Central Garden & Pet Company — Fiscal 2019 First Quarter 10-Q
Reporting period: Three months ended December 29, 2018; comparative period ended December 30, 2017. The interim financial statements are unaudited. Results are seasonally affected by the Garden business and are not necessarily indicative of the full fiscal year.
Business Context
Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party pet and garden products, primarily in the United States. Reportable segments are Pet and Garden. Fiscal 2018 acquisitions of General Pet Supply and Bell Nursery materially affected the quarter’s reported results.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $462.0 million | $442.0 million | Up 4.5% |
| Gross profit | $130.2 million | $131.8 million | Down 1.3% |
| Gross margin | 28.2% | 29.8% | Down 160 bps |
| Operating income | $10.2 million | $22.5 million | Down $12.3 million |
| Operating margin | 2.2% | 5.1% | Down 290 bps |
| Net income attributable to Central | $1.8 million | $26.2 million | Down $24.4 million |
| Diluted EPS | $0.03 | $0.50 | Down $0.47 |
| Adjusted diluted EPS | $0.03 | $0.19 | Down $0.16 |
| Operating cash flow | $6.8 million | $(24.2) million | Improved $31.0 million |
| EBITDA | $22.5 million | $33.7 million | Down $11.2 million |
Net income in the prior-year quarter included a $16.3 million provisional tax benefit from the Tax Cuts and Jobs Act. Excluding that benefit, prior-year net income was $9.9 million, or $0.19 per diluted share.
Segment Performance
- Pet: Sales increased 4.7% to $340.4 million, including $17.2 million from General Pet Supply. Organic sales declined 0.6%. Operating income fell 17.7% to $29.8 million, and operating margin declined to 8.7% from 11.1%.
- Garden: Sales increased 4.0% to $121.6 million, including $10.1 million from Bell Nursery. Organic sales declined 4.6%. Operating income declined to a $4.6 million loss from $2.3 million of income, primarily reflecting Bell Nursery’s seasonal losses and lower controls and fertilizer sales.
Liquidity, Cash Flow and Capital Structure
- Cash and cash equivalents were $478.7 million; cash, cash equivalents and restricted cash totaled $489.7 million at December 29, 2018.
- Operating cash flow was $6.8 million. Capital expenditures were $7.8 million, and net cash used in investing activities was $9.4 million.
- Total debt was $692.4 million, consisting principally 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 credit facility had no borrowings or letters of credit outstanding, with reported borrowing availability of $356.6 million. The Company was in compliance with applicable financial covenants.
- Inventory increased to $493.7 million from $440.4 million a year earlier, consistent with seasonal preparation for the Garden selling season.
- Management expects fiscal 2019 capital expenditures of approximately $45 million and believes available cash, operating cash flow, the revolving facility and supplier arrangements will meet anticipated needs for at least the next 12 months.
Material Changes and Management Commentary
- Reported sales growth was acquisition-driven: acquisitions contributed $27.3 million, while organic sales decreased $7.3 million, or 1.7%.
- Margins were pressured by acquired businesses with lower margins, unfavorable sales mix, higher raw material, labor and transportation costs, and increased selling, general and administrative expenses.
- Management implemented price increases generally effective in January 2019 to offset cost inflation, but did not expect year-over-year gross-margin and operating-margin improvement until the third fiscal quarter.
- Management expects the full-year fiscal 2019 effective tax rate to be closer to the statutory rate of 24.5%.
- In February 2019, the Company acquired the remaining 55% interest in Arden Companies for approximately $13.4 million and subsequently used approximately $40 million to eliminate most of Arden’s acquired debt.
- The Company adopted ASC Topic 606 and several other accounting updates in fiscal 2019 without a material income-statement impact. It expects adoption of the new lease standard in September 2019 to result in material long-term operating lease liabilities and right-of-use assets.
Risks, Contingencies and Unusual Items
- Garden results are highly seasonal; approximately 68% of Garden sales historically occur in the second and third fiscal quarters, and the segment typically incurs a first-quarter operating loss.
- Key risks include raw-material, fuel and transportation cost inflation; inability to pass through cost increases; adverse weather; consumer spending weakness; tariffs and trade disputes; retail consolidation; competition; acquisition integration; supply shortages; international sourcing; cyberattacks; product recalls; regulatory matters; and potential goodwill or intangible-asset impairment.
- A jury awarded Nite Glow Industries approximately $12.6 million in June 2018 in a patent, contract and misappropriation case involving flea and tick product applicators. Post-trial proceedings and a potential appeal were pending. Management believes the matter will not materially affect the consolidated financial statements but acknowledges that the ultimate outcome is uncertain.
- State examinations concerning unclaimed-property compliance were at an early stage, and the potential impact could not be determined.
- No goodwill impairment was recorded during either comparable quarter. The Company reported no material changes to market-risk exposure, off-balance-sheet arrangements, contractual obligations or risk factors from its fiscal 2018 Form 10-K.
Investor Verification Checklist
- Verify whether January 2019 pricing actions offset raw-material, labor and transportation inflation and whether margins improved as management expected.
- Monitor organic sales trends, particularly Pet animal health and live fish and Garden controls and fertilizer products.
- Assess Bell Nursery’s seasonal contribution and the effect of acquisitions on consolidated margins and cash conversion.
- Review leverage, interest expense, 2023 and 2028 note maturities, and availability under the asset-based revolving facility.
- Track the Nite Glow litigation, unclaimed-property examinations and any related cash or earnings impact.
- Evaluate the Arden acquisition, including the approximately $40 million debt repayment and integration benefits.
- Confirm the effect of ASC 842 lease adoption and other future accounting standards on reported assets, liabilities and disclosures.