Business Context and Reporting Period
Central Garden & Pet Company filed an unaudited Form 10-Q for the third quarter and nine months ended June 29, 2013, compared with the periods ended June 23, 2012. The company operates through Pet and Garden segments, with highly seasonal Garden results. Fiscal 2013 contains one fewer week than fiscal 2012.
Key Financial Metrics
| Metric | Three Months Ended June 29, 2013 | Three Months Ended June 23, 2012 | Nine Months Ended June 29, 2013 | Nine Months Ended June 23, 2012 |
|---|---|---|---|---|
| Net sales | $494.1 million | $533.8 million | $1,284.8 million | $1,302.8 million |
| Gross profit | $152.5 million | $180.7 million | $382.6 million | $409.1 million |
| Gross margin | 30.9% | 33.8% | 29.8% | 31.4% |
| Income from operations | $32.9 million | $49.0 million | $66.5 million | $82.9 million |
| Net income attributable to Central | $13.7 million | $22.7 million | $20.7 million | $31.2 million |
| Diluted EPS | $0.28 | $0.47 | $0.42 | $0.65 |
- Quarterly selling, general and administrative expense declined to $119.6 million, or 24.2% of sales, from $131.7 million, or 24.7%.
- Nine-month SG&A declined to $316.1 million, or 24.6% of sales, from $326.2 million, or 25.0%.
- Quarterly operating margin was approximately 6.7%, compared with approximately 9.2% in the prior-year quarter. Nine-month operating margin was approximately 5.2%, compared with approximately 6.4%.
- Effective income tax rates were 34.3% for the quarter and 34.1% for the nine-month period, compared with 37.9% and 37.7%, respectively.
- Pet sales declined to $237.9 million for the quarter and $667.8 million for nine months. Garden sales were $256.3 million for the quarter and $617.0 million for nine months.
- Cash and cash equivalents were $20.5 million at June 29, 2013, compared with $48.5 million at September 29, 2012.
- Nine-month operating cash flow was negative $65.5 million, compared with positive $64.2 million in the prior-year period. Investing cash flow was negative $19.5 million, including $19.5 million of capital expenditures and $4.8 million for the FourStar Microbial acquisition.
- Nine-month financing cash flow was positive $57.4 million, principally reflecting $281.0 million of revolving-credit borrowings and $221.0 million of repayments.
Debt, Liquidity and Balance Sheet
- Total debt was $509.6 million at June 29, 2013, including approximately $449.4 million of 8.25% senior subordinated notes due 2018 and $60.0 million outstanding under the revolving credit facility. Total debt was $449.9 million at June 23, 2012.
- The revolving facility has $375 million of borrowing capacity, with $315 million of unused commitments and $147.8 million available after financial covenants. Other letters of credit totaled $17.5 million.
- The company reported a total leverage ratio of 4.9 to 1.0, senior secured leverage ratio of 0.6 to 1.0, and interest coverage ratio of 2.6 times at June 29, 2013. It was in compliance with its financial covenants at that date.
- Effective August 1, 2013, the minimum interest coverage covenant was reduced from 2.5 times to 2.25 times and a 1.1 times minimum asset coverage ratio was added through the quarter ending March 29, 2014.
- Inventories increased to $413.1 million from $330.0 million at September 29, 2012, driven by safety-stock requirements for new Garden products, strategic purchases and cost inflation.
- Management stated that operating cash flow, revolving-facility availability and supplier arrangements should provide adequate liquidity for at least the next 12 months, but noted that future financing availability and terms cannot be assured.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales fell 7.4%, primarily because prior-year results benefited from an initial Pet-channel sell-in and shipments of orders delayed from the second quarter.
- Pet quarterly sales declined 12.3%, including a $23.2 million decrease in animal-health sales, principally flea and tick products. Pet operating income declined 18.1% to $33.1 million.
- Garden quarterly sales declined 2.4%, principally because controls and fertilizer sales fell $13.0 million. Lower consumer sell-through of new products, product-support costs, lower fertilizer margins, and weaker décor margins reduced profitability. Garden operating income declined 39.5% to $13.7 million.
- Gross margin contracted 290 basis points in the quarter and 160 basis points for the nine months, reflecting lower-margin product mix, higher ingredient costs, product introduction costs, returns and weaker volumes.
- Nine-month operating cash flow changed from a $64.2 million inflow to a $65.5 million outflow, primarily due to increased receivables and an $83.2 million increase in inventory-related working capital use.
- Corporate operating expense increased $6.9 million for the nine months, primarily due to higher insurance and information-technology costs.
- The company acquired the remaining majority interest in FourStar Microbial Products for approximately $4.8 million in cash, with possible contingent performance-based payments. Purchase-price allocation was not finalized, and the acquisition was not expected to materially affect fiscal 2013 results.
Outlook, Risks and Unusual Items
- Management expected fiscal 2013 capital expenditures not to exceed $30 million, including investment in an enterprise-wide information-technology platform. It planned up to $11 million of additional fiscal 2013 spending on the platform.
- No earnings or revenue guidance was provided in the filing. Management’s liquidity outlook assumes access to operating cash flow, the revolving facility and supplier credit.
- The company stated that Garden-season results are not indicative of full-year performance because the Garden business is highly seasonal and typically generates most of its sales and operating income in the second and third quarters.
- Goodwill totaled $210.2 million, including $202.5 million associated with Pet and $7.7 million associated with Garden. No impairment was recorded, but management identified potential future Garden goodwill impairment if operating trends and forecasts deteriorate.
- Commodity derivatives are used to economically hedge grain and protein costs, not for speculation. Derivative losses recorded in other income were $0.9 million for the nine months, compared with a nominal gain in the prior-year period.
- Key risks include raw-material, grain, seed and energy costs; the ability to pass through cost increases; weather and seasonality; consumer spending; customer concentration and retail consolidation; competition; acquisitions; ERP implementation; goodwill impairment; product liability, recalls and regulatory matters; litigation; cyber risks; and access to capital.
- The filing reported no material legal proceedings, product recalls or product-liability matters expected to materially affect financial position or results of operations.
Important Facts for Investors to Verify
- Whether the August 2013 credit-facility amendments and reduced interest-coverage covenant improve near-term covenant headroom or signal greater financial pressure.
- Whether Pet flea-and-tick sales normalize after the prior-year channel sell-in and whether Pet margins recover.
- Whether Garden new-product sell-through, fertilizer margins and décor returns improve during the remainder of the season.
- Whether elevated inventory converts to sales and cash without increased markdowns, obsolescence or further working-capital borrowing.
- Whether negative operating cash flow and total leverage decline as seasonal receivables are collected.
- Whether Garden operating trends or market capitalization changes trigger an impairment charge for the company’s goodwill and other intangible assets.
- Whether the FourStar Microbial purchase-price allocation and any contingent payments become material.