Central Garden & Pet Company — Fiscal 2013 Second-Quarter Form 10-Q
Business context and reporting period
Central Garden & Pet is a supplier of branded pet and lawn-and-garden products, operating through Pet and Garden reportable segments. This unaudited report covers the three and six months ended March 30, 2013, compared with the periods ended March 24, 2012. Fiscal 2013 contains one fewer week than fiscal 2012. Results are seasonal, particularly in Garden; approximately 66% of fiscal 2012 Garden sales occurred in the second and third quarters.
Financial performance and position
| Metric | Three months ended Mar. 30, 2013 | Three months ended Mar. 24, 2012 | Six months ended Mar. 30, 2013 | Six months ended Mar. 24, 2012 |
|---|---|---|---|---|
| Net sales | $498.2 million | $466.9 million | $790.7 million | $769.0 million |
| Gross profit | $153.2 million | $147.7 million | $230.1 million | $228.4 million |
| Gross margin | 30.7% | 31.6% | 29.1% | 29.7% |
| Operating income | $46.7 million | $45.2 million | $33.7 million | $33.9 million |
| Net income attributable to Central | $22.2 million | $21.6 million | $6.9 million | $8.5 million |
| Diluted EPS | $0.46 | $0.45 | $0.14 | $0.18 |
- Second-quarter sales rose 6.7%, with Pet sales up 5.5% to $234.8 million and Garden sales up 7.8% to $263.4 million.
- Second-quarter operating income increased 3.4%. Pet operating income rose 30.7% to $27.5 million, while Garden operating income declined 7.3% to $34.0 million.
- Six-month sales increased 2.8%, but operating income declined 0.9% and net income attributable to Central declined 18.8%.
- Second-quarter SG&A was $106.4 million, or 21.4% of sales, compared with 21.9% previously. Six-month SG&A was $196.5 million, or 24.9% of sales, compared with 25.3%.
- Six-month net cash used in operating activities was $162.2 million, compared with $93.4 million in the prior-year period. The principal drivers were higher accounts receivable and inventory, including safety stock for new Garden products and delayed seasonal demand.
- Capital expenditures were $16.2 million for the six months, and cash used in investing activities was $16.1 million. The Company also paid $4.8 million for the remaining majority interest in FourStar Microbial Products, with possible contingent performance payments.
- Cash provided by financing activities was $141.5 million, primarily reflecting $186.0 million of revolving-credit borrowings and $42.0 million of repayments. Cash and cash equivalents declined to $11.3 million from $48.5 million at September 29, 2012; short-term investments were $17.8 million.
- Total debt was $593.7 million at March 30, 2013, including $449.4 million of 8.25% senior subordinated notes due 2018 and $144.0 million outstanding under the revolving facility. The estimated fair value of the notes was $463.7 million.
- The revolving facility had $231.0 million of unused commitments, or $89.9 million of availability after financial covenants. The Company was in compliance with all financial covenants; total leverage was 5.1-to-1, senior secured leverage was 1.2-to-1, and interest coverage was 3.0 times.
- Total assets were $1.35 billion and total equity was $475.6 million at March 30, 2013. Inventories were $435.9 million, compared with $330.0 million at September 29, 2012.
Material changes versus the prior comparable period
- Sales benefited from new product launches and the absence of prior-year supply-chain disruptions. The prior year also included deferred shipments and initial flea-and-tick sell-in that will not recur in fiscal 2013.
- Gross margin contracted because of Garden product-launch expenses, lower fertilizer margins, sales returns, and adverse late-spring weather. Pet margin was broadly consistent but included facility-consolidation transition costs.
- Pet performance improved materially, while Garden profitability weakened despite higher sales. Corporate operating expense increased, including higher medical-program insurance and shared-service-center start-up costs.
- Interest expense rose because of higher average debt and borrowing rates. The average borrowing rate was 7.8% in the second quarter and 8.2% for the six months, versus 7.6% and 7.9%, respectively.
- Six-month other expense increased to $1.0 million from $0.1 million, primarily due to realized and unrealized losses on commodity derivatives.
- The effective tax rate decreased to 35.8% from 36.8% in the quarter and to 33.6% from 37.2% for the six months, primarily due to additional tax credits.
Guidance, outlook, risks, contingencies and unusual items
- Management stated that fiscal third-quarter 2013 results were likely to be lower than the prior year because fiscal 2012 benefited from deferred shipments and initial flea-and-tick sell-in that will not recur.
- Management expected the fiscal 2013 effective tax rate to be similar to the fiscal 2012 rate.
- Fiscal 2013 capital expenditures were expected not to exceed $40 million, including up to $11 million for the enterprise-wide information technology platform. The Company had invested approximately $78.5 million in that initiative through fiscal 2012.
- Management believed operating cash flow, supplier arrangements and available revolving-facility capacity would fund working capital and other needs for at least the next 12 months, while noting that future liquidity and financing availability cannot be assured.
- Key risks include seasonality, late or adverse weather, commodity and raw-material inflation, energy costs, inability to pass through cost increases, consumer spending, customer concentration, competition, acquisitions, transformation initiatives, implementation of the enterprise resource planning system, product liability and recalls, regulatory matters, cyber attacks and access to capital.
- Commodity derivatives are used to economically hedge anticipated grain and protein purchases and are not used for speculation. Derivative liabilities were $0.5 million at March 30, 2013.
- No material legal proceedings, product recalls, product-liability matters, off-balance-sheet changes or changes in previously disclosed risk factors were reported. Disclosure controls were deemed effective.
- John R. Ranelli became President and Chief Executive Officer effective February 11, 2013.
Important facts for investors to verify
- Whether Garden demand and margins recover as seasonal weather normalizes, particularly in grass seed, fertilizer, controls and décor.
- Whether elevated inventory and receivables convert to cash during the peak selling season and whether operating cash flow improves.
- Debt reduction, revolving-credit availability and compliance with leverage and interest-coverage covenants.
- The effect of product launches, facility consolidation and transformation or information-technology initiatives on margins and expenses.
- Whether the stated likelihood of lower fiscal third-quarter results develops as expected and how the comparison affects full-year performance.
- Future commodity, fuel and raw-material costs, derivative results and the Company’s ability to pass through cost increases.
- The final purchase-price allocation and any contingent payments related to the FourStar Microbial acquisition.