Central Garden & Pet Company — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Three and six months ended March 25, 2017, compared with periods ended March 26, 2016. The interim financial statements are unaudited. The business is seasonal, particularly the Garden segment, and quarterly results are not necessarily indicative of full-year performance.
Business context
Central Garden & Pet operates through Pet and Garden segments, supplying branded and third-party pet, lawn and garden products. Approximately 66% of Garden segment sales in fiscal 2016 occurred during the second and third fiscal quarters. The October 2016 acquisition of Segrest, an aquarium-fish wholesaler, contributed materially to Pet segment growth.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $569.9 million | $541.2 million | $989.4 million | $901.1 million |
| Gross profit | $183.5 million | $169.3 million | $304.2 million | $269.1 million |
| Gross margin | 32.2% | 31.3% | 30.8% | 29.9% |
| Operating income | $63.9 million | $59.4 million | $83.8 million | $68.2 million |
| Operating margin | 11.2% | 11.0% | 8.5% | 7.6% |
| Net income attributable to Central | $34.7 million | $32.7 million | $42.3 million | $24.1 million |
| Diluted EPS | $0.67 | $0.65 | $0.82 | $0.48 |
- Q2 sales increased 5.3%; Pet sales rose 8.4% to $298.4 million and Garden sales rose 2.1% to $271.5 million.
- Six-month sales increased 9.8%; Pet sales rose 15.0% to $602.4 million and Garden sales rose 2.6% to $387.0 million.
- Q2 SG&A increased 8.9% to $119.7 million and rose to 21.0% of sales from 20.3%. Six-month SG&A was 22.3% of sales, unchanged from the prior year.
- Six-month organic sales increased 3.8%, while reported growth included $54.4 million of acquisition and divestiture effects. Q2 organic sales increased 1.7%.
- Effective tax rates were 37.1% for Q2 and 36.9% for six months, compared with 36.0% and 35.4%, respectively, in the prior-year periods.
Cash flow, balance sheet, debt and liquidity
- Six-month operating cash flow was negative $96.2 million, compared with negative $50.8 million in the prior year, primarily due to higher accounts receivable and inventory supporting growth.
- Investing cash outflow was $82.0 million, including $60.0 million for the Segrest acquisition, $26.8 million of capital expenditures, and $2.0 million invested in an equity-method investee.
- Financing cash inflow was $91.6 million, including $216.0 million of revolving borrowings, $115.0 million of revolving repayments, $20.2 million of share repurchases and tax-withholding-related share activity, and $13.2 million of excess tax benefits.
- Cash and cash equivalents declined to $6.2 million at March 25, 2017, from $93.0 million at September 24, 2016. Restricted cash was $11.0 million and is held as collateral for letters of credit.
- Total debt was $496.2 million, consisting primarily of $400.0 million of 6.125% senior notes due 2023 and $101.0 million outstanding under the asset-based revolving facility. Remaining borrowing availability was $238.9 million.
- The Company reported compliance with the covenants under both the senior notes and revolving credit facility. Management stated that available liquidity should meet working capital, capital spending and other expected needs for at least the next 12 months.
- Fiscal 2017 capital expenditures are expected to be approximately $40 million to $45 million, including spending on facilities, equipment and enterprise information technology.
Material changes versus the prior comparable periods
- Profitability improved, with Q2 operating income up 7.5% and six-month operating income up 22.9%. Gross margin expanded by 90 basis points in both comparisons.
- Net income growth benefited from substantially lower interest expense in the six-month period. The prior-year period included approximately $14.3 million of costs related to redeeming the 8.25% 2018 notes and issuing the 2023 notes.
- Pet growth was driven primarily by acquisitions, including Segrest, and organic growth in dog and cat products. Garden growth reflected stronger controls and fertilizer sales, product mix and manufacturing efficiencies, partly offset by declines in wild bird feed, grass seed and seasonal décor.
- Working-capital investment increased substantially, resulting in greater operating cash usage despite higher earnings.
- The Company acquired Segrest for approximately $60.0 million, including $6.0 million held in escrow subject to future events. On April 28, 2017, after quarter-end, it acquired K&H Manufacturing, a premium pet-supplies producer; purchase price details were not provided in the filing text.
Outlook, commentary, risks and unusual items
- Management expects liquidity from operations, the revolving facility and supplier arrangements to fund anticipated requirements, but cautions that financing availability and terms are not assured.
- Key risks include seasonal operating results and cash flow, adverse weather, commodity and fuel-price volatility, difficulty passing cost increases to customers, consumer-spending weakness, retail-industry consolidation, customer concentration, competition, acquisition execution, international sourcing, product recalls, litigation and product liability, environmental and regulatory matters, cyber attacks, ERP implementation, and goodwill or intangible-asset impairment.
- The Garden business is highly seasonal; adverse weather or changes in retailer inventory decisions could materially affect sales, margins and cash flow.
- Q2 other expense increased to $1.0 million from $0.1 million, primarily due to equity-method losses associated with a fiscal 2017 startup investment.
- A $2.0 million gain from the sale of a distribution facility was recorded in the first quarter of fiscal 2017. No significant impairment charges were recorded during the six months ended March 25, 2017.
- Management reported no material legal proceedings, no material changes in off-balance-sheet arrangements or contractual obligations, and no material changes to previously disclosed risk factors or market-risk exposures.
- The filing provides no specific full-year revenue or earnings guidance.
Important facts for investors to verify
- Whether acquisition-driven Pet growth converts into sustained organic growth and acceptable margins after integration costs.
- Whether the significant seasonal working-capital build converts into operating cash during the remainder of the fiscal year.
- Actual borrowing-base availability, revolver utilization, interest-rate exposure and compliance with fixed-charge and other debt covenants.
- Purchase accounting, goodwill and intangible-asset values associated with Segrest and the subsequent K&H acquisition.
- The effect of weather, commodity prices, retailer inventory levels and the Company’s ability to pass through input-cost increases.
- The purchase price and financing terms of K&H Manufacturing, which were not clearly provided in this filing.