion, cost savings and profitability 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 27, 2019. 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?

Thanks, Howard. Good afternoon, everyone, and thank you for joining our Q3 earnings call. I hope you, your colleague and love ones are all safe and healthy. Thankfully, the Central team has continued to see a relatively small number of cases of COVID-19, and our facilities remain diligent about maintaining the highest health and safety standards. Thanks to our team's hard work, all of our manufacturing facilities and distribution centers remain open and fully operational. I'm very proud to share that Central Garden & Pet's third quarter was the best-performing quarter in our company's history. As you saw in our press release, overall sales for the quarter increased 18% versus prior year. Our sales growth was driven by broad-based organic strength of 16.5% with contributions from both segments as well as the inorganic contribution of our C&S acquisition. As I reflect on how our company has been managing over the past few months, I attribute our strong performance to a few factors. First, and most importantly, our people. I continue to be inspired by the resilience and dedication of our employees across the company as they collaborate with each other, with their communities and with customers to ensure our business operates safely and as seamlessly as possible in these truly unprecedented times. This has required incredible commitment and coordination. In recognition of our front-line workers across manufacturing, logistics and merchandising, I am pleased to share that we recently awarded a well-deserved special bonus to thank them for their unwavering dedication. Second, the attractiveness and resilience of our industries. Despite the volatility and upward – downward pressure seen across various industries over the last few months, both the pet and garden industries have remained strong, proving that they can weather tough storms and maintain a resiliency in recessionary environments. Our retail…

Thank you, Tim. Good afternoon, everyone. Third quarter total company sales increased 18% or $127 million to $834 million from $707 million in the third quarter of last year. Acquisitions contributed $10 million of revenues in the quarter. Organic sales were up 16.5%, aided by gains in both segments, particularly in the e-commerce channel, as Tim described earlier. Consolidated gross profit for the quarter increased $43 million and gross margin increased 40 basis points to 31.4%, driven by favorable mix of product sales and pricing. SG&A expense for the quarter increased 5% or $7 million versus a year ago. This increase was driven by a number of factors, including higher variable compensation accruals and logistics costs in conjunction with strong results, inorganic spending from our C&S acquisition as well as PPE costs. These increases were partially offset by lower travel and entertainment and promotional spending. Our corporate expense increase was primarily due to higher variable compensation accruals and PPE costs. As a percent of sales, SG&A decreased 240 basis points to 18.9%. Central's operating income for the quarter increased to $105 million, and operating margin increased 290 basis points to 12.6% due to higher sales and gross margin as well as accretion from the C&S acquisition, partially offset by higher SG&A expenses. EBITDA for the quarter increased 44% to $118 million. Turning now to the Garden segment. For the quarter, Garden segment sales rose 18% or $64 million to $420 million. The increase in sales, which was all organic, was driven by growth in garden distribution, controls and fertilizers, wild bird feed and late season strength in grass seed, partially offset by the decline related to our exited pottery business. Garden segment operating income for the quarter increased by approximately $25 million or 46% compared to prior year to a…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Peter Grom with JPMorgan. Please proceed with your question.

Hi, good afternoon everyone and congrats on a great quarter, really impressive.

Thanks, Peter.

So I just wanted to touch on the cadence in the quarter and to the extent you were willing to share. Could you maybe speak to the trends you kind of saw in April and May and then kind of June as restrictions were lifted? And is there anything that we need to be aware of from a sell-in versus sellout standpoint? And then my second question. I know Q4 isn't a huge quarter for your business, but the company is cycling kind of onetime cost, and I kind of was hoping you could help me bridge to your guidance. You mentioned top line momentum is expected to continue. Does that mean similar strength versus Q3 and that any benefit from that strong growth will be fully reinvested? So just anything you're willing to share on Q4 would be great.

Sure. Peter, this is Tim. I'll give it a start, and others can kick in. I think to your first question, we definitely saw shifting dynamics as you went through the quarter. So you said, "Hey, what about April, May versus June?" So if you go back to that kind of March early days of pandemic and those first shelter-in-place orders that started taking place mid-March through really April, that was an unfavorable period for us. And we saw that particularly on the Garden side as a number of our retail partners took certain decisions to either close the open garden center or meter limit the traffic into the garden area. And that made for a difficult and challenging start to the quarter. On the Pet side, we saw some similar dynamics in terms of some pet independents not opening as well as, in particular, on the live animal business. Really a shutdown of that entire business for a period of time through retail partners. As quickly as that develops in the kind of mid-March to mid-April time frame, Peter, things began to open up on the other side. And so by May and then June, we saw just a completely different dynamic. We saw all of our retail partners opening up, and we saw, quite honestly, unprecedented consumer demand in both of our categories, both Garden and in Pet. That was driven fundamentally by increases in household penetration. We have data through the end of June that reinforce that this demand was a combination of both existing category users in Garden and Pet increasing their buy rate, spending a little bit more in terms of purchase per occasion, dollar per occasion. But importantly, incremental households. And as you would know, that is one of the more challenging and one…

Peter, this is Niko. I would just add to what Tim said. Think of the investment in Q4, more or less, as a timing shift. What we talked about a couple of quarters ago was our growth challenge and incremental investment that we wanted to make. The pandemic kind of threw that on its head a little bit. And we backed off in Q2 and 3 on investment, waiting to see how it played out. We've seen our businesses perform rather well during the pandemic, and we want to execute on the overall strategy and continue to invest in the business. It's just now shifted to Q4 as we move forward. So I think that's really the right way to think about it.

That’s helpful. Thanks. I will pass it on.

Thank you. Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Hi, good afternoon. Thanks for taking my questions. Let me add my congratulations as well on a nice quarter, nice execution here.

Thanks, Brad.

Thanks, Brad.

Sure, sure. I want to first ask about some of the performance in the Pet category. We get a lot of questions from investors about the sustainability of some of the trends in the market. And I was hoping you could share some details perhaps on trends within the type of animal, what you're seeing out of dog, cat and versus other and then maybe the nature of some of the more repeatable purchases of items that you sell versus items that might be more onetime in nature and may not continue with the same strength that we saw in this quarter.

Sure. This is John. Really good question. As Tim mentioned in the remarks, we saw increase in pet ownership of 4% in total. And it was pretty much across the board, small animal, dog and cat. And with that, we saw increase in household penetration of many of our categories combined up 3%. And because of this, we saw the type of POS consumption increases across brick-and-mortar and that explosive growth in e-com. And as we look forward, we anticipate continued momentum in Pet. We got this tailwind in the front half of fiscal 2021 until we lap the first wave of COVID-19, which would be late Q2, early Q3. I would say after that, it will become much more difficult to predict what longer-term demand might look like. But certainly, with new pet ownership, it's a good indicator of sustained increase in the category consumption versus pre-COVID. Hopefully, that answers your question.

Brad, I would add one other thing, too, is one of the more fractured parts of the pet industry has been the live animal supply chain. And so we've seen a lot of folks that actually wanted live animals that can't get them. And so I think you're going to see probably a little bit of a reloading there where more live animals become available. And so we're not convinced that we're done with the cycle of the penetration rate. That could go on for a little bit longer just because that supply chain has been really, really fractured.

That's really helpful. And if I could add a follow-up just about how to think about modeling 4Q. I guess Niko, can you give us any more quantification of the magnitude of what the investments would be that you're making in 4Q specifically for 1, for 2? Should we think of that as a new step-up in a run rate? I mean are those things like advertisement will continue through next year? Are they more onetime in nature? And just any more description of what exactly you'll be spending on in the quarter.

Well, we're not going to guide on the amount of the investments. And – but what I would tell you is the way to think about it is more of a run rate. We aim to invest in the business and continue to invest in the business. So it's by no means a one-shot kind of deal. So that's the way we feel we want to look really long term and we have nice momentum right now to build off of. And a lot of the investments will be CapEx. And I can't think of a better way to invest in the business from a long-term perspective. And it really demonstrates conviction behind our business as we invest in CapEx and capacity. So it's going to be substantial. We're not going to guide on it. And I think look for more investment as we go down the line.

Understood. Well, congratulations and looking forward to even more detail when you hold your event in November.

Thanks, Brad.

Thank you.

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

Hi, thanks for taking the question. Given the strong results, you certainly have lots of cash. I guess given the higher share price, how are you viewing allocation at this point in terms of share repurchases versus M&A? I guess how are you trying to balance those?

Good question. We still value M&A and internal investment as the priority. As the share price dips and goes up and down, we'll be opportunistic. As you can see, as the share price went up in Q3, we were less aggressive in the market around buybacks. But Tim and I view this as a huge opportunity to invest in the business. And then, of course, M&A being core here at Central and a huge priority for us. So I would look at it in those terms.

I know historically, you've been pretty disciplined, but I imagine valuations for both Pet and Garden are relatively elevated right now given the strength. Would you consider acquisitions outside of those areas if there were synergies in terms of distribution or manufacturing customers, et cetera?

Absolutely. We're evaluating a number of them now. And you hit the nail on the head. We look for synergies around delivering to the same customers, same channels, things of that nature. And again, we just continue to evaluate everything and anything right now.

Great. Thanks for taking my questions. I will pass others.

Thank you. Our next question comes from the line of Bill Chappell for Truist Securities. Please proceed with your question.

Hi. This is actually Grant on for Bill. Thanks for taking my questions. Good afternoon everyone.

Good afternoon.

Good afternoon. I had wanted to start just on the e-commerce growth. Trying to get a sense of the margin mix implications as both Garden and Pet e-commerce seem to be growing faster than the brick-and-mortar business. I would imagine a lot of the Garden is click and collect, correct me if I'm wrong; the Pet side maybe more DTC. But any margin impacts going forward as that business continues to grow?

Sure. I'll start. I mean first of all, on e-commerce, there's no doubt, as I said earlier, we're seeing that dramatic increase. And really, that consumer shift in terms of channel choice. This last quarter, I think we had maybe 10 consecutive weeks of growth kind of in that 80% to 100% range. So truly explosive growth on e-commerce on the Pet side, also the Garden side. Clearly, in Garden, we're on a smaller base. The – it's a significantly underdeveloped set of categories. And so you're looking at kind of low single-digit as a percent of total sales on the Garden side. Whereas on the Pet side, as I mentioned earlier, for Pet, if you look at our Pet branded consumer business, you're looking at more like 20% of the entire business. So to your point, it's becoming increasingly meaningful, and we are investing in it accordingly. In terms of margins, at present, we've got a margin structure that is more or less parity to our brick and mortar. And it differs by delivery mode, and obviously, it differs by product line. To your question, it's something we're very much paying very close attention to because as you play this out over the next many years, we do want to be sure that, that is not presenting an unnecessary headwind to our overall objective to grow margins.

That's helpful. And actually, just one on the Garden side, a question kind of going into the fall here with the consumer engagement in the category. I would think there would still be some strong demand for the grass seed business. I want to get your thoughts on that. And then how are inventory levels coming out of the main season looking to that business?

Sure. This is J.D. Thanks for the question. I'll take that. I would say going into Q4 and into the fall season, we are – we feel very optimistic. The trends that we've seen, the strong trends that we've seen in grass seed, it's been referenced a couple of times, continue to be strong going into the fall. The retailer inventory levels are at an acceptable level, they're not out of balance. And Tim's talked about new users in the category. So we feel good about that. Our customers are bullish on the category, and we are investing in demand creation for the fall. So all of those are reasons for us to feel confident and bullish on the fall season. I will say, as always, weather is a critical factor. So lawn damage during the summer will certainly lead to stronger fall demand. And if we see the excessive heat during the fall that we saw last year, that could have a dampening effect on our retail takeaway. But overall, I'd say, we're cautiously optimistic as we move forward.

Thank you. I will pass it on.

Thank you. [Operator Instructions] The next question comes from the line of Karru Martinson with Jefferies. Please proceed with your question.

Good afternoon. It's been a while since we've heard weather was very good and that was a driver of the business. I'm happy to hear that. Just when you guys talked about the supply chain being stressed, I mean, are we – but inventories at retail, you said, are within the normal bounds. So what is the stress that's being created? Are we missing orders? Are there sales that are falling through or being delayed? What are we seeing there? And what investment needs to be made to ease that stress on the supply chain?

Sure. First, to your point on weather, indeed, weather was favorable this year, and it hasn't been for the last 2 years. So both in 2018 and especially in 2019, it was a headwind. Sadly, that's the nature of weather. It's – can be cyclical and unpredictable. And obviously, it is a corollary to the strength of the garden season. This year, it happens to be a beneficial one. To your question on supply chain. It is stressed. That's a word I chose carefully. And it's stressed in a number of ways. First, there are increased costs to running our supply chain. And those costs are driven by the incremental safety precautions we have taken to address our number one priority, which is obviously the health and safety of our employees. So it's increased PPE. It's increased sanitation, and that does manifest in higher cost in the supply chain. Second, there are select raw material supply challenges. There are some import restrictions we've worked through. Obviously, you're well aware of some continuing macro challenges with China. As Niko referenced earlier, particularly in live animals, there's been some supply challenge, particularly, I would say, in areas like fish, tropical fish, especially. There are even some product lines we make that has sources of raw materials or packaging equipment that compete with other categories that are in great demand given the current pandemic. Think spray bottles, think waste management pads, et cetera, vis-à-vis face masks. In select cases, I would tell you, there are some labor availability challenges. And while I'm pleased to report that as of today, all of our facilities, manufacturing plants and distribution centers are up and operational. Throughout the last quarter, there were days where a given facility needed temporary shutdown. And then finally, it is given the strength of the demand in both of our core categories, we are finding that, that demand is occasionally outstripping our near end capacity. And to your question, yes, that has resulted in compromise service levels on certain lines at certain times with certain customers below our ideal promise to our retail partner. So the stress is real. I think on the positive side, despite everything I've just shared per your question, we were still able to execute very well and deliver a historic quarter.

And Tim, if I could, I'd just like to add a comment too for clarification. When I talked about the retail inventories being not out of balance, I was specifically speaking to grass seed there going into the fall season. But some of our other categories are much more stressed, much more challenged. And there's no question, we left some money on the table during the quarter.

Okay. And then just lastly, in terms of the tariff aspect, when you talked about certainly not getting some of the raw materials out of China, is there a tariff headwind still that we need to be factoring into our models? Or is that just now anniversaried and we go forward from here?

I'll do it. I would say the tariff situation is going to continue for us. But I'll remind everyone that we really only have about 10% of our cost of goods exposure to China. And we continue to look for remedies around the tariffs. And that – things like sourcing from different countries. We also work with the vendors to lower the cost. We look to in-source things that were previously outsourced. And then when all else fails, we will take price where needed. So we think it will be a continuing issue going forward. But so far, we've dealt with it quite well, and we expect to do the same in the future.

Thank you very much guys. I appreciate it.

Thank you. Our next question comes from the line of Jim Chartier with Monness, Crespi. Please proceed with your question.

First, did you guys quantify the amount of the special bonus…

Okay, it’s Devin, I am back with you. I apologize for that. Give me one moment.

Yes, Alan, I think we heard Jim, Jim’s question. Hope the bonus. Jim?

Yes, sure guys. Did you guys quantify the amount of the special bonus during the quarter? And then just looking at your gross margin for fourth quarter, last year, it was down, I think, about 180 basis points. Could you just remind us what the drivers of that decline were last year? And how are you thinking about gross margin this year?

So we typically don't give margin guidance, so I'll speak more qualitatively. Last year, if you recall, we had quite a bit of bad weather and our animal health business was really affected by that. And we had some write-downs in that area in Q4. As far as the onetime bonus, we have not quantified that. And then, again, as far as the margins go into Q4 of this year, we again, don't guide on that. Really, it comes down to mix being such a big deal for us, and it's very difficult for us to guide on that. And obviously, the mix is really heavily dictated by weather. So we're always very cautious around that.

Great. And then just looking at the press release, I think it says that grass seed for you is down year-to-date. Can you just kind of talk about that given what seems to be a pretty strong season for the grass seed business?

Yes. So to be clear, the grass seed businesses from a POS standpoint, from a consumption standpoint, is up versus prior year. It was late in coming, though. And during the spring season, we had a number of canceled promotions that we have planned on that retailers at the time of the onset of the pandemic canceled a lot of their promotional support. That impacted our business. But we've seen strength in the grass seed business over the last couple of months. And given what I said earlier, retail inventories being in good shape, strong promotional support going into the fall. We believe that we've worked through any inventory issues in retail, and we believe that the future looks bright for that business.

Great. Thanks and best of luck in fourth quarter.

Thank you.

Thank you.

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

I'm wondering if you could give us a little bit more color on the Pet segment. How much of your sales today are coming from that specialty channel versus mass versus online only? And how that's changed? And how you expect it to change post COVID?

For our organic growth, as we look at it in Q3, about 2/3 of it came from brick-and-mortar and about 1/3 of it came from e-com. So as we look at our brick-and-mortar business, we get Nielsen and syndicated data for the top 25 customers, and then we get POS for many of the others. It's really clear in brick-and-mortar that we gained share. And that's a good place to be. And when we look at e-com, clearly, with our largest customer, we gained share as well. So we're feeling pretty good from a Pet consumer product standpoint that we gained share in the market in Q3. If you look at our pet distribution business, we had very strong volume in that. And it was really driven by service reliability versus competition. So we feel good relative to our competitors in that channel as well and believe we gained share there as well.

That’s great. Thank you very much.

With that, we have time for one more question, operator.

We actually have no further questions in the queue at this time.

Perfect. I thank everyone for joining today's call, and we look forward to speaking with you again for our fourth quarter earnings release as well as our first Investor Day. Have a good day.

This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.