Central Garden & Pet Company: Fiscal 2017 Third-Quarter 10-Q
Reporting period: Quarter and nine months ended June 24, 2017, compared with June 25, 2016. The interim financial statements are unaudited. Results are seasonal, particularly in the Garden segment, and are not necessarily indicative of full-year performance.
Business Context
Central Garden & Pet develops, markets, manufactures and distributes branded and third-party products in the pet and lawn-and-garden industries. Reportable segments are Pet and Garden. The company completed the acquisitions of Segrest, Inc. in October 2016 and K&H Manufacturing on April 28, 2017, with aggregate consideration of approximately $106.8 million during the first nine months.
Key Financial Metrics
| Metric | Q3 FY2017 | Q3 FY2016 | 9M FY2017 | 9M FY2016 |
|---|---|---|---|---|
| Net sales | $574.6 million | $514.5 million | $1,564.0 million | $1,415.6 million |
| Gross profit | $183.3 million | $163.7 million | $487.5 million | $432.9 million |
| Gross margin | 31.9% | 31.8% | 31.2% | 30.6% |
| Operating income | $57.9 million | $48.2 million | $141.7 million | $116.4 million |
| Operating margin | 10.1% | 9.4% | 9.1% | 8.2% |
| Net income attributable to Central | $32.2 million | $26.0 million | $74.6 million | $50.1 million |
| Diluted EPS | $0.62 | $0.51 | $1.44 | $0.99 |
- Q3 sales increased 11.7%; organic sales increased 7.6%.
- Q3 Pet sales increased 9.1% to $313.4 million, including 1.7% organic growth. Pet operating income declined 6.9% to $36.1 million, and Pet operating margin decreased to 11.5% from 13.5%.
- Q3 Garden sales increased 14.9% to $261.2 million, entirely organically. Garden operating income increased 45.1% to $38.4 million, and operating margin improved to 14.7% from 11.6%.
- For nine months, Pet sales increased 12.9% to $915.9 million and Garden sales increased 7.2% to $648.1 million.
- Q3 selling, general and administrative expense increased 8.5% to $125.3 million but declined to 21.8% of sales from 22.5%. The nine-month ratio also improved, to 22.1%.
- Q3 effective tax rate was 37.2%, compared with 35.9%; the nine-month rate was 37.0%, compared with 35.6%.
Cash Flow, Liquidity and Debt
- Cash provided by operating activities for the first nine months was $42.6 million, down from $89.6 million, primarily because receivables and inventories increased to support growth.
- Cash used in investing activities was $149.9 million, including $106.8 million for acquisitions, $37.1 million of capital expenditures and $11.5 million invested in an equity-method investee.
- Cash provided by financing activities was $28.9 million. The company ended the period with $14.5 million of cash and $11.0 million of restricted cash.
- Total debt was $435.4 million at June 24, 2017, compared with $395.1 million at June 25, 2016. Debt consisted primarily of $400 million of 6.125% senior notes due 2023 and $40.0 million drawn under the asset-based revolving facility.
- The revolving facility had approximately $360.0 million of remaining borrowing availability and matures in April 2021. The company was in compliance with its debt covenants.
- Management expects fiscal 2017 capital expenditures of approximately $40 million to $45 million and believes available liquidity will fund working capital, capital spending and other needs for at least the next 12 months, subject to the stated risks.
Material Changes and Unusual Items
- Growth benefited from the Segrest and K&H acquisitions, particularly in Pet. Management reported that acquisitions and divestitures contributed $21.0 million of Q3 sales growth and $75.5 million of nine-month sales growth.
- Garden performance benefited from an extended season, increased promotional and private-label activity, higher controls and fertilizer sales, and improved grass-seed manufacturing efficiency and product mix. Wild bird feed sales declined.
- Pet profitability was pressured by acquisition-related costs, facility expansion, movement and consolidation costs, higher selling and administrative expenses, and comparison with a $2.4 million facility-sale gain in the prior-year quarter.
- Nine-month interest expense was $21.0 million versus $36.2 million, reflecting the prior-year $14.3 million expense associated with refinancing the 2018 notes. Current-period debt was higher than the prior year.
- The company recognized a $2.0 million gain from the sale of a Garden distribution facility during the first quarter. No significant nonfinancial asset impairment was recorded during the nine months.
- Contingent consideration liability was $4.1 million at June 24, 2017. Management reported no material legal proceedings or material changes to previously disclosed contractual obligations and risk factors.
Outlook, Commentary and Risks
Management expects continued reliance on operating cash flow, supplier credit and the revolving facility to fund seasonal working-capital needs. The Garden business is highly seasonal, with approximately 66% of Garden sales historically occurring in the second and third fiscal quarters. Management also expects to continue evaluating acquisitions, which could require additional external capital.
Key risks include seasonality and weather; commodity, grain, seed, energy and fuel costs; difficulty passing cost increases to customers; consumer spending and macroeconomic conditions; competition and retail-industry consolidation; dependence on major customers; acquisition integration and execution; goodwill and intangible-asset impairment; supply shortages; international sourcing and currency exposure; product liability, recalls and regulatory matters; cybersecurity; ERP implementation; access to capital; and the voting power of Class B stock. The filing contains no separate full-year earnings or sales guidance.
Facts Investors Should Verify
- Whether Pet margins recover as acquisition integration and facility-consolidation costs moderate.
- Whether Garden growth and margins remain sustainable after the peak seasonal selling period.
- Cash conversion, particularly the elevated accounts receivable and inventory balances and the decline in operating cash flow.
- Integration results, purchase-price allocations and goodwill or intangible-asset impairment exposure related to Segrest and K&H.
- Debt levels, borrowing-base availability, interest-rate exposure and compliance with revolving-facility and senior-note covenants.
- Achievement of the $40 million to $45 million fiscal 2017 capital-expenditure expectation and management’s stated liquidity assumptions.
- The effect of higher effective tax rates, commodity costs, weather, promotional activity and retail-channel conditions on future margins.