Central Garden & Pet Company — Fiscal 2018 First Quarter 10-Q
Business context and reporting period
Central Garden & Pet produces and distributes branded and private-label pet supplies and lawn and garden products. The filing covers the unaudited three months ended December 30, 2017, compared with the three months ended December 24, 2016. The Garden business is highly seasonal; management states that approximately 66% of Garden sales and 56% of consolidated sales occurred in the second and third fiscal quarters in fiscal 2017.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $442.0 million | $419.5 million | +5.4% |
| Gross profit | $131.8 million | $120.7 million | +9.2% |
| Gross margin | 29.8% | 28.8% | +100 basis points |
| Operating income | $22.5 million | $19.9 million | +13.0% |
| Operating margin | 5.1% | 4.8% | +30 basis points |
| Net income attributable to Central | $26.2 million | $7.6 million | + $18.6 million |
| Diluted EPS | $0.50 | $0.15 | +$0.35 |
| Cash flow from operations | $(24.2) million | $(13.3) million | Use increased by $10.9 million |
Reported net income benefited from a provisional $16.3 million tax benefit related to the Tax Cuts and Jobs Act. Excluding that benefit and the prior-year gain on a distribution-facility sale, non-GAAP net income was $9.9 million, or $0.19 diluted EPS, versus $6.3 million, or $0.12 diluted EPS, in the prior-year quarter.
- Pet sales increased 6.9% to $325.1 million; organic Pet sales increased 1.1%, with growth attributed primarily to e-commerce.
- Garden sales increased 1.3% to $116.9 million, entirely from organic growth; management cited improved control and fertilizer sales, partly offset by lower wild bird feed sales.
- Pet operating income increased to $36.2 million from $33.4 million, while Garden operating income was $2.3 million versus $2.7 million. Excluding the prior-year facility-sale gain, Garden operating performance improved.
- SG&A increased 8.5% to $109.3 million and rose to 24.7% of sales from 24.0%, reflecting acquisition-related costs and increased selling, marketing, warehouse and administrative expenses.
- Cash and cash equivalents were $283.5 million at December 30, 2017, compared with $32.4 million at September 30, 2017 and $6.6 million at December 24, 2016. Restricted cash was $12.4 million.
- Inventories were $440.4 million, up from $382.1 million at September 30, 2017 and $430.2 million in the prior-year comparable quarter.
- Capital expenditures were $8.2 million. Net cash used in investing activities was $15.7 million, compared with $67.4 million in the prior-year quarter, which included $60.0 million of acquisition payments.
Debt, liquidity and material changes
- Total debt was $691.3 million at December 30, 2017, compared with $395.4 million at December 24, 2016. Long-term debt included $400 million of 6.125% senior notes due 2023 and newly issued $300 million of 5.125% senior notes due 2028.
- The 2028 notes were issued in December 2017 to fund future acquisitions and general corporate purposes. Debt issuance costs were approximately $4.6 million.
- The $400 million asset-based revolving credit facility had no borrowings outstanding and $330.2 million of remaining borrowing availability, subject to borrowing-base restrictions. Other letters of credit totaled $1.8 million.
- Net cash provided by financing activities was $291.0 million, primarily reflecting the 2028-note issuance. The company expects fiscal 2018 capital expenditures of approximately $40 million.
- Management believes operating cash flow, revolver availability and supplier financing will be adequate for working capital, capital expenditures and other needs for at least the next 12 months, while noting that future acquisitions could require additional external capital.
- The company acquired K&H Manufacturing in April 2017 for approximately $48.0 million. The acquisition contributed to Pet growth and the purchase-price allocation had not been finalized at the reporting date.
Guidance, outlook, risks and unusual items
- Management expects a fiscal 2018 effective tax rate of approximately 27%, excluding discrete items such as deferred-tax remeasurement and the adoption of ASU 2016-09.
- The provisional Tax Reform Act benefit may change during the permitted measurement period as interpretations and implementation guidance develop. The ongoing effect of the lower statutory tax rate is not included in the non-GAAP adjustment.
- Other expense increased to $3.1 million from $1.0 million, primarily because of losses from two investments made in fiscal 2017. Management expects other expense or income to be more favorable in the second and third fiscal quarters because one investment is seasonal.
- Principal risks include seasonality, weather, commodity and energy-price volatility, inability to pass through cost increases, consumer spending weakness, competition, customer concentration, retail consolidation, acquisition execution, goodwill or intangible impairment, international sourcing, product liability, recalls, regulatory matters, cybersecurity, ERP implementation, tax-law changes and access to capital.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors or market-risk exposures, and effective disclosure controls as of December 30, 2017. It was in compliance with debt covenants.
- The company adopted ASU 2016-09 and ASU 2015-11 in the quarter without a material overall financial-statement impact. It expects the future lease standard to result in material operating lease liabilities and right-of-use assets upon adoption.
Facts investors should verify
- Separate the $16.3 million provisional tax benefit from recurring earnings and assess the sustainability of the stated approximately 27% fiscal 2018 tax rate.
- Evaluate leverage and interest burden after the $300 million note issuance, including the 5.125% 2028 notes and 6.125% 2023 notes.
- Monitor operating cash flow, inventory growth and working-capital needs as the company enters its peak Garden selling season.
- Assess whether Pet growth is being driven by durable organic demand or primarily by recent acquisitions; reported consolidated organic sales growth was only 1.1%.
- Review acquisition integration, contingent consideration, goodwill and intangible-asset carrying values, particularly given the company’s acquisition strategy.
- Consider the sensitivity of Garden results to weather, wild bird feed and other commodity costs, and the company’s ability to recover input-cost inflation through pricing.