Business Context and Reporting Period
Central Garden & Pet Company is a marketer, producer and distributor of branded and third-party products for the pet and lawn-and-garden markets. This unaudited Form 10-Q covers the three and six months ended March 26, 2016, compared with the periods ended March 28, 2015. Results are seasonal, particularly in Garden, with approximately 66% of Garden sales historically occurring in the second and third fiscal quarters.
Financial Performance and Position
| Metric | Three Months Ended March 26, 2016 | Year-over-Year Change | Six Months Ended March 26, 2016 | Year-over-Year Change |
|---|---|---|---|---|
| Net sales | $541.2 million | 8.8% | $901.1 million | 11.9% |
| Gross profit | $169.3 million | 12.8% | $269.1 million | 13.1% |
| Gross margin | 31.3% | Up 110 basis points | 29.9% | Up 30 basis points |
| Income from operations | $59.4 million | 18.9% | $68.2 million | 33.4% |
| Operating margin | 11.0% | Up from 10.0% | 7.6% | Up from 6.3% |
| Net income attributable to Central | $32.7 million | 40.7% | $24.1 million | 37.4% |
| Diluted EPS | $0.65 | Up from $0.47 | $0.48 | Up from $0.35 |
Pet sales increased 24.3% in the quarter and 24.5% year to date, supported by acquisitions and organic growth in dog and cat products and animal health. Garden sales declined 3.7% in the quarter and 1.8% year to date, primarily due to the exit from seasonal décor and a private-label fertilizer relationship and lower wild bird feed volume. Earlier spring conditions supported higher grass seed sales.
Quarterly SG&A increased 9.8% to $109.9 million and rose to 20.3% of sales from 20.1%. For the six-month period, SG&A increased 7.5% but declined to 22.3% of sales from 23.2%, reflecting operating leverage. Pet operating margin declined to 11.8% for the quarter and 11.2% year to date, partly because recent acquisitions generally carry lower margins. Garden operating income increased 12.9% in the quarter and 15.0% year to date.
Net interest expense was $7.1 million in the quarter, down from $11.9 million, but was $29.2 million year to date, up from $22.4 million. The year-to-date amount includes approximately $14.3 million of incremental expense associated with refinancing and redeeming the prior 8.25% notes.
At March 26, 2016, cash and cash equivalents were $9.8 million, restricted cash was $11.9 million, inventories were $390.8 million and total assets were $1.32 billion. Total debt was $497.0 million, including $394.0 million carrying value of the 6.125% senior notes due 2023 and $102.0 million outstanding under the revolving facility. The company reported $264.1 million of remaining availability under the then-existing credit facility and compliance with applicable debt covenants.
Cash Flow, Liquidity and Capital Allocation
- Operating cash flow was negative $50.8 million for the six months, an improvement from negative $98.5 million in the prior-year period, principally reflecting better working-capital management.
- Investing cash flow was negative $81.0 million, including $68.9 million for acquisitions and $12.8 million of capital expenditures.
- Financing cash flow was positive $94.4 million, reflecting $400.0 million of new long-term debt, revolving borrowings and repayments, debt refinancing costs and limited share repurchases.
- Cash declined by $37.8 million from $47.6 million at the beginning of the fiscal year to $9.8 million at March 26, 2016.
- Management expected fiscal 2016 capital expenditures not to exceed $40 million and stated that operating cash flow, revolver availability and supplier arrangements should fund anticipated needs for at least the next 12 months, while noting that financing availability is not guaranteed.
Material Changes, Transactions and Outlook
- The company issued $400 million of 6.125% senior notes due 2023 in November 2015 and redeemed its $400 million of 8.25% senior subordinated notes in December 2015. The refinancing reduced the stated interest rate but generated a $14.3 million year-to-date incremental interest expense.
- Acquisitions included Hydro-Organics Wholesale, DMC’s pet bedding business and certain assets, and IMS Trading. The filing reported approximately $68.9 million of acquisition cash payments during the six months. DMC’s purchase-price allocation remained incomplete at quarter end.
- On April 22, 2016, the company amended and restated its asset-based revolver, increasing the facility to $400 million, extending maturity to April 22, 2021 and providing $281.8 million of availability based on $86.0 million of borrowings at closing.
- George C. Roeth was announced as the incoming President and Chief Executive Officer effective June 1, 2016. John R. Ranelli was expected to remain Senior Advisor through September 30, 2016 and continue as a director.
- No specific revenue or earnings guidance was provided in the filing. Management expected additional capital expenditures for infrastructure, manufacturing, distribution and enterprise information technology improvements and continued to evaluate acquisitions.
Risks, Contingencies and Unusual Items
- Key risks include seasonality and weather, raw-material and commodity-price volatility, inability to pass through cost increases, consumer spending, retail-customer concentration and consolidation, competition, acquisition integration, goodwill and intangible-asset impairment, international sourcing, product liability, recalls, regulatory matters, cyberattacks, ERP implementation and CEO succession.
- The company stated that no current legal proceedings were expected to have a material effect on financial position or results of operations.
- Goodwill was $213.8 million and other intangible assets were $83.0 million at March 26, 2016. No significant non-financial asset impairment testing charge was recorded during the six months.
- The filing states that Garden seasonality makes interim results not indicative of full-year performance.
- Disclosure controls were considered effective as of March 26, 2016, and management reported no material change in internal control over financial reporting.
Investor Verification Points
- Verify whether Pet acquisition growth, particularly from IMS and DMC, converts into sustainable organic growth and improved margins after integration.
- Monitor Garden sales, weather conditions, grass-seed performance and the effect of discontinued seasonal décor and private-label activities.
- Reconcile reported cash generation with the seasonal build in receivables and inventory and assess liquidity after the April 2016 revolver amendment.
- Assess leverage, interest costs and covenant headroom under the 2023 notes and amended secured credit facility.
- Review the final purchase-price allocation for DMC and the valuation of goodwill, intangible assets and contingent consideration.
- Follow the CEO succession process and the potential effects of leadership transition on execution and strategy.