Central Garden and Pet Co Barclays 19th Annual Global Consumer Conference

All right, let's get started. I'm Hale Holden, head of U.S. Credit Fundamental Research at Barclays. It's my pleasure to welcome back Central Garden & Pet to the Staples Conference. Joining me today is Brad Smith, Central's Chief Financial Officer. Since you were here a year ago, Brad, Central comes back with a more simple portfolio, better margins. Your cash flow is near record highs. You just raised 2026 guidance. At the same time, you exited pet distribution, and you announced the acquisition of an 80% interest in TRIXIE, which for those of you that don't know, is a German pet, not U.S. cereal. Thank you for being here. I would say that this is a better pitch than our neighbors at Procter & Gamble next door, I think, are given. Let's start at a high level.

You spent the last several years simplifying the business, improving execution, and strengthening cash generation. How has that changed the cash profile of the company and the consistency of the business?

I would say if we look at simplification, over the past three years or so, we've taken huge steps to remove cost and complexity from the business. We've consolidated our network to improve efficiencies in both segments, taking out, I would say, between pet and garden, roughly 20 facilities, which was some very heavy lifting. We've also exited less profitable businesses, many of which also tended to carry higher levels of inventory. Our durable businesses in pet, which we've rationalized, and then obviously the exit of our pet distribution business. These efforts have both improved our cash earnings and significantly reduced our working capital requirements. Execution is another thing that's been, I think, a big lever for us in the past couple of years.

Our leadership team has significantly improved its level of collaboration across our business units and its ability to control what we can control as a company, and that's really resulted in the predictability of our results improving. As a result, if we look at our free cash flow, and I exclude the impact of M&A, over the last 10 years, you can really see the impact. The past three years, free cash flow has consistently been in the $300 million-$350 million a year range. If you go back to the previous seven years in comparison, I think we only had one year where we eclipsed $200 million. So it's really been a quantum shift in terms of free cash flow generation, and that's really reflective of the combined efforts around simplification and just improved execution.

Where do you think the biggest gaps are now between where you want to be and where your potential is? You are not allowed to tell me that it is a good garden weather season.

Sorry, Jason. M&A, clearly the biggest gap in priority we have. We have aspirations. We talk about it publicly every quarter to significantly increase the size of Central, and that does not happen without aggressive M&A. That has been a key part of our financial algorithm historically. But the deal environment has just been really tepid, as you know, Hale, up until recently. As a result, now we are sitting on over $1 billion in cash. We are aggressively on the hunt for deals, and deal flow is fortunately finally starting to improve. We obviously announced the acquisition in Europe, which you mentioned a few minutes ago. I do feel good that we are finally going to be seeing more deals get done in the coming quarters. Organic innovation would probably be the second opportunity.

Niko and I have been talking about this as a strategic initiative over the past year. It is the most effective way to create a moat around your brands, command strong margins, and gain additional placements on shelf. I would say we are hitting singles and doubles in that area, but we can do much, much better. Improving innovation, that a major initiative started this year. We are in early innings on that. It is a difficult muscle to develop into a strength, but I have been very encouraged by progress to date. I am encouraged by where we are heading. Lastly, I would be remiss if I did not mention cat. We have talked about this as well publicly. We are under-indexed in cat. That is the one species that continues to grow in terms of new animal ownership each year.

Between M&A and innovation, we have really got a full court press on growing our cat products portfolio.

Because I sit in front of Excel all day and hit Shift F9. With the 10-year almost 5% and the rate move, I just assume when you think about M&A deals that you look through this and plug in an average rate, or does that change your metrics as you're thinking on a live basis?

What's that? Come again? The question is, with the current rate environment and the increase in rate- Yeah Does that change your view of how you want to fund M&A, or do you just put an average rate in and hope for the best in the future?

No, if we look at our cash flow generation, we are in a position where we are really able to fund deals through existing cash flow. If we ever did a significant deal, we would be willing to lever up more than we are right now and then take it down relatively quickly. But the current interest rate environment is not factoring into our decisions on M&A.

Yep. The current story, at least on your last quarter, was sort of driven by more margin improvement and cash flow than broad-based volume growth. You had some puts and takes in some of the asset divestitures there. But in the third quarter, organic sales increased 2% for both pet and garden. What needs to happen for Central to be sort of a more balanced algorithm between organic growth and margin expansion?

I would say, we have talked about our long-term algorithm around the goal is to grow organic top line at or above the category rate in the categories we compete in, which is low single digits, and continuing to expand our operating margin. I would say, post-COVID, the big challenge for us has been top-line growth. We are finally turning the corner on that this year organically. We are seeing growth in both segments, and that is really happened by focusing on the channels and customers where we are winning, particularly the Costcos of the world, Walmart, and e-commerce, and gaining distribution in those channels, which has really been helped through gains that we have had in new products and innovation. Within e-com, to continue and expand beyond 1P into 3P, and really also doing more direct fulfillment on behalf of retailers.

We have had a fair amount of success the past few years in expanding margin. I think we expect that to continue, and that is really been a function of continued mix shift to consumables as well as branded product, taking cost out of the business, and then really being disciplined on pricing. Going forward, all the ingredients to continue to grow in line with our algorithm is it is going to be M&A, which I have mentioned, innovation, which I have mentioned, continued advances in the use of AI, continued discipline in pricing and cost as well.