Central Garden & Pet Company — Fiscal 2017 First Quarter 10-Q
Reporting period: Three months ended December 24, 2016, compared with the three months ended December 26, 2015. The interim financial statements are unaudited. Results are seasonal, particularly in the Garden segment, and the first quarter is not indicative of full-year performance.
Business Context
Central Garden & Pet develops, markets, manufactures and distributes branded and third-party pet and lawn-and-garden products. Reportable segments are Pet and Garden. The company completed the acquisition of Segrest, Inc., an aquarium-fish wholesaler, on October 24, 2016, for approximately $60.0 million, including $6.0 million held in escrow subject to future events. It also sold a small veterinary-products division and a Garden distribution facility during the quarter.
Financial Performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $419.5 million | $359.8 million | +16.6% |
| Gross profit | $120.7 million | $99.8 million | +20.9% |
| Gross margin | 28.8% | 27.7% | +110 bps |
| Operating income | $19.9 million | $8.8 million | +$11.1 million |
| Operating margin | 4.8% | 2.4% | +240 bps |
| Net income attributable to Central | $7.6 million | $(8.6) million | Improved $16.2 million |
| Diluted EPS | $0.15 | $(0.18) | Improved $0.33 |
| Net cash used in operating activities | $(13.3) million | $(0.5) million | $(12.8) million |
- Pet sales increased 22.2% to $304.0 million, including $40.5 million from two recent acquisitions; organic Pet sales increased 6.1%. Pet operating income rose 27.5% to $33.4 million, with an 11.0% margin.
- Garden sales increased 4.0% to $115.5 million. Garden operating income improved to $2.7 million from a $3.3 million loss, aided by lower input costs, favorable mix, reduced expenses and a facility-sale gain.
- SG&A increased 10.7% to $100.7 million, but declined to 24.0% of sales from 25.3%. The quarter included a $2.0 million gain on the sale of a distribution facility.
- Excluding the facility-sale gain, operating income was $17.9 million and operating margin was 4.3%. Non-GAAP net income was $6.3 million, or $0.12 per diluted share, versus $0.3 million, or $0.01 per diluted share, in the prior-year quarter after adjustments.
- Interest expense declined to $6.9 million from $22.1 million. The prior-year period included $14.3 million of costs related to refinancing and redeeming the former 2018 notes.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $6.6 million at December 24, 2016, compared with $93.0 million at September 24, 2016. Restricted cash was $11.0 million.
- Operating cash flow was negative $13.3 million, primarily because of the seasonal inventory build. Inventory increased to $430.2 million from $362.0 million at fiscal year-end.
- Investing cash outflows were $67.4 million, including $60.0 million for the Segrest acquisition and $13.0 million of capital expenditures, partly offset by $8.0 million of asset-sale proceeds.
- Total debt was $395.4 million, compared with $395.3 million at September 24, 2016 and $436.2 million at December 26, 2015. Debt principally consisted of $400.0 million of 6.125% senior notes due 2023.
- The $400 million asset-based revolving facility had no borrowings or letters of credit outstanding, with reported borrowing availability of $329.1 million; other letters of credit totaled $2.6 million.
- Management stated that operating cash flow, supplier arrangements and available revolver capacity should be adequate for working capital, capital expenditures and other needs for at least the next 12 months. Planned capital expenditures over the next 12 months were estimated at $40 million to $45 million.
- The company was in compliance with the covenants governing its senior notes and revolving credit facility as of December 24, 2016.
Material Changes, Outlook and Risks
- Reported sales growth was significantly acquisition-driven: organic consolidated sales increased 7.0% to $377.7 million.
- Management attributed margin improvement to favorable product mix, lower Garden input costs and recent acquisitions. Garden sales remain highly seasonal, with approximately 66% of annual Garden sales historically occurring in the second and third fiscal quarters.
- No specific full-year revenue or earnings guidance was provided in the filing. Management expects continued evaluation of acquisitions and identified potential future acquisition funding needs.
- Key risks include seasonality and weather, raw-material and energy-price volatility, inability to pass through cost increases, consumer spending weakness, competition and retail consolidation, acquisition integration, goodwill and intangible impairment, international sourcing, product recalls and liability, cyberattacks, ERP implementation, liquidity and access to capital, and dependence on key executives and major customers.
- The filing notes a recent CEO transition and dependence on the company’s CEO and other key executives. No material legal proceedings were reported, and management stated that there were no material changes to previously disclosed risk factors, contractual obligations, off-balance-sheet arrangements or market-risk exposures.
- Disclosure controls and procedures were deemed effective as of December 24, 2016, with no material change in internal control over financial reporting.
Important Facts to Verify
- Whether organic Pet growth and acquisition synergies continue after the Segrest and other recent acquisitions are fully integrated.
- Whether the seasonal inventory build converts to operating cash flow during the Garden selling season without elevated markdowns or obsolescence.
- The sustainability of the 28.8% gross margin and the normalized operating margin excluding the $2.0 million facility-sale gain.
- Revolver availability, borrowing-base calculations, covenant compliance and liquidity as seasonal working-capital needs increase.
- Future contingent consideration and the final purchase-price allocation for Segrest, including the $6.0 million escrow arrangement.
- Commodity costs, weather conditions, retail demand and the impact of the Garden business’s seasonal concentration.