Central Garden & Pet Company — Fiscal 2015 First-Quarter 10-Q
Reporting period: Three months ended December 27, 2014, compared with the three months ended December 28, 2013. Results are unaudited. The business is seasonal, with Garden sales and operating income concentrated primarily in the second and third fiscal quarters.
Business context
Central Garden & Pet operates through Pet and Garden segments, selling branded and third-party pet supplies, animal health products, lawn and garden products, seed, bird feed, controls, fertilizer, pottery and seasonal décor.
Key financial metrics
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $307.3 million | $290.5 million | Up 5.8% |
| Gross profit | $88.0 million | $79.7 million | Up 10.3% |
| Gross margin | 28.6% | 27.4% | Up 120 basis points |
| SG&A | $86.8 million | $88.1 million | Down 1.4% |
| SG&A as percentage of sales | 28.3% | 30.3% | Down 200 basis points |
| Operating income (loss) | $1.1 million | $(8.4) million | Improved $9.5 million |
| Net loss attributable to Central | $(5.7) million | $(12.7) million | Improved $7.0 million |
| Basic and diluted loss per share | $(0.12) | $(0.26) | Improved $0.14 |
| Net cash from operating activities | $15.9 million | $30.0 million | Down $14.1 million |
Segment performance
- Pet: Sales increased 8.0% to $199.3 million; operating income increased to $20.6 million from $14.4 million. Growth reflected higher animal health volumes, increased third-party product sales and a favorable mix toward higher-margin products.
- Garden: Sales increased 2.0% to $108.0 million; operating loss narrowed to $3.5 million from $6.2 million. Branded sales declined, particularly seasonal décor and bird feed, while third-party product sales increased.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $79.6 million at December 27, 2014, plus $19.7 million of restricted cash and $10.0 million of short-term investments.
- Total debt was $450.2 million, including approximately $449.6 million of 8.25% senior subordinated notes due March 2018. The notes had an estimated fair value of $461.9 million.
- The $390 million asset-based revolving credit facility had no borrowings or letters of credit outstanding; borrowing availability was approximately $293.6 million, with $12.6 million of other letters of credit outstanding.
- The company reported compliance with the covenants governing both the notes and credit facility.
- Inventories were $399.9 million, compared with $427.4 million a year earlier and $326.4 million at fiscal year-end. Management attributed the lower operating cash flow primarily to a larger inventory build during the quarter.
- Capital expenditures were $4.1 million in the quarter. Fiscal 2015 capital expenditures were expected not to exceed $30 million.
Material changes versus the prior comparable period
- Sales growth, improved product mix and lower SG&A moved the company from an operating loss to operating income.
- Net loss narrowed despite the company remaining unprofitable in the seasonally weak first quarter.
- Net interest expense declined 14.5% to $10.4 million, primarily because the prior-year period included a $1.7 million non-cash write-off of deferred financing costs.
- Operating cash flow declined because inventory investment increased, partially offset by higher accounts payable.
- The company repurchased approximately $5.1 million of common stock during the quarter; approximately $45.0 million remained under the authorization.
Outlook, unusual items and risks
- Management stated that available cash, operating cash flow, supplier arrangements and revolver capacity should be adequate for anticipated working capital, capital spending and other cash needs for at least the next 12 months, while noting that financing availability and terms cannot be assured.
- In January 2015, the company called $50.0 million of the 2018 notes for redemption on March 1, 2015 at 102.063% of principal. It expected to record an approximately $1.5 million second-quarter charge for the premium and write-off of financing costs, with future interest savings.
- After quarter-end, the company invested $16 million in two related joint ventures focused on intellectual property for pet, animal health and pesticide products.
- Harbinger Group notified the board in January 2015 that it would not pursue its previously proposed transaction.
- Key risks include Garden seasonality and weather, raw-material and commodity-price volatility, inability to pass through cost increases, retailer and customer concentration, competition, acquisitions, goodwill and intangible-asset impairment, ERP implementation, cyber attacks, product liability, recalls, regulatory matters and access to capital.
- Several states are examining the company’s compliance with unclaimed-property laws. The examinations are at an early stage, and management cannot determine their potential impact.
- No material legal proceedings, material changes to previously disclosed risk factors, or material changes to off-balance-sheet arrangements were reported.
Investor verification points
- Verify whether Pet segment momentum and improved mix can offset Garden seasonality and weaker branded décor and bird-feed sales.
- Track inventory levels, working-capital conversion and operating cash flow during the seasonal build and peak selling periods.
- Confirm completion and accounting treatment of the $50 million note redemption, including the expected $1.5 million charge and subsequent interest savings.
- Assess leverage, the 2018 note maturity, revolver availability and compliance with credit and debt covenants.
- Evaluate the return potential and execution risks associated with the $16 million joint-venture investment and ongoing product development.
- Monitor the unclaimed-property examinations and any developments involving litigation, recalls, regulatory matters or cyber risk.