Central Garden & Pet Company — Fiscal 2021 Third-Quarter Form 10-Q
Business Context and Reporting Period
Central Garden & Pet manufactures, markets and distributes branded, private-label and third-party pet and garden products. The filing covers the three and nine months ended June 26, 2021, compared with the periods ended June 27, 2020. The business is seasonal, particularly the Garden segment. Segment results were recast to report outdoor cushion operations within Pet rather than Garden.
Key Financial Metrics
| Metric | Q3 FY2021 | Q3 FY2020 | Change |
|---|---|---|---|
| Net sales | $1,037.1 million | $833.5 million | +24.4% |
| Gross profit | $320.3 million | $262.1 million | +22.2% |
| Gross margin | 30.9% | 31.4% | -50 bps |
| Operating income | $113.2 million | $104.6 million | +8.2% |
| Operating margin | 10.9% | 12.6% | -170 bps |
| Net income attributable to Central | $76.2 million | $68.8 million | +10.7% |
| Diluted EPS | $1.37 | $1.27 | +7.9% |
| Net interest expense | $13.1 million | $11.5 million | +14.1% |
| Metric | Nine Months FY2021 | Nine Months FY2020 | Change |
|---|---|---|---|
| Net sales | $2,564.6 million | $2,019.5 million | +27.0% |
| Gross profit | $758.1 million | $600.4 million | +26.3% |
| Gross margin | 29.6% | 29.7% | -10 bps |
| Operating income | $244.9 million | $172.8 million | +41.7% |
| Operating margin | 9.5% | 8.6% | +90 bps |
| Net income attributable to Central | $154.8 million | $107.1 million | +44.5% |
| Diluted EPS | $2.80 | $1.95 | +43.6% |
Q3 organic sales increased 8.7%, including 11.4% in Pet and 5.5% in Garden. Nine-month organic sales increased 17.2%. Q3 adjusted EBITDA was $134.2 million, compared with $117.9 million in the prior-year quarter; nine-month adjusted EBITDA was $297.7 million, compared with $212.4 million. These are non-GAAP measures.
Pet Q3 sales increased 10.0% to $507.8 million and operating income increased 11.7% to $71.0 million. Garden sales increased 42.3% to $529.3 million and operating income increased to $67.0 million, although Garden operating margin declined 480 basis points to 12.7%.
Cash Flow, Liquidity and Capital Structure
- Nine-month operating cash flow was $178.6 million, up from $88.9 million.
- Investing cash flow used $788.9 million, including $733.6 million for acquisitions and $57.0 million of capital expenditures.
- Financing cash flow provided $471.1 million, principally reflecting $900 million of senior-note issuance, partially offset by debt repayments and issuance costs.
- Cash, cash equivalents and restricted cash were $528.7 million at June 26, 2021, including $517.1 million of unrestricted cash and cash equivalents.
- Total debt was $1.184 billion, compared with $694.0 million at June 27, 2020. Debt consisted primarily of $300 million of 2028 Notes, $500 million of 2030 Notes and $400 million of 2031 Notes, net of issuance costs.
- The $400 million asset-based revolving facility had no borrowings or letters of credit outstanding and $400 million of net availability at quarter-end. The facility matures in September 2024.
- Management stated that available cash, operating cash flow and revolving-credit capacity should be adequate for anticipated needs for at least the next 12 months.
Material Changes and Unusual Items
- Central acquired DoMyOwn for approximately $81 million, Hopewell Nursery for approximately $81 million and Green Garden Products for approximately $571 million. Approximately $544 million of acquisition consideration remained unallocated in other assets pending purchase accounting.
- Green Garden contributed approximately $57 million of Q3 sales and a $3 million net loss; nine-month contributions were approximately $112 million of sales and $2 million of net income.
- In October 2020, Central issued $500 million of 4.125% 2030 Notes and redeemed its $400 million of 6.125% 2023 Notes. The redemption generated approximately $10.0 million of incremental interest expense and related costs.
- In April 2021, Central issued $400 million of 4.125% 2031 Notes, using proceeds partly to repay revolving borrowings.
- Q3 gross margin was pressured by acquisition-related inventory purchase-accounting adjustments, commodity, labor and freight inflation. SG&A rose to 20.0% of sales from 18.9%.
- The company recorded a $2.6 million loss on the sale of the Breeder’s Choice business during the first quarter.
- On June 30, 2021, after quarter-end, Central acquired D&D Commodities for approximately $88 million in cash and assumed approximately $30 million of long-term debt.
Guidance, Outlook, Management Commentary and Risks
The filing does not provide specific full-year revenue, earnings or margin guidance. Management expects fiscal 2021 capital expenditures of approximately $75 million, of which approximately $57 million had been incurred through June 26, 2021.
Management expects continued demand and long-term growth but noted that COVID-19 has created supply-chain, labor, logistics and forecasting challenges. Facilities remained operational, but fill rates and productivity were affected by employee absences and supply constraints. Commodity, labor and freight inflation were expected to continue, and management did not expect to fully offset cost pressures through price increases in 2021.
Key risks include COVID-19 and variants, reduced future demand following pandemic-related category growth, inflation and inability to pass through costs, supply shortages, adverse weather, seasonality, customer concentration, acquisition integration and purchase accounting, competition, tariffs, international sourcing, cybersecurity, product liability and recalls, litigation, goodwill or intangible impairment, and access to capital.
The Nite Glow litigation remains unresolved. Following a July 2021 appellate decision, a new trial on limited damages related to alleged misuse of confidential information was ordered. Management believes the matter will not materially affect the consolidated financial statements, but acknowledges that the ultimate outcome is uncertain. The company also disclosed ongoing state unclaimed-property examinations.
Important Facts for Investors to Verify
- Whether pandemic-driven organic demand persists as consumer behavior normalizes.
- The ability to recover commodity, labor and freight inflation through pricing without weakening demand or margins.
- Integration progress, purchase-accounting effects and eventual allocation of the three fiscal 2021 acquisitions, including the substantial amount recorded in other assets.
- Leverage, interest expense and debt-service capacity following the acquisitions and issuance of the 2030 and 2031 Notes.
- Working-capital requirements and cash conversion given Garden seasonality and elevated inventories of $626.6 million versus $425.9 million a year earlier.
- The financial impact and timing of the D&D Commodities acquisition completed after quarter-end.
- The potential liability and legal costs associated with the Nite Glow damages retrial and ongoing unclaimed-property examinations.
- That the company excluded the three recent acquisitions from its internal-control effectiveness assessment while integration continues.