Central Garden & Pet Company — Fiscal 2020 Second-Quarter Form 10-Q
Business context and reporting period
Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party pet and garden products. The filing covers the three and six months ended March 28, 2020, compared with periods ended March 30, 2019. The Pet and Garden businesses are seasonal, with Garden sales and operating income concentrated in the second and third fiscal quarters.
Financial performance and liquidity
| Metric | Q2 FY2020 | Q2 FY2019 | Change |
|---|---|---|---|
| Net sales | $703.2 million | $673.7 million | Up 4.4% |
| Gross profit | $207.1 million | $206.1 million | Up 0.5% |
| Gross margin | 29.5% | 30.6% | Down 110 bps |
| Operating income | $66.1 million | $62.2 million | Up 6.4% |
| Operating margin | 9.4% | 9.2% | Up 20 bps |
| Net income attributable to Central | $42.7 million | $42.4 million | Up 0.7% |
| Diluted EPS | $0.78 | $0.73 | Up $0.05 |
- Six-month net sales were $1.186 billion, up 4.4%; organic sales increased 0.2%.
- Six-month operating income was $68.2 million versus $72.3 million, and diluted EPS was $0.69 versus $0.76. Six-month operating margin declined to 5.7% from 6.4%.
- Q2 selling, general and administrative expense declined 2.0% to $141.0 million and represented 20.1% of sales versus 21.4%.
- Pet Q2 sales increased 6.7% to $360.8 million, including $9.9 million from C&S Products; organic Pet sales increased 3.8%. Pet operating income rose 24.6% to $33.6 million.
- Garden Q2 sales increased 2.1% to $342.4 million, while organic sales declined 2.8%. Garden operating income decreased 0.6% to $53.0 million.
- Six-month net cash used in operating activities was $92.7 million, compared with $79.3 million used in the prior-year period. Capital expenditures were $19.5 million.
- Cash, cash equivalents and restricted cash totaled $344.6 million at March 28, 2020, including $331.6 million of unrestricted cash and cash equivalents.
- Total debt was $693.7 million, consisting primarily of $400 million of 6.125% senior notes due 2023 and $300 million of 5.125% senior notes due 2028. No borrowings were outstanding under the $400 million asset-based revolving facility at quarter end.
- Subsequent to quarter end, the Company borrowed $200 million under the revolving facility to increase flexibility during the COVID-19 disruption.
Material changes versus the prior comparable period
- Reported sales growth was primarily acquisition-related: acquisitions and other portfolio changes contributed $26.1 million of the $29.5 million quarterly increase. Organic sales increased only $3.4 million.
- Pet performance benefited from C&S Products and COVID-19-related pantry loading in dog and cat consumables, while live fish sales declined because of a major retailer’s exit from that business and reduced retail traffic.
- Garden organic sales declined because of lower grass seed sales, reduced promotional support and in-store traffic, and the exit from fashion décor pottery. Increased third-party product sales also pressured mix and margins.
- Gross margin declined despite higher gross profit, primarily because of unfavorable product mix, lower live fish sales, lower-margin third-party sales and weaker Garden mix.
- Corporate expense increased, primarily because of higher medical insurance and equity compensation costs.
- The Company adopted ASC 842 on September 29, 2019, recognizing $99.1 million of operating lease right-of-use assets and $103.2 million of operating lease liabilities at March 28, 2020. Comparative periods were not restated.
- The Company repurchased approximately $48.0 million of stock during the six months, including approximately $47.2 million of open-market purchases. The remaining authorization under the 2019 repurchase program was $100 million at quarter end.
Outlook, commentary, risks and unusual items
- Management stated that Central is an essential business in most jurisdictions and expected adequate liquidity, supported by cash and revolving-credit availability, for at least the next 12 months.
- Management expected most COVID-19 effects to appear in the third and fourth fiscal quarters. Demand increased for certain pet consumables but weakened for live animals, live plants, pet bedding, aquatics and some UK operations. The filing states that the timing and extent of recovery cannot be predicted.
- COVID-19 created risks relating to employee absences, reduced productivity, facility or distribution disruptions, supply-chain and logistics costs, customer closures, collection delinquencies, demand volatility and potential asset impairments. No COVID-19-related impairment charge was recorded in Q2.
- A November 2019 fire at the DMC facility in Athens, Texas generated estimated losses of $35 million to $40 million. By March 28, 2020, approximately $25 million of losses had been incurred and $19 million of insurance proceeds received, leaving approximately $6 million of costs in excess of proceeds recorded on the balance sheet.
- A second April 2020 fire at an Athens, Texas property caused approximately $10 million of estimated inventory and property-related losses and temporarily limited fulfillment for certain customers. Management believed insurance coverage was sufficient, but the event could affect subsequent results.
- The Company was evaluating fiscal 2020 capital expenditures; its prior estimate was $45 million to $50 million. The filing does not provide a revised capital-expenditure target or earnings guidance.
- A Nite Glow patent and related litigation produced a 2018 jury verdict and approximately $12.6 million of damages. Post-trial proceedings and a potential appeal remained pending; management believed the ultimate resolution would not be material, while acknowledging litigation uncertainty.
- No goodwill impairment was recorded. The remaining contingent consideration liability was $1.3 million after a $6.1 million Segrest payment in December 2019.
Investor verification points
- Verify the effect of the subsequent $200 million revolver draw on debt, interest expense, covenant compliance and liquidity in the next filing.
- Track COVID-19 effects on third- and fourth-quarter demand, customer receivables, inventory, supply-chain costs and potential impairments.
- Reconcile insurance recoveries and additional losses from both DMC fires, including the April 2020 event.
- Assess whether organic Garden sales and gross margins recover during the peak seasonal period.
- Review the maturity and refinancing or redemption plan for the $400 million of senior notes due November 2023.
- Monitor operating cash flow, which was negative for the first six months despite reported profitability, and the Company’s revised fiscal 2020 capital-spending plans.