CENTRAL GARDEN & PET CO quarterly report, Q2 FY2021

Central Garden & Pet Company — Fiscal 2021 Second-Quarter Form 10-Q

Business Context and Reporting Period

Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party pet and garden products. The filing covers the three and six months ended March 27, 2021, compared with the periods ended March 28, 2020. Operations are reported through the Pet and Garden segments. Outdoor cushion operations were reclassified from Garden to Pet, with prior periods recast. Results are seasonal, particularly in Garden, and are not necessarily indicative of full-year performance.

Key Financial Metrics

Metric	Three Months Ended March 27, 2021	Prior Year	Six Months Ended March 27, 2021	Prior Year
Net sales	$935.3 million	$703.2 million	$1,527.5 million	$1,186.1 million
Gross profit	$272.4 million	$207.1 million	$437.8 million	$338.4 million
Gross margin	29.1%	29.5%	28.7%	28.5%
Operating income	$104.6 million	$66.1 million	$131.7 million	$68.2 million
Operating margin	11.2%	9.4%	8.6%	5.7%
Net income attributable to Central	$73.0 million	$42.7 million	$78.6 million	$38.3 million
Diluted EPS	$1.32	$0.78	$1.43	$0.69

Quarterly sales increased 33.0%; organic sales increased 23.2%. Six-month sales increased 28.8%; organic sales increased 23.2%.
Quarterly Pet sales increased 21.3% to $492.0 million and Garden sales increased 48.9% to $443.3 million. Garden included $76.1 million of sales from recent acquisitions.
Quarterly selling, general and administrative expense increased 19.0% to $167.8 million but declined to 17.9% of sales from 20.1%. Six-month SG&A declined to 20.0% of sales from 22.8%.
Six-month adjusted EBITDA, a non-GAAP measure, was $163.4 million versus $94.5 million in the prior year. Quarterly adjusted EBITDA was $123.5 million versus $79.3 million.
Net cash used in operating activities was $120.2 million for the six months, compared with $92.7 million used in the prior year. Working capital consumption included a $131.9 million increase in inventory and a $191.3 million increase in accounts receivable.
Net cash used in investing activities was $765.4 million, primarily reflecting $733.7 million of acquisition payments and $33.6 million of capital expenditures.
Capital expenditures were approximately $34 million year to date; management expects approximately $75 million for fiscal 2021.
Cash and cash equivalents were $39.9 million at March 27, 2021, or $52.5 million including restricted cash, versus $331.6 million and $344.6 million, respectively, a year earlier.
Total debt was $979.0 million at March 27, 2021 versus $693.7 million at March 28, 2020. The balance included $300 million of 2028 Notes, $500 million of 2030 Notes and $190 million drawn under the asset-based revolving facility.
Net availability under the revolving facility was $210 million at quarter-end. The company reported compliance with applicable debt covenants.

Material Changes Versus the Prior Comparable Period

Demand increased across both segments, which management attributed significantly to pandemic-related pet ownership and home gardening activity, as well as retailer listing gains.
Quarterly gross margin decreased 40 basis points because of purchase-accounting inventory adjustments from recent Garden acquisitions and higher commodity, labor and freight costs. Six-month gross margin increased 20 basis points, primarily from Garden operating leverage and pricing.
Operating income growth substantially exceeded sales growth because of improved SG&A leverage. Pet operating income increased 42.7% in the quarter, while Garden operating income increased from $43.2 million to $66.0 million.
The company acquired DoMyOwn for approximately $81 million, Hopewell Nursery for approximately $81 million and Green Garden Products for approximately $571 million. Purchase-price allocations remained preliminary, with approximately $587 million of these acquisition costs recorded in other assets pending allocation.
Green Garden contributed approximately $55 million of sales and $5 million of net income during the quarter and year-to-date periods presented.
The company sold certain Breeder’s Choice assets for $2.4 million and recorded a $2.6 million loss.
The company issued $500 million of 4.125% senior notes due 2030 and redeemed $400 million of 6.125% senior notes due 2023. Related call premiums, overlapping interest and financing-cost write-offs increased interest expense by approximately $10.0 million during the first six months.

Outlook, Commentary, Risks and Unusual Items

Management did not provide specific consolidated revenue or earnings guidance in the filing. Management stated that liquidity should be adequate for working capital, capital expenditures and other needs for at least the next 12 months, based on operating cash flow, cash, supplier arrangements and revolving-credit availability.

COVID-19 continued to support demand but created supply-chain, fill-rate, labor-availability and logistics challenges. Facilities were generally operating, although employee absences and additional sanitation and protective-equipment costs continued.
Management expects forecasting to remain difficult because of volatile demand, changing consumption patterns, vaccination uncertainty and potential virus variants. It also warned that demand could later decline in categories benefiting from the pandemic.
Inflation in commodities, seeds and grains, fuel, freight and labor could pressure margins. The company may not be able to pass through cost increases promptly or fully.
Garden operations are highly seasonal; approximately 67% of Garden sales historically occur in the second and third fiscal quarters.
Other identified risks include acquisition integration and purchase accounting, weather, supply shortages, retailer concentration, competition, tariffs, international sourcing, ERP implementation, cybersecurity, product liability, recalls, environmental matters, goodwill impairment and access to capital.
A $12.4 million Nite Glow patent and related-claims judgment remained on appeal. Management believes the matter will not materially affect the consolidated financial statements, but acknowledges that the ultimate outcome is uncertain.
The company had approximately $10 million of costs in excess of insurance proceeds related to prior facility fires at March 27, 2021 and subsequently received approximately $9.3 million of insurance proceeds.
On April 30, 2021, after quarter-end, the company issued $400 million of 4.125% senior notes due 2031. Proceeds were used partly to repay all amounts outstanding under the revolving facility, with the remainder available for general corporate purposes.
Internal control over financial reporting was effective as of March 27, 2021, but the three recent acquisitions were excluded from management’s assessment while integration continues.

Important Facts for Investors to Verify

Whether pandemic-related demand remains durable and how normalization affects organic sales, especially in Garden.
The final purchase-price allocations and resulting amortization, goodwill, intangible assets and deferred-tax effects for the three acquisitions.
Inventory and receivables growth, seasonal working-capital needs and the company’s ability to convert earnings into operating cash flow.
Post-quarter-end debt refinancing, including repayment of the revolving facility and the company’s resulting interest expense, leverage and liquidity.
The effect of commodity, labor and freight inflation and the timing and effectiveness of price increases.
The outcome and potential financial exposure from the Nite Glow litigation and unclaimed-property examinations.
Whether the company achieves its approximately $75 million fiscal 2021 capital-expenditure expectation and maintains compliance with debt covenants.