Central Garden & Pet Company: Fiscal 2018 Second-Quarter 10-Q
Business context and reporting period
Central Garden & Pet is a branded and private-label supplier and distributor serving the Pet and Garden markets. The filing covers the three and six months ended March 31, 2018, compared with March 25, 2017. Results are seasonal, particularly in Garden; approximately 66% of Garden sales historically occur in the second and third fiscal quarters.
Financial performance and liquidity
| Metric | Q2 FY2018 | Q2 FY2017 | Change |
|---|---|---|---|
| Net sales | $613.1 million | $569.9 million | +7.6% |
| Gross profit | $194.5 million | $183.5 million | +6.0% |
| Gross margin | 31.7% | 32.2% | -50 basis points |
| Operating income | $65.8 million | $63.9 million | +3.0% |
| Operating margin | 10.7% | 11.2% | -50 basis points |
| Net income attributable to Central | $45.2 million | $34.7 million | +30.4% |
| Diluted EPS | $0.86 | $0.67 | +28.4% |
- Six-month net sales were $1.055 billion, up 6.6%; operating income was $88.3 million, up 5.4%; and diluted EPS was $1.36 versus $0.82.
- Six-month gross margin increased to 30.9% from 30.7%, while operating margin declined to 8.4% from 8.5% on a GAAP basis.
- Q2 Pet sales rose 7.8% to $321.7 million, while Garden sales rose 7.3% to $291.4 million. Organic sales increased 6.1% overall, with Pet up 6.3% and Garden up 5.8%.
- Q2 Pet operating income declined 5.4% to $32.8 million, with margin falling to 10.2% from 11.6%. Garden operating income increased 10.3% to $50.7 million, with margin improving to 17.4% from 16.9%.
- Six-month net cash used in operating activities was $94.0 million, compared with $96.2 million in the prior-year period. Working-capital investment included $154.7 million of accounts-receivable growth and $58.0 million of inventory growth.
- Capital expenditures were $17.6 million and acquisition payments were $63.4 million during the first six months.
- Cash and cash equivalents were $132.3 million at March 31, 2018, plus $13.9 million of restricted cash. Total debt was $691.1 million, versus $496.2 million at March 25, 2017.
- The company had no borrowings under its asset-based revolving facility and reported $354.3 million of borrowing availability; $3.3 million of other letters of credit were outstanding.
- Debt consists primarily of $400 million of 6.125% senior notes due 2023 and $300 million of 5.125% senior notes due 2028. The company reported compliance with applicable financial covenants.
Material changes versus the prior comparable period
- Sales growth was supported by volume increases in Dog & Cat, Pet distribution, Wild Bird Feed, Garden controls and fertilizer, and grass seed.
- Pet profitability was pressured by unfavorable product mix, colder weather affecting Animal Health, higher material and transportation costs, and acquisition-related expenses.
- Garden profitability benefited from higher sales, improved product mix, cost initiatives, and greater in-house production efficiency.
- Interest expense increased because of higher average debt following the December 2017 issuance of the 2028 Notes.
- The company acquired Bell Nursery on March 12, 2018, for approximately $62 million plus contingent consideration of up to $10 million. Purchase-price allocation remained incomplete at quarter-end.
- On April 2, 2018, after quarter-end, the company acquired the business assets of General Pet Supply. The filing does not provide a purchase price or pro forma financial information for this transaction.
- Six-month GAAP earnings included a provisional $16.3 million tax benefit from remeasurement of deferred tax accounts under the Tax Cuts and Jobs Act. Excluding this item and the prior-year facility-sale gain, non-GAAP diluted EPS was $1.05 versus $0.79.
Guidance, outlook, commentary and risks
- Management expects an approximately 27% fiscal 2018 effective tax rate, excluding discrete items such as deferred-tax remeasurement and stock-compensation tax effects.
- Fiscal 2018 capital expenditures are expected to be approximately $40 million to $45 million, including investments in facilities, equipment and an enterprise-wide information-technology platform.
- Management believes operating cash flow, supplier arrangements and available revolver capacity will fund anticipated working capital, capital expenditures and other needs for at least the next 12 months, while noting that additional acquisitions could require external capital.
- Key risks include seasonality and weather, commodity and transportation costs, inability to pass through cost increases, consumer spending, retail customer concentration and consolidation, competition, acquisition execution, goodwill or intangible impairment, supply shortages, international sourcing, product liability and recalls, cyberattacks, regulatory matters, environmental liabilities and tax-law changes.
- The company stated that it was not involved in legal proceedings expected to have a material effect and that there were no material changes to previously disclosed risk factors or market-risk exposures.
- Tax accounting under the Tax Cuts and Jobs Act remained provisional under SAB 118 and may change during the permitted measurement period.
Important facts for investors to verify
- Whether Pet gross-margin pressure and lower Pet operating margins persist as product mix, weather and transportation costs evolve.
- Conversion of seasonal receivables and inventories into operating cash flow during the remainder of fiscal 2018.
- Leverage, interest costs and covenant headroom following the $300 million 2028 Notes issuance.
- Integration and financial contribution from Bell Nursery, K&H Manufacturing and the post-quarter-end General Pet Supply acquisition.
- Final accounting effects of the Tax Cuts and Jobs Act and the sustainability of the company’s projected approximately 27% tax rate.
- Progress and cost of the enterprise resource-planning and broader information-technology implementation.