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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 27, 2004

 

or

 

¨ TRANSITION REPORT PURSUANT OF SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission File Number: 0-20242

 


 

CENTRAL GARDEN & PET COMPANY

 


 

Delaware   68-0275553

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

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 April 30, 2004

   18,411,602

Class B Stock Outstanding as of April 30, 2004

   1,654,462

 



Table of Contents
     PART I. FINANCIAL INFORMATION    

Item 1.

 

Financial Statements

   3
   

Condensed Consolidated Balance Sheets September 27, 2003 and March 27, 2004

   3
   

Condensed Consolidated Statements of Operations Three and Six Months Ended March 29, 2003 and March 27, 2004

   4
   

Condensed Consolidated Statements of Cash Flows Six Months Ended March 29, 2003 and March 27, 2004

   5

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   15

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

   19

Item 4.

 

Controls and Procedures

   19
PART II. OTHER INFORMATION

Item 1.

 

Legal Proceedings

   20

Item 2.

 

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

   20

Item 3.

 

Defaults Upon Senior Securities

   20

Item 4.

 

Submission of Matter to a Vote of Securities Holders

   20

Item 5.

 

Other Information

   21

Item 6.

 

Exhibits and Reports on Form 8-K

   22

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

 

This Form 10-Q includes “forward-looking statements.” Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, our competitive strengths and weaknesses, our business strategy and the trends we anticipate in the industries and economies in which we operate and other information that is not historical information. When used in this Form 10-Q, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, our examination of historical operating trends, are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith, and we believe there is a reasonable basis for them, but we cannot assure you that our expectations, beliefs and projections will be realized.

 

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this Form 10-Q. Important factors that could cause our actual results to differ materially from the forward-looking statements we make in this Form 10-Q are set forth in our Form 10-K for the fiscal year ended September 27, 2003, including the factors described in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Factors.” If any of these risks or uncertainties materialize, or if any of our underlying assumptions are incorrect, our actual results may differ significantly from the results that we express in or imply by any of our forward-looking statements. We do not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances. Presently known risk factors include, but are not limited to, the following factors:

 

  consolidation trends in the retail industry;

 

  dependence on a few customers for a significant portion of each of our businesses;

 

  uncertainty of our product innovations and marketing successes;

 

  fluctuations in market prices for seeds and grains;

 

  competition in our industries;

 

  risks associated with our acquisition strategy;

 

  adverse weather during the peak gardening season;

 

  seasonality and fluctuations in our operating results and cash flow;

 

  dependence upon our key executive officers;

 

  potential environmental liabilities and product liability claims; and

 

  pending litigation and claims.

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CENTRAL GARDEN & PET COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

 

    

September 27,

2003


   

March 27,

2004


 
ASSETS                 

Current assets:

                

Cash and equivalents

   $ 77,604     $ 12,568  

Restricted investments

     —         15,179  

Accounts receivable (less allowance for doubtful accounts of $6,575 and $9,583)

     146,075       225,381  

Inventories

     217,156       252,614  

Prepaid expenses and other

     15,222       10,766  
    


 


Total current assets

     456,057       516,508  

Land, buildings, improvements and equipment—net

     101,538       101,347  

Goodwill

     222,780       281,108  

Deferred income taxes and other assets

     48,723       54,374  
    


 


Total

   $ 829,098     $ 953,337  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 105,103     $ 133,543  

Accrued expenses

     47,061       55,663  

Current portion of long-term debt

     1,028       1,027  
    


 


Total current liabilities

     153,192       190,233  

Long-term debt

     249,225       311,296  

Other long-term obligations

     1,585       1,580  

Shareholders’ equity:

                

Convertible preferred stock, $.01 par value: 100 shares issued and outstanding at March 27, 2004

     —         3,000  

Class B stock, $.01 par value: 1,654,462 shares outstanding at September 27, 2003 and March 27, 2004

     16       16  

Common stock, $.01 par value: 31,909,919 and 32,128,852 issued and 18,167,669 and 18,386,602 outstanding at September 27, 2003 and March 27, 2004

     319       321  

Additional paid-in capital

     545,228       549,159  

Retained earnings

     24,360       42,559  

Treasury stock

     (144,827 )     (144,827 )
    


 


Total shareholders’ equity

     425,096       450,228  
    


 


Total

   $ 829,098     $ 953,337  
    


 


 

See notes to condensed consolidated financial statements.

 

3


Table of Contents

CENTRAL GARDEN & PET COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

     Three Months Ended

    Six Months Ended

 
     March 29,
2003


    March 27,
2004


    March 29,
2003


    March 27,
2004


 

Net sales

   $ 330,509     $ 358,985     $ 542,445     $ 581,335  

Cost of goods sold and occupancy

     231,419       246,959       382,137       407,238  
    


 


 


 


Gross profit

     99,090       112,026       160,308       174,097  

Selling, general and administrative expenses

     70,916       77,669       130,170       136,180  
    


 


 


 


Income from operations

     28,174       34,357       30,138       37,917  

Interest expense

     (6,341 )     (4,459 )     (9,184 )     (8,564 )

Interest income

     44       123       70       322  

Other income

     671       985       330       270  
    


 


 


 


Income before income taxes

     22,548       31,006       21,354       29,945  

Income taxes

     9,019       12,162       8,542       11,746  
    


 


 


 


Net income

   $ 13,529     $ 18,844     $ 12,812     $ 18,199  
    


 


 


 


Income per common share:

                                

Basic

   $ 0.70     $ 0.94     $ 0.67     $ 0.91  
    


 


 


 


Diluted

   $ 0.68     $ 0.91     $ 0.64     $ 0.88  
    


 


 


 


Weighted average shares used in the computation of income per share:

                                

Basic

     19,234       20,030       19,147       19,939  

Diluted

     20,009       20,803       19,900       20,646  

 

See notes to condensed consolidated financial statements.

 

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CENTRAL GARDEN & PET COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended

 
     March 29,
2003


    March 27,
2004


 

Cash flows from operating activities:

                

Net income

   $ 12,812     $ 18,199  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation and amortization

     8,824       8,933  

Change in assets and liabilities (excluding businesses acquired):

                

Receivables

     (69,970 )     (72,044 )

Inventories

     (38,279 )     (23,272 )

Prepaid expenses and other assets

     16,309       1,169  

Accounts payable

     33,052       25,948  

Accrued expenses

     5,478       8,955  

Other long-term obligations

     116       (5 )
    


 


Net cash used in operating activities

     (31,658 )     (32,117 )

Cash flows used in investing activities:

                

Additions to land, buildings, improvements and equipment

     (6,810 )     (6,348 )

Businesses acquired, net of cash acquired

     —         (76,290 )

Restricted investments

     —         (15,179 )
    


 


Net cash used in investing activities

     (6,810 )     (97,817 )

Cash flows from financing activities:

                

Borrowings under lines of credit, net

     21,772       —    

Borrowings on revolving line of credit

     —         60,000  

Proceeds from issuance of long-term debt

     150,000       —    

Repayments of long-term debt

     (135,499 )     (526 )

Loan fees and financing costs paid

     (6,000 )     —    

Proceeds from issuance of stock

     4,318       5,424  
    


 


Net cash provided by financing activities

     34,591       64,898  

Net decrease in cash and equivalents

     (3,877 )     (65,036 )

Cash and equivalents at beginning of period

     10,884       77,604  
    


 


Cash and equivalents at end of period

   $ 7,007     $ 12,568  
    


 


Supplemental information:

                

Cash paid for interest

   $ 7,546     $ 8,168  
    


 


Cash paid (refunds received) for income taxes—net

   $ (6,468 )   $ (121 )
    


 


 

See notes to condensed consolidated financial statements.

 

 

5


Table of Contents

CENTRAL GARDEN & PET COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended March 27, 2004

(unaudited)

 

1. Basis of Presentation

 

The condensed consolidated balance sheet of Central Garden & Pet Company and subsidiaries (the “Company” or “Central”) as of March 27, 2004, the condensed consolidated statements of operations for the three and six months ended March 29, 2003 and March 27, 2004 and the condensed consolidated statements of cash flows for the six months ended March 29, 2003 and March 27, 2004 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 six months ended March 27, 2004 are not indicative of the operating results that may be expected for the year ending September 25, 2004. 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 2003 Annual Report on Form 10-K which has previously been filed with the Securities and Exchange Commission.

 

2. Stock Plan Information

 

The Company has various non-qualified stock-based compensation programs, which include stock options and restricted stock awards. The Company’s stock option plans 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:

 

     Three Months Ended

    Six Months Ended

 
     March 29,
2003


    March 27,
2004


    March 29,
2003


    March 27,
2004


 
     (in thousands)     (in thousands)  

Net income, as reported

   $ 13,529     $ 18,844     $ 12,812     $ 18,199  

Deduct: Total stock-based employee compensation expense determined under fair value based method for awards, net of related tax effects

     (448 )     (441 )     (906 )     (763 )
    


 


 


 


Pro forma net income

   $ 13,081     $ 18,403     $ 11,906     $ 17,436  
    


 


 


 


Net income per common equivalent share:

                                

Basic – as reported

   $ 0.70     $ 0.94     $ 0.67     $ 0.91  

Basic – pro forma

   $ 0.68     $ 0.92     $ 0.62     $ 0.87  

Diluted – as reported

   $ 0.68     $ 0.91     $ 0.64     $ 0.88  

Diluted – pro forma

   $ 0.65     $ 0.88     $ 0.60     $ 0.84  

 

6


Table of Contents

3. Earnings Per Share

 

The following is a reconciliation of the numerators and denominators of the basic and diluted per-share computations for income from continuing operations:

 

    

Three Months Ended

March 27, 2004


   

Six Months Ended

March 27, 2004


 
     Income

   Shares

   Per Share

    Income

   Shares

   Per Share

 
     (in thousands, except per share amounts)  

Basic EPS:

                                        

Net income

   $ 18,844    20,030    $ 0.94     $ 18,199    19,939    $ 0.91  

Effect of dilutive securities:

                                        

Options to purchase common stock

          773      (0.03 )          707      (0.03 )
    

  
  


 

  
  


Diluted EPS:

                                        

Net income attributable to common shareholders

   $ 18,844    20,803    $ 0.91     $ 18,199    20,646    $ 0.88  
    

  
  


 

  
  


 

    

Three Months Ended

March 29, 2003


   

Six Months Ended

March 29, 2003


 
     Income

   Shares

   Per
Share


    Income

   Shares

   Per
Share


 
     (in thousands, except per share amounts)  

Basic EPS:

                                        

Net income

   $ 13,529    19,234    $ 0.70     $ 12,812    19,147    $ 0.67  

Effect of dilutive securities:

                                        

Options to purchase common stock

          775      (0.02 )          753      (0.03 )
    

  
  


 

  
  


Diluted EPS:

                                        

Net income attributable to common shareholders

   $ 13,529    20,009    $ 0.68     $ 12,812    19,900    $ 0.64  
    

  
  


 

  
  


 

Options to purchase 2,348,108 shares of common stock at prices ranging from $1.30 to $33.85 per share were outstanding at March 27, 2004 and options to purchase 2,555,121 shares at prices ranging from $1.30 to $30.00 were outstanding at March 29, 2003. For the three month periods ended March 27, 2004 and March 29, 2003, options to purchase 42,310 and 6,000 shares of common stock, respectively, 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 six month periods ended March 27, 2004 and March 29, 2003, options to purchase 42,310 and 120,620 shares of common stock, respectively, 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.

 

Shares of common stock from the assumed conversion of the Company’s previously outstanding convertible notes totaling 4,107,143 were not included in the computation of diluted EPS for the three and six-month periods ended March 29, 2003, because the assumed conversion would have been anti-dilutive. These convertible notes were redeemed in February 2003.

 

4. Businesses Acquired

 

In January 2004, the Company acquired substantially all of the assets of Kent Marine, Inc., a leading supplier of saltwater aquarium supplements and conditioners sold under the brand name “Kent Marine”, for approximately $10 million in cash. The acquisition has been accounted for as a purchase. The purchase price exceeded the fair market value of the net tangible assets acquired by approximately $9 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Kent Marine from the date of acquisition. The Company may be required to pay up to $700,000 of additional cash consideration over the next three years, contingent upon actual earnings of the acquired business.

 

In February 2004, the Company acquired substantially all of the assets of New England Pottery, Inc., a marketer and seller of decorative pottery and seasonal Christmas products, for approximately $66 million in cash. Its proprietary brand names include “New England Pottery” and “GKI/Bethlehem Lighting.” The acquisition has been accounted for as a purchase. The purchase price exceeded the fair market value of the net tangible assets acquired by approximately by approximately $49 million, which was recorded as goodwill. The consolidated financial statements include the operating results of New England Pottery from the date of acquisition.

 

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Table of Contents

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.

 

     Three Months Ended

    Six Months Ended

 
     March 29,
2003


    March 27,
2004


    March 29,
2003


    March 27,
2004


 
     (in thousands)  

Net sales:

                                

Garden Products

   $ 201,894     $ 213,986     $ 295,142     $ 306,817  

Pet Products

     128,615       144,999       247,303       274,518  
    


 


 


 


Total net sales

   $ 330,509     $ 358,985     $ 542,445     $ 581,335  
    


 


 


 


Income (loss) from operations:

                                

Garden Products

   $ 23,887     $ 26,874     $ 20,666     $ 23,964  

Pet Products

     13,043       15,695       22,916       26,560  

Corporate

     (8,756 )     (8,212 )     (13,444 )     (12,607 )
    


 


 


 


Total income from operations

     28,174       34,357       30,138       37,917  
    


 


 


 


Interest expense—net

     (6,297 )     (4,336 )     (9,114 )     (8,242 )

Other income

     671       985       330       270  

Income taxes

     9,019       12,162       8,542       11,746  
    


 


 


 


Net income

   $ 13,529     $ 18,844     $ 12,812     $ 18,199  
    


 


 


 


Depreciation and amortization:

                                

Garden Products

   $ 1,319     $ 1,341     $ 2,650     $ 2,730  

Pet Products

     2,877       2,788       5,922       5,854  

Corporate

     127       187       252       349  
    


 


 


 


Total depreciation and amortization

   $ 4,323     $ 4,316     $ 8,824     $ 8,933  
    


 


 


 


 

     September 27,
2003


   March 27,
2004


     (in thousands)

Assets:

             

Garden Products

   $ 281,679    $ 399,242

Pet Products

     208,703      215,497

Corporate

     338,716      338,598
    

  

Total assets

   $ 829,098    $ 953,337
    

  

Goodwill (included in corporate assets):

             

Garden Products

   $ 105,681    $ 155,383

Pet Products

     117,099      125,725
    

  

Total goodwill

   $ 222,780    $ 281,108
    

  

 

6. Contingencies

 

Central does not believe that the outcome of the following legal proceedings will have a material adverse effect on its results of operations, liquidity or financial position taken as a whole. However, because these proceedings may raise complex factual and legal issues and are subject to uncertainties, Central cannot predict with assurance the outcome of these proceedings. Accordingly, adverse settlements or resolutions may occur and negatively impact earnings in the quarter of settlement or resolution.

 

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 (the “Axelrod Loan”), 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,

 

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Table of Contents

Herbert R. Axelrod and Evelyn Axelrod v. Central Garden & Pet Company; Glen S. Axelrod; Gary Hersch; William E. Brown; Robert B. Jones; Glenn 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.

 

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.

 

On April 12, 2004, one of the former owners of TFH, Herbert Axelrod, was indicted by a federal grand jury. The two-count federal indictment, which is based on actions taken by Herbert Axelrod before Central acquired TFH, charges Herbert Axelrod with conspiracy to defraud the United States Internal Revenue Service and aiding and abetting the filing of false tax returns by a former Vice President of TFH. Herbert Axelrod failed to appear for his arraignment, and a federal warrant has been issued for his arrest. He is now reportedly residing in Cuba. Central has information that Herbert Axelrod has liquidated and transferred assets out of the United States. The status of Herbert Axelrod and his assets has raised questions, which cannot presently be answered, about Central’s ability to collect on any of its claims against Herbert Axelrod or the Axelrod Loan. If Central is unsuccessful in its claims against Mr. Axelrod regarding the Axelrod Loan or is unable to collect any judgment awarded, Central would be required to write-off the Axelrod Loan, which would result in a non-cash charge against its future earnings. The Axelrod Loan is currently carried on the financial statements of Central as an “Other Asset” in the amount of $10.2 million.

 

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 that was severed from the remainder of the case). The net verdict was in favor of Scotts in the amount of $10.4 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 to this order, the Court awarded prejudgment interest to Scotts in the net amount of $2.8 million. On October 3, 2003, Central and Scotts settled the oral contract claim that had previously been severed from the remainder of the case. Pursuant to the settlement, Scotts reduced the judgment amount by $300,000. Central and Scotts have each filed notices of appeal from different aspects of the prior judgment and post-judgment orders. In connection with the appeal, Central has paid approximately $15 million into an escrow account which is reported as restricted investments on our balance sheet.

 

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. Central has appealed the judgment entered pursuant to the court’s order. On January 15, 2004, the Ninth Circuit Court of Appeals affirmed the judgment.

 

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 also filed a purported class action lawsuit alleging claims for bodily injury and property damage as a result of the fire. This lawsuit has now been settled as to all parties, and has received Court approval. As part of the settlement, Central’s liability insurers will pay $7,825,000 on behalf of Central in May 2004. The building owner and several nearby businesses have also filed lawsuits for property damage and business interruption, which are being coordinated with the remaining tenant lawsuit. 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

 

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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 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.

 

7. Shareholders’ Equity

 

At March 27, 2004, there were 100 shares of Series B Convertible Preferred Stock ($0.01 par value) authorized, issued and outstanding. In February 2004, in connection with the agreement to purchase New England Pottery, the Company received $3,000,000 from certain members of management of New England Pottery in exchange for its issuance to them of 100 shares of Series B convertible preferred stock. Each share of Series B convertible preferred stock is entitled to a liquidation preference of the greater of $30,000 per share (the purchase price of the shares) or the amount that would have been payable if the shares had been converted to common stock, is initially convertible into 864 shares of common stock, is entitled to (on an as converted basis) dividends equal to any dividends paid on the common stock and has no voting rights, except as required by law.

 

8. 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.

 

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In lieu of providing separate unaudited financial statements for the Guarantor Subsidiaries, the Company has included the accompanying unaudited condensed consolidating 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.

 

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Three Months Ended March 27, 2004

(in thousands)

(unaudited)

 

     Parent

   

Guarantor

Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 118,375     $ 267,771     $ (27,161 )   $ 358,985  

Cost of products sold and occupancy

     86,470       187,069       (26,580 )     246,959  
    


 


 


 


Gross profit

     31,905       80,702       (581 )     112,026  

Selling, general and administrative expenses

     29,216       48,453       —         77,669  
    


 


 


 


Income (loss) from operations

     2,689       32,249       (581 )     34,357  

Interest – net

     (4,284 )     (52 )     —         (4,336 )

Other income

     203       782       —         985  
    


 


 


 


Income (loss) before income taxes

     (1,392 )     32,979       (581 )     31,006  

Income taxes

     546       (12,936 )     228       (12,162 )
    


 


 


 


Net income (loss)

     (846 )     20,043       (353 )     18,844  

Equity in undistributed income of guarantor subsidiaries

     19,690       —         (19,690 )     —    
    


 


 


 


Net income (loss)

   $ 18,844     $ 20,043     $ (20,043 )   $ 18,844  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Three Months Ended March 29, 2003

(in thousands)

(unaudited)

 

     Parent

   

Guarantor

Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 102,906     $ 250,077     $ (22,474 )   $ 330,509  

Cost of products sold and occupancy

     76,739       176,282       (21,602 )     231,419  
    


 


 


 


Gross profit

     26,167       73,795       (872 )     99,090  

Selling, general and administrative expenses

     26,330       44,586       —         70,916  
    


 


 


 


Income (loss) from operations

     (163 )     29,209       (872 )     28,174  

Interest – net

     (5,867 )     (430 )     —         (6,297 )

Other income

     458       213       —         671  
    


 


 


 


Income (loss) before income taxes

     (5,572 )     28,992       (872 )     22,548  

Income taxes

     2,229       (11,597 )     349       (9,019 )
    


 


 


 


Net income (loss)

     (3,343 )     17,395       (523 )     13,529  

Equity in undistributed income of guarantor subsidiaries

     16,872       —         (16,872 )     —    
    


 


 


 


Net income (loss)

   $ 13,529     $ 17,395     $ (17,395 )   $ 13,529  
    


 


 


 


 

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CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Six Months Ended March 27, 2004

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 195,688     $ 428,982     $ (43,335 )   $ 581,335  

Cost of goods sold and occupancy

     143,740       306,075       (42,577 )     407,238  
    


 


 


 


Gross profit

     51,948       122,907       (758 )     174,097  

Selling, general and administrative expenses

     51,200       84,980       —         136,180  
    


 


 


 


Income (loss) from operations

     748       37,927       (758 )     37,917  

Interest – net

     (8,308 )     66       —         (8,242 )

Other income (expense)

     (361 )     631       —         270  
    


 


 


 


Income (loss) before income taxes

     (7,921 )     38,624       (758 )     29,945  

Income taxes

     3,107       (15,150 )     297       (11,746 )
    


 


 


 


Net income (loss)

     (4,814 )     23,474       (461 )     18,199  

Equity in undistributed income of guarantor subsidiaries

     23,013       —         (23,013 )     —    
    


 


 


 


Net income (loss)

   $ 18,199     $ 23,474     $ (23,474 )   $ 18,199  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Six Months Ended March 29, 2003

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 174,457     $ 403,735     $ (35,747 )   $ 542,445  

Cost of goods sold and occupancy

     129,190       288,070       (35,123 )     382,137  
    


 


 


 


Gross profit

     45,267       115,665       (624 )     160,308  

Selling, general and administrative expenses

     47,850       82,320       —         130,170  
    


 


 


 


Income (loss) from operations

     (2,583 )     33,345       (624 )     30,138  

Interest – net

     (8,292 )     (822 )     —         (9,114 )

Other income (expense)

     (180 )     510       —         330  
    


 


 


 


Income (loss) before income taxes

     (11,055 )     33,033       (624 )     21,354  

Income taxes

     4,422       (13,214 )     250       (8,542 )
    


 


 


 


Net income (loss)

     (6,633 )     19,819       (374 )     12,812  

Equity in undistributed income of guarantor subsidiaries

     19,445       —         (19,445 )     —    
    


 


 


 


Net income (loss)

   $ 12,812     $ 19,819     $ (19,819 )   $ 12,812  
    


 


 


 


 

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Table of Contents

CONSOLIDATING CONDENSED BALANCE SHEET

March 27, 2004

(in thousands)

 

     Parent

   Guarantor
Subsidiaries


   Eliminations

    Consolidated

ASSETS                             

Cash and equivalents

   $ 10,302    $ 2,266    $ —       $ 12,568

Restricted investments

     15,179      —        —         15,179

Accounts receivable

     71,383      171,109      (17,111 )     225,381

Inventories

     70,848      181,766      —         252,614

Prepaid expenses and other

     3,330      7,436      —         10,766
    

  

  


 

Total current assets

     171,042      362,577      (17,111 )     516,508

Land, buildings, improvements and equipment, net

     9,215      92,132      —         101,347

Goodwill

     281,108      —        —         281,108

Investment in Guarantors

     353,552      —        (335,552 )     —  

Deferred income taxes and other assets

     53,160      1,214      —         54,374
    

  

  


 

Total

   $ 868,077    $ 455,923    $ (370,663 )   $ 953,337
    

  

  


 

LIABILITIES                             

Accounts payable

   $ 79,001    $ 71,653    $ (17,111 )   $ 133,543

Accrued expenses and other current liabilities

     27,546      29,144      —         56,690
    

  

  


 

Total current liabilities

     106,547      100,797      (17,111 )     190,233

Long-term debt

     311,296      —        —         311,296

Other long-term obligations

     6      1,574      —         1,580

Equity

     450,228      353,552      (353,552 )     450,228
    

  

  


 

Total

   $ 868,077    $ 455,923    $ (370,663 )   $ 953,337
    

  

  


 

 

CONSOLIDATING CONDENSED BALANCE SHEET

September 27, 2003

(in thousands)

 

     Parent

   Guarantor
Subsidiaries


   Eliminations

    Consolidated

ASSETS                             

Cash and equivalents

   $ 76,354    $ 1,250    $ —       $ 77,604

Accounts receivable

     43,209      113,415      (10,549 )     146,075

Inventories

     55,718      161,438      —         217,156

Prepaid expenses and other

     10,198      5,024      —         15,222
    

  

  


 

Total current assets

     185,479      281,127      (10,549 )     456,057

Land, buildings, improvements and equipment, net

     10,092      91,446      —         101,538

Goodwill

     222,780      —        —         222,780

Investment in Guarantors

     281,522      —        (281,522 )     —  

Deferred income taxes and other assets

     47,607      1,116      —         48,723
    

  

  


 

Total

   $ 747,480    $ 373,689    $ (292,071 )   $ 829,098
    

  

  


 

LIABILITIES                             

Accounts payable

   $ 53,024    $ 62,628    $ (10,549 )   $ 105,103

Accrued expenses and other current liabilities

     20,131      27,958      —         48,089
    

  

  


 

Total current liabilities

     73,155      90,586      (10,549 )     153,192

Long-term debt

     249,200      25      —         249,225

Other long-term obligations

     29      1,556      —         1,585

Equity

     425,096      281,522      (281,522 )     425,096
    

  

  


 

Total

   $ 747,480    $ 373,689    $ (292,071 )   $ 829,098
    

  

  


 

 

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Table of Contents

CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS

Six Months Ended March 27, 2004

(in thousands)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net cash provided (used) by operating activities

   $ 33,859     $ (42,502 )   $ (23,474 )   $ (32,117 )

Expenditures for land, buildings, improvements and equipment

     (1,336 )     (5,012 )     —         (6,348 )

Businesses acquired

     (76,290 )     —                 (76,290 )

Investments

     (15,179 )     —                 (15,179 )

Investment in guarantor subsidiaries

     (72,030 )     (48,556 )     23,474       —    
    


 


 


 


Net cash provided (used) by investing activities

     (164,835 )     43,544       23,474       (97,817 )
    


 


 


 


Borrowings on revolving line of credit

     60,000       —         —         60,000  

Payments on long-term debt

     (500 )     (26 )     —         (526 )

Proceeds from issuance of stock

     5,424       —         —         5,424  
    


 


 


 


Net cash provided (used) by financing activities

     64,924       (26 )     —         64,898  
    


 


 


 


Net increase (decrease) in cash and equivalents

     (66,052 )     1,016       —         (65,036 )

Cash and equivalents at beginning of period

     76,354       1,250       —         77,604  
    


 


 


 


Cash and equivalents at end of period

   $ 10,302     $ 2,266     $ —       $ 12,568  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS

Six Months Ended March 29, 2003

(in thousands)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net cash provided (used) by operating activities

   $ 4,015     $ (33,559 )   $ (2,114 )   $ (31,658 )

Expenditures for land, buildings, improvements and equipment

     (841 )     (5,969 )     —         (6,810 )

Investment in guarantor subsidiaries

     (86,503 )     84,389       2,114       —    
    


 


 


 


Net cash provided (used) by investing activities

     (87,344 )     78,420       2,114       (6,810 )
    


 


 


 


Borrowings (repayments) under lines of credit, net

     47,755       (25,983 )     —         21,772  

Proceeds from long-term debt

     150,000       —                 150,000  

Payments on long-term debt

     (119,848 )     (15,651 )     —         (135,499 )

Loan fees and financing costs paid

     (6,000 )     —         —         (6,000 )

Proceeds from issuance of stock

     4,318       —         —         4,318  
    


 


 


 


Net cash provided (used) by financing activities

     76,225       (41,634 )     —         34,591  
    


 


 


 


Net increase in cash and equivalents

     (7,104 )     3,227       —         (3,877 )

Cash and equivalents at beginning of period

     10,080       804       —         10,884  
    


 


 


 


Cash and equivalents at end of period

   $ 2,976     $ 4,031     $ —       $ 7,007  
    


 


 


 


 

9. Subsequent Events

 

In April 2004, the Company acquired substantially all of the assets of Interpet Limited, a leading marketer and manufacturer of pet supplies based in England, for approximately $28 million. The Company also announced that it had entered into a letter of intent for the acquisition, which has yet to close, of the assets of a related U.S. subsidiary, Aquarium Products, for approximately $1 million. These acquisitions will be accounted for as purchases. The operating results of Interpet will be included in the Company’s consolidated financial statements from the date of acquisition.

 

In March 2004, we amended our senior credit facility to increase the maximum amount available under the revolving credit portion by $25 million to $125 million (effective April 2004) and to give the option to borrow in Euros, Canadian Dollars and Pounds Sterling (effective March 2004).

 

For recent developments regarding the TFH litigation see note 6, Contingencies.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Central Garden & Pet Company is a leading innovator, 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, $7.5 billion U.S. pet supplies industry and in the $51.9 billion U.S. lawn and garden supplies industry. Our pet products include pet bird, small animal and wild bird food, 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, Oceanic, Zodiac, Pre-Strike, Altosid, Nylabone, TFH and Four Paws. Our lawn and garden products include grass seed, wild bird food, 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, Lilly Miller, Matthews Four Seasons, AMDRO and Grant’s. In fiscal 2003, our consolidated net sales were $1.15 billion, of which our pet products segment, or Pet Products, accounted for $501.7 million and our lawn and garden products segment, or Garden Products, accounted for $643.3 million. In fiscal 2003, our income from operations was $72.3 million, of which Pet Products accounted for $52.7 million and Garden Products accounted for $39.3 million, before corporate expenses and eliminations of $19.7 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

 

We have transitioned our company to a leading marketer and producer of branded products from a traditional pet and lawn and garden supplies distributor. We initiated 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; AMDRO and All-Glass Aquarium in fiscal 2000; Lilly Miller in fiscal 2001; Alaska Fish Fertilizer in fiscal 2002; and Kent Marine and New England Pottery in fiscal 2004.

 

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. 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. Subsequently, we downsized our distribution operations and integrated these 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 $863 million, or approximately 75% of total sales, in fiscal 2003. During this same period, our sales of other manufacturers’ products have declined to approximately $282 million, or approximately 25% of total sales, and our gross profit margins have improved from 13.6% in fiscal 1996 to 29.1% in fiscal 2003.

 

Recent Developments

 

In January 2004, we acquired Kent Marine, Inc., a leading supplier of saltwater aquarium supplements and conditioners sold under the brand name “Kent Marine”, for approximately $10 million in cash. We accounted for the acquisition as a purchase. The purchase price exceeded the fair market value of the net tangible assets acquired by approximately $9 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Kent Marine from the date of acquisition. We may be required to pay up to $700,000 of additional cash consideration over the next three years, contingent upon actual earnings of the acquired business.

 

In February 2004, we acquired substantially all of the assets of New England Pottery, Inc., a marketer and seller of decorative pottery and seasonal Christmas products, for approximately $66 million in cash. Its proprietary brand names include “New England Pottery” and “GKI/Bethlehem Lighting.” We accounted for the acquisition as a purchase. The purchase price exceeded the fair market value of the net tangible assets acquired by approximately by approximately $49 million, which was recorded as goodwill. The consolidated financial statements include the operating results of New England Pottery from the date of acquisition.

 

In April 2004, we acquired substantially all of the assets of Interpet Limited, a leading marketer and manufacturer of pet supplies based in England, for approximately $28 million in cash. We also announced that we have entered into a letter of intent for the acquisition, which has yet to close,

 

15


Table of Contents

of the assets of a related U.S. subsidiary, Aquarium Products, for approximately $1 million. We will account for these acquisitions as purchases. The operating results of Interpet will be included in our consolidated financial statements from the date of acquisition.

 

In March 2004, we amended our senior credit facility to increase the maximum amount available under the revolving credit portion by $25 million to $125 million (effective April 2004) and to give the option to borrow in Euros, Canadian Dollars and Pounds Sterling (effective March 2004).

 

For recent developments regarding the TFH litigation see note 6, Contingencies.

 

Accounting for Stock-Based Compensation

 

We currently measure compensation expense for our employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and provide pro forma disclosures of the effect on net income and earnings per share as if the fair value-based method had been applied in measuring compensation expense. We have elected to follow APB Opinion No. 25 because the alternative fair value accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB Opinion No. 25, when the exercise price of our employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.

 

On March 31, 2004, the FASB issued an exposure draft of a new accounting standard for Share-Based Payments, to require all companies to expense the fair value of employee stock options. Among other things, the exposure draft addresses possible methods to determine the fair value of employee stock options, the timing and amount of compensation expense, and adjustments to recognized expense for actual option forfeitures. The methods to determine the fair value of employee stock options mentioned in the exposure draft include the Black-Scholes formula and a lattice model (a binomial method). These valuation approaches and their input factors have been the subject of significant criticism as they relate to stock options.

 

Since changes could be made to the FASB exposure draft upon final adoption we have decided not to expense the value of employee stock options until the FASB finalizes this new accounting standard. We based this decision on the FASB’s announced intention to soon require all companies to expense the value of employee stock options and the FASB’s review of technical issues that will play a significant role in determining the fair value of and accounting for employee stock options. We monitor progress at the FASB and other developments with respect to the general issue of employee stock compensation. In the future, should we expense the value of employee stock options, we may have to recognize substantially more compensation expense in future periods that could have a material impact on our results of operations reported in future periods.

 

Critical Accounting Policies, Estimates and Judgments

 

There have been no material changes to our critical accounting estimates and assumptions or the judgments affecting the application of those estimates since our Annual Report on Form 10-K for the fiscal year ended September 27, 2003.

 

Three Months Ended March 27, 2004

Compared with Three Months Ended March 29, 2003

 

Net sales for the three months ended March 27, 2004 increased $28.5 million, or 8.6%, to $359.0 million from $330.5 million for the three months ended March 29, 2003 as branded product sales increased $14.5 million and sales of other manufacturers’ products increased $14.0 million. Net sales increased $16.4 million, or 12.7%, in Pet Products and $12.1 million, or 6.0%, in Garden Products. Our Pet Products’ branded sales increased $11.9 million due primarily to a $4.6 million increase in aquarium product sales and $2.2 million from our recent acquisition of Kent Marine. Our Garden Products’ branded product sales increased $2.6 million due primarily to $5.1 million of sales related to the recent acquisition of New England Pottery, partially offset by a decline in grass seed sales of approximately $5 million. Grass seed sales in 2003 were stronger than normal which contributed to the unfavorable comparison with 2004 sales.

 

Gross profit for the three months ended March 27, 2004 increased $12.9 million, or 13.0%, to $112.0 million from $99.1 million for the three months ended March 29, 2003. Gross profit increased $6.5 million in Garden Products and $6.4 million in Pet Products. Gross profit as a percentage of net sales increased to 31.2% for the three months ended March 27, 2004, from 30.0% for the three months ended March 29, 2003, as both Garden Products’ and Pet Products’ margins improved. The margin improvements were due primarily to higher margins realized for our wild bird feed products.

 

Selling, general and administrative expenses increased $6.8 million, or 9.6%, from $70.9 million for the three months ended March 29, 2003 to $77.7 million for the three months ended March 27, 2004. As a percentage of net sales, selling, general and administrative expenses remained relatively flat at 21.6% for the three months ended March 27, 2004, compared to 21.5% in the comparable prior year period.

 

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Selling and delivery expenses increased $2.9 million, or 8.4%, from $34.5 million for the three months ended March 29, 2003 to $37.4 million for the three months ended March 27, 2004 due to increased sales. Selling and delivery expenses, as a percentage of net sales, were 10.4% for both periods.

 

Facilities expense increased $0.4 million to $3.0 million for the three months ended March 27, 2004 from $2.6 million for the three months ended March 29, 2003. The increase is primarily related to shutdown costs for a pet manufacturing facility.

 

Warehouse and administrative expenses increased $3.5 million, or 10.4%, from $33.8 million for the three months ended March 29, 2003 to $37.3 million for the three months ended March 27, 2004. The increase was due primarily to increased warehousing costs, which include outside shipping costs, of $1.1 million, a $0.6 million increase in litigation costs and $1.4 million in professional fees incurred over the prior six months that were expensed as acquisitions being pursued did not materialize.

 

Net interest expense for the three months ended March 27, 2004 decreased $2.0 million, or 31.7%, to $4.3 million from $6.3 million for the three months ended March 29, 2003. The decrease was due primarily to $1.4 million of nonrecurring interest expensed in the second quarter of fiscal 2003, related to the refinancing of our convertible subordinated notes and lines of credit.

 

Other income increased $0.3 million to $1.0 million for the quarter ended March 27, 2004 from $0.7 million for the quarter ended March 29, 2003. Other income represents income from equity method investments. The increase in the fiscal 2004 quarter was attributed primarily to a new equity method investment made in the fourth quarter of fiscal 2003.

 

Our effective income tax rate for the quarter ended March 27, 2004 was 39.2% compared with 40.0% for the quarter ended March 29, 2003.

 

Six Months Ended March 27, 2004

Compared with Six Months Ended March 29, 2003

 

Net sales for the six months ended March 27, 2004 increased $38.9 million, or 7.2%, to $581.3 million from $542.4 million for the six months ended March 29, 2003 as both branded product sales increased $20.4 million and sales of other manufacturers’ products increased $18.5 million. Net sales increased $27.2 million, or 11.0%, in Pet Products and $11.7 million, or 4.0%, in Garden Products. Our Pet Products’ branded sales increased $18.3 million due primarily to a $9.0 million increase in sales of aquarium products and $2.2 million from our recent acquisition of Kent Marine. Our Garden Products’ branded product sales increased $2.1 million due primarily to $5.1 million of sales derived from the recent acquisition of New England Pottery, partially offset by a $5 million decline in grass seed sales. Grass seed sales in 2003 were stronger than normal which contributed to the unfavorable comparison to 2004 sales.

 

Gross profit for the six months ended March 27, 2004 increased $13.8 million, or 8.6%, to $174.1 million from $160.3 million for the six months ended March 29, 2003. Gross profit increased $6.5 million in Garden Products and $7.3 million in Pet Products. Gross profit as a percentage of net sales increased to 29.9% for the six months ended March 27, 2004, from 29.6% for the six months ended March 29, 2003. The margin improvements were due primarily to higher margins realized for our wild bird feed products.

 

Selling, general and administrative expenses increased $6.0 million, or 4.6%, from $130.2 million for the six months ended March 29, 2003 to $136.2 million in the six months ended March 27, 2004. As a percentage of net sales, selling, general and administrative expenses decreased from 24.0% for the six months ended March 29, 2003 to 23.4% for the six months ended March 27, 2004 due to higher sales relative to expenses.

 

Selling and delivery expenses increased $3.3 million, or 5.3%, from $62.5 million for the six months ended March 29, 2003 to $65.8 million for the comparable fiscal 2004 period. The increased selling and delivery expenses were attributable to a higher volume of business in 2004, but such expenses as a percentage of net sales remained relatively flat at 11.5% for the six month period ending March 27, 2004.

 

Facilities expense increased $0.3 million to $5.5 million for the six months ended March 27, 2004 from $5.2 million for the six months ended March 29, 2003. The increase is due primarily to shutdown costs of a pet manufacturing facility.

 

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Warehouse and administrative expenses increased $2.4 million, or 3.8%, from $62.5 million for the six months ended March 29, 2003 to $64.9 million for the six months ended March 27, 2004. The increase is due primarily to a $0.6 million increase in litigation costs and $1.4 million in professional fees incurred over the prior six months that were expensed as acquisitions being pursued did not materialize.

 

Net interest expense for the six months ended March 27, 2004 decreased $0.9 million, or 9.6%, to $8.2 million from $9.1 million for the six months ended March 29, 2003. The decrease was due primarily to nonrecurring interest expensed in the second quarter of 2003, related to the refinancing of our convertible subordinated notes and lines of credit.

 

Other income remained relatively flat at $0.3 million for the six months ended March 27, 2004 and March 29, 2003. Other income represents income from equity method investments.

 

Our effective income tax rate for the six months ended March 27, 2004 was 39.2% compared with 40.0% for the six months ended March 29, 2003.

 

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 garden 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 65% of Garden Products’ aggregate sales occurring during the second and third fiscal quarters. 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 used in operating activities was essentially flat at $31.7 million for the six months ended March 29, 2003 versus $32.1 million for the six months ended March 27, 2004. This small change obscures large income tax refunds received in the period ending March 29, 2003 offset by a lower inventory build-up during the period ending March 27, 2004, as compared to the prior year period. Net cash used in investing activities increased $91 million due to the $76.3 million paid for Kent Marine and New England Pottery and $15.2 million paid into an escrow account, which is classified as restricted investments on the balance sheet, in connection with our appeal in the Scotts litigation. Net cash provided by financing activities increased $30.3 million due primarily to borrowings on our line of credit to finance two acquisitions in the current fiscal year.

 

At March 27, 2004, our total debt was $312.3 million versus $250.3 million at March 29, 2003, due to borrowings on our line of credit to finance two acquisitions in fiscal 2004.

 

In May 2003, we closed a $200 million senior secured credit facility consisting of a five-year $100 million revolving credit facility and a six-year $100 million term loan. In April 2004, we amended the facility to increase the maximum amount available under the revolving credit portion by $25 million to $125 million and the option to borrow in Euros, Canadian Dollars and Pounds Sterling. Interest on the term loan is based on a rate equal to LIBOR + 2.25% or the prime rate plus 0.75%, 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 our assets, contains certain financial covenants

 

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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 restricts our ability to make treasury stock purchases and pay dividends. We were in compliance with all financial covenants as of March 27, 2004. This facility also requires the lenders’ prior written consent to any material investments in or acquisitions of a business. The balance outstanding at March 27, 2004 under the $100 million revolving credit facility was $60.0 million and the remaining available borrowing capacity was $33.1 million. The $6.9 million difference represents outstanding letters of credit. Subsequent to the quarter ended March 27, 2004, we increased our borrowings by approximately $27 million under the $100 million credit facility to finance our acquisition of Interpet.

 

In October 2003, we entered into a $75 million pay-floating interest rate swap effectively converting half of our $150 million fixed rate 9-1/8 percent senior subordinated notes to a floating rate of LIBOR + 4.04%.

 

In November 2003, we deposited approximately $15 million into an escrow account in connection with an appeal in the Scotts litigation. The use of this cash is restricted from general corporate purposes and is reflected as a Restricted Investment on our balance sheet at March 27, 2004. See Note 6 – “Contingencies” to our unaudited condensed consolidated financial statements.

 

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 million for the next 12 months.

 

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.

 

Off-Balance Sheet Arrangements

 

There have been no material changes to the information provided in our Annual Report on Form 10-K for the fiscal year ended September 27, 2003 regarding off-balance sheet arrangements.

 

Contractual Obligations

 

There have be no material changes outside the ordinary course of business in our contractual obligations set forth in the Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources in our Annual Report on Form 10-K for the fiscal year ended September 27, 2003.

 

Weather and Seasonality

 

Historically, our 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 2003, 65% of Garden Products’ net sales and 59% 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

 

We believe there has been no material change in our exposure to market risk from that discussed in our fiscal 2003 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-15(e) and 15d-15(e)) 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 the controls and procedures in place are effective 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 controls during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

For information on our material legal proceedings, you should read note 6 “Contingencies” to the unaudited condensed consolidated financial statements in Part I – Item 1 of this report.

 

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

We did not purchase any of our equity securities during the fiscal quarter ended March 27, 2004.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable

 

Item 4. Submission of Matter to a Vote of Securities Holders

 

(a) The annual meeting of shareholders was held on February 9, 2004.

 

(b) The following directors were elected at the meeting

 

William E. Brown

Glenn W. Novotny

Brooks M. Pennington III

John B. Balousek

David N. Chichester

Daniel P. Hogan, Jr.

Bruce A. Westphal

 

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Set forth below is the tabulation with respect to the matter voted on at the meeting:

 

     For

   Against or
Withheld


William E. Brown

         

Common

   11,850,395    4,501,970

Class B

   15,865,688    0

Glenn W. Novotny

         

Common

   11,909,735    4,442,630

Class B

   15,865,688    0

Brooks M. Pennington III

         

Common

   11,700,495    4,651,870

Class B

   15,865,688    0

John B. Balousek

         

Common

   15,649,810    702,555

Class B

   15,865,688    0

David N. Chichester

         

Common

   15,995,973    356,392

Class B

   15,865,688    0

Daniel P. Hogan, Jr.

         

Common

   15,645,810    706,555

Class B

   15,865,688    0

Bruce A. Westphal

         

Common

   15,649,910    702,455

Class B

   15,865,688    0

 

Item 5. Other Information

 

On February 9, 2004, Alfred Piergallini was elected to our Board of Directors. Effective April 30, 2004, Daniel P. Hogan, Jr. resigned from our Board of Directors.

 

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Item 6. Exhibits and Reports on Form 8-K

 

  (a) Exhibits

 

3.1.2   Certificate of Designation - Series B Convertible Preferred Stock
10.2.2   Second Amendment to Credit Agreement dated February 12, 2004, between Central Garden & Pet Company and Canadian Imperial Bank of Commerce et al.
10.2.3   Third Amendment to Credit Agreement dated March 26, 2004, between Central Garden & Pet Company and Canadian Imperial Bank of Commerce et al.
31.1   Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350.
32.2   Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350.

 

  (b) The following reports on Form 8-K were filed during the quarter ended March 27, 2004.

 

  a. On January 26, 2004, Central Garden & Pet Company issued a press release announcing it has agreed to acquire substantially all of the assets of New England Pottery, Inc.

 

  b. On February 27, 2004, Central Garden & Pet Company issued a press release announcing it has acquired substantially all of the assets of New England Pottery, Inc.

 

The following current report on Form 8-K was furnished during the quarter ended March 27, 2004:

 

  a. Form 8-K filed February 5, 2004 relating to our press release announcing our financial results for the quarter ended December 27, 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.

 

CENTRAL GARDEN & PET COMPANY
Registrant

Dated: May 11, 2004

/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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