Central Garden & Pet Company — Fiscal 2019 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended June 29, 2019, compared with June 30, 2018. The interim financial statements are unaudited. Central manufactures, markets and distributes branded, private-label and third-party pet and garden products, primarily in the United States. Results are highly seasonal, particularly in the Garden segment.
Financial performance and position
| Metric | Q3 FY2019 | Q3 FY2018 | 9M FY2019 | 9M FY2018 |
|---|---|---|---|---|
| Net sales | $706.6 million | $657.9 million | $1,842.3 million | $1,713.0 million |
| Gross profit | $219.3 million | $202.1 million | $555.5 million | $528.4 million |
| Gross margin | 31.0% | 30.7% | 30.2% | 30.8% |
| Operating income | $68.9 million | $60.8 million | $141.2 million | $149.1 million |
| Operating margin | 9.7% | 9.2% | 7.7% | 8.7% |
| Net income attributable to Central | $46.2 million | $41.5 million | $90.3 million | $113.0 million |
| Diluted earnings per share | $0.80 | $0.79 | $1.56 | $2.15 |
For the quarter, sales increased 7.4%, while organic sales increased 0.6%. Gross profit increased 8.5%, and SG&A increased 6.5% to $150.4 million, declining to 21.3% of sales from 21.5%. Net interest expense declined to $8.5 million from $10.0 million, primarily because of higher interest income.
For the nine months, sales increased 7.5%, but organic sales increased only 0.6%. SG&A rose 9.3% to $414.3 million, or 22.5% of sales, and operating income declined 5.3%. The prior-year period benefited from a $16.3 million provisional tax benefit related to the Tax Cuts and Jobs Act; the current-year effective tax rate was 22.3% versus 7.2% reported in the prior year, or 20.5% excluding that prior-year benefit.
Segment results
- Pet: Q3 sales declined 1.3% to $350.2 million and operating income declined 10.6% to $35.1 million. Nine-month sales increased 2.7% to $1,028.8 million, while operating income declined 15.2% to $91.8 million. Weakness included animal health, pet distribution, behavior-modification products and a soft flea-and-tick season.
- Garden: Q3 sales increased 17.5% to $356.4 million and operating income increased 29.7% to $53.1 million. Nine-month sales increased 14.3% to $813.5 million and operating income increased 8.3% to $101.8 million. Growth was led by acquisitions, live plants and garden distribution, partly offset by weather-related weakness in controls and fertilizer.
Cash flow, debt and liquidity
- Cash flow from operations for the nine months was $92.8 million, versus $17.8 million in the prior-year period.
- Investing cash outflow was $65.0 million, including $20.9 million of capital expenditures and $41.2 million for acquisitions.
- Financing cash outflow was $64.1 million, including $46.2 million of debt repayments and $17.8 million for share repurchases and tax withholding.
- Cash, cash equivalents and restricted cash were $456.6 million at June 29, 2019, compared with $493.0 million at September 29, 2018.
- Total debt was $693.1 million, consisting primarily of $400 million of 6.125% senior notes due November 2023 and $300 million of 5.125% senior notes due February 2028.
- The $400 million asset-based revolving facility had no borrowings outstanding, $400 million of reported availability and $3.2 million of other letters of credit outstanding. The Company reported compliance with applicable financial covenants.
Material changes and unusual items
- Central acquired C&S Products in May 2019 for approximately $30.0 million and used approximately $4.7 million to eliminate acquired debt.
- Central acquired the remaining 55% of Arden Companies in February 2019 for approximately $13.4 million and recorded a provisional non-cash gain of approximately $3.2 million from remeasuring its previously held interest. Approximately $36 million was used to repay most of Arden’s acquired debt.
- The Company recorded a $2.5 million non-cash Pet intangible-asset impairment after a retail customer exited the live-fish business.
- Central exited glazed pottery and wood products within its decor business because of operating complexity, cost and lack of profitability; it retained its terra cotta pottery business.
- Approximately 0.6 million Class A shares were repurchased during the nine months for approximately $14.3 million, with $20.7 million remaining under the authorized repurchase program at June 29, 2019.
- ASC Topic 606 revenue recognition was adopted at the beginning of fiscal 2019 without an opening retained-earnings adjustment. The Company expects to adopt the new lease standard on September 29, 2019 and expects significant operating lease liabilities and right-of-use assets to be recorded.
Outlook, risks and contingencies
- Management expects fiscal 2019 capital expenditures of approximately $35 million to $40 million and stated that operating cash flow, supplier arrangements and revolver availability should be adequate for anticipated needs for at least the next 12 months.
- Management expects a higher fiscal 2019 effective tax rate than the prior year, excluding the prior-year Tax Reform Act benefit. No specific revenue or earnings guidance was provided.
- Key risks include seasonality and weather, commodity and transportation costs, difficulty passing through cost increases, tariffs and international sourcing, consumer spending, customer concentration, competition, acquisitions, goodwill and intangible impairment, ERP implementation, cybersecurity, product liability and recalls.
- President and CEO George C. Roeth announced plans to retire in September 2019. The Company identified succession and retention of key personnel as an additional risk.
- Nite Glow Industries obtained a jury verdict of approximately $12.6 million in 2018 concerning patent, contract and misappropriation claims related to flea-and-tick product applicators. Post-trial proceedings and a potential appeal were pending; management expected to prevail but acknowledged the outcome could result in expense above expectations.
- State examinations concerning compliance with unclaimed-property laws remained at an early stage, and the potential financial impact was not determinable.
Facts investors should verify
- Whether Pet segment weakness, particularly in animal health and distribution, persists after the quarter.
- Whether Garden growth and margin improvement remain dependent on acquisitions and favorable live-plant performance.
- The final purchase-price accounting for C&S Products and Arden, including the provisional Arden gain.
- The ultimate resolution and potential cash cost of the Nite Glow litigation.
- The balance-sheet impact of adopting the lease standard and the Company’s ability to maintain margins amid commodity, freight and labor inflation.
- CEO succession execution and any related changes in strategy, capital allocation or acquisition activity.