Central Garden & Pet Company — Fiscal 2014 Third-Quarter 10-Q Summary
Business context and reporting period
Central Garden & Pet is a supplier of branded and other pet supplies and lawn-and-garden products, operating through Pet and Garden reportable segments. The unaudited quarter ended June 28, 2014 and the nine months then ended are compared with June 29, 2013. Results are highly seasonal, particularly in Garden; management states that the interim periods are not indicative of full-year results.
Financial performance and liquidity
| Metric | Three months ended June 28, 2014 | Three months ended June 29, 2013 | Nine months ended June 28, 2014 | Nine months ended June 29, 2013 |
|---|---|---|---|---|
| Net sales | $438.0 million | $494.1 million | $1,230.1 million | $1,284.8 million |
| Gross profit | $119.1 million | $152.5 million | $346.5 million | $382.6 million |
| Gross margin | 27.2% | 30.9% | 28.2% | 29.8% |
| Income from operations | $18.4 million | $32.9 million | $54.8 million | $66.5 million |
| Operating margin | 4.2% | 6.7% | 4.5% | 5.2% |
| Net income attributable to Central | $4.7 million | $13.7 million | $12.9 million | $20.7 million |
| Diluted EPS | $0.09 | $0.28 | $0.26 | $0.42 |
- Pet sales declined 4.5% in the quarter and 5.9% for the nine months. Garden sales declined 17.7% in the quarter and 2.5% for the nine months.
- Quarterly net sales fell 11.4%; nine-month sales fell 4.3%. Branded product sales declined, while sales of other manufacturers’ products increased through expanded distribution.
- Net interest expense was $10.4 million for the quarter and $33.0 million for the nine months. The nine-month amount included a $1.7 million non-cash write-off of deferred financing costs related to replacing the prior revolving facility.
- Cash provided by operating activities was $68.9 million for the nine months, compared with $65.5 million of cash used in the prior-year period, primarily because of lower working-capital investment and reduced inventories.
- Investing cash usage was $25.2 million, including $20.3 million for the acquisition of Envincio assets and $13.7 million of capital expenditures, partly offset by $5.2 million of proceeds from asset sales.
- Financing cash usage was $27.2 million, reflecting $23.0 million of net revolving-credit repayments, financing costs, debt repayments, and other equity-related outflows.
- At June 28, 2014, cash and cash equivalents were $31.8 million and short-term investments were $14.2 million. Total debt was $450.3 million, producing reported net debt of $404.2 million, versus $471.3 million a year earlier.
- The company had no borrowings under its $390 million asset-based revolving credit facility and reported full $390 million availability, subject to borrowing-base requirements. It was in compliance with applicable credit-facility and senior-note covenants.
Material changes versus the prior comparable period
- Results were materially affected by a $16.9 million Garden charge for inventory write-offs, product returns, promotional allowances, and other costs associated with discontinuing two products introduced in 2013. The company expects up to $2.5 million of additional disposal costs in the fourth quarter and future periods.
- Garden sales were also affected by retailer inventory being built earlier for the spring season, shifting sales from the third quarter into the second quarter. Garden operating income fell to $4.0 million from $13.7 million; excluding the charge and a $2.0 million asset-sale gain, adjusted Garden operating income was $18.9 million versus $13.7 million.
- Excluding the Garden charge and asset-sale gain, third-quarter operating income was $33.3 million versus $32.9 million, adjusted net income was $14.1 million versus $13.7 million, and adjusted diluted EPS was $0.28 versus $0.28. Nine-month adjusted operating income was $69.8 million versus $66.5 million.
- Pet operating income declined 14.2% in the quarter to $28.4 million, primarily because of lower sales and higher selling and administrative expenses. Pet operating margin declined to 12.5% from 13.9%.
- Management cited industry weakness, lost shelf space, increased flea-and-tick competition, and volume declines in bird and small-animal and aquatic categories. Lower commodity costs and manufacturing efficiencies helped Pet margins.
- The company acquired certain Envincio LLC assets on April 1, 2014 for approximately $20 million. The purchase-price allocation was not finalized; approximately $14 million was recorded in deferred taxes and other assets pending allocation to acquired intangible assets. The acquisition did not materially affect reported results.
- Goodwill declined year over year because the Garden segment recorded a $7.7 million non-cash impairment charge in fiscal 2013; remaining goodwill at June 28, 2014 was $205.8 million, all attributed to Pet.
Outlook, commentary, risks, and contingencies
- Management expects fiscal 2014 capital expenditures not to exceed $20 million, primarily for plant and equipment replacements and the enterprise-wide information technology platform.
- Management believes operating cash flow and available capacity under the asset-based facility should meet 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 June 2014, Harbinger Group proposed either acquiring all outstanding shares for $10 per share in cash or acquiring the Pet segment for $750 million, subject to due diligence. The Board retained independent financial and legal advisors. The company expects higher administrative, legal, and advisory costs and identified potential effects on employees, customers, and business performance.
- Key ongoing risks include seasonality and weather, commodity and raw-material costs, inability to pass through cost increases, competition and retail consolidation, customer concentration, consumer spending, acquisitions, goodwill and intangible impairment, ERP implementation, international sourcing, product recalls and liability, cyber attacks, access to capital, and the voting power of Class B stock.
- The company reported no material litigation, no material changes to off-balance-sheet arrangements or contractual obligations, and effective disclosure controls as of June 28, 2014.
Important facts for investors to verify
- Whether Garden sales and margins recover after the discontinued-product charge and whether the estimated additional disposal costs remain within the stated $2.5 million.
- The sustainability of lower Pet sales, particularly in animal health, bird and small-animal, and aquatic categories, and the effect of lost shelf space and competition.
- Actual borrowing-base availability, covenant headroom, and refinancing or repayment plans for the $450 million of debt, including the 8.25% notes due in 2018.
- The final purchase-price allocation and strategic contribution of the Envincio acquisition.
- The outcome and costs of the Harbinger proposals, including any effect on customers, employees, strategy, or capital allocation.
- Whether improved operating cash flow is sustained as seasonal receivables, inventories, and supplier balances normalize.