Central Garden & Pet Company — Fiscal 2016 Form 10-K
Reporting period: Fiscal year ended September 24, 2016; 52 weeks. The filing is an annual Form 10-K rather than a quarterly filing. Central operates through Pet and Garden segments, primarily serving U.S. pet supplies and lawn-and-garden markets.
Financial performance and liquidity
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Net sales | $1,829.0 million | $1,650.7 million | +10.8% |
| Gross profit | $553.1 million | $488.1 million | +13.3% |
| Gross margin | 30.2% | 29.6% | +60 bps |
| Operating income | $129.4 million | $91.4 million | +41.5% |
| Operating margin | 7.1% | 5.5% | +160 bps |
| Net income attributable to Central | $44.5 million | $32.0 million | +39.2% |
| Diluted EPS | $0.87 | $0.64 | +$0.23 |
| Cash flow from operations | $151.4 million | $87.4 million | +$64.0 million |
| Free cash flow | $123.8 million | $65.4 million | +$58.4 million |
- Pet sales were $1,081.9 million, up 20.9%; organic Pet sales increased 6.0% after excluding acquisitions. Pet operating income was $119.9 million, with an 11.1% margin.
- Garden sales were $747.2 million, down 1.2%; operating income increased 16.9% to $70.3 million, and the operating margin improved to 9.4%.
- Cash and cash equivalents were $93.0 million, versus $47.6 million at the prior year-end. Working capital was $512.6 million.
- Total debt was $395.3 million, compared with $397.0 million. The company had $400 million of 6.125% senior notes due November 2023 and no borrowings under its asset-based revolving facility at year-end.
- The revolving facility had $318.2 million of borrowing availability and matures April 22, 2021. The company reported compliance with applicable debt covenants.
- Capital expenditures were $27.6 million. Management expected fiscal 2017 capital expenditures of approximately $40 million to $45 million.
Material changes versus the prior comparable period
- Growth was led by Pet, including the DMC pet-bedding acquisition and expanded distribution of other manufacturers’ products. Pet organic sales growth was volume-based.
- Garden sales declined due mainly to the exit from holiday décor, the exit from a private-label fertilizer relationship and lower wild-bird-feed pricing; grass-seed sales benefited from comparison with weather-affected fiscal 2015.
- Gross margin improved despite acquired Pet businesses carrying lower historical margins. Garden margin benefited from product mix, higher grass-seed sales and the holiday-décor exit.
- SG&A increased 8.4% to $421.9 million but declined to 23.1% of sales from 23.6%, reflecting operating leverage and lower corporate expenses.
- Operating results included a $1.8 million non-cash Pet intangible impairment and a $2.4 million gain on the sale of a Pet manufacturing plant.
- The company refinanced its debt, replacing 8.25% senior subordinated notes due 2018 with $400 million of 6.125% senior notes due 2023. Refinancing-related expense was $14.3 million, but expected annual interest expense was approximately $8.5 million lower prospectively.
Fourth-quarter items and unusual events
- Fourth-quarter fiscal 2016 net loss attributable to Central was $5.6 million, or $(0.11) diluted EPS, versus a $4.4 million loss in the fourth quarter of fiscal 2015.
- The fourth quarter included a $16.6 million non-cash impairment of two equity-method investments, reducing their carrying value to zero, and a $1.8 million non-cash impairment of Pet indefinite-lived intangible assets.
- George C. Roeth became President and Chief Executive Officer on June 1, 2016. Howard Machek became Principal Financial Officer in September 2016.
- After year-end, Central acquired Segrest, Inc. for $60 million, including $6 million contingent on future events, to expand its aquarium-fish business. The company also sold a veterinary-products division with fiscal 2016 sales of $8.6 million; the division had not been profitable.
Outlook, risks and contingencies
- Management expects liquidity from operating cash flow, the asset-based facility and supplier credit to fund anticipated needs for at least the next 12 months, but notes that financing availability and acquisition funding are not assured.
- Results are seasonal: approximately 66% of Garden sales and 58% of total sales occurred in fiscal quarters two and three, with substantially all Garden operating income generated during that period.
- Key risks include weather, commodity and chemical costs, the ability to pass through cost increases, retail customer concentration, competition and retailer consolidation, e-commerce disruption, acquisitions and goodwill or intangible impairments.
- Wal-Mart represented approximately 15% of total sales; the top five customers represented approximately 42%. Concentration increases exposure to retailer pricing, inventory, credit and relationship risks.
- Fixed commodity purchase commitments totaled approximately $183.8 million. Management estimated that a 10% commodity-price change could produce an approximately $18.4 million pretax gain or loss as related inventory is sold.
- Contractual obligations totaled approximately $865.6 million, including $400.9 million of debt principal, $174.6 million of estimated interest, $106.3 million of operating leases and $183.8 million of purchase commitments.
- Unclaimed-property examinations by several states were at an early stage, and management could not estimate any potential impact. No current legal proceeding was considered material by management.
- The company depends on Chinese third-party manufacturing, faces product-liability, recall, regulatory, environmental and cybersecurity risks, and continues implementation of its SAP enterprise resource planning system.
- William E. Brown controlled approximately 55% of voting power through Class B stock as of November 18, 2016. The company does not expect to pay cash dividends in the foreseeable future.
Investor verification points
- Reconcile reported Pet growth with the 6.0% organic growth rate and assess the sustainability of acquisition-driven revenue and earnings.
- Review the quality of the $151.4 million operating cash flow, particularly receivables, inventory and seasonal working-capital movements.
- Assess leverage, the 2023 note maturity, refinancing savings, covenant headroom and the $318.2 million borrowing-base availability.
- Evaluate exposure to Wal-Mart and the other major retailers, including concentration of sales and accounts receivable.
- Monitor commodity commitments, pricing pass-through capability and Garden seasonality and weather sensitivity.
- Review the Segrest acquisition allocation, contingent consideration and integration results, as well as the veterinary-products divestiture.
- Track potential future impairments given $231.4 million of goodwill, $95.9 million of other intangible assets and the fiscal 2016 impairment charges.
- Confirm the company’s implementation plans and future financial statement effects for pending revenue-recognition, lease, stock-compensation and inventory accounting standards.