Business Context and Reporting Period
Central Garden & Pet Company filed an unaudited Form 10-Q for the fiscal quarter and nine months ended June 27, 2020, compared with June 29, 2019. The company manufactures, markets and distributes branded, private-label and third-party pet and lawn-and-garden products through its Pet and Garden segments. Results are seasonal, particularly in Garden, with approximately 69% of fiscal 2019 Garden sales generated in the second and third fiscal quarters.
Financial Performance and Position
| Metric | Q3 FY2020 | Q3 FY2019 | Change |
|---|---|---|---|
| Net sales | $833.5 million | $706.6 million | 18.0% increase |
| Gross profit | $262.1 million | $219.3 million | 19.5% increase |
| Gross margin | 31.4% | 31.0% | 40 basis-point increase |
| Operating income | $104.6 million | $68.9 million | 51.7% increase |
| Operating margin | 12.6% | 9.7% | 290 basis-point increase |
| Net income attributable to Central | $68.8 million | $46.2 million | 49.1% increase |
| Diluted EPS | $1.27 | $0.80 | 58.8% increase |
Q3 organic net sales increased 16.5%, including 15.0% growth in Pet and 17.9% growth in Garden. Pet sales increased 18.0% to $413.3 million, including $10.4 million from the C&S Products acquisition. Garden sales increased 17.9% to $420.2 million, entirely organically. Management attributed growth to increased pet ownership, consumer home gardening, favorable weather, new listings and stronger e-commerce demand.
SG&A increased 4.7% to $157.4 million but declined to 18.9% of sales from 21.3%, reflecting operating leverage, lower travel and entertainment expense, reduced merchandising activity and COVID-19-related promotional reductions. Pet operating income increased 44.8% to $50.8 million, while Garden operating income increased 46.5% to $77.8 million.
| Metric | Nine months FY2020 | Nine months FY2019 | Change |
|---|---|---|---|
| Net sales | $2,019.5 million | $1,842.3 million | 9.6% increase |
| Gross profit | $600.4 million | $555.5 million | 8.1% increase |
| Gross margin | 29.7% | 30.2% | 50 basis-point decrease |
| Operating income | $172.8 million | $141.2 million | 22.4% increase |
| Operating margin | 8.6% | 7.7% | 90 basis-point increase |
| Net income attributable to Central | $107.1 million | $90.3 million | 18.5% increase |
| Diluted EPS | $1.95 | $1.56 | 25.0% increase |
Nine-month organic sales increased 6.4%. The nine-month gross margin declined because of product mix, lower live-fish volume, increased third-party sales, lower grass-seed sales and the exit from the fashion-décor pottery line. SG&A declined to 21.2% of sales from 22.5%, supporting higher operating income.
Nine-month net cash provided by operating activities was $88.9 million, compared with $92.8 million in the prior-year period. The decrease primarily reflected a $203.1 million increase in accounts receivable, driven by strong late-quarter sales. Capital expenditures were $26.8 million, compared with $20.9 million, and net cash used in investing activities was $31.8 million versus $65.0 million, primarily because the prior year included acquisitions.
Cash and cash equivalents were $495.3 million at June 27, 2020, or $508.9 million including restricted cash. Total debt was $694.0 million, consisting primarily of $400 million of 6.125% senior notes due 2023 and $300 million of 5.125% senior notes due 2028. The $400 million asset-based revolving facility, with a potential additional $200 million accordion, had no borrowings outstanding at quarter-end. The company temporarily borrowed and repaid $200 million under the facility during the quarter.
Material Changes Versus the Prior Comparable Period
- Q3 sales growth accelerated sharply, with organic sales up 16.5%, compared with nine-month organic growth of 6.4%.
- Q3 profitability improved materially as gross margin expanded and SG&A leverage increased; nine-month gross margin remained below the prior-year level.
- Pet and Garden both benefited from COVID-19-related demand shifts, including pet adoption, home gardening and e-commerce, while live fish, live plants, pet bedding and aquatics remained challenged.
- Other expense included a $3.6 million impairment of two private-company investments affected by COVID-19.
- The company repurchased approximately $52.3 million of common stock in the first nine months, excluding approximately $5.4 million of share withholding and other activity; $100 million remained authorized under the principal repurchase program at quarter-end.
- Operating lease right-of-use assets and lease liabilities were newly recognized following adoption of ASC 842 in fiscal 2020; reported operating lease liabilities totaled $103.1 million at quarter-end.
Guidance, Outlook, Risks and Unusual Items
The company did not provide a specific revenue or earnings forecast in the filing. Management stated that liquidity should be adequate for working capital, capital spending and other needs for at least the next 12 months, subject to the uncertainties associated with COVID-19. Previously estimated fiscal 2020 capital expenditures of $40 million to $45 million were being reevaluated; approximately $27 million had been invested year to date.
COVID-19 created both demand benefits and operating risks. All manufacturing facilities and distribution centers were open and operational at quarter-end, but employee absences, reduced productivity, increased protective and sanitation costs, distribution constraints and lower fill rates could continue. Management warned that demand volatility, customer closures, collection delinquencies and additional supply-chain disruption make forecasting difficult.
The DMC business unit experienced fires in November 2019 and April 2020 at an Athens, Texas facility. Estimated losses totaled approximately $46 million, and approximately $18 million of costs in excess of insurance proceeds were recorded as of June 27, 2020. The company subsequently received approximately $9 million of insurance proceeds and believed coverage was sufficient for remaining asset and business-interruption losses.
A patent and related claims lawsuit brought by Nite Glow resulted in a $12.4 million judgment after post-trial reductions. Central has appealed, and the plaintiffs have cross-appealed. Management believes the ultimate resolution will not materially affect the consolidated financial statements, but acknowledges that the outcome is uncertain.
Other risks include seasonality, raw-material and energy-cost volatility, inability to pass through cost increases, customer concentration, competition, acquisitions, tariffs, international sourcing, goodwill and intangible-asset impairment, cyberattacks, product liability, recalls, regulatory matters and the phase-out of LIBOR. The company recorded no goodwill impairment during the reported periods and remained in compliance with debt covenants.
Important Facts for Investors to Verify
- Whether COVID-19-driven demand in pet consumables, gardening and e-commerce persists after temporary stocking and shelter-in-place effects subside.
- Accounts-receivable collections, customer credit quality and working-capital requirements following the substantial late-quarter sales increase.
- The final insurance recovery and accounting treatment for the DMC fire losses.
- The outcome and potential cash impact of the Nite Glow litigation and appeal.
- Future impairment risk for private-company investments, goodwill, intangible assets and other long-lived assets.
- Progress against revised fiscal 2020 capital-spending plans and the timing of the Vision 2025 strategy, which management expected to communicate in late 2020.
- Liquidity, covenant compliance and refinancing considerations for the $400 million of senior notes due 2023 and the $300 million of senior notes due 2028.