Ladies and gentlemen, thank you for standing by. Welcome to Central Garden & Pet's Fiscal 2021 Second Quarter Earnings Call. 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, David. 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 begin with a business update and Niko will discuss our Q2 results and our outlook for fiscal 2021 in more detail. After the prepared remarks, J.D. and John will join us for the management Q&A. Our press release providing the results for our second quarter ended March 27, 2021 and related materials are available on our website at ir.central.com and contain the GAAP to non-GAAP reconciliations 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, 2020. Central undertakes no obligation to publicly update these forward-looking statements to reflect new information, subsequent events, or otherwise. Now, I will turn over the call to our CEO, Tim Cofer. Tim?

Thanks Friederike, and good afternoon, everyone. Thank you for joining our Q2 earnings call. Today, Niko and I will discuss our second quarter results, our perspective on how Central is performing in the current environment, and how we are approaching the back half of fiscal 2021 to drive future growth. Before we get started, I want to take a moment to recognize that it's been a little over a year since the onset of COVID-19. This time last year, we were about a month into the pandemic and most concerned about how to protect the health and safety of our employees, while serving our customers and consumers. As we look at where we are today, I'm hopeful that we're seeing a light at the end of the tunnel. As vaccine rollouts accelerate across the country, I'm optimistic they will play an important role continuing to keep our frontline colleagues safe, assisting in the return to our offices, and helping all of us get back to doing the things we love.

Thank you, Tim. Good afternoon, everyone. We continue to be extremely pleased with the performance of our business. Second quarter net sales reached $935 million, an increase of 33% or 232 million, driven by organic growth in both segments. Organic sales increased 23%. Our three recent acquisitions added $76 million in net sales. Consolidated gross profit increased $65 million to $272 million. However, gross margin decreased 40 basis points to 29.1% due to the impact of initial purchase accounting adjustments related to our three recent acquisitions, as well as cost inflation in key commodities, labor and freight, in particular ocean freight. SG&A expense increased 19% to $168 million, driven by the inorganic increases related to our recent acquisitions as well as higher payroll-related and logistics costs resulting from our increased volumes, partially offset by lower travel and entertainment expense. Conversely, SG&A decreased 220 basis points to 17.9% of net sales, driven by improved operating leverage. Operating income increased 39 million to 105 million, driven by higher sales volumes, partially offset by higher SG&A expenses. Operating margin increased 180 basis points to 11.2% due to improved operating leverage. EBITDA increased 56% to $123 million. Turning now to our Garden segment, Garden segment sales increased 49% or $146 million to $443 million. Excluding acquisitions, organic sales increased 23% and were broad-based across the segment, with the most notable growth coming from our garden distribution, fertilizers and controls, wild bird feed, and grass seed businesses. And our acquisitions added $76 million in net sales. Garden segment operating income was $66 million, an increase of 53%. Garden segment operating margin increased by 40 basis points to 14.9%. The improvement was driven by the organic growth mentioned previously as well as SG&A efficiencies. Garden segment EBITDA increased 63% to $75 million.

Thank you. . Our first question comes from Bill Chappell with SunTrust. Please proceed with your question.

Thanks. Good afternoon.

Hey, Bill.

Hey, Bill.

Hey. I wanted to -– I appreciate things are still in flux in terms of the recent deals. But can you give us maybe a little more color on sales contribution this year and probably more importantly EBITDA contribution because EPS, it's tougher to kind of understand if we don't especially know what the kind of D&A will be with those deals?

Yeah. Well, the sales for the quarter were $76 million for the quarter.

Sure.

So we've got that. And then EBITDA was fairly deminimus honestly because the bulk of it was taken out via purchase accounting. So it wasn't a huge EBITDA contribution there, Bill.

Well, I guess, when I'm looking at the sales, I know there's some of our seasonal businesses is $76 million a good number to use going forward, or how should I be thinking about that?

Yeah. I mean, the way to think about it is two of the three, so Hopewell, Green Garden are highly seasonal. DoMyOwn is a little more what I would say spread out even keeled over the year. But for instance, DoMyOwn is – or excuse me, Hopewell is going to do – have a really big Q3. And in fact, it's a lot like Bell which we did back in 2018 where the bulk of their, if not all their EBIT will hit in that one quarter. The other three quarters will be losses, similar to Bell. So that's the way to think about it. And then Green Garden, also seasonal kind of think the same sort of seasonality as Garden as a whole, although I would say their season sort of kicks off earlier and then, of course, ends a little bit earlier. So they're already past kind of their peak revenue is the way to think about it and they're kind of on a little bit of a decline now going forward.

Okay. And then just as I look at the Garden business, I mean, Scotts earlier today talked about taking pricing to offset commodities but not doing it till kind of the end of the fiscal year, which is similar to your fiscal year, just because where the season will be largely over, I guess. Are you thinking that same way that you need to take some prices to offset commodities but don't let mean to take it necessarily near-term?

Hi, Bill it's J.D. I'll take that question.

Hey, J.D.

What I'd say in terms of pricing, we have taken some pricing already this year in categories where we saw dramatic increases in cost of goods. Specifically, there, the wild bird food category where we saw a spike in the grain costs. So we will take it if we see significant movement in our cost of goods. Going forward for this year, I mean certainly there's inflation. Niko touched on it earlier. Commodities will impact this in fertilizer with the N, P and K grains, and then some is still unknown like grass seed for example because that harvest is still in front of us. But we do anticipate some inflation. Earlier Tim talked about our net productivity work to try to offset that inflation, but we do plan on taking some pricing. It won't be this year. We will take our pricing in concert with the customers on their normal cadence, their cycle with the upcoming year for F 2022.

Okay. And then last one for me just on Pet. Appreciate the strength of the business and certainly Pet is on trend. But maybe you could talk a little bit more beyond companion pets and just in terms of were the growth rates of aquatics and reptile and bird similar to the overall category, were they lot lower, was companion pet that much higher, just kind of understanding what the makeup of that growth was?

Hey Bill, this is John. Yeah, we're seeing solid growth rates across all animal types. And as you know, we've got a live animal business that had strong double-digit growth rate in Q2. And we also believe it's got a good start to Q3 and we also believe there's a lot of pent-up demand for more animals. So it's very widespread across animal type.

Maybe putting a finer point on it, Bill, if you're – when you say companion animal, are you saying dog and cat?

Correct.

Different people have different definition. Okay, fine.

Yeah. And more with the gerbils and guinea pigs and fish and birds, or everyone.

Totally. And that's where I was going, Bill. As you know that rest of the kind of animal kingdom beyond dog and cat is a big part of our business. That's where we've got some great brands and strong leadership position. So, if you start with the animal itself, what our data shows is dogs overall in this COVID period are up about 5% in terms of households owning dogs. Cats are up at around 5% as well, sorry, dogs are up 8%, cats are up 5%. And then all other pets are up about 11%. So we're seeing really strong growth in that all other what you call companion animal. And to John Hanson's point, we're seeing that reflected in the POS as well. And so we had real strengths, for example, in our aquatics business, our small animal business, our pet bird business and supplies, their food and supplies. So we're seeing good growth in those other animal classes beyond the conventional dog and cat.

No, that's great color. Thanks so much.

Thank you.

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

Hi, good afternoon. Congrats on the continued momentum here. I wanted to follow-up on some of the questions with the Garden segment and see if maybe Tim you or J.D. could give us a little more color about what you're hearing from your retailers as we get into May, how were trends going as we comp the increasingly difficult comparisons, how are inventory levels, and if the retailers want to keep those inventory levels up or are they pulling back on their orders?

Sure. J.D.?

Hi, Brad. It's J.D. I'll take the question. First of all, I'd say we're just now starting to comp against the COVID spike from last year, the last couple of weeks. Until then, business was pretty much the way -– the strength of the business was very similar to the way it was over the prior three quarters. So we're just now starting to see some of the anticipated headwinds. I'd say the retailers are remaining very engaged and optimistic about the business, and they've reflected that with their -– you asked about inventories, they took a very aggressive position in getting the stores ready for the season and that's helped with POS as well. So, at this point, I think we're all waiting to see how the season unfolds. We're two weeks into it. The weather hasn't been ideal. So we're starting to worry about weather maybe for the first time in the last year or so. And I think that in terms of the stores being ready, they're certainly ready. We're ready from an execution standpoint. The big unknown here is consumers, as they start to perhaps travel and gather, how engaged will they remain in our categories. And we believe that through demand creation and the retailers continuing to stay in the business, the consumer will stay engaged as well. But too early to tell. I'd say the next six weeks or so will shed a lot of light on this.

Yeah. That's very helpful. Thank you, J.D. And if I could ask a follow-up about guidance, I'm just thinking about high-level moving pieces. You clearly had a great quarter here. You've raised the full-year guidance, which is at least kind of number. You've given us commentary around how much acquisitions could add. I guess, when we think about your outlook for the underlying organic business and we think about some of the investments you may be making and some of the rising input costs, etcetera, how are you thinking about the level of investments versus the performance of the core business we think about, what you've assumed for the balance of the year?

Well, I mean we're plot committed on the investments. We talked about the CAPEX on the call being up 100%. And that's going to have a two-fold impact. One, it's going to allow us to expand capacities and meet those fill rates and be a better service provider to our customers; and two, to combat the commodity, inflation, and the labor issues is we're trying to automate more. So, take cost out, consolidate different businesses into one location, and really work on becoming much more efficient in terms of how we produce product.

And the other part of the investment envelope, as Niko said, first part and the key part is CAPEX, and the other is we will take this opportunity again in the back half of fiscal 2021 to further invest in our consumer-oriented growth agenda. And that will include investments in sharpening consumer insights across both Pet and Garden. We've got some brand investments planned on four or five of our biggest power brands across both Pet and Garden. The benefits of that work will start to show up in 2022. And then finally, the innovation agenda against those brands. So we're – as we have exceeded some of our expectations here in the front half and given the call up of the year, we're taking some of that favorability, consistent with the algorithm that Niko has shared at Investor Day and reinvesting that back in our business in the back half.

Really helpful. Thank you, Tim. Thank you, Niko.

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

Hi. I'm not sure what you can provide here, but you mentioned most of the price increases are going to go kind of when retailers reset towards the end of the year, except for those that were taken on some of the bird seed milo-millet products. I guess, is there any way for us to get a sense for what type of cost of goods inflation you're estimating this year, I know you said there's some that's yet to come, but if you were just to put an estimate on it?

Well first of all, I'll jump in and then Niko can build as well. I mean first, I think the – kind of first part of your question premise, that is rooted on the Garden side. So, on Garden, conventionally you price at the beginning of the season and kind of intra-season price increases are things that our customers and we tend to like to avoid because the planograms are set and the season is executed. And so, to your point that's what J.D. covered in his earlier comments. On the Pet side, we have more flexibility given the seasonality of the business to price more as needed and I would say there are more frequent price increases on the Pet side, including this year, than what we're seeing on the Garden side. In general, the pricing this year we believe when the year settles out will be insufficient in covering the entire inflationary headwinds facing our business. That'd be inclusive of the commodity increases, the labor inflation, the freight inflation, particularly ocean freight as Niko said earlier. So, on a dollar basis we'll fall a little short of covering all of that. We've got plans in place, as J.D. said earlier and same on the Pet side, to put in a fresh round of pricing at fiscal year-end into the 1st of next year to recoup that. And I don't know, Niko, any further builds?

No. I think you summed it up really well that the inflation piece is absolutely staggering. If I were to add any color, I would say the bulk of it is coming from commodities and transportation. And we're going to be aggressive on price, but we also believe it won't be enough to cover it completely. And we're going to have to figure out creative ways to take cost out of the business to try to maintain our margins. That'll be the challenge going forward.

That's all helpful. I guess, I might get one more shot at it here. There's things like urea that are up 50%, ocean freight are up 200%. Is there any number, so for the lawn and garden side is where I'm speaking at specifically here, those which you usually take when you have your shelf space resets at the end of the season, do you have a number you could give us, just because these numbers are so big, it's hard to even guess at what the total inflationary number may be?

William, this is J.D. With regard to urea specifically, really all of the inputs from diammonium phosphate, urea, potash, all of those are escalating this year. I think one of the good things from our standpoint is most of our goods for this year were already built. So the impact for this year will be – we'll feel it but it won't be as significant for next year, we'll take pricing in our lawn reviews for the upcoming year. I know you're looking for a specific number here, but that's something we typically don't disclose.

Okay. Thanks for taking the question. I'll pass to others.

Thank you. Our next question comes from Andrea Teixeira with J.P. Morgan. Please proceed with your question.

Hi, good afternoon and congrats on the results. I was hoping if you can elaborate a little bit more on your assumptions for the categories. I know it's tough because obviously you're lapping tough comps ahead on the second half. But if despite these tough comparisons, obviously you called out the category as you said 11% for companion animals, ex-cats and dogs. And that’s in gardening obviously more people having that. Is there any other metric you can share for organic where you're still assuming like distribution gains or on top of the pricing to help us kind of bridge how we should be thinking on the second half or obviously, you're probably going to go negative, I mean, your guidance, the minimal of is still kind of in balance a really wide range of possibilities, I think you probably are conservative, it kind of implies as if -– at the bottom implies that you'll go negative on the top line. So can you help us like how negative like we should be assuming going forward? That would be super helpful. Thank you.

Sure. This is Tim. I'll take a broad shot at your question, Andrea. I think, first, you got to step back and talk about Garden versus Pet, because the dynamics are different. From a kind of sales guidance standpoint, I'd go back in terms of long-term and guide consistent with what Niko and I guided at Investor Day. And that is our objective is to grow at or above the categories in which we compete. For us, if you take out the COVID period, that's a low-single-digit number. And that's what we're trying to do over time. We want to be the leaders in our categories and grow at or above that rate. Obviously, COVID threw a wonderful tailwind and wildcard into it and so, if –- I think your question is a little bit more about the back half. If you look at the front half, let's start with Garden. You're having POS trends in the mid-20s on brick-and-mortar basis in terms of growth versus prior year. But as J.D. Walker said earlier, we are now getting into the key comp timeframe of last year's. First of all, incredible weather garden season and of course, all of the favorable stay-at home COVID gardening impact. And so we are definitely seeing in these last few weeks a slowdown of POS as we lap those huge mountains of last year. And as J.D. Walker said earlier, very honestly on the Garden side weather does play a really important role. These last few weeks, particularly in the Southeast, has been unfavorable weather, a lot of severe weather. It's been a wet weather. That's not good for garden season. And so we're taking a cautious approach on the Garden side but I think a prudent one, and that's reflected in our guidance. On the Pet side, you're also seeing very strong POS growth again kind of right now in the 20s type of brick-and-mortar number and then north of 50% on the e-commerce number in terms of growth versus prior. We're also now just beginning to lap those early impacts of COVID prior year. And we're seeing a slight slowdown but less than we're seeing on the Garden side. And I think that's supported by that incremental pet adoption that I went through earlier on the call across dog, cat and all other animal classes. And so, on that one, we're I would say a little bit more bullish that the sportier trends can continue through the back half. And I think that's about as far as we'll go. We don't guide on sales intra-quarter so we're not going to give you a number. But hopefully that helps you in terms of long-term expectations and then a few of the dynamics across the two industries.

That's super helpful. Thank you very much. I'll pass it on.

Thank you. Our next question comes from Hale Holden with Barclays. Please proceed with your question.

Hi, thanks for taking the call. I just had two questions. The first one was, I was wondering if the increased sales velocity this quarter than what you've talked about a little bit on the margin cost side, plus the three acquisitions you just closed, changed your working capital assumptions kind of for the remainder of the year or not?

Definitely. These acquisitions come with inventory and the big bump in inventory was largely driven by the acquisitions. And then, secondarily, our organic revenue grew substantially and so with that comes higher inventory levels and more AR. So we definitely ramped up and I would say we ramped up earlier on the working cap. So we saw the peak kind of hit earlier than what we normally experience.

Got it. And then my second question is, when you guys are thinking about the distribution center upgrades that you're doing and then the stuff you talked about at the Investor Day in terms of e-commerce strategies, I was wondering if you were getting any pushback from some of your wholesale clients to do direct distributionships from your DCs?

Actually, it's more of a partnership where they're actually asking us to engage with them and to help them fulfill the direct-to-consumer type of shipments. So we're starting to do a little bit of that and create a really nice relationship with the retailer. We also have to be mindful that it needs to be profitable. So we're very clear on what our cost structure is and how to price that. And so far, we think it's working pretty well. We do have ways to go in terms of getting better at it. So we're taking a continuous improvement mindset, but we feel like with the ship points that we have, it creates a nice extension for the retailers.

Great. Thank you very much.

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 just wanted to circle back on the acquisitions. Maybe I think in the cash flow statement your $734 million were spent on acquisitions. Maybe you can give us a blended multiple EBITDA on what you paid, on what you think maybe normalized EBITDA for those businesses is?

Yeah. I'll give it a shot. I would say it's going to be a high-single-digit multiple on what I would say a normalized kind of sustainable level. Two of them were, one was double-digit, the big one again if you do the math, it looks really reasonable. But we did normalize it so that ups that multiples, but I would say it's high-single digit.

Great. That's very helpful. Thanks. And then on the expansion projects, where are you, are those on track, are you expecting to still get some benefit this year, and then are there opportunities for similar projects to undertake next year? Thanks.

Yes, they are underway across the patch. It's pretty broad-based, Jim. So, for example, significant investment in our dog and cat facilities that make both edible and plastic dog treats and toys and chews. Also significant investment in capacity expansion in our aquatics business, small animal and pet vetting, wild bird, and grass seed and controls. So, really across both Garden and Pet we have put the tens of millions of dollars to work that Niko referenced in his commentary, doubling our CAPEX budget. And yes Jim, to your question, I would say -– let's call it maybe two-thirds of that begins to come online in the back half of fiscal 2021, the balance coming online in fiscal 2022.

Great. And then I guess how much sales do you feel like you've missed over the last 12 months in those categories where you're expanding capacity in?

Yeah, always a little difficult to put a fine point on it, but I would say Jim, it's on the timeframe you inquired about. It's in the tens of millions of missed opportunity associated with our capacity relative to the extraordinary demand presented over the last 12 months from COVID.

Great, thanks. And best of luck.

Thank you. And we're on it. We are not yet satisfied with our service levels to our retail partners. You can imagine that's an important part of our dialogue each day on both the Garden and the Pet side. But per the earlier commentary, we are on it in terms of adding capacity and recapturing that opportunity.

Right. Thank you.

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

Hi. One question just on -- you raised your EPS guidance for the year and talked about cost increases. Does that imply that how much of the increase in the EPS is driven by this quarter sales outperformance versus expected sales through the remainder of the year or are there any other below the line items, SG&A or something below even the EBITDA line?

Well, we – typically our policy is just to guide for the year. So we're not going to necessarily break out a quarter or first half versus second half. I will say that the first half has definitely exceeded what we thought it was going to be. That said, we do see continued momentum in the second half. I think if you look at the magnitude of the raise in guidance, it's going to incorporate both halves. It's not just a first half story.

Okay, great. And then can you talk about what you're seeing from an M&A pipeline standpoint, if any of that's on hold because you're focused on investing in your facilities?

Well, I would say that we have a team of five that are conducting corp dev type of activities and we still have a very robust pipeline. One really doesn't have anything to do with the other. We have different people working on the expansions and then others working on deals. So I would say that won't slow us down. The only thing where we could have a little bit of a bottleneck would be on the integration side because we did all three one after the other. We've got to get the accounting and the IT stuff synced up as far as integrating. But having cash and the capacity to do deals, we still have that. We just need to be mindful of our internal resources.

Okay. Great. Thank you.

Thank you. Our next question comes from Karru Martinson with Jefferies. Please proceed with your question.

Good afternoon. Just to follow-up on that with kind of a high-single-digit acquisition multiples out there, where are you guys comfortable for taking leverage to while you integrate any potential acquisitions?

Sure. So, as we've stated pretty consistently, our comfort zone is in that 3 to 3.5 times. For the right deal we would stretch and go to 4 and then de-lever as quick as we could back to that comfort zone of 3 to 3.5.

Okay. And then just on the labor inflation you guys mentioned, but I was curious as to the labor availability. We've been hearing that that's becoming a bit of a bottleneck. And is that something that you are seeing as you guys look to increase incremental capacity?

Yeah. We can certainly confirm that dynamic. We are not immune to that. We are finding it more difficult in the last few months in particular and I would say post the stimulus, most recent stimulus in attracting and retaining hourly employees in a number of our key facilities. We're addressing that on a case-by-case basis, location-by-location. We are making some select adjustments to our compensation scheme, either temporary or permanent based on that. We're doing competitive market scans to understand and ensure that our rates are fair and competitive to other labor choices in that kind of radius of our plants and our DCs. But to your point, we can definitely confirm that pressure and that's one of the call-outs we made in my and Niko's comments is that we are seeing some labor inflation in that kind of low to mid-single-digit range.

Thank you very much guys. Appreciate it.

And I think operator with that we're at time. So I'll take the opportunity to thank everyone for joining this quarter's call. Thank you for your interest in Central Garden & Pet. And if you have any further questions, please don't hesitate to reach out to Friederike and our Investor Relations team. Have a good day.

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.