Central Garden & Pet Company — Fiscal 2019 Form 10-K
Reporting period: Fiscal year ended September 28, 2019, comprising 52 weeks. The filing is an annual Form 10-K rather than a standalone quarterly filing; fiscal fourth-quarter net sales were $540.7 million and net income attributable to Central was $2.4 million.
Business Context
Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party products in the U.S. pet supplies and lawn-and-garden markets. Reportable segments are Pet and Garden. Fiscal 2019 sales were $1,384.7 million in Pet and $998.3 million in Garden. The company had approximately 5,800 employees and operated 42 manufacturing facilities and 60 sales and logistics facilities.
Financial Performance and Liquidity
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Net sales | $2,383.0 million | $2,215.4 million | +7.6% |
| Gross profit | $704.0 million | $675.4 million | +4.2% |
| Gross margin | 29.5% | 30.5% | -100 bps |
| Operating income | $152.1 million | $167.3 million | -9.1% |
| Operating margin | 6.4% | 7.6% | -120 bps |
| Net income attributable to Central | $92.8 million | $123.6 million | -24.9% |
| Diluted EPS | $1.61 | $2.32 | -30.6% |
| Cash flow from operations | $205.0 million | $114.1 million | +$90.9 million |
| Capital expenditures | $31.6 million | $37.8 million | -$6.3 million |
Segment performance: Pet sales increased 3.3%, but Pet operating income declined 12.6% to $122.7 million and its operating margin fell to 8.9% from 10.5%. Garden sales increased 14.2% and operating income increased 6.9% to $102.2 million. Corporate expenses increased to $72.8 million from $68.6 million.
Balance sheet and liquidity: Cash and cash equivalents were $497.7 million, restricted cash was $13.0 million, working capital was $1,028.7 million and total debt was $693.2 million at year-end. The company had no borrowings under its $400 million asset-based revolving credit facility, which was amended to mature September 27, 2024. Management stated that operating cash flow, available revolver capacity and supplier arrangements should be adequate for anticipated needs for at least the next 12 months. Planned capital expenditures were approximately $45 million over the subsequent 12 months.
Debt consisted principally of $400 million of 6.125% senior notes due November 2023 and $300 million of 5.125% senior notes due February 2028. Contractual obligations totaled approximately $1.25 billion, including $700.3 million of debt principal, $230.7 million of estimated interest and $129.0 million of operating lease payments.
Material Changes Versus Fiscal 2018
- Reported growth was acquisition-led: acquisitions and dispositions contributed $134.7 million of the $167.6 million sales increase; organic sales increased 1.5%.
- Pet organic sales declined 0.2%, reflecting weakness in animal health, pet behavior products and flea-and-tick products. Garden organic sales increased 4.0%.
- Margins deteriorated because of commodity, transportation and other cost inflation, unfavorable product mix, and lower-margin acquired distribution and garden businesses. Pricing actions only partially offset these pressures.
- SG&A increased 8.6% to $552.0 million, including higher warehouse and administrative expenses, bad-debt expense, acquisition costs, CEO hiring costs and legal expenses.
- Net income was adversely affected by the absence of fiscal 2018’s $21.5 million Tax Cuts and Jobs Act benefit. The fiscal 2019 effective tax rate was 22.3%, compared with 2.6% in fiscal 2018.
- Diluted weighted-average shares increased 8.0% to 57.6 million, following the 2018 Class A equity offering, contributing to the EPS decline.
- Cash generation improved substantially, while investing cash use declined to $76.3 million from $140.9 million. Fiscal 2019 acquisitions included C&S Products for approximately $30 million and the remaining 55% of Arden Companies for $13.4 million.
Guidance, Outlook, Risks and Unusual Items
- Management did not provide specific fiscal 2020 revenue or earnings guidance in the filing. Its strategy emphasizes organic innovation, acquisitions, e-commerce capabilities, supply-chain productivity and annual cost reductions of approximately 1% to 2% of cost of goods sold and administrative spending.
- The Garden business is highly seasonal: approximately 69% of Garden sales and 58% of total company sales occurred in fiscal quarters two and three, with substantially all Garden operating income generated during that period. Weather can materially affect demand and cash flow.
- Commodity exposure includes grains, grass seed, chemicals, fertilizer inputs and pet-food ingredients. Fixed purchase commitments totaled approximately $191.8 million; management estimated that a 10% commodity-price change could produce an approximately $19.2 million pretax gain or loss as related inventory is sold.
- Customer concentration is significant: the top five customers represented approximately 49% of fiscal 2019 sales, including approximately 16% from Walmart and 12% from Home Depot. Retail consolidation, inventory destocking, private-label substitution and e-commerce shifts could pressure results.
- In November 2019, after the reporting date, a fire at the DMC facility in Athens, Texas caused estimated inventory and property losses of $15 million to $25 million and temporarily limited fulfillment for certain customers. The company believed insurance would cover asset and business-interruption losses, but recovery and timing remained uncertain.
- A jury awarded Nite Glow approximately $12.6 million in a patent, contract and confidential-information dispute involving flea-and-tick product applicators. Post-trial proceedings and an appeal were pending; management believed the ultimate resolution would not be material but acknowledged uncertainty.
- The company recorded a $2.5 million Pet intangible-asset impairment after a retail customer exited the live-fish business and a $3.2 million non-cash gain from remeasuring its prior Arden investment. No goodwill impairment was recorded.
- Key risks include leverage and variable-rate debt, the 2023 debt maturity, tariffs and China sourcing, product liability and recalls, environmental and regulatory obligations, cyber threats, ERP implementation, acquisition integration, goodwill impairment and founder control through Class B shares.
- The company adopted the new lease standard beginning fiscal 2020 and expected to recognize more than $110 million of additional operating lease liabilities, with corresponding right-of-use assets.
Facts Investors Should Verify
- Whether Pet operating performance and animal-health weakness improve, and whether Garden growth remains profitable after acquisition-related margin pressure.
- The amount and timing of insurance recoveries, business-interruption proceeds and operational disruption arising from the DMC fire.
- Progress on refinancing or repaying the $400 million of notes due in 2023 and sensitivity to interest-rate changes and LIBOR replacement.
- Actual organic sales, gross-margin recovery and the sustainability of cost savings versus acquisition-driven growth.
- Resolution and ultimate cash impact of the Nite Glow litigation and any other legal or regulatory matters.
- Integration and purchase-price accounting for Arden and C&S Products, including potential goodwill or intangible-asset impairments.
- Exposure to major retailers, tariffs, China sourcing, commodity prices and adverse weather.
- The effect of the fiscal 2020 lease-standard adoption on reported assets, liabilities, leverage and operating metrics.