Central Garden & Pet Company — Fiscal 2018 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended June 30, 2018, compared with June 24, 2017. The filing is unaudited. The Garden business is highly seasonal, so quarterly and year-to-date results are not necessarily indicative of full-year performance.
Business Context
Central Garden & Pet manufactures and distributes branded and private-label pet supplies and lawn and garden products through its Pet and Garden segments. During fiscal 2018, the Company acquired Bell Nursery and General Pet Supply.
Financial Performance and Key Metrics
| Metric | Q3 FY2018 | Q3 FY2017 | 9M FY2018 | 9M FY2017 |
|---|---|---|---|---|
| Net sales | $657.9 million | $574.6 million | $1,713.0 million | $1,564.0 million |
| Gross profit | $202.1 million | $183.3 million | $528.4 million | $487.5 million |
| Gross margin | 30.7% | 31.9% | 30.8% | 31.2% |
| Operating income | $60.8 million | $57.9 million | $149.1 million | $141.7 million |
| Operating margin | 9.2% | 10.1% | 8.7% | 9.1% |
| Net income attributable to Central | $41.5 million | $32.2 million | $113.0 million | $74.6 million |
| Diluted EPS | $0.79 | $0.62 | $2.15 | $1.44 |
- Third-quarter sales increased 14.5%; Pet sales rose 13.2% and Garden sales rose 16.1%. However, consolidated organic sales declined 0.1%, reflecting a 6.6% increase in Pet and an 8.2% decline in Garden.
- Nine-month sales increased 9.5%, while organic sales increased 2.5%. Pet organic sales rose 4.7%; Garden organic sales declined 0.6%.
- Third-quarter gross profit increased 10.3%, but gross margin declined 120 basis points because of unfavorable product mix, lower Garden volumes, and higher raw material, freight and labor costs.
- Third-quarter SG&A increased 12.7% to $141.2 million, while SG&A as a percentage of sales improved 30 basis points to 21.5%.
- Net interest expense increased 38.7% in the quarter and 29.9% year to date, primarily because of higher debt following the December 2017 issuance of $300 million of 5.125% senior notes due 2028.
- The nine-month effective tax rate was 7.2%, compared with 37.0% in the prior-year period. The change included a provisional $16.3 million benefit from the Tax Cuts and Jobs Act and approximately $7 million of tax benefit from adoption of ASU 2016-09.
Cash Flow, Debt and Liquidity
| Metric | June 30, 2018 | June 24, 2017 | September 30, 2017 |
|---|---|---|---|
| Cash and cash equivalents | $204.4 million | $14.5 million | $32.4 million |
| Restricted cash | $14.0 million | $11.0 million | $12.6 million |
| Total debt | $691.9 million | $435.4 million | $395.7 million |
| Equity | $744.7 million | $629.0 million | $637.1 million |
- Nine-month operating cash flow was $17.8 million, down from $42.6 million, primarily because of working-capital investment, including increases in accounts receivable and inventories.
- Investing cash flow was negative $125.8 million, including $86.8 million for acquisitions and $27.0 million of capital expenditures.
- Financing cash flow was positive $280.1 million, principally from the $300 million senior-note issuance. The Company also repurchased $12.9 million of common stock, including shares surrendered for tax withholding.
- The $400 million asset-based revolving credit facility had no borrowings outstanding and $400 million of remaining borrowing availability at June 30, 2018, subject to borrowing-base requirements. Other letters of credit totaled $3.3 million.
- Management stated that available liquidity, operating cash flow and supplier arrangements should 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.
Material Changes Versus the Prior Comparable Period
- Reported growth was substantially acquisition-driven. Bell Nursery contributed approximately $63.4 million of third-quarter Garden sales, and General Pet Supply contributed to Pet sales.
- Organic Garden sales declined because of unfavorable weather, lower demand, lower grass-seed and fertilizer sales, and a shift in quarter-end timing.
- Bell Nursery is extremely seasonal: although it contributed significantly to third-quarter earnings, management expects its other three quarters typically to incur losses or generate little income.
- Debt increased by approximately $256.5 million from June 24, 2017, while cash increased substantially following the senior-note issuance and seasonal collections.
- Goodwill increased to $268.2 million from $230.4 million at June 24, 2017, and other intangible assets increased to $138.6 million from $90.0 million, primarily reflecting acquisitions.
- The Company adopted ASU 2016-09 and recorded excess tax benefits from stock compensation in income taxes. It also adopted inventory measurement guidance without a material effect.
Outlook, Commentary, Risks and Unusual Items
- Management expected the fiscal 2018 effective tax rate to be approximately 27%, excluding discrete items such as the deferred-tax remeasurement and stock-compensation tax effects.
- Fiscal 2018 capital expenditures were expected to be approximately $40 million to $45 million, including investments in facilities, equipment and the enterprise-wide information-technology platform.
- Management identified seasonality, weather, raw-material and freight costs, labor costs, consumer spending, customer concentration, competition, acquisitions, international sourcing, tariffs and potential trade-war effects as key risks.
- Approximately 10% of products sold in the United States were manufactured in China; proposed or implemented tariffs could increase costs and reduce demand.
- On June 27, 2018, a jury found for Nite Glow Industries in litigation involving applicators for certain flea-and-tick products and awarded approximately $12.6 million. The Company was pursuing post-trial remedies and an appeal and stated that the ultimate outcome was uncertain.
- The Company recorded no significant impairment of goodwill or intangible assets during the period and stated that it was in compliance with applicable debt covenants.
Important Facts for Investors to Verify
- Whether organic Pet growth can offset the expected seasonal losses and weaker organic performance in Garden.
- The sustainability of margins given lower product mix, higher raw-material, freight and labor costs, and the lower-margin distribution acquisitions.
- Cash conversion and working-capital requirements as the seasonal Garden cycle progresses.
- Debt reduction capacity, interest burden and compliance with senior-note and revolving-credit covenants.
- Final accounting for the Tax Cuts and Jobs Act provisional benefit and the resulting normalized tax rate.
- The ultimate resolution and financial impact of the Nite Glow litigation.
- The final purchase-price allocations and performance of Bell Nursery and General Pet Supply.