If you have any questions, please reach out to your Morgan Stanley sales representative. Brad, happy to have you here with us today.
Thank you.
Thanks for taking the time. And so maybe just to kick it off, for those in the room who may not know Central as much as other staples companies, can you give us a little background on the company and how you think about it?
Now, thank you very much for having us here today. As the name suggests, we are a Pet and Garden supplies company located in the San Francisco Bay Area. We have roughly $3 billion+ in annual net sales. We do primarily branded consumables, and they're best known by the brand names of the products that we sell. So two good examples would be Nylabone Treats and Toys. If you own a dog, you probably know the name Nylabone. And then Pennington, which is very big in fertilizer and grass seed, as well as in wild bird. Attributes that make us unique as a company, there's several.
First of all, our business was really built on acquiring companies that had founders that grew them to a certain point, decided to take some money off the table, but wanted to stay on and run and continue to grow the businesses in an employee capacity. And so we tend to have a very entrepreneurial spirit with the GMs that are in our businesses. Pet and Garden spaces tend to be somewhat recession resistant and are supported by favorable long-term demographic trends. In both Pet and Garden, we compete in a relatively broader number of categories than our competition. And many of our brands across our categories have number one and number two positions in the market. We're concentrated in customers and channels that are winning right now online with e-comm and with some of the bigger customers we have around Walmart and Costco.
We have very strong partnerships with these customers. Lastly, I would say, I mean, we have extremely low leverage and high liquidity right now versus our competition set. That really sets us up for many things, but in particular to do some meaningful M&A in the coming months and years.
We'll dig into that in a bit. Let's talk a little bit about your consumer. Who is your consumer? Are they different between Pet and Garden? Do they act differently? How have you seen the year and what do you see them? How do you see them stacking up for 2026?
Yeah. In both Pet and Garden, our consumer spans all ages and backgrounds. Millennials are the largest cohort of gardeners as well as pet owners in the U.S. right now, with Gen Z increasing rapidly in both Garden and Pet. Our consumers continue to spend on their existing pets and on normal lawn and garden maintenance. And in most of our categories, they've stayed with branded goods. So there's not been really a huge shift down to private label in the categories that we play in.
That said, given the current environment, they are increasingly focused on value for money, particularly the low to low-mid income shoppers, and are holding off on getting new pets in our big and bigger ticket lawn and garden projects that tend to be tied more to HELOC rates, which are a bit high right now versus the level that triggers a desire for these bigger projects. Barring any unforeseen improvement in the macroeconomic environment, we would expect these trends to continue into 2026.
Gotcha. You talked a little bit about Millennials, Gen Z. Do they act differently? Have they taken longer to get to lawn care than prior generations? And here in New York, I see more pets than lawns. How do you think about that geographically as well?
Yeah. So let's talk about lawn and grass first. I mean, there are obviously, with the younger cohorts, challenges with being a first-time home buyer. So it's had an impact on single-family housing. And that obviously impacts our business. But still, we are expecting modest growth in demand for grass seed this year. This is being driven by existing homeowners that, with their increased focus on outdoor living, curb appeal, and eco-friendly products, continue to spend and tend to upgrade their spend. We're seeing growth in multi-unit family unit construction, which it doesn't drive as much incremental demand for grass seed, but it still is incremental. And then there's certainly a continued increase in commercial green spaces. So if you look at the cohorts and how they're operating in the rest of gardening and in pet, in gardening, the younger generations have really, really embraced gardening.
Really, it's not like my father's generation. Really, for them, it's around health and wellness and really connecting with nature. Over 70% of the U.S. population aged 18- 35 is doing some form of gardening, and that includes the urban areas, and those who live in apartments and condos are very active, and where they're active is in a small space gardening, which would be balconies and windowsills in urban locations, as well as in bird feeding, wild bird feeding and watching, which is a big category for us. If you get to the pet side, we continue to see the overall trend toward humanization of pets, along with couples choosing to either delay or forego having children. Pets are seen as family members now more than ever, and pet parents care very much about health and emotional well-being, just like they would their normal biological children.
And then they're very focused on extending the longevity of their pets as well, which is something that's more recent. As a result, the garden and pet consumers, they're increasingly making choices around sustainability. Think low-water grass seed or recycled fishnet for dog chews. Wellness, such as growing native plants or their own veggies or organic seeds, cat calming diffusers on the pet side, and convenience, which is really around smaller and easy-to-use e-com-friendly pack sizes and whatnot. So we continue to leverage consumer insights to update our existing products and to launch new products to cater to their preferences based on what we're seeing.
Gotcha. And let's take the two businesses one at a time. Thinking about pet, largest segment or largest part of the business, and you've made a handful of operational changes over the past few years, particularly shifting a bit away from durables. Can you talk us through the changes that you've made and the outlook for the next year? And then one other I'd be really interested in is how are you seeing the channels play out? Specialty versus mass versus online?
Okay, so Niko and I and the rest of the leadership team have been very focused the past few years, and particularly last year, on continuing to improve the profitability of Central and really focusing on strong differentiated consumable brands. As a result, we took a hard look at our durables portfolio coming out of COVID, and when we saw the continued decline in demand and challenges, particularly coming out of China around competition for products that are where inputs or finished goods are actually being sourced from there, and we decided that an extensive SKU reduction and plant consolidation was really necessary to right-size those businesses.
We, in addition, determined that we could deliver a lot more profit from our international sales by closing our U.K. distribution business and replacing that with a model whereby we sell and ship full containers from our U.S. factories direct to the U.K. and EU retailers that we serve. So we completed that closure just in the second half of this last year. The net result is we are going to have a bit of transitional top-line hit in fiscal 2026 coming out of this, but we're expecting these moves to be profit-accretive in 2026, given the cost and complexity that we've taken out of the business. If you move to channel performance, we continue to see an ongoing shift from pet specialty toward pure play online. Think of Amazon and Chewy as good examples, and towards Walmart and Costco as consumers seek increasing value as well as online convenience.
Pet specialty is going to remain an important channel long-term. There is a role for it, and it's really going to stay relevant for pet acquisition. You've either bought a pet and you need to come in for guidance and help and supplies, or you go there to buy a pet and premium products and services, but we do expect to see more consolidation in that space in the coming years. We're not out of the woods on that yet.
Interesting. And then as we think about garden, you've also exited some businesses around your garden business as part of cost and simplicity over the past few years. Can you give us a sense of how that sets up garden for the future?
Yeah. I would say similar to what I just shared with pet, all of this work around pottery and garden distribution was in service of having a more resilient, streamlined, branded consumer business. And those businesses that we exited had a very high degree of complexity and low profitability. So they were difficult moves to make, and it's taken a while, but we've come out on the other end much leaner and much more profitable and streamlined as a result.
And how are you using some of that profitability? I mean, it strikes me in consumer products, innovation is a big piece of it. How are you bringing innovation, and how does that work within pet, within garden?
Yeah. So it's an important lever to driving organic growth and reinforcing brand strength long-term. It's typically done at the BU level. And there is some oversight we provide at corporate, but it's really BU-generated. I would say we don't really share any data related to our innovation at this point. But in general, I would characterize our new product launches as generally being successful, but really hitting singles and doubles and not as many home runs as we would like. So improving innovation capabilities is, along with M&A, a big strategic priority for us this year. It's going to be a multi-year initiative, and it's just getting out of the gate. We want to build the same level of capability and innovation that we've built in taking cost out of the business.
It's probably a slightly more challenging muscle to build, but clearly, I think we can get there over time. We have made significant, meaningful progress in building capabilities this last year in consumer insights, digital marketing, and direct-to-consumer capabilities that is going to further augment each business unit's ability to launch new products, and those investments and capabilities really have already started to deliver results for our customers and us. Most recently evidenced in a new product launch we just did for one of our largest customers, which is helping them to bring in new customers into the wild bird category and significantly drive sales and share, so it's really been a win, and it's due to these capabilities that we've brought to bear on this launch.
I would say lastly, we are also starting to bring in some external innovation experts who are helpful to work with our BUs to help ideate and widen the aperture in order to really kind of identify additional product opportunities that perhaps they wouldn't have thought of otherwise, so that's something we're just getting started on as well that hopefully should start to bear fruit and help us build some muscle there.
You mentioned cost, and we've talked a little bit about how you've taken cost out of the business. And certainly, the cost and simplicity plan has kind of been a hallmark of the last few years. On this last call, Niko mentioned that the low-hanging fruit are picked. I wonder if you might talk a little bit about what you've been able to do and where you expect it to go from here. And maybe long-term, how do you think about the profitability of the business?
Okay. So I would say over the past two years or more, our efforts have been. It's been the single biggest driver of our gross margin and operating margin expansion, the cost and simplicity work we've done. We've streamlined our portfolio by closing and consolidating roughly 20 facilities between Pet and Garden, which is a lot. And we've exited unprofitable businesses in distribution and in durables on our branded business. We've unlocked a significant amount of sourcing savings as well. And the list goes on. So primarily structural in nature, but a lot of other work as well. Continuing to find ways to take cost out of the business. It's a core strength of ours now. It's now part of our DNA after really focusing on it for three years. And so I'm confident longer term we'll continue to find more.
Over the next two years, which is what I have probably the best line of sight to, I can say that we've got a nice pipeline of additional projects between further site consolidations that we have in the pipeline and other projects that should expect meaningful continued benefits and help us drive some modest margin expansion in 2026, albeit not to the levels of what the contributions have been in prior few years.
Gotcha. And you really made it a point to exit durables across Pet and Garden. You mentioned, I think Pet's now 80% + consumables. Can you talk about optimizing the portfolio? What are the differences between the consumables and the durables businesses? And is there some sort of margin threshold that is where you decide to cut?
I would expect eventually that durables will be close to around 10% of pet sales at some point in the future and close on the garden side, close to zero, and limited to those products that we've concluded we can make a good profit on long-term and retain the right to win, so very limited number of categories and products. The decision criteria on whether a business or product line should stay or go, it's a bit more nuanced. However, I would share that the products and businesses that we've exited were generally at or on their way to single-digit operating margins or worse. Yeah.
As I think about cost, maybe the other thing that a lot of people think about is tariffs and tariff mitigation. Clearly, your business is less exposed than most. Can you talk a little bit about how exposed you are, where you expect to be in 2026, and maybe some mitigation strategies?
Yeah. It's primarily the businesses in our pet segment that are exposed. And almost every business in our pet portfolio has some exposure, but individually with a couple of exceptions, like perhaps Wee-Wee Pads. The percentage of COGS is relatively small. So it's kind of death from a thousand cuts, if you will, across the portfolio. But in the aggregate, I would say our exposure is far less than our competition. And we've disclosed that we've got gross incremental tariff impact of around $20 million in 2026. And to offset that exposure the past few quarters, we've been busy working our plans around vendor concessions, cost concessions, country of origin changes, SKU redesign, and SKU rationalization. In addition, we've had to take pricing, which a lot of our other competitors have had to do as well. And it's obviously been painful.
Most of those negotiations are completed, as we discussed on last week's earnings call. We've got a few more that need to come later this quarter and maybe a little bit in the Q2. But the vast majority is behind us, and we're shipping with those customers at the higher price points now. Our net goal is to continue to preserve, or actually modestly continue to expand our margins through a combination of those cost-out initiatives that I just described, as well as our price increases and improvements in mix, which we're seeing as a result of the SKU rationalization work we've done.
Interesting.
One of the things you've recently highlighted that really struck me was gardens growing 60% online. Certainly, as you've talked about some of your distribution centers and consolidation, a lot of that, or at least some of that, has been around DTC-enabled and e-commerce-enabled. I wonder if you might talk a little bit about e-commerce and Pet and Garden and what it means from a cost and margin perspective, and how does the evolution of the business look as e-com penetration increases?
Yeah. E-com, it's the fastest growing channel in both Pet and Garden. Pet was much earlier to the party than garden, but they both continue to grow rapidly. Our e-com business is currently about 27% of our pet sales. On the garden side, we breached 10% and, as you mentioned, growing double digits on a lower base, but a meaningful base at this point. I would say the e-com channel is rapidly evolving. What we had in the past, and it's still the majority of our business, is a traditional 1P model where, for example, we sell and ship to Amazon as our customer and Amazon then sells to you as the end consumer. And what we're seeing is that is increasingly shifting to a variety of other models. It would include 1P models where Amazon's still the customer, but we hang on to our inventory. They score the sale.
They then instruct us to ship direct to the end consumer. As well as increasingly what we call third-party or 3P models, where Amazon is not the customer, but instead is just providing marketplace services. We will sell and ship directly to you as the end consumer using Amazon's marketplace as the medium. Then we will pay Amazon a service fee for that. More and more moving to a direct-to-consumer model, whether you're looking at 1P or 3P, where we're fulfilling. These increased variety of options, particularly the added 3P options, are good as they enable us to sell more products online that we wouldn't be able to sell profitably otherwise and maximize profits for each SKU based on dimensions, weights, retail price points, and other factors.
Longer term, as this evolves, I could see, and it's anybody's guess, let's be honest, but I could see our business increasing in pet to north of 40% of sales online and in garden, perhaps 20%+. So we'll see. But there's plenty of runway ahead in both channels. And from a financial perspective, I would expect we'll continue to. It's a profitable channel, and we'll continue to be so. But really, what I'd emphasize for somebody that's looking at financials is that the shape of the P&L is going to change over time because as you get more and more into these 3P models, you're not spending money on trade spend. So your gross margin goes up, but you're investing in, could be logistics fees. It could be other forms of service fees and commissions to use their marketplace.
So you end up with much more spending in SG&A and less in cost or in net sales offset. So the shape of the P&L is going to evolve as 3P evolves.
Makes sense, and as you think about e-commerce and digital, you think about digital spend and what you're spending on retailer media as well. Can you talk about how your approach is changing? I mean, you certainly, on recent calls, you've talked about some successes there. Can you talk about how that's changing, and maybe just for the group, give us a sense of how much of marketing spend is going to digital versus traditional?
So at this stage, there is very little traditional TV, radio, print ad spend. In fact, knowing that this question was going to be asked, I had to go back and check because I hadn't heard of a discussion on traditional print for the last several quarters. So it exists, but it is tiny right now compared to even a few years ago. The vast majority of our marketing spend is now going to digital marketing, which includes retail media. And because our consumers, I mean, they're going online to do, probably like all of you, all their research and deciding on their purchases. So the mix of our digital media spend is rapidly evolving.
A few years ago, it was almost entirely on retail media, which we call lower funnel spend, which is really focused on converting potential customers who already know your product into paying customers with things like special offers to these days where we are getting more into upper funnel marketing, which is really more around building brand awareness and generating interest among a broad audience through content marketing, social media, and display ads, and the upper funnel is also important because that's where you really start to bring new people into the category. Wild bird would be a great example where they weren't in wild bird, and through social media, they learn about it, and they try it out.
It's been a fantastic category.
It's been a fantastic category, and then you kind of lead them to your brand to try it out, so more and more we're doing that, and in the end, I mean, we're really using a variety of tactics and obviously AI increasingly, and we look at the holistic consumer journey to assess where's the most efficient investment, upper funnel or market funnel, to optimize return, connecting the dots between digital media that may focus on more awareness and retail media that actually ends up driving conversion and ultimately a sale at the end.
You mentioned AI there. Certainly, a lot of retailers right now talking about AI agents and how that's changing not only their business, but how consumers find them. How is it affecting your business? How are you investing in it? How are you getting out in front of this future?
I don't know if anybody in our space is on the front end. But I mean, it's evolving so rapidly. And I mean, it's obviously having a huge impact on how consumers search for and choose products to buy and from which retailer. And I mean, if I look at how it's changing consumer behavior and what it means for us, I mean, a large number of consumers that search on Google, they completely bypass Google search results now. And to their question, they'll go straight to AI-generated Google responses. I'm guilty of doing that too. Yeah, exactly. And so that impact is that means that AI has control over the content that's most likely to be read and acted on by you and me. And the actual research results from Google have lost their value. So this changes our approach to search engine optimization.
And now we have to focus on generative engine optimization and answer engine optimization. So it's a lot more for us to stay on top of from a content perspective. I mean, consumers, they're now leveraging AI summary and e-commerce platforms to understand the content of the reviews rather than wading through and reading the top and bottom reviews. And that means that we've got to be extra vigilant about understanding the content of our reviews, ensuring we've got four and five-star ratings, and continuing to drive additional ratings and reviews wherever and whenever possible. And finally, it's fueling the algorithms for most, if not all, of our social platforms. I experience it myself whenever I'm on Instagram. And I mean, it's just more and more in my face, the stuff that they know I'm interested in to the point where it's almost invasive.
And so I mean, it's not only the creator, but it's the curator. Sorry. And this is going to have a significant impact on the requirement for hyper-personalization and automated media selection. And frankly, it increases the risk of potential misinformation, which I've seen often. So that's the consumer and how they're behaving and how we're using AI. Our consumer insights and our marketing teams are using various AI tools to rapidly identify and address risks and opportunities in our digital content, our product detail pages and packaging. In our social listening platform, we use AI to help automate dashboards, reporting, and alerts so we can quickly respond to consumer conversations and potential opportunities. And then lastly, we're leveraging AI to synthesize consumer reviews around hundreds of retailers to help us identify product opportunities, gaps, and innovation ideas.
So I mean, we're investing heavily behind this to continue growing the business longer term. It's an important area. We're committed to investing as needed and exciting area, but it keeps us busy.
Do you think ultimately it favors players like yourself or maybe upstarts?
Good question. I think we're in a good position because, frankly, we have the financial wherewithal to really stay not so much. Again, I don't know that anybody's ahead of the curve on this stuff, but we can really put some muscle behind what we're doing.
Yeah. Makes sense. So you mentioned at the top liquidity, and you just mentioned financial wherewithal. And simply put, you're sitting on a lot of cash, almost $900 million as of last quarter. You're also very cash-generative. How should we think, or how do you view capital allocation? Where does that cash go? Should we expect a large share buyback or a one-time dividend?
Yeah. So I mean, our criteria, number one would be M&A. Number two would be investing in the organic business. Number three would be share buybacks. So priority one continues to be M&A, and we want to keep plenty of dry powder for that. But we will probably continue share repurchasing. I see that being something we'll do into 2026. I don't anticipate us doing a huge one-time dividend at this time, so.
Got it. Let's dig in on M&A. I mean, you mentioned everything you just mentioned, a lot of cash, well below your gross margin target. You publicly stated before you'd go up to 4x-4.5x , which means you clearly have capacity to do a big deal, to do multiple small deals. Where are you looking? Is it in core categories? Is it outside the core? How do you think about the M&A environment?
Yeah. So clearly, our bias is toward margin accretive pet consumables. However, we are open to explore opportunities beyond our existing core Pet and Garden categories if they're margin and growth accretive. They have a clear investment thesis, a moat around them in terms of the defensibility, right to win, and relevant scale. So if we get beyond pet consumables, it would really be ideally an adjacent category that has some sort of coherent relationship to what we currently manufacture. And as you and I discussed earlier today when we were meeting, I mean, we recently looked at a non-crop chemical company that would have given us the ability to significantly expand our pest control business, which currently serves the pet market, the garden market, and other areas such as cattle, swine, and commercial pest control into even more areas of pest control that we don't play in now.
Something like that, where we've already got some capabilities that augments our capabilities and then kind of 1 + 1 = 3 or 4 , would be really interesting.
Fantastic. I see we've got under 10 minutes left. Maybe we'll open it up for questions right now. All right. If not, I'll end with maybe a unique question. One of the things from your calls and maybe some direct peers we often hear is how the weather was in the spring, when spring started, how many weekends were rainy. I wonder if you might help us think about the seasonality pieces of the business, what percentage is really considered weather sensitive, and maybe we can both hope for an earlier spring and sunny weekends.
Sunny weekends in the Boston and New York area. Yeah. So I would say I had to take a look at this because when we look at weather sensitivity, a good chart, I would say upwards of 90% of our garden business has some sensitivity to weather. But it's not all about having a nice spring. I mean, wild bird is a big part of our business, for example, on the garden side. But it actually has a very different when it's cold, even if it's cold and wet, that's great for wild bird sales. So we do have some counterbalance in terms of what drives what the sensitivities to weather are. But I would say the vast majority of our garden portfolio has that weather sensitivity.
And that's one of the reasons from an M&A standpoint that we're like, "We don't want to add more of that to our portfolio." So on the pet side, it's a little bit different. I would say it's maybe about 15% between, which is really very different. It's the fly control products for our equine or horse business, our flea and tick products for dogs and cats and whatnot, and our pest control products in the professional space, which, it depends based on the nature of the pest and the region of the US. But overall, pets only about 15%.
Interesting. All right. I think we'll wrap it up there. Brad, I just want to say thanks for joining us for Central Garden & Pet joining the conference. I really appreciate you coming out.
Thank you.