Central Garden & Pet Company — Fiscal 2016 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended June 25, 2016, compared with June 27, 2015. The interim financial statements are unaudited. The Garden business is highly seasonal, so quarterly and nine-month results are not necessarily indicative of full-year performance.
Business Context
Central Garden & Pet operates through Pet and Garden segments, selling branded and third-party pet supplies, lawn and garden products, animal health products, seeds, fertilizers, controls and decorative products. Fiscal 2016 results include acquisitions of IMS Trading, Hydro-Organics Wholesale and DMC, primarily affecting the Pet segment.
Financial Performance
| Metric | Q3 FY2016 | Q3 FY2015 | 9M FY2016 | 9M FY2015 |
|---|---|---|---|---|
| Net sales | $514.5 million | $459.4 million | $1,415.6 million | $1,264.4 million |
| Gross profit | $163.7 million | $142.0 million | $432.9 million | $380.1 million |
| Gross margin | 31.8% | 30.9% | 30.6% | 30.1% |
| Income from operations | $48.2 million | $39.0 million | $116.4 million | $90.1 million |
| Operating margin | 9.4% | 8.5% | 8.2% | 7.1% |
| Net income attributable to Central | $26.0 million | $18.8 million | $50.1 million | $36.3 million |
| Diluted EPS | $0.51 | $0.38 | $0.99 | $0.73 |
- Third-quarter sales increased 12.0%; Pet sales rose 20.6% to $287.2 million and Garden sales rose 2.7% to $227.3 million.
- Nine-month sales increased 12.0%; Pet sales increased 23.1% to $811.2 million, while Garden sales decreased 0.2% to $604.4 million.
- Third-quarter SG&A increased 12.1% to $115.6 million and represented 22.5% of sales, compared with 22.4% in the prior-year quarter. Nine-month SG&A increased 9.1% but declined to 22.4% of sales from 22.9%.
- Third-quarter effective tax rate was 35.9%, compared with 37.5%; the nine-month rate was 35.6%, compared with 36.5%.
Cash Flow, Debt and Liquidity
- Operating cash flow for the first nine months was $89.6 million, up from $56.6 million, driven by stronger operating performance and improved working-capital management.
- Investing cash use was $83.9 million, including $68.9 million for acquisitions and $19.5 million of capital expenditures. The company expects fiscal 2016 capital expenditures not to exceed $35 million.
- Cash and cash equivalents were $40.0 million at June 25, 2016, compared with $47.6 million at September 26, 2015. Restricted cash was $12.0 million.
- Total debt was $395.1 million, compared with $397.0 million at September 26, 2015. The company had $394.6 million of long-term debt and $0.5 million of current debt.
- The company issued $400 million of 6.125% senior notes due 2023 and used the proceeds, together with cash, to redeem $400 million of 8.25% senior subordinated notes due 2018.
- The amended asset-based revolving facility provides up to $400 million, with a potential $200 million accordion subject to lender consent. There were no borrowings or facility letters of credit outstanding, and reported borrowing availability was $400.0 million at June 25, 2016. Other letters of credit totaled $6.0 million.
- Management stated that operating cash flow, facility availability and supplier arrangements should be adequate to meet anticipated needs for at least the next 12 months, while noting that future acquisitions could require additional capital.
Material Changes and Unusual Items
- Pet growth was substantially acquisition-driven: two recent acquisitions contributed $38.8 million of third-quarter Pet sales and $104.5 million for the first nine months. Excluding these acquisitions, third-quarter Pet sales increased 4.3%.
- Garden branded sales were pressured by the exit from seasonal decor and a prior-year timing benefit in grass seed, partly offset by higher wild bird feed and third-party product sales.
- Third-quarter operating income included a $2.4 million gain on the sale of a manufacturing plant. Excluding the gain, operating income increased 17.5% year over year and adjusted diluted EPS was $0.48 versus reported EPS of $0.51.
- Nine-month interest expense included $14.3 million of costs related to the 2018 note redemption, including an $8.3 million call premium, $2.7 million of overlapping interest and a $3.3 million non-cash write-off. Excluding this item, adjusted nine-month diluted EPS was $1.14 versus reported EPS of $0.99.
- George C. Roeth became President and Chief Executive Officer on June 1, 2016. John R. Ranelli remained as Senior Advisor through September 26, 2016 and served as acting principal financial officer for the filing.
- Goodwill increased to $233.0 million from $209.1 million at the prior-year comparison date, primarily from fiscal 2016 acquisitions. No significant non-financial asset impairment measurement was required during the reported periods.
Outlook, Risks and Contingencies
- No specific revenue or earnings guidance was provided in the filing.
- Management expects increased capital spending through fiscal 2016 and fiscal 2017 to improve infrastructure, manufacturing and distribution efficiency and implement an enterprise-wide information technology platform.
- Key risks include seasonality and weather, raw-material and commodity-price volatility, inability to pass through cost increases, consumer spending, retailer concentration and consolidation, competition, acquisition integration, goodwill or intangible impairment, supply shortages, international sourcing, cyberattacks, product liability and recalls, regulatory matters, litigation and access to capital.
- The company stated that it was in compliance with applicable 2023 Notes and credit-facility covenants as of June 25, 2016. No legal proceeding was identified as likely to have a material effect on financial position or results of operations.
- The company is evaluating several accounting standards not yet adopted, including revenue recognition, leases, stock-based compensation, consolidation, cloud-computing costs, inventory measurement and deferred-tax classification.
- Disclosure controls and procedures were deemed effective as of June 25, 2016, and management reported no material change in internal control over financial reporting during the quarter.
Investor Verification Checklist
- Verify the sustainability of acquisition-driven Pet growth and the lower margins of the acquired businesses.
- Assess Garden segment performance after the seasonal-decor exit and the effects of weather and seasonal timing.
- Reconcile reported GAAP results with management’s non-GAAP adjustments, particularly the $14.3 million debt-refinancing charge and $2.4 million plant-sale gain.
- Review cash conversion, receivables and inventory levels as the seasonal selling cycle progresses.
- Confirm the company’s ability to maintain liquidity and covenant compliance while funding acquisitions and planned capital expenditures.
- Monitor goodwill, intangible assets and contingent acquisition consideration, including the $6.4 million fair value of contingent consideration at June 25, 2016.