Central Garden & Pet Company — Fiscal 2012 Second-Quarter Form 10-Q
Business context and reporting period
Central Garden & Pet markets branded and other pet products and lawn-and-garden products through two reportable segments: Pet Products and Garden Products. This unaudited filing covers the three and six months ended March 24, 2012, compared with periods ended March 26, 2011. Results are highly seasonal, particularly in Garden Products; approximately 67% of Garden Products sales historically occur in the second and third fiscal quarters.
Financial metrics
| Metric | Three months ended March 24, 2012 | Prior year | Six months ended March 24, 2012 | Prior year |
|---|---|---|---|---|
| Net sales | $466.9 million | $485.7 million | $769.0 million | $767.4 million |
| Gross profit | $147.7 million | $163.3 million | $228.4 million | $246.3 million |
| Gross margin | 31.6% | 33.6% | 29.7% | 32.1% |
| Income from operations | $45.2 million | $59.6 million | $33.9 million | $53.1 million |
| Operating margin | 9.7% | 12.3% | 4.4% | 6.9% |
| Net income attributable to Central | $21.6 million | $31.8 million | $8.5 million | $22.2 million |
| Diluted EPS | $0.45 | $0.54 | $0.18 | $0.37 |
Six-month operating cash flow was negative $93.4 million, compared with negative $106.2 million in the prior year. Investing cash outflow was $17.0 million, including $17.0 million of capital expenditures and no acquisition payments, versus $38.0 million of investing outflow in the prior year. Financing activities provided $108.5 million, including $49.3 million of net proceeds from the additional notes issuance, $254.0 million of revolver borrowings and $172.0 million of revolver repayments. Cash and cash equivalents were $10.3 million at March 24, 2012, and short-term investments were $17.8 million.
Total debt was $566.9 million at March 24, 2012, consisting primarily of $449.3 million carrying value of 8.25% senior subordinated notes due 2018 and $117.0 million outstanding under the revolving credit facility. The facility had $258.0 million of unused commitments, or $116.2 million after financial-covenant limitations. The company reported a total leverage ratio of 5.5 to 1.0, a senior secured leverage ratio of 1.1 to 1.0, and interest coverage of 2.8 times, and was in compliance with all financial covenants.
Material changes versus the prior comparable period
- Second-quarter sales declined 3.9%, while six-month sales increased only 0.2%.
- Second-quarter Garden Products sales fell 6.1% to $244.4 million; Pet Products sales fell 1.3% to $222.5 million. For the six-month period, Pet Products sales increased 2.3% while Garden Products sales declined 2.3%.
- Second-quarter operating income declined 24.2%, and six-month operating income declined 36.1%. Management attributed the decline primarily to supply-chain and distribution disruptions related to its transformational change initiative, including the closure of five warehouses and one manufacturing facility.
- Gross margin contracted by 200 basis points in the quarter and 240 basis points year to date, reflecting operational disruption, unfavorable product mix, higher input costs, lower grass-seed and garden chemical sales, and lower higher-margin product sales.
- Interest expense increased to $10.5 million in the quarter and $20.0 million year to date because of higher debt outstanding, despite lower average borrowing rates.
- In February 2012, the company issued an additional $50 million of 8.25% senior subordinated notes due 2018 and used the proceeds to reduce revolver borrowings. Six-month share repurchases were $20.9 million, down from $53.9 million in the prior year.
Guidance, outlook, commentary, risks and unusual items
Management stated that the operational issues associated with facility closures and supply-chain changes were short term, while the transformational initiative remains a multi-year effort covering sales, marketing and supply chain activities. The filing does not provide formal revenue or earnings guidance.
Capital expenditures for fiscal 2012 were expected not to exceed $45 million, including up to $15 million for the enterprise-wide information technology platform. Management believed operating cash flow, supplier arrangements and available revolver capacity would satisfy anticipated working-capital, capital-spending and other cash needs for at least the next 12 months, but noted that financing availability and terms cannot be assured.
- Key risks include execution of the transformation initiative, distribution disruptions, seasonality, weather, consumer spending, raw-material and fuel inflation, and the ability to pass cost increases through to customers.
- High leverage and credit-facility covenants limit certain stock repurchases, acquisitions, investments, capital expenditures and dividends. The company had substantial unused revolver capacity but only $116.2 million after covenant adjustments.
- The company reported two unrelated 2012 product recalls involving one batch of baby-bird feed and one lot of mice, rat and hamster feed. Management did not expect material costs but could not determine the ultimate impact.
- No material adverse legal proceedings, material changes in off-balance-sheet arrangements, or material changes in market-risk exposure were reported.
- Goodwill impairment was not indicated in the prior annual assessment, and no significant nonfinancial assets required fair-value measurement during the period.
Most important facts for investors to verify
- Whether distribution and facility-consolidation disruptions were resolved and whether sales backlogs, lost sales and margins recovered in subsequent quarters.
- The sustainability of gross-margin performance amid grain, seed, chemical, fuel and other input-cost pressures.
- Debt maturity and refinancing risk, including the 2018 notes, revolver availability after covenants, leverage ratios and interest coverage.
- Seasonal working-capital needs, negative first-half operating cash flow, inventory levels and the company’s ability to fund peak-season requirements.
- The financial, regulatory and reputational effects of the reported product recalls and any additional recalls or product-liability claims.
- Progress, remaining cost and expected benefits of the transformational initiative and enterprise resource planning implementation.