Central Garden & Pet Company — Fiscal 2011 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended June 25, 2011, compared with periods ended June 26, 2010. The interim financial statements are unaudited. Results are highly seasonal because the Garden Products business generates most sales and operating income in the second and third fiscal quarters.
Business Context
Central Garden & Pet is a branded supplier of pet supplies and lawn and garden products. Reportable segments are Pet Products and Garden Products. Major products include pet food, treats, toys, health products, bird and small-animal products, grass seed, bird feed, garden chemicals and seasonal outdoor products.
Key Financial Metrics
| Metric | Q3 FY2011 | Q3 FY2010 | 9M FY2011 | 9M FY2010 |
|---|---|---|---|---|
| Net sales | $484.3 million | $465.5 million | $1,251.7 million | $1,176.7 million |
| Gross profit | $149.4 million | $162.8 million | $395.7 million | $411.7 million |
| Gross margin | 30.8% | 35.0% | 31.6% | 35.0% |
| Income from operations | $36.6 million | $52.6 million | $89.7 million | $113.7 million |
| Net income attributable to Central | $17.1 million | $25.9 million | $39.3 million | $54.6 million |
| Diluted EPS | $0.31 | $0.40 | $0.68 | $0.83 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $(1.5) million | $91.4 million |
Operating margins: Q3 operating margin was approximately 7.6%, versus 11.3% in the prior-year quarter. Nine-month operating margin was approximately 7.2%, versus 9.7% in the prior-year period. SG&A was $112.8 million in Q3 and $306.0 million for nine months; SG&A as a percentage of sales declined modestly to 23.3% and 24.4%, respectively.
Segment performance: Q3 Pet Products sales increased 2.1% to $227.3 million, while operating income declined to $27.2 million from $32.6 million. Garden Products sales increased 5.8% to $257.0 million, while operating income declined to $18.0 million from $30.1 million. For nine months, Pet Products sales rose 2.0% to $639.5 million and Garden Products sales rose 11.3% to $612.3 million.
Balance Sheet, Cash Flow, Debt and Liquidity
- At June 25, 2011, cash and cash equivalents were $11.2 million and short-term investments were $15.3 million, compared with combined cash and short-term investments of $106.8 million at September 25, 2010.
- Accounts receivable were $257.4 million and inventories were $343.8 million, reflecting seasonal working-capital buildup and higher input costs.
- Total debt was $450.5 million, consisting primarily of $400.0 million of 8.25% senior subordinated notes due 2018 and $50.0 million drawn under the revolving credit facility.
- The amended revolving facility increased borrowing capacity from $275 million to $375 million and extended maturity to June 2016. Remaining borrowing capacity after covenants was $211.4 million, with $5.6 million of letters of credit outstanding.
- The company was in compliance with its debt covenants. Total leverage was 3.4 to 1.0, senior secured leverage was 0.4 to 1.0, and interest coverage was 3.8 times versus a 2.50-times minimum.
- Nine-month operating cash flow declined to a use of $1.5 million, primarily because accounts receivable and inventories increased. Investing cash use was $44.6 million, including $24.4 million for an acquisition and $20.2 million of capital expenditures.
- Nine-month share repurchases totaled $83.6 million. The company authorized a new $100 million repurchase program, with approximately $97.1 million remaining available at June 25, 2011.
Material Changes Versus Prior Comparable Period
- Sales increased 4.0% in Q3 and 6.4% for nine months, driven primarily by branded products, grass seed, bird feed and seasonal décor.
- Gross profit declined 8.2% in Q3 and 3.9% for nine months. Gross margin contracted by approximately 420 basis points in Q3 and 340 basis points for nine months.
- Net income attributable to Central declined 34.0% in Q3 and 28.1% for nine months; diluted EPS declined from $0.40 to $0.31 in Q3 and from $0.83 to $0.68 for nine months.
- Higher grain and other raw-material prices, adverse product mix, lower sales of higher-margin pet health and garden chemical products, and increased brand-building expenditures reduced profitability.
- Q3 net interest expense was approximately unchanged because lower borrowing rates offset higher debt. Nine-month net interest expense increased 14.1% to $28.0 million.
- The company acquired certain assets of a premium fertilizer producer on February 28, 2011, for approximately $23 million in cash.
Outlook, Commentary, Risks and Unusual Items
- Management expects raw-material inflation to continue pressuring margins in the fourth quarter. Since October 2010, sunflower prices increased more than 120% and millet prices more than 70%; corn and milo also increased significantly.
- Price increases have not fully offset input-cost inflation, and the company cannot assure the timing or extent of additional price increases or its ability to retain pricing if costs decline.
- Management expects the fiscal 2011 effective tax rate to be similar to fiscal 2010, approximately 37%.
- Fiscal 2011 capital expenditures are expected not to exceed $30 million, including approximately $10 million for the enterprise-wide information technology platform.
- Management believes operating cash flow, available revolver capacity and supplier arrangements will fund anticipated working-capital requirements for the foreseeable future, but acquisitions could require additional external capital.
- Weather adversely affected pet health and garden chemical sales, while major retailers initiated inventory reductions late in the quarter.
- Legal proceedings are described as ordinary-course matters that management does not believe will materially affect financial position or results. No material changes to previously disclosed risk factors were reported other than expanded commodity-price risk.
- Other key risks include seasonality, consumer spending, customer concentration, retail consolidation, competition, acquisition execution, international sourcing, product liability, environmental matters and implementation of the new enterprise resource planning system.
Investor Verification Checklist
- Verify whether commodity prices, particularly seeds and grains, stabilize or continue to outpace the company’s pricing actions.
- Assess whether gross margins recover after the sharp Q3 decline and whether lower-margin product mix persists.
- Monitor seasonal working-capital conversion, accounts receivable, inventories and operating cash flow in the fourth quarter.
- Review debt covenant headroom, revolver usage, interest rates and the company’s ability to fund repurchases and acquisitions.
- Evaluate the performance and integration of the premium fertilizer asset acquisition.
- Track garden chemical and control-product demand, retailer inventory levels and weather conditions.
- Confirm the remaining authorization and pace of share repurchases, including potential effects on liquidity and leverage.
- Review the timing, cost and execution risks of the enterprise resource planning implementation.