Business Context and Reporting Period
Central Garden & Pet Company’s Form 10-K covers the fiscal year ended September 30, 2017. Fiscal 2017 included 53 weeks versus 52 weeks in fiscal 2016. The company manufactures and distributes branded, private-label and third-party pet supplies and lawn and garden products through its Pet and Garden segments.
- Pet segment: $1,246.4 million of sales and $131.6 million of operating income.
- Garden segment: $808.1 million of sales and $87.3 million of operating income.
- Corporate expenses were $62.8 million.
Financial Performance and Key Metrics
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Net sales | $2,054.5 million | $1,829.0 million | +12.3% |
| Gross profit | $632.8 million | $553.0 million | +14.4% |
| Gross margin | 30.8% | 30.2% | +60 bps |
| Operating income | $156.1 million | $129.4 million | +20.7% |
| Operating margin | 7.6% | 7.1% | +50 bps |
| Net income attributable to Central | $78.8 million | $44.5 million | +77.1% |
| Diluted EPS | $1.52 | $0.87 | +$0.65 |
| Operating cash flow | $114.3 million | $151.4 million | -$37.1 million |
| Capital expenditures | $44.7 million | $27.6 million | +$17.0 million |
| Free cash flow | $69.7 million | $123.8 million | -$54.2 million |
Net income margin was approximately 3.8%, compared with 2.4% in fiscal 2016. The effective tax rate increased to 36.9% from 34.5%. Net interest expense declined to $28.1 million from $42.7 million, primarily because fiscal 2016 included $14.3 million of costs related to refinancing the company’s notes.
At September 30, 2017, cash and cash equivalents were $32.4 million, restricted cash was $12.6 million, working capital was $462.8 million and total debt was $395.7 million. The $400 million asset-based revolving facility had no borrowings outstanding, and reported borrowing availability was $368.9 million. Total assets were $1.31 billion and total equity was $637.1 million.
Material Changes Versus the Prior Comparable Period
- Reported sales growth benefited from the extra fiscal week by an estimated $35 million. Organic sales increased 6.6%, or approximately 4.8% after adjusting for the extra week.
- Pet sales increased 15.2%; organic Pet sales increased 5.0%, or approximately 3.0% excluding the extra week. Growth was driven primarily by dog and cat products, animal health and acquisitions.
- Garden sales increased 8.2%; organic Garden sales increased 8.9%, or approximately 7.4% excluding the extra week. Growth was driven by controls and fertilizer, grass seed, new customer listings and third-party products.
- Pet operating margin declined to 10.6% from 11.1%, despite higher operating income, reflecting acquisition-related and other selling, general and administrative costs.
- Garden operating margin improved to 10.8% from 9.4%, aided by higher volume, favorable mix and manufacturing efficiencies.
- Operating cash flow and free cash flow declined as increased sales raised receivables and inventory, while capital expenditures increased.
- Central acquired Segrest for approximately $60 million in October 2016 and K&H Manufacturing for approximately $48 million in April 2017. It also invested $12.5 million in two equity-method ventures and sold a small veterinary products division.
- Fiscal 2017 had no intangible asset or goodwill impairment charges. Fiscal 2016 included $1.8 million of intangible impairment and a $16.6 million impairment of two joint-venture investments.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management stated that it expects liquidity sources to be adequate for working capital, capital spending and other cash needs for at least the next 12 months. Planned capital expenditures were approximately $40 million over the next 12 months. Management continues to pursue product innovation, cost savings of approximately 1% to 2% annually in cost of goods sold and administrative spending, supply-chain improvements and selective acquisitions. The filing does not provide formal revenue or earnings guidance.
- The business is seasonal: approximately 66% of Garden sales and 56% of total company sales occurred in the second and third fiscal quarters; substantially all Garden operating income is generated during that period.
- Key customer concentration is significant. The five largest customers represented approximately 44% of fiscal 2017 sales, and the largest customer represented approximately 16%.
- Commodity exposure includes grains, grass seed, chemicals, fertilizer ingredients and pet food ingredients. Fixed purchase commitments totaled approximately $171.1 million; a 10% commodity-price change could produce an estimated $17.1 million pretax gain or loss as related inventory is sold.
- The company relies on international sourcing, including third-party manufacturing in China, and faces potential tariff, transportation, quality, supply and geopolitical risks.
- Acquisition-related risks include integration, contingent consideration, retention of personnel, increased goodwill and potential future impairment. Goodwill was $256.3 million at year-end, and no fiscal 2017 goodwill impairment was identified.
- Contractual obligations totaled approximately $807.5 million, including $400.5 million of debt obligations, $124.5 million of estimated interest payments, $111.4 million of operating leases and $171.1 million of purchase commitments.
- The company was in compliance with its debt covenants. The $400 million of 6.125% senior notes mature in November 2023; the secured revolving facility matures in April 2021.
- Potential contingencies include product liability, recalls, environmental remediation, regulatory matters, cybersecurity incidents and state unclaimed-property examinations. Management reported no legal proceedings expected to have a material effect, but stated that the unclaimed-property examinations were at an early stage and their impact could not be determined.
- William E. Brown, the chairman, beneficially controlled approximately 55% of voting power through the company’s dual-class structure. The company does not currently intend to pay cash dividends.
Most Important Facts for an Investor to Verify
- Separate the underlying 4.8% organic sales growth from reported growth, which benefited from the extra fiscal week and acquisitions.
- Assess whether Pet margin stabilization and Garden margin gains can continue after acquisition and integration costs.
- Reconcile the decline in operating cash flow and free cash flow with receivables, inventory, capital expenditures and seasonal borrowing needs.
- Review leverage, the November 2023 debt maturity, interest costs and actual availability under the asset-based facility.
- Evaluate customer concentration, retailer bargaining power, weather sensitivity and commodity-price pass-through capacity.
- Monitor acquisition performance, contingent consideration, goodwill and intangible-asset impairment exposure.
- Review the expected accounting effects of pending revenue-recognition, lease, stock-compensation, inventory and cash-flow standards.