Business Context and Reporting Period
Central Garden & Pet Company is a U.S.-focused producer, marketer and distributor of branded, private-label and third-party products for the pet supplies and lawn-and-garden markets. This Form 10-K covers the 52-week fiscal year ended September 29, 2018; fiscal 2017 contained 53 weeks. The filing includes fourth-quarter data, but it is an annual report rather than a standalone quarterly filing.
- Pet segment: pet supplies, animal health, aquatics, live fish and small animals; fiscal 2018 sales of $1,340.9 million.
- Garden segment: seed, fertilizer, controls, bird feed, decorative products and live plants; fiscal 2018 sales of $874.5 million.
- Approximately 5,400 employees and 33 manufacturing facilities.
Financial Performance and Key Metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $2,215.4 million | $2,054.5 million | +7.8% |
| Gross profit | $675.4 million | $632.8 million | +6.7% |
| Gross margin | 30.5% | 30.8% | -30 bps |
| Operating income | $167.3 million | $156.1 million | +7.2% |
| Operating margin | 7.6% | 7.6% | Flat |
| Net income attributable to Central | $123.6 million | $78.8 million | +56.8% |
| Diluted EPS | $2.32 | $1.52 | +$0.80 |
| Cash from operating activities | $114.1 million | $114.3 million | Flat |
| Capital expenditures | $37.8 million | $44.7 million | Lower |
Fiscal 2018 net income benefited from a $21.5 million tax benefit related to remeasurement of deferred tax assets and liabilities under the Tax Cuts and Jobs Act, plus approximately $6.9 million of tax benefits from stock compensation accounting. Excluding the transitional tax remeasurement and the prior-year facility-sale gain, non-GAAP net income was $102.1 million, or $1.91 per diluted share, versus $77.5 million, or $1.50 per diluted share.
- Pet operating income increased to $140.4 million from $131.6 million; operating margin declined to 10.5% from 10.6%.
- Garden operating income increased to $95.6 million from $87.3 million; operating margin increased to 10.9% from 10.8%.
- Fourth-quarter net sales were $502.3 million and net income attributable to Central was $10.6 million, or $0.19 diluted EPS. Fourth-quarter results included a $5.2 million tax benefit from the Tax Cuts and Jobs Act.
Liquidity, Cash Flow and Capital Structure
- Cash and cash equivalents were $482.1 million at September 29, 2018, compared with $32.4 million a year earlier. Restricted cash was $10.9 million.
- Working capital was $1,004.3 million, compared with $462.8 million in fiscal 2017.
- Total debt was $692.2 million, up from $395.7 million, primarily due to the issuance of $300 million of 5.125% senior notes due February 2028.
- The company also has $400 million of 6.125% senior notes due November 2023. The asset-based revolving credit facility provides up to $400 million, with $394.8 million of borrowing availability and no borrowings outstanding at year-end.
- Fiscal 2018 financing cash flow of $474.8 million primarily reflected the new senior notes and approximately $195.6 million of net proceeds from a Class A common-stock offering.
- Management expects approximately $45 million of capital expenditures over the next 12 months and believes liquidity sources are adequate for at least the next 12 months, subject to seasonal needs and acquisition activity.
- No cash dividends are currently expected. No shares were repurchased under the share-repurchase program during fiscal 2018, although approximately $35.0 million remained available.
Material Changes Versus the Prior Comparable Period
- Reported sales growth was partly acquisition-driven. Organic sales increased 1.0%, or approximately 2.6% after adjusting for fiscal 2017’s extra week.
- Pet organic sales increased 3.1%, or approximately 4.8% after the extra-week adjustment. Growth was driven by dog and cat products and distribution, while Animal Health was affected by unfavorable weather.
- Garden organic sales declined 2.2%, or approximately 0.8% after the extra-week adjustment, primarily because unfavorable weather reduced demand for grass seed and garden distribution products.
- Gross margin declined because acquisitions, product mix, freight, commodity and other input costs were dilutive. SG&A declined to 22.9% of sales from 23.2%.
- Interest expense increased 28.5% to $36.1 million due to higher average debt, despite a lower average borrowing rate of 5.8%.
- Central acquired Bell Nursery for approximately $61 million plus contingent consideration of up to $10 million, General Pet Supply for approximately $24.3 million, and two smaller distributors for approximately $8 million.
- Bell Nursery contributed $84.1 million of fiscal 2018 Garden sales. Management noted that the live-goods business is highly seasonal and is expected to incur losses or break even in quarters outside the peak season, including two quarters of expected fiscal 2019 losses.
Guidance, Outlook, Risks and Unusual Items
- Management targets annual cost-of-goods-sold and administrative savings of approximately 1% to 2% through supply-chain optimization, productivity initiatives and scale benefits.
- Management expects a 21% federal corporate tax rate and an approximately 24.5% combined federal and state statutory rate in fiscal 2019; the fiscal 2018 effective rate was unusually low at 2.6% because of tax-reform and stock-compensation benefits.
- Key operating risks include seasonality, adverse weather, commodity and freight inflation, limited ability to pass through cost increases, consumer spending, retail consolidation, e-commerce competition and dependence on major customers.
- Walmart represented approximately 16% of consolidated sales and Home Depot approximately 11%; the five largest customers represented approximately 48% of sales.
- Approximately 10% of products sold in the United States are manufactured in China, exposing the company to tariffs, trade restrictions, sourcing disruption, quality and transportation risks.
- A jury awarded Nite Glow approximately $12.6 million in June 2018 in patent, contract and confidentiality litigation involving flea-and-tick product applicators. Post-trial proceedings and an appeal were pending; management expected the ultimate resolution not to be material but acknowledged uncertainty and possible additional expense.
- Commodity purchase commitments totaled approximately $173.1 million. A 10% change in related commodity prices could produce an estimated $17.3 million pretax gain or loss as inventory is sold.
- No goodwill or intangible-asset impairment was recorded in fiscal 2018. Goodwill totaled $281.2 million and other intangible assets totaled $152.3 million at year-end.
- Management stated that disclosure controls and internal control over financial reporting were effective. The acquired Bell Nursery and General Pet Supply operations, representing approximately 5% of consolidated assets and sales, were excluded from the year-one internal-control assessment.
Investor Verification Checklist
- Reconcile reported EPS and net income with the $21.5 million tax-reform benefit and the $6.9 million stock-compensation tax benefit.
- Assess whether organic growth, particularly in Garden, improves after the fiscal 2017 extra-week comparison and whether weather-normalized demand supports management’s strategy.
- Monitor integration, margins and seasonal losses associated with Bell Nursery and General Pet Supply.
- Evaluate leverage, refinancing requirements for the 2023 notes, and the company’s ability to maintain liquidity through peak seasonal working-capital needs.
- Follow the Nite Glow litigation, potential damages and related legal costs.
- Assess exposure to Walmart, Home Depot and other concentrated customers, as well as tariff and China-sourcing developments.
- Review the pending revenue-recognition adoption and future lease-accounting adoption, which management expected to have limited income impact but potentially material balance-sheet effects for leases.