UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 28, 2003
or
For the transition period from to
Commission File Number: 0-20242
CENTRAL GARDEN & PET COMPANY
3697 Mt. Diablo Blvd., Suite 310, Lafayette, California 94549
(Address of principle executive offices)
(925) 283-4573
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). x Yes ¨ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock Outstanding as of July 31, 2003
Class B Stock Outstanding as of July 31, 2003
PART I. FINANCIAL INFORMATION
Financial Statements
Condensed Consolidated Balance Sheets September 28, 2002 and March 29, 2003
Condensed Consolidated Statements of Operations Three and Six Months Ended March 30, 2002 andMarch 29, 2003
Condensed Consolidated Statements of Cash Flows Six Months Ended March 30, 2002 and March 29,2003
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Controls and Procedures
Legal Proceedings
Changes in Securities and Use of Proceeds
Defaults Upon Senior Securities
Submission of Matter to a Vote of Securities Holders
Other Information
Exhibits and Reports on Form 8-K
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.
This quarterly report contains “forward-looking” statements based on current expectations that involve risks and uncertainties. Actual results and the timing of certain events may differ significantly from those projected in these forward-looking statements due to the factors listed below, under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Relating to Forward-Looking Statements” in our Annual Report on Form 10-K for the fiscal year ended September 28, 2002, and from time to time in our filings with the Securities and Exchange Commission. These risks and uncertainties include the resolution of the litigation between the Company and The Scotts Company; the success of and the costs associated with the realignment of the Company’s lawn and garden distribution operations; any liabilities to which the Company may become subject as a result of the August 2, 2000 fire at its Phoenix distribution center; and the impact of any other outstanding or potential litigation.
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Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable (less allowance for doubtful accounts of $7,597 and $7,688)
Inventories
Prepaid expenses and other assets
Total current assets
Land, buildings, improvements and equipment—net
Goodwill
Deferred income taxes and other assets
Total
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Notes payable
Accounts payable
Accrued expenses
Current portion of long-term debt
Total current liabilities
Long-term debt
Other long-term obligations
Shareholders’ equity:
Class B stock, $.01 par value: 1,655,462 and 1,654,462 shares outstanding at September 28, 2002 and June 28, 2003
Common stock, $.01 par value: 31,008,198 and 31,492,819 issued and 17,265,948 and 17,750,569 outstanding at September 28, 2002 and June 28, 2003
Additional paid-in capital
Retained earnings (deficit)
Treasury stock
Total shareholders’ equity
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Net sales
Cost of goods sold and occupancy
Gross profit
Selling, general and administrative expenses
Income from operations
Interest expense
Interest income
Other income
Income before income tax expense and cumulative effect of accounting change
Income tax expense
Income before cumulative effect of accounting change
Cumulative effect of accounting change, net of tax (Note 7)
Net income (loss)
Basic income (loss) per common share:
Before cumulative effect of accounting change
Cumulative effect of accounting change
Basic income (loss) per common share
Diluted income (loss) per common share:
Diluted income (loss) per common share
Weighted average shares used in the computation of income (loss) per share:
Basic
Diluted
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Write-off of equity method investment
Loss (gain) on fixed asset disposals
Depreciation and amortization
Deferred income taxes
Change in assets and liabilities:
Receivables
Net cash provided by operating activities
Cash flows from investing activities:
Additions to land, buildings, improvements and equipment
Net cash used in investing activities
Cash flows from financing activities:
Repayments of lines of credit, net
Proceeds from issuance of long-term debt
Repayments of long-term debt
Deferred financing costs
Proceeds from issuance of common stock
Net cash provided by (used in) financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental information:
Cash paid for interest
Cash paid (refunds received) for income taxes—net
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three and Nine Months Ended June 28, 2003
1. Basis of Presentation
The condensed consolidated balance sheet as of June 28, 2003, the condensed consolidated statements of operations for the three and nine months ended June 29, 2002 and June 28, 2003 and the condensed consolidated statements of cash flows for the nine months ended June 29, 2002 and June 28, 2003 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary to present fairly the financial position, results of operations and cash flows of the Company for the periods mentioned above, have been made.
Due to the seasonal nature of the Company’s business, the results of operations for the three and nine months ended June 28, 2003 are not indicative of the operating results that may be expected for the year ending September 27, 2003. It is suggested that these interim financial statements be read in conjunction with the annual audited financial statements, accounting policies and financial notes thereto, included in the Company’s 2002 Annual Report on Form 10-K which has previously been filed with the Securities and Exchange Commission.
2. New Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company expects that the adoption of SFAS No. 150 will have no material impact on its financial position or on its results of operations.
3. Stock Plan Information
The Company has various non-qualified stock-based compensation programs, which include stock options and restricted stock awards.
The Company has various stock option plans that provide for the granting of stock options to officers, key employees and directors. The Company has elected to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” whereby the options are granted at market price, and therefore no compensation costs are recognized. As required by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” the Company has provided fair value based pro-forma disclosures in its interim financial statements.
If compensation expense for the Company’s various stock option plans had been determined based upon the projected fair values at the grant dates for awards under those plans in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s pro-forma net earnings, basic and diluted earnings per common share would have been as follows:
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Net income (loss), as reported
Deduct: Total stock-based employee compensation expense determined under fair value based method for awards, net of related tax effects
Pro forma net income (loss)
Net income (loss) per common equivalent share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
4. Earnings Per Share
The following is a reconciliation of the numerators and denominators of the basic and diluted per-share computations for income (loss) from continuing operations:
Three Months Ended
June 28, 2003
Nine Months Ended
Basic EPS:
Net income
Effect of dilutive securities:
Options to purchase common stock
Convertible notes
Diluted EPS:
Net income attributable to common shareholders
June 29, 2002
Net income (loss) attributable to common shareholders
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Shares of common stock from the assumed conversion of the Company’s convertible securities totaling 4,107,143 were not included in the computation of diluted EPS for the three month period ended June 28, 2003, because the notes were repaid in February 2003 and were not outstanding during the period. Shares of common stock from the assumed conversion of the Company’s convertible securities totaling 4,107,143 were included in the computation of diluted EPS for the nine month period ended June 28, 2003 and the three and nine-month periods ended June 29, 2002.
Options to purchase 2,531,680 and 2,875,152 shares of common stock at prices ranging from $1.30 to $30.00 per share were outstanding at June 28, 2003 and from $1.30 to $33.94 at June 29, 2002, respectively. For the three month periods ended June 28, 2003 and June 29, 2002, options to purchase 6,000 and 659,448 shares of common stock were outstanding but were not included in the computation of diluted earnings per share because the option exercise prices were greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive. For the nine month periods ended June 28, 2003 and June 29, 2002, options to purchase 277,107 and 1,048,275 shares of common stock were outstanding but were not included in the computation of diluted earnings per share because the option exercise prices were greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive.
5. Segment Information
Management has determined that the reportable segments of the Company are Garden Products and Pet Products, based on the level at which the chief operating decision making group reviews the results of operations to make decisions regarding performance assessment and resource allocation.
Net sales:
Garden Products
Pet Products
Total net sales
Income (loss) from operations:
Corporate
Total income from operations
Interest expense—net
Cumulative effect of accounting change, net of tax
Depreciation and amortization:
Total depreciation and amortization
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Assets:
Total assets
Goodwill (included in corporate assets):
Total goodwill
6. Consolidating Condensed Financial Information of Guarantor Subsidiaries
Certain wholly-owned subsidiaries of the Company (as listed below, collectively the “Guarantor Subsidiaries”) have guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under the Company’s $150,000,000 9 1/8% Senior Subordinated Notes (the “Notes”) issued on January 30, 2003. Certain subsidiaries and operating divisions are not guarantors of the Notes and have been included in the financial results of the Parent in the information below. Those subsidiaries that are guarantors of the Notes are as follows:
Four Paws Products Ltd.
Grant Laboratories, Inc.
Kaytee Products, Incorporated
Matthews Redwood & Nursery Supply, Inc.
Pennington Seed, Inc. (including Phaeton Corporation (dba Unicorn Labs), Seeds West, Inc., All-Glass
Aquarium Co., Inc. (including Oceanic Systems, Inc.))
T.F.H. Publications, Inc.
Wellmark International
Norcal Pottery Products, Inc.
Pennington Seed, Inc. of Nebraska
Gro Tec, Inc.
In lieu of providing separate unaudited financial statements for the Guarantor Subsidiaries, the Company has included the accompanying unaudited consolidating condensed financial statements based on the Company’s understanding of the Securities and Exchange Commission’s interpretation and application of Rule 3-10 of the Securities and Exchange Commission’s Regulation S-X.
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CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS
Three Months Ended June 28, 2003
Guarantor
Subsidiaries
Income (loss) from operations
Interest – net
Income (loss) before income taxes
Income taxes
Equity in undistributed income of guarantor subsidiaries
Three Months Ended June 29, 2002
10
Nine Months Ended June 28, 2003
Nine Months Ended June 29, 2002
Income (loss) before income taxes and cumulative effect of accounting change
Income (loss) before cumulative effect of accounting change
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CONSOLIDATING CONDENSED BALANCE SHEET
Cash and equivalents
Accounts receivable
Prepaids and other assets
Land, buildings, improvements and equipment, net
Investment in Guarantors
LIABILITIES
Accrued expenses and other liabilities
Deferred income taxes and other long-term obligations
Equity
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September 28, 2002
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CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Net cash provided (used) by operating activities
Expenditures for land, buildings, improvementsand equipment
Investment in guarantor
Net cash provided (used) by investing activities
Borrowings (repayments) under lines of credit,net
Payments on long-term debt
Proceeds from issuance of stock
Net cash provided (used) by financing activities
Net increase in cash and cashequivalents
Cash and cash equivalents at beginning ofperiod
Net cash used by financing activities
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7. Cumulative Effect of Accounting Change – Adoption of SFAS No. 142
During fiscal 2002, management completed its measurement of the goodwill impairment resulting from the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets.” The amount of goodwill impairment upon adoption is reflected as the cumulative effect of an accounting change as of September 30, 2001 in the accompanying condensed consolidated financial statements.
Goodwill balances within the Pet Products and Garden Products segments were tested for impairment as of September 30, 2001. Based on the analysis performed, the Company recorded a non-cash charge to write down goodwill in its Pet Products segment by $94.8 million ($70.1 million after tax) and in its Garden Products segment by $51.9 million ($42.1 million after tax).
8. Contingencies
TFH Litigation. In December 1997, Central acquired all of the stock of TFH Publications, Inc. (“TFH”). In connection with the transaction, Central made a $10 million loan to the sellers, which was evidenced by a Promissory Note. In September 1998, the prior owners of TFH brought suit against Central and certain executives of Central for damages and relief from their obligations under the Promissory Note, alleging, among other things, that Central’s failure to properly supervise the TFH management team had jeopardized their prospects of achieving certain earnouts. Central believes that these allegations are without merit. Central counterclaimed against the prior owners for enforcement of the Promissory Note, rescission and/or damages and other relief, alleging, among other things, fraud, misrepresentation and breach of fiduciary duty by the prior owners of TFH. These actions, Herbert R. Axelrod and Evelyn Axelrod v. Central Garden & Pet Company; Glenn S. Axelrod; Gary Hersch; William E. Brown; Robert B. Jones; Glen Novotny; and Neill Hines, Docket No. MON-L-5100-99, and TFH Publications, Inc. v. Herbert Axelrod et al., Docket No. L-2127-99 (consolidated cases), are in the New Jersey Superior Court. It is currently anticipated that this case will be tried in late 2003 or early 2004.
During the course of discovery in this action, Central has become aware of certain information which shows that prior to the acquisition of TFH by Central, certain records of TFH were prepared in an inaccurate manner which, among other things, resulted in underpayment of taxes by certain individuals. Those individuals could be liable for back taxes, interest, and penalties. In addition, even though all of the events occurred prior to the acquisition of TFH by Central, there is a possibility that TFH could be liable for penalties for events which occurred under prior management. Central believes that TFH has strong defenses available to the assertion of any penalties against TFH. Central cannot predict whether TFH will be required to pay any such penalties. In the event that TFH were required to pay penalties, Central would seek compensation from the prior owners.
Central does not believe that the outcome of the above matters will have a material adverse impact on its operations, financial position, or cash flows.
Scotts Litigation. On June 30, 2000, The Scotts Company filed suit against Central to collect the purchase price of certain lawn and garden products previously sold to Central. See The Scotts Company v. Central Garden & Pet Company, Docket No. C2 00-755 (U.S. Dist Ct. N.D. Ohio). Central filed its answer and a counter complaint asserting various claims for breaches of contracts.
In April 2002, trial occurred on the claims and counterclaims of the parties (excluding one oral contract claim made by Central recently added to the case). The net verdict was in favor of Scotts in the amount of $10.425 million which had previously been recorded as an obligation by the Company. Scotts and Central filed post-trial motions. In a March 20, 2003 order, the district court denied Scotts’ motion for attorneys’ fees, granted Scotts’ motion to set aside $750,000 of the jury amount awarded to Central, denied Central’s motion for a new trial, granted Central’s motion for prejudgment interest, and granted in part and denied in part Scotts’ motion for prejudgment interest. The court directed each party to re-determine the amount of their respective interest claims in light of the Court’s ruling and to submit their respective determinations. On July 11, 2003, the Court issued an order resolving the remaining prejudgment interest issues and directing the parties to submit calculations in accordance with its decision. Pursuant
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to this order, the Court will award prejudgment interest to Scotts in the net amount of $2.827 million, which has been previously provided for by the Company. Trial on Central’s remaining claim is scheduled for October 6, 2003.
On July 7, 2000, Central filed suit against Scotts and Pharmacia Corporation (formerly know as Monsanto Company) seeking damages and injunctive relief for, among other things, violations of the antitrust laws. See Central Garden & Pet Company, v. The Scotts Company, and Pharmacia Corporation, formerly known as Monsanto Company, Docket No. C 00 2465, (U.S. Dist Ct. N.D. Cal.). Pursuant to a settlement reached with Pharmacia, Central and Pharmacia agreed that all antitrust claims against Pharmacia and Monsanto would be resolved, and the federal action has been dismissed as to Pharmacia and Monsanto. In May 2002, Scotts filed a motion for summary judgment in the federal action based on res judicata. The court granted the res judicata motion, did not rule on the antitrust motions. Central is appealing the judgment entered pursuant to the court’s order.
Central does not believe that the outcome of the above remaining matters will have a material adverse impact on its operations, financial position, or cash flows.
Phoenix Fire. On August 2, 2000, a fire destroyed Central’s leased warehouse space in Phoenix, Arizona, and an adjoining warehouse space leased by a third party. On July 31, 2001, the adjoining warehouse tenant filed a lawsuit against Central and other parties in the Superior Court of Arizona, Maricopa County, seeking to recover $47 million for property damage from the fire. See Cardinal Health Inc., et al. v. Central Garden & Pet Company, et al., Civil Case No. CV2001-013152. Local residents have also filed a purported class action lawsuit alleging claims for bodily injury and property damage as a result of the fire. The building owner and several nearby businesses have also now filed lawsuits for property damage and business interruption, which we expect to be consolidated with the tenant and local resident lawsuits. Each of these lawsuits is currently pending in the Superior Court of Arizona, Maricopa County. The Arizona Department of Environmental Quality, after monitoring the cleanup operations and asking Central, the building owner and the adjoining warehouse tenant to assess whether the fire and fire suppression efforts may have caused environmental impacts to soil, groundwater and/or surface water, has now issued a letter stating that Central need take no further action at the site with respect to environmental issues. In early 2001, the EPA requested information relating to the fire. On July 17, 2002, the EPA informed Central that it intended to file a civil administrative complaint seeking penalties of up to $350,000 for certain alleged post-fire reporting violations. Central and the EPA have recently settled those allegations for $65,000. The overall amount of the damages to all parties caused by the fire, and the overall amount of damages which Central may sustain as a result of the fire, have not been quantified. At the time of the fire, Central maintained property insurance covering losses to the leased premises, Central’s inventory and equipment, and loss of business income. Central also maintained insurance providing $51 million of coverage (with no deductible) against third party liability. Central believes that this insurance coverage will be available with respect to third party claims against Central if parties other than Central are not found responsible. The precise amount of the damages sustained in the fire, the ultimate determination of the parties responsible and the availability of insurance coverage are likely to depend on the outcome of complex litigation, involving numerous claimants, defendants and insurance companies.
9. Subsequent Event
In July 2003 the Company acquired a 49 percent equity interest in the E. M. Matson lawn and garden business. E. M. Matson is a leading lawn and garden manufacturer in the Western U.S. which markets and sells slug & snail products, moss controls and animal repellants under the Corry’s, Deadline and Moss-B-Ware brand names. Annual sales are approximately $8 million. This investment provides the Company with additional premium brands to add to its stable of leading brands and brings in additional management talent.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Central Garden & Pet Company is a leading marketer and producer of quality branded products for the pet and lawn and garden supplies markets. We are one of the largest companies in the fragmented, $5.1 billion U.S. pet supplies industry and one of the largest companies in the $52.5 billion U.S. lawn and garden supplies industry. Our
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pet products include pet bird and small animal food, wild bird seed, aquarium products, flea, tick, mosquito and other insect control products, edible bones, cages, carriers, pet books, and other dog, cat, reptile and small animal products. These products are sold under a number of brand names, including Kaytee, All-Glass Aquarium, Zodiac, Nylabone, TFH and Four Paws. Our lawn and garden products include grass seed, wild bird seed, weed and insect control products, decorative outdoor patio products and ant control products. These products are sold under a number of brand names, including Pennington, Norcal Pottery, Matthews Four Seasons, AMDRO and Grant’s. In fiscal 2002, our consolidated net sales were $1.1 billion, of which our pet products segment, or Pet Products, accounted for $471.1 million and our lawn and garden products segment, or Garden Products, accounted for $606.7 million. Our income from operations was $52.8 million, of which Pet Products accounted for $43.4 million and Garden Products accounted for $37.3 million, before corporate expenses and eliminations of $27.9 million.
Central was incorporated in Delaware in June 1992 and is the successor to a California corporation which was incorporated in 1955. References to “we,” “us,” “our,” or “Central” mean Central Garden & Pet Company and its subsidiaries and divisions, and their predecessor companies and subsidiaries.
Background
During the past several years, we have transitioned to a leading marketer and producer of branded products from a traditional pet and lawn and garden supplies distributor. We undertook this transition because we recognized the opportunity to build a portfolio of leading brands and improve profitability by capitalizing on our knowledge of the pet and lawn and garden supplies sectors, our strong relationships with retailers and our nationwide sales and logistics network. Our goal was to diversify our business and improve operating margins by establishing a portfolio of leading brands. Since 1997, we have acquired numerous branded products companies and product lines, including Wellmark and Four Paws in fiscal 1997; Kaytee Products, TFH and Pennington Seed in fiscal 1998; Norcal Pottery in fiscal 1999; and AMDRO and All-Glass Aquarium in fiscal 2000.
While expanding our branded products business, we experienced adverse events in our distribution business. From 1995 to 1999, we were the master distributor of Round Up and Ortho products. In January 1999, The Scotts Company, one of our largest distribution suppliers at the time, acquired Ortho and became the marketing agent for Round Up. In July 2000, Scotts terminated its relationship with us. Due to these events, we significantly downsized our garden distribution operations and closed a total of 25 facilities from fiscal 1999 to fiscal 2001. We have incurred significant legal expenses associated with lawsuits with Scotts and others. In fiscal 2001, we integrated our sales and logistics networks into our pet and lawn and garden products businesses to allow us to focus resources and provide strategic sales support for our brands.
Virtually all of our sales before fiscal 1997 were from distributing other manufacturers’ products. Since then, our branded product sales have grown to approximately $800 million, or approximately 75% of total sales, in fiscal 2002. During this same period, sales of other manufacturers’ products have declined to approximately $250 million, or approximately 25% of total sales, and our gross profit margins improved from 13.6% in fiscal 1996 to 29.7% in fiscal 2002.
Recent Developments
In July 2003, we acquired a 49 percent equity interest in the E. M. Matson lawn and garden business. E. M. Matson is a leading lawn and garden manufacturer in the Western U.S. which markets and sells slug & snail products, moss controls and animal repellants under the Corry’s, Deadline and Moss-B-Ware brand names. Annual sales are approximately $8 million.
In May 2003, we closed a $200 million senior secured credit facility. The new credit facility consists of a five-year $100 million revolving credit facility and a six-year $100 million term loan. The new facility replaced the Company’s $175 million asset-based revolving credit facility. Net proceeds from the new facility were used to retire the outstanding debt under the asset-based revolving credit facility. The remaining net proceeds will be used to retire other existing debt as well as provide capital for general corporate purposes and acquisitions and investments.
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Compared with Three Months Ended June 29, 2002
Results for the third quarter of fiscal 2003 continued to reflect our transition to a leading marketer and producer of branded products from a distributor of other manufacturers’ products. Branded product sales continued to increase while sales of other manufacturer’s products decreased. Net sales for the three months ended June 28, 2003 increased $9.5 million, or 2.8%, to $345.1 million from $335.6 million for the three months ended June 29, 2002 due to increased branded product sales partially offset by decreased sales of other manufacturers’ products. Net sales increased $8.9 million, or 7.3%, in Pet Products and $0.6 million, or 0.3%, in Garden Products. Our branded product sales increased $6.7 million in Pet Products, due primarily to increased sales of mosquito and pest control products and aquariums, and $6.1 million in Garden Products, due primarily to increased sales of grass seed, pottery and fire ant products.
Gross profit for the quarter ended June 28, 2003 increased $1.2 million, or 1.2%, to $102.2 million from $101.0 million for the quarter ended June 29, 2002. Pet Product’s gross profit increased as a result increased sales, partially offset by a slight decrease in Garden Products as a result of higher than normal grain prices. Gross profit as a percentage of net sales decreased from 30.1% for the quarter ended June 29, 2002 to 29.6% for the same quarter in 2003. Our gross margins continued to be impacted by higher than normal grain prices caused by last year’s drought in the Plains states. However, we do not expect our gross margins to be impacted by the higher than normal grain prices in the fourth quarter of fiscal 2003. Wild bird feed margins are recovering as we use the higher priced grain inventories purchased earlier in the season and we have improved pricing to retailers, the last of which was implemented in mid-March.
Selling, general and administrative expenses decreased $5.1 million, or 6.8%, from $74.7 million for the quarter ended June 29, 2002 to $69.6 million in the current quarter. As a percentage of net sales, selling, general and administrative expenses decreased from 22.3% for the quarter ended June 29, 2002 to 20.2% for the quarter ended June 28, 2003. The decrease in selling, general and administrative expenses as a percentage of net sales was due to decreased facility and warehouse and administrative expenses partially offset by increased selling and delivery expenses.
Selling and delivery expenses increased $5.2 million, or 15.0%, from $34.6 million for the quarter ended June 29, 2002 to $39.8 million for the current quarter. Increased selling and delivery expense in Pet Products resulted from increased revenues, while increased media advertising and increased revenues led to increased expenses in Garden Products.
Facilities expense decreased by $0.2 million, or 7.4%, from $2.7 million for the quarter ended June 29, 2002 to $2.5 million for the current quarter. The decrease was related to the reduction of Garden Products facilities that occurred subsequent to the June 29, 2002 quarter.
Warehouse and administrative expenses decreased $10.1 million, or 27.0%, from $37.4 million for the quarter ended June 29, 2002 to $27.3 million for the quarter ended June 28, 2003. Warehouse and administrative expenses decreased $1.1 million in Pet Products, $4.0 million in Garden Products and $5.0 million at Corporate. The decrease was due primarily to significantly reduced legal and litigation expenses in the current year quarter and increased purchasing, merchandise handling and storage costs included as inventory costs as a result of the increase in both sales and inventory levels. Expenses were further reduced by the consolidation of Garden Products administrative functions that occurred subsequent to June 29, 2002. In the prior year quarter, increased charges resulted from a discontinued product line as well as insurance costs.
Operating income increased $6.3 million, or 24%, compared to the prior year quarter as a result of increased sales and lower selling, general and administrative expenses.
Net interest expense for the quarter ended June 28, 2003 increased by $1.7 million, or 46.3%, to $5.4 million from $3.7 million for the quarter ended June 29, 2002. Approximately $0.4 million was for fees and expenses in connection with the refinancing of our senior credit facility. The remainder of the increase is due to the higher interest expense primarily associated with higher rates on our $150 million senior subordinated notes due 2013.
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Other income decreased $2.8 million from $4.4 million for the quarter ended June 29, 2002 to $1.6 million for the quarter ended June 28, 2003. The decrease is due primarily to $6 million of life insurance proceeds, partially offset by a $2.8 million charge related to the write-down of an equity method investment, included in the quarter ended June 29, 2002. Earnings from equity method investments were $1.6 million for the quarter ended June 28, 2003 compared to $1.2 million for the quarter ended June 29, 2002.
The Company’s effective income tax rate for the quarter ended June 28, 2003 was 40.0% compared with 31.9% for the quarter ended June 29, 2002. The lower effective tax rate in the quarter ended June 29, 2002 was primarily the result of non-taxable insurance proceeds.
Compared with Nine Months Ended June 29, 2002
Net sales for the nine months ended June 28, 2003 increased by $50.6 million, or 6.1%, to $887.6 million from $837.0 million for the nine months ended June 29, 2002. The increase in net sales was comprised of a $21.7 million, or 6.1%, increase in Pet Products and a $28.9 million, or 6.0%, increase in Garden Products. Increased sales in both segments are the result of increased sales or our branded products, primarily mosquito, fire ant and pest control products, grass and bird seed. The wet spring weather in 2003 dampened our garden sales. However, the impact has been offset by the large population of insects and pests the wet weather has brought and continued concerns over the West Nile virus.
Gross profit for the nine months ended June 28, 2003 increased $9.1 million, or 3.6%, to $262.5 million from $253.4 million for the nine months ended June 29, 2002. Gross profit increased in both Garden Products and Pet Products as a result of increased sales. Gross profit as a percentage of net sales decreased from 30.3% for the nine months ended June 29, 2002 to 29.6% for the nine months ended June 28, 2003. Garden and Pet Product gross margins continued to be impacted by higher than normal grain prices caused by last year’s drought in the Plains states. However, wild bird feed margins are recovering as we use the higher priced grain inventories purchased earlier in the season and from improved pricing to retailers, the last of which was implemented in mid-March.
Selling, general and administrative expenses decreased $4.1 million, or 2.0%, from $203.9 million for the nine months ended June 29, 2002 to $199.8 million for the nine months ended June 28, 2003. As a percentage of net sales, selling, general and administrative expenses decreased from 24.4% for the nine months ended June 29, 2002 to 22.5% for the nine months ended June 28, 2003. The decrease in selling, general and administrative expense was due to decreased facilities and warehouse and administrative expenses partially offset by increased selling and delivery expenses.
Selling and delivery expenses increased by $9.4 million, or 10.1%, from $92.9 million for the nine months ended June 29, 2002 to $102.3 million for the nine months ended June 28, 2003. The increase in revenues in both Garden Products and Pet Products and increased media advertising led to increased selling and delivery expenses.
Facilities expense decreased by $0.8 million, or 9.3%, from $8.5 million for the nine months ended June 29, 2002 to $7.7 million for the nine months ended June 28, 2003. The decrease was primarily related to facility shutdown costs in Pet Products incurred in the prior year period and reduced costs in Garden Products due to facility consolidations subsequent to June 29, 2002.
Warehouse and administrative expenses decreased $12.7 million, or 12.4%, from $102.5 million for the nine months ended June 29, 2002 to $89.8 million for the nine months ended June 28, 2003. Warehouse and administrative expenses decreased $3.5 million in Garden Products, $2.8 million in Pet Products and $6.4 million at Corporate. The decrease was due primarily to significantly reduced legal and litigation expenses in the current fiscal year. Additionally, increased charges from a discontinued product line were incurred in the prior year. Also contributing to the decrease was increased purchasing, merchandise handling and storage costs included as inventory costs as a result of the increase in both sales and inventory. Expenses were further reduced by the consolidation of Garden Products administrative functions that occurred subsequent to June 29, 2002.
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Net interest expense for the nine months ended June 28, 2003 increased $3.2 million, or 28.8%, to $14.5 million from $11.3 million for the nine months ended June 29, 2002. The increase is due to $1.8 million of fees and expenses related to the issuance and retirement of debt in fiscal 2003 and the higher interest expense associated with the higher rates on our new capital structure, primarily the $150 million of 9 1/8% senior subordinated notes due 2013.
Other income decreased $2.9 million from $4.8 million for the nine months ended June 29, 2002 to $1.9 million for the nine months ended June 28, 2003. The decrease is due to $6 million of life insurance proceeds, partially offset by a $2.8 million charge related to the write-down of an equity method investment, included in the nine months ended June 29, 2002. Earnings from equity method investments increased $0.3 million in the current fiscal year.
Our effective income tax rate before the cumulative effect of accounting change for the nine months ended June 29, 2002 was 35.3% compared with 40.0% for the nine months ended June 28, 2003. The lower effective tax rate in for the nine months ended June 29, 2002 was primarily the result of non-taxable insurance proceeds.
We recorded net income for the nine months ended June 28, 2003 of $30.0 million compared with $27.8 million, before the effect of adopting Statement of Financial Accounting Standards (“SFAS”) No. 142, in the prior year nine month period. Improved operating results were offset partially by increased interest expense and income taxes and reduced other income. Fully diluted earnings per share improved from $1.36, before the effect of adopting SFAS No. 142, in the prior year nine months to $1.49 in the current year nine months. In addition to the improved net income in the current year, the fully diluted weighted average shares outstanding decreased due to the redemption of our $115 million convertible subordinated notes in February 2003.
In the first quarter of fiscal 2002, we reported a cumulative effect of accounting change charge in the amount of $112.2 million. In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 changes the accounting for goodwill and intangible assets with indefinite lives from an amortization method to an impairment approach. Other intangible assets will continue to be amortized over their estimated useful lives. Amortization of goodwill, including goodwill recorded in prior business combinations, ceased upon the adoption of the standard, which we adopted for the fiscal year beginning September 30, 2001. As required by SFAS No. 142, we performed our goodwill impairment analysis and recorded a non-cash charge to write down goodwill in our Garden Products segment by $51.9 million ($42.1 million after tax) and in our Pet Products segment by $94.8 million ($70.1 million after tax) in the quarter ended December 29, 2001.
Liquidity and Capital Resources
We have financed our growth through a combination of bank borrowings, supplier credit, internally generated funds and sales of equity and debt securities to the public.
Historically, our business has been seasonal and our working capital requirements and capital resources tracked closely to this seasonal pattern. During the first fiscal quarter, accounts receivable reach their lowest level while inventory, accounts payable and short-term borrowings begin to increase. During the second fiscal quarter, receivables, accounts payable and short-term borrowings begin to increase, reflecting the build-up of inventory and related payables in anticipation of the peak lawn and garden selling season. During the third fiscal quarter, inventory levels remain relatively constant while accounts receivable peak and short-term borrowings start to decline as cash collections are received during the peak selling season. During the fourth fiscal quarter, inventory levels are at their lowest, and accounts receivable and payables are substantially reduced through conversion of receivables to cash. As a result of the reduction in sales of products manufactured by other parties as a percentage of overall sales, this seasonal pattern has become somewhat less significant.
We service two broad markets: pet supplies and lawn and garden supplies. Our pet supplies businesses involve products that have a year round selling cycle with very little change quarter to quarter. As a result, it is not necessary to carry large quantities of inventory to meet peak demands. Additionally, this level sales cycle eliminates the need for manufacturers to give extended credit terms to either distributors or retailers. On the other hand, our lawn and garden businesses are highly seasonal with approximately 64% of Garden Products’ aggregate sales
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occurring during the second and third fiscal quarters in fiscal year 2002. For many manufacturers of garden products, this seasonality requires them to move large quantities of their product well ahead of the peak selling periods. To encourage distributors to carry large amounts of inventory, industry practice has been for manufacturers to give extended credit terms and/or promotional discounts.
Cash provided by operating activities decreased $19.0 million from $48.7 million for the nine months ended June 29, 2002 to $29.7 million for the nine months ended June 28, 2003. The decrease was primarily attributable to increased inventory and accounts receivable levels due primarily to softness in sales in the Garden segment and the build up for the expected strong summer demand for insect control products. This was partially offset by increased accounts payable, related to the increased inventory, and accrued expenses due primarily to increased accrued taxes and interest. Net cash used in investing activities increased $4.3 million primarily as a result of capital expenditures associated with the construction of a manufacturing facility. Net cash provided by financing activities increased $87.0 million due to the net proceeds received from the issuance of $150 million of senior subordinated notes in January 2003, $100 million senior term loan in May 2003 and employee stock option exercises. These proceeds were partially offset by the redemption of our $115 million convertible subordinated notes in February 2003, the repayment of the outstanding borrowings under our credit facility in May 2003, and the repayment of two senior secured term loans.
At June 28, 2003, our total debt was $262.0 million versus $233.8 million at June 29, 2002. Net debt, total debt less cash and cash equivalents, was $186.5 million at June 28, 2003 versus $224.6 million at June 29, 2002.
In May 2003, we closed a new $200 million senior secured credit facility consisting of a five-year $100 million revolving credit facility and a six-year $100 million term loan. Interest on the term loan is based on a rate equal to LIBOR plus 2.75% or the prime rate plus 1.25%, at our option. Interest on the revolving credit facility is based on a rate equal to prime plus a margin which fluctuates from 0.25% to 1.25% or LIBOR plus a margin which fluctuates from 1.75% to 2.75%, determined quarterly based on consolidated total debt to consolidated EBITDA for the most recent trailing 12-month period. This facility is secured by essentially all of the Company’s assets, contains certain financial covenants requiring maintenance of minimum levels of interest coverage and tangible net worth and maximum levels of senior debt to EBITDA and total debt to EBITDA and places a ceiling on the Company’s treasury stock purchases. We were in compliance with all financial covenants as of June 28, 2003. This facility also requires the lenders’ prior written consent to any material investments in or acquisitions of a business. The new facility replaced our $175 million asset-based revolving credit facility. We anticipate the new credit facility will result in slightly higher annual interest expense. A portion of the net proceeds from the $100 million term loan were used to retire the outstanding debt under the asset-based revolving credit facility. The remaining net proceeds will be used to retire other existing debt and, along with the amounts available under the $100 million revolving credit facility, will provide capital for general corporate purposes, acquisitions and investments. No balances were outstanding at June 29, 2003 under the $100 million revolving credit facility.
In January 2003, we issued $150 million of 9 1/8% senior subordinated notes due 2013. The net proceeds of approximately $144 million were used to redeem $115 million of 6% subordinated convertible notes due November 2003. We used the balance of the net proceeds, combined with additional borrowings under the our line of credit with Congress Financial Corporation (Western), to repay the outstanding borrowings under our Pennington credit facility and two senior secured term loans of All-Glass. In conjunction with these repayments, we terminated the Pennington and All-Glass credit facilities. As a result of our private placement of $150 million of 9 1/8% senior subordinated notes due 2013, we estimate that our interest expense will increase approximately $6 million per year.
As a result of these refinancings, we have increased our financial flexibility by replacing our long-term debt, putting in place a layer of medium-term capital and increased our access to additional lenders. We believe that this increased financial flexibility will allow us to more effectively pursue growth opportunities and potential acquisitions on a prudent basis.
We believe that cash flows from operating activities, funds available under our credit facility, and arrangements with suppliers will be adequate to fund our presently anticipated working capital requirements for the foreseeable future. We anticipate that our capital expenditures will not exceed $15.0 million for the next 12 months, including approximately $5.0 million for the construction of a manufacturing facility scheduled for completion in the fall of 2003.
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As part of our growth strategy, we have engaged in acquisition discussions with a number of companies in the past, and we anticipate that we will continue to evaluate potential acquisition candidates. If one or more potential acquisition opportunities, including those that would be material, become available in the near future, we may require additional external capital. In addition, such acquisitions would subject us to the general risks associated with acquiring companies, particularly if the acquisitions are relatively large.
Weather and Seasonality
Historically, the Company’s sales of lawn and garden products have been influenced by weather and climate conditions in the markets it serves. Additionally, Garden Products’ business has been highly seasonal. In fiscal 2002, 64% of Garden Products net sales and 58% of our total net sales occurred in the Company’s second and third fiscal quarters. Substantially all of Garden Products’ operating income is typically generated in this period, which has historically offset the operating loss incurred during the first fiscal quarter of the year.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company believes there has been no material change in its exposure to market risk from that discussed in the Company’s fiscal 2002 Annual Report filed on Form 10-K.
Item 4. Controls and Procedures
(a) Our Chief Executive Officer and Chief Financial Officer have reviewed, as of the end of the period covered by this report, the “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) that ensure that information relating to the company required to be disclosed by us in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported in a timely and proper manner. Based upon this review, we believe that there are adequate controls and procedures in place to ensure that information relating to the company that is required to be disclosed by us in the reports that we file or submit under the Exchange Act is properly disclosed as required by the Exchange Act and related regulations.
(b) Changes in internal controls. There were no significant changes in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For information on our material legal proceedings, you should read note 8 “Contingencies” to the unaudited financial statements in Part I – Item 1 of this report.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
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Item 4. Submission of Matter to a Vote of Securities Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(b) The following current report on Form 8-K was filed during the quarter ended June 28, 2003:
The following current report on Form 8-K was furnished during the quarter ended June 28, 2003:
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.
/s/ GLENN W. NOVOTNY
Glenn W. Novotny
President and Chief Executive Officer
/s/ STUART W. BOOTH
Stuart W. Booth
Vice President and Chief Financial Officer
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