Business Context and Reporting Period
Central Garden & Pet Company filed its Form 10-K for the 52-week fiscal year ended September 24, 2011. The company markets branded and third-party pet supplies and lawn and garden products through its Pet Products and Garden Products segments.
- Fiscal 2011 net sales were $1.629 billion: Pet Products $851.3 million and Garden Products $777.3 million.
- Branded products represented approximately 84% of consolidated sales.
- The company operates in highly seasonal markets, with approximately 60% of total sales and 67% of Garden Products sales generated in fiscal second and third quarters.
Financial Performance and Key Metrics
| Metric | Fiscal 2011 | Fiscal 2010 | Change |
|---|---|---|---|
| Net sales | $1,628.7 million | $1,523.6 million | Up 6.9% |
| Gross profit | $493.9 million | $515.2 million | Down 4.1% |
| Gross margin | 30.3% | 33.8% | Down 350 basis points |
| Income from operations | $85.2 million | $109.1 million | Down 21.9% |
| Net income attributable to Central | $28.3 million | $45.8 million | Down 38.2% |
| Diluted EPS | $0.50 | $0.70 | Down $0.20 |
| Cash flow from operations | $51.0 million | $135.2 million | Down $84.2 million |
| Capital expenditures | $31.6 million | $24.2 million | Up $7.4 million |
Fiscal fourth-quarter 2011 net sales were $376.9 million, gross profit was $98.2 million, and net loss attributable to Central was $10.9 million, or $0.21 diluted loss per share. The filing does not provide a separately reported fourth-quarter operating margin.
- SG&A increased 3.7% to $408.7 million, but declined to 25.1% of sales from 25.9%.
- Net interest expense increased to approximately $37.7 million from $33.6 million; average debt rose to approximately $443 million and the average interest rate increased to 8.1% from 6.8%.
- Effective income tax rate increased to 40.8% from 37.0%.
- Cash and cash equivalents were $12.0 million at year-end, and short-term investments were $17.8 million, for approximately $29.9 million of cash and short-term investments.
- Working capital was $410.7 million; total assets were $1.093 billion and total equity was $456.8 million.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by Garden Products, whose sales increased 13.8% to $777.3 million. Grass seed sales increased $49.2 million and bird feed sales increased $23.7 million.
- Pet Products sales increased only 1.3% to $851.3 million. Wild bird feed and aquatic products grew, while flea, tick and mosquito products declined because of generic competition and unfavorable weather.
- Primary grain costs increased approximately 41% per pound. Price increases did not fully offset raw-material inflation, and product mix shifted toward lower-margin products.
- Operating income declined in both segments: Pet Products to $77.6 million from $97.9 million and Garden Products to $50.0 million from $53.0 million, before corporate expenses and eliminations.
- Operating cash flow declined sharply because of lower earnings and approximately $54 million of increased working capital, principally higher inventory.
- The company repurchased $108.7 million of stock, including 3.3 million voting common shares and 8.6 million non-voting Class A shares. Approximately $72 million remained under the new $100 million authorization at fiscal year-end.
- The company acquired certain premium fertilizer assets for approximately $23 million in cash and recorded approximately $1.0 million of related goodwill.
Debt, Liquidity, Guidance, and Risks
- Total debt was $435.6 million at September 24, 2011, compared with $400.3 million at the prior year-end. The debt primarily consisted of $400 million of 8.25% senior subordinated notes due 2018 and $35 million outstanding under the revolving credit facility.
- The revolving credit facility was amended to increase capacity from $275 million to $375 million, extend maturity to June 2016, and reduce certain pricing and covenant requirements. Remaining borrowing capacity after covenant effects was approximately $339.9 million.
- The company reported compliance with all financial covenants. Total leverage was 3.6x, senior secured leverage was 0.3x, and interest coverage was 3.4x versus a 2.50x minimum.
- Management believed available cash, operating cash flow, supplier arrangements, and revolver capacity would meet working capital and other needs for at least the next 12 months. The company expected capital expenditures not to exceed $45 million in the next 12 months, including up to $15 million for fiscal 2012 enterprise resource planning implementation.
- Management targeted a reduction in fiscal 2012 inventories of approximately $60 million and expected to consolidate approximately six additional facilities during the first half of fiscal 2012.
- A two- to three-year transformational change program is intended to integrate the businesses, consolidate facilities, establish shared services, standardize processes, and reduce costs. Management warned that substantial investments and transitional costs would adversely affect results for the next several quarters.
- Key risks include commodity and energy-price volatility, inability to pass through cost increases, adverse weather and seasonality, consumer spending weakness, customer concentration, retailer consolidation, competition, acquisition integration, supply dependence on China and selected raw materials, ERP implementation, environmental and product-liability exposure, and substantial leverage.
- The top five customers represented approximately 45% of fiscal 2011 sales; the largest customer represented approximately 16% and the second-largest approximately 12%. The company does not expect to pay dividends in the foreseeable future.
- No material pending legal proceedings were reported. Fiscal 2011 goodwill testing indicated no impairment; fiscal 2010 included a non-cash $12.0 million intangible-asset impairment charge.
Most Important Facts for Investors to Verify
- Whether gross-margin recovery depends on successful pricing actions, commodity-cost relief, and a favorable product mix.
- Progress and total cost of the transformational change program, facility consolidations, and the planned $60 million inventory reduction.
- Liquidity during peak seasonal borrowing periods, including revolver availability, covenant headroom, and cash generation.
- Debt-service capacity given $400 million of 8.25% notes due in 2018 and variable-rate revolver exposure.
- Customer concentration and the effect of purchasing or pricing decisions by Wal-Mart, Lowe’s, Home Depot, PETsMART, and PETCO.
- Execution of the SAP enterprise resource planning implementation and the risk of business interruption or additional costs.
- Whether fiscal 2011 margin pressure, weaker cash flow, and lower profitability represent temporary commodity and weather effects or a more persistent deterioration.