Central Garden & Pet Company — Fiscal 2012 Third-Quarter Form 10-Q
Business context and reporting period
Central Garden & Pet is a branded manufacturer and marketer serving the pet and lawn-and-garden markets through its Pet Products and Garden Products segments. This unaudited filing covers the three and nine months ended June 23, 2012, compared with the periods ended June 25, 2011. Results are seasonal, particularly in Garden Products, and are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Three months ended June 23, 2012 | Three months ended June 25, 2011 | Nine months ended June 23, 2012 | Nine months ended June 25, 2011 |
|---|---|---|---|---|
| Net sales | $533.8 million | $484.3 million | $1,302.8 million | $1,251.7 million |
| Gross profit | $180.7 million | $149.4 million | $409.1 million | $395.7 million |
| Gross margin | 33.8% | 30.8% | 31.4% | 31.6% |
| Income from operations | $49.0 million | $36.6 million | $82.9 million | $89.7 million |
| Net income attributable to Central | $22.7 million | $17.1 million | $31.2 million | $39.3 million |
| Diluted EPS | $0.47 | $0.31 | $0.65 | $0.68 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $64.2 million | $(1.5) million |
Third-quarter sales increased 10.2%, gross profit increased 20.9%, and operating income increased approximately 33.8%. The nine-month sales increase was 4.1%, while operating income declined 7.6% and net income attributable to Central declined 20.4%.
Third-quarter selling, general and administrative expense was $131.7 million, or 24.7% of sales, compared with $112.8 million, or 23.3%, in the prior-year quarter. Nine-month SG&A was $326.2 million, or 25.0% of sales, compared with 24.4% previously. Net interest expense was $10.7 million in the quarter and $30.7 million for the nine-month period.
Pet Products generated third-quarter sales of $271.3 million and operating income of $40.5 million. Garden Products generated sales of $262.5 million and operating income of $22.6 million. For the nine-month period, Pet Products sales increased to $693.1 million and operating income to $71.2 million, while Garden Products sales declined slightly to $609.7 million and operating income declined to $48.1 million.
Liquidity, cash flow and debt
- Cash and cash equivalents were $40.7 million at June 23, 2012, and short-term investments were $17.8 million, for total cash and short-term investments of $58.5 million.
- Operating cash flow was $64.2 million for the first nine months, compared with cash used of $1.5 million in the prior-year period, primarily reflecting lower working-capital investment.
- Capital expenditures were $26.9 million for the first nine months, and management expected approximately $40 million of fiscal 2012 capital expenditures.
- Total debt was $449.9 million, consisting primarily of 8.25% senior subordinated notes due 2018. The company issued an additional $50 million of these notes in February 2012 and used the proceeds to repay part of its revolving credit borrowings.
- The $375 million revolving credit facility had no outstanding balance and no letters of credit at June 23, 2012. Unused commitments were $375.0 million, or $231.9 million after financial-covenant limitations.
- The company reported a total leverage ratio of 3.9 to 1.0, an interest coverage ratio of 3.0 times, and compliance with all financial covenants.
- Management stated that available liquidity, operating cash flow and supplier arrangements should be adequate for anticipated needs for at least the next 12 months, while noting that future financing availability is not assured.
Material changes versus the prior comparable period
- Third-quarter performance improved substantially as operational disruptions from the transformation initiative were mostly resolved. Pet Products led the improvement, particularly Animal Health products, including flea and tick products.
- Garden Products benefited from increased garden chemical and control sales, including fulfillment of orders delayed in the prior quarter, but grass seed demand remained below expectations.
- Nine-month gross margin declined modestly because of Garden Products input and production costs, lower-margin product mix, weaker grass seed and seasonal décor sales, and prior-quarter operational disruption.
- SG&A increased due to higher advertising and brand-building activity, variable compensation, delivery costs, legal and litigation costs, and software amortization related to the SAP enterprise resource planning implementation.
- Share repurchases totaled $23.2 million in cash during the first nine months, compared with $83.6 million in the prior-year period. The quarter included 66,033 shares withheld for taxes, not program repurchases.
Guidance, outlook, risks and unusual items
- Management expected the fiscal 2012 effective tax rate to be slightly below the 40.8% reported for fiscal 2011; the nine-month 2012 effective rate was 37.7% versus 35.5% in the prior-year period.
- Management was reviewing fiscal 2013 plans and product listings because commodity prices had begun increasing again, primarily due to drought conditions. Grain, seed, fuel, fertilizer and chemical costs remain material margin risks.
- The multi-year transformation initiative included closing five warehouses and one manufacturing facility and changing other facilities. The company stated that most fiscal second-quarter fulfillment and execution issues had been resolved during the third quarter.
- Garden Products is highly seasonal, with approximately 67% of segment sales historically occurring in the second and third fiscal quarters. Weather and consumer spending can materially affect results and cash flow.
- The company reported two unrelated 2012 product recalls involving one batch of baby bird feed and a separate lot of mice, rat and hamster feed. Management did not expect material costs but could not be certain of the ultimate impact.
- No legal proceedings were identified that management believed would have a material adverse effect. No material changes were reported in off-balance-sheet arrangements, market-risk exposure or critical accounting policies.
- Disclosure controls and procedures were considered effective as of June 23, 2012, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the improved third-quarter operating results and margin expansion persist after seasonal Garden Products demand subsides.
- The pace and cost of completing the transformation initiative and SAP ERP implementation, including any remaining fulfillment or supply-chain disruptions.
- Exposure to drought-related grain, seed and other commodity inflation and the company’s ability to pass those increases through to customers.
- Debt covenant headroom, available revolver capacity and refinancing requirements for the $450 million of 8.25% notes due in 2018.
- Performance of Garden Products, particularly grass seed and seasonal décor, and sustainability of growth in Pet Products Animal Health categories.
- Any financial, regulatory or reputational consequences from the 2012 product recalls or other product-liability matters.