Central Garden & Pet Company — Fiscal 2019 Second-Quarter 10-Q
Business context and reporting period
Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party pet and lawn-and-garden products, primarily in the United States. This unaudited Form 10-Q covers the three and six months ended March 30, 2019, compared with the periods ended March 31, 2018. Results are seasonal, particularly in Garden; management states that approximately 68% of Garden sales historically occur in the second and third fiscal quarters.
Financial performance and liquidity
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $673.7 million | $613.1 million | $1,135.7 million | $1,055.1 million |
| Gross profit | $206.1 million | $194.5 million | $336.2 million | $326.3 million |
| Gross margin | 30.6% | 31.7% | 29.6% | 30.9% |
| Operating income | $62.2 million | $65.8 million | $72.3 million | $88.3 million |
| Operating margin | 9.2% | 10.7% | 6.4% | 8.4% |
| Net income attributable to Central | $42.4 million | $45.2 million | $44.2 million | $71.5 million |
| Diluted EPS | $0.73 | $0.86 | $0.76 | $1.36 |
Q2 sales increased 9.9%, including 2.1% organic growth. Pet sales rose 5.1% to $338.2 million, with organic sales essentially flat. Garden sales rose 15.1% to $335.5 million, including 4.4% organic growth. Six-month sales increased 7.6%, while organic sales increased 0.5%.
For the six months, net cash used in operating activities was $79.3 million, compared with $94.0 million used in the prior-year period. Investing cash use was $27.6 million versus $89.7 million, primarily reflecting lower acquisition spending. Financing cash use was $40.3 million, compared with $284.7 million provided in the prior year, which included the $300 million senior-notes issuance. Capital expenditures were $14.3 million for the six months.
At March 30, 2019, cash and cash equivalents were $329.7 million and restricted cash was $16.1 million. Total debt was $697.8 million, consisting primarily of $400 million of 6.125% senior notes due 2023 and $300 million of 5.125% senior notes due 2028. The $400 million asset-based revolving facility had no borrowings outstanding, $374.0 million of borrowing availability and $8.2 million of other outstanding letters of credit. Management represented that liquidity should be adequate for at least the next 12 months; fiscal 2019 capital expenditures are expected to be approximately $40 million.
Material changes versus the prior comparable periods
- Sales growth was driven substantially by recent acquisitions: three acquisitions contributed to Q2 growth, while organic growth was modest.
- Gross margin declined 110 basis points in Q2 and 130 basis points for the six months, primarily due to acquired businesses, including lower-margin General Pet Supply, Bell Nursery seasonality, Arden purchase accounting and higher grass-seed commodity costs.
- Q2 SG&A increased 11.8% to $143.9 million, and SG&A as a percentage of sales rose to 21.4% from 21.0%. Higher freight, acquisition-related expenses and lease-standard implementation costs contributed.
- Pet Q2 operating income declined 17.7% to $27.0 million, partly due to a $2.5 million non-cash intangible-asset impairment related to a retail customer exiting the live-fish business.
- Garden Q2 operating income increased 5.1% to $53.4 million, but management reported that Garden non-GAAP operating income declined after excluding a $3.2 million provisional gain related to the Arden acquisition.
- Six-month net income and EPS were adversely affected by the absence of the prior-year $16.3 million provisional tax benefit from the Tax Cuts and Jobs Act, as well as Bell Nursery’s seasonal losses and higher shares outstanding.
- In February 2019, Central acquired the remaining 55% of Arden Companies for approximately $13.4 million, recorded a provisional non-cash gain of approximately $3.2 million on remeasurement of its prior interest, and used approximately $36 million to repay most of Arden’s acquired debt.
Guidance, outlook, risks and unusual items
Management expects pricing actions implemented primarily in January 2019 to help offset inflationary pressures, including higher raw-material, freight and labor costs. No formal revenue or earnings guidance is provided in the filing. Management expects to continue evaluating acquisitions, which could require additional external capital.
Key risks include seasonality and weather, raw-material and energy-price volatility, the ability to pass through cost increases, consumer spending, tariffs and international sourcing, customer concentration, competition, acquisition integration, goodwill and intangible-asset impairment, ERP and lease-system implementation, product liability and recalls, cybersecurity, regulatory matters, and access to capital.
Chief Executive Officer George C. Roeth announced plans to retire in September 2019, creating succession and key-personnel risk. A New Jersey patent and related-claims lawsuit resulted in a June 2018 jury verdict awarding approximately $12.6 million to Nite Glow; post-trial proceedings and a potential appeal remained pending, and management stated that the ultimate outcome is uncertain. State unclaimed-property examinations were also ongoing with no estimable impact.
The company adopted ASC 606 revenue recognition using the modified retrospective method at the start of fiscal 2019, with no retained-earnings adjustment. It expects to adopt the new lease standard in fiscal 2020 and anticipates recording significant operating-lease liabilities and right-of-use assets.
Important facts for investors to verify
- Whether acquisition-related revenue growth converts into sustained organic sales and margin improvement.
- The effect of General Pet Supply, Bell Nursery and Arden on segment margins and seasonality.
- Trends in live-fish, animal-health, controls-and-fertilizer sales and the related intangible-asset impairment risk.
- Operating cash flow, working-capital needs and liquidity during the peak Garden selling season.
- Debt maturities, covenant compliance, revolving-facility availability and refinancing requirements.
- The final purchase-price allocation and gain for Arden, including any subsequent adjustments.
- The outcome and potential cost of the Nite Glow litigation and state unclaimed-property examinations.
- CEO succession execution and the impact of the planned lease-standard adoption.
- Differences between GAAP results and management’s non-GAAP measures, including adjustments for the Arden gain, impairment charge and prior-year tax benefit.