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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 June 26, 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 July 30, 2004

  18,534,469

Class B Stock Outstanding as of July 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 June 26, 2004    3
    Condensed Consolidated Statements of Operations Three and Nine Months Ended June 28, 2003 and June 26, 2004    4
    Condensed Consolidated Statements of Cash Flows Nine Months Ended June 28, 2003 and June 26, 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    20

Item 4.

  Controls and Procedures    20
    PART II. OTHER INFORMATION     

Item 1.

  Legal Proceedings    21

Item 2.

  Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    21

Item 3.

  Defaults Upon Senior Securities    21

Item 4.

  Submission of Matter to a Vote of Securities Holders    21

Item 5.

  Other Information    21

Item 6.

  Exhibits and Reports on Form 8-K    21

 

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 flows;

 

  dependence upon our key executive officers;

 

  potential environmental liabilities and product liability claims; and

 

  pending litigation and claims.

 

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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


   

June 26,

2004


 
ASSETS                 

Current assets:

                

Cash and equivalents

   $ 77,604     $ 18,211  

Restricted investments

     —         15,307  

Accounts receivable (less allowance for doubtful accounts of $6,575 and $11,177)

     146,075       187,360  

Inventories

     217,156       242,972  

Prepaid expenses and other

     15,222       10,235  
    


 


Total current assets

     456,057       474,085  

Land, buildings, improvements and equipment—net

     101,538       101,760  

Goodwill

     222,780       310,560  

Deferred income taxes and other assets

     48,723       56,423  
    


 


Total

   $ 829,098     $ 942,828  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 105,103     $ 106,241  

Accrued expenses

     47,061       75,403  

Current portion of long-term debt

     1,028       1,026  
    


 


Total current liabilities

     153,192       182,670  

Long-term debt

     249,225       288,450  

Other long-term obligations

     1,585       1,564  

Shareholders’ equity:

                

Convertible preferred stock, $.01 par value: 100 shares issued and outstanding at June 26, 2004

     —         3,000  

Class B stock, $.01 par value: 1,654,462 shares outstanding at September 27, 2003 and June 26, 2004

     16       16  

Common stock, $.01 par value: 31,909,919 and 32,224,080 issued and 18,167,669 and 18,481,830 outstanding at September 27, 2003 and June 26, 2004

     319       322  

Additional paid-in capital

     545,228       550,846  

Retained earnings

     24,360       60,500  

Treasury stock

     (144,827 )     (144,827 )

Accumulated other comprehensive income

     —         287  
    


 


Total shareholders’ equity

     425,096       470,144  
    


 


Total

   $ 829,098     $ 942,828  
    


 


 

See notes to condensed consolidated financial statements.

 

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CENTRAL GARDEN & PET COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

     Three Months Ended

    Nine Months Ended

 
    

June 28,

2003


   

June 26,

2004


   

June 28,

2003


   

June 26,

2004


 

Net sales

   $ 345,115     $ 374,431     $ 887,560     $ 955,766  

Cost of goods sold and occupancy

     242,908       256,506       625,045       663,744  
    


 


 


 


Gross profit

     102,207       117,925       262,515       292,022  

Selling, general and administrative expenses

     69,628       86,183       199,798       222,363  
    


 


 


 


Income from operations

     32,579       31,742       62,717       69,659  

Interest expense

     (5,495 )     (4,959 )     (14,679 )     (13,523 )

Interest income

     69       89       139       411  

Other income

     1,563       1,665       1,893       1,935  
    


 


 


 


Income before income taxes

     28,716       28,537       50,070       58,482  

Income taxes

     11,486       10,596       20,028       22,342  
    


 


 


 


Net income

   $ 17,230     $ 17,941     $ 30,042     $ 36,140  
    


 


 


 


Income per common share:

                                

Basic

   $ 0.89     $ 0.89     $ 1.56     $ 1.81  
    


 


 


 


Diluted

   $ 0.86     $ 0.86     $ 1.49     $ 1.74  
    


 


 


 


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

                                

Basic

     19,357       20,086       19,217       19,968  

Diluted

     20,137       20,974       21,794       20,753  

 

See notes to condensed consolidated financial statements.

 

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CENTRAL GARDEN & PET COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Nine Months Ended

 
    

June 28,

2003


   

June 26,

2004


 

Cash flows from operating activities:

                

Net income

   $ 30,042     $ 36,140  

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

                

Gain on fixed asset disposals

     (175 )     —    

Depreciation and amortization

     13,297       13,625  

Change in assets and liabilities (excluding businesses acquired):

                

Receivables

     (38,279 )     (21,183 )

Inventories

     (19,074 )     (2,578 )

Prepaid expenses and other assets

     15,136       902  

Accounts payable

     9,105       (5,023 )

Accrued expenses

     17,502       21,896  

Other long-term obligations

     281       (21 )
    


 


Net cash provided by operating activities

     27,835       43,758  
    


 


Cash flows used in investing activities:

                

Additions to land, buildings, improvements and equipment

     (11,515 )     (10,503 )

Businesses acquired, net of cash acquired

     —         (122,926 )

Restricted investments

     —         (15,307 )
    


 


Net cash used in investing activities

     (11,515 )     (148,736 )
    


 


Cash flows from financing activities:

                

Repayments of lines of credit, net

     (59,975 )     —    

Repayments on revolving line of credit

     —         (51,823 )

Borrowings on revolving line of credit

     —         91,823  

Proceeds from issuance of long-term debt

     250,000       —    

Repayments of long-term debt

     (140,878 )     (777 )

Deferred financing costs

     (7,700 )     —    

Proceeds from issuance of stock

     6,943       6,075  
    


 


Net cash provided by financing activities

     48,390       45,298  
    


 


Effect of exchange rate changes on cash and equivalents

     —         287  
    


 


Net increase (decrease) in cash and equivalents

     64,710       (59,393 )

Cash and equivalents at beginning of period

     10,884       77,604  
    


 


Cash and equivalents at end of period

   $ 75,594     $ 18,211  
    


 


Supplemental information:

                

Cash paid for interest

   $ 9,268     $ 9,795  
    


 


Cash (refunds received) paid for income taxes—net

   $ (4,922 )   $ 8,323  
    


 


 

See notes to condensed consolidated financial statements.

 

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Table of Contents

CENTRAL GARDEN & PET COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and Nine Months Ended June 26, 2004

(unaudited)

 

1. Basis of Presentation

 

The condensed consolidated balance sheet of Central Garden & Pet Company and subsidiaries (the “Company” or “Central”) as of June 26, 2004, the condensed consolidated statements of operations for the three and nine months ended June 28, 2003 and June 26, 2004 and the condensed consolidated statements of cash flows for the nine months ended June 28, 2003 and June 26, 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.

 

For the Company’s foreign business in the UK, the local currency is the functional currency. Assets and liabilities are translated using the exchange rate in effect at the balance sheet date. Income and expenses are translated at the average exchange rate for the period. Translation gains and losses not reflected in earnings are reported in accumulated other comprehensive income, a separate component of shareholders’ equity. Deferred taxes are not provided on translation gains and losses, because the Company expects earnings of its foreign subsidiary to be permanently reinvested. Transaction gains and losses are included in results of operations.

 

Due to the seasonal nature of the Company’s garden business, the results of operations for the three and nine months ended June 26, 2004 are not indicative of the operating results that may be expected for the year ending September 25, 2004. These interim financial statements should 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 provide for stock option grants and restricted stock awards. Stock options may be granted 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

    Nine Months Ended

 
    

June 28,

2003


   

June 26,

2004


   

June 28,

2003


   

June 26,

2004


 
     (in thousands)     (in thousands)  

Net income, as reported

   $ 17,230     $ 17,941     $ 30,042     $ 36,140  

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

     (448 )     (447 )     (1,354 )     (1,210 )
    


 


 


 


Pro forma net income

   $ 16,782     $ 17,494     $ 28,688     $ 34,930  
    


 


 


 


Net income per common equivalent share:

                                

Basic – as reported

   $ 0.89     $ 0.89     $ 1.56     $ 1.81  

Basic – pro forma

   $ 0.87     $ 0.87     $ 1.49     $ 1.75  

Diluted – as reported

   $ 0.86     $ 0.86     $ 1.49     $ 1.74  

Diluted – pro forma

   $ 0.83     $ 0.83     $ 1.43     $ 1.68  

 

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

June 26, 2004


   

Nine Months Ended

June 26, 2004


 
     Income

   Shares

   Per Share

    Income

   Shares

   Per Share

 
     (in thousands, except per share amounts)  

Basic EPS:

                                        

Net income

   $ 17,941    20,086    $ 0.89     $ 36,140    19,968    $ 1.81  

Effect of dilutive securities:

                                        

Options to purchase common stock

          802      (0.03 )          747      (0.07 )

Convertible preferred stock

          86      —              38      —    
    

  
  


 

  
  


Diluted EPS:

                                        

Net income attributable to common shareholders

   $ 17,941    20,974    $ 0.86     $ 36,140    20,753    $ 1.74  
    

  
  


 

  
  


 

    

Three Months Ended

June 28, 2003


   

Nine Months Ended

June 28, 2003


 
     Income

   Shares

   Per Share

    Income

   Shares

   Per Share

 
     (in thousands, except per share amounts)  

Basic EPS:

                                        

Net income

   $ 17,230    19,357    $ 0.89     $ 30,042    19,217    $ 1.56  

Effect of dilutive securities:

                                        

Options to purchase common stock

          780      (0.03 )          752      (0.06 )

Convertible notes

                         2,428    1,825      (0.01 )
    

  
  


 

  
  


Diluted EPS:

                                        

Net income attributable to common shareholders

   $ 17,230    20,137    $ 0.86     $ 32,470    21,794    $ 1.49  
    

  
  


 

  
  


 

Options to purchase 2,238,380 shares of common stock at prices ranging from $1.30 to $38.41 per share were outstanding at June 26, 2004 and options to purchase 2,531,680 shares at prices ranging from $1.30 to $30.00 were outstanding at June 28, 2003. For the three month periods ended June 26, 2004 and June 28, 2003, options to purchase 7,500 and 42,310 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 nine month periods ended June 26, 2004 and June 28, 2003, options to purchase 52,310 and 277,107 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 convertible preferred stock totaling 86,404 and 38,296 were included in the computation of diluted EPS for the three and nine-month periods ended June 26, 2004, respectively.

 

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 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 previously outstanding convertible notes were included in the computation of diluted EPS for the nine month period ended June 28, 2003.

 

4. Businesses Acquired

 

In May 2004, the Company acquired substantially all of the assets of KRB Seed Company, LLC (dba “Budd Seed”), a leading provider of high-quality grass seed brands under the “Rebel” brand for approximately $18 million in cash. The acquisition has been accounted for as a purchase. The purchase price exceeded the fair market value of the net tangible and intangible assets acquired by approximately $9 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Budd Seed from the date of acquisition.

 

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 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 $20 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Interpet from the date of acquisition.

 

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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 $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 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.

 

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

    Nine Months Ended

 
     June 28,
2003


    June 26,
2004


    June 28,
2003


    June 26,
2004


 
     (in thousands)  

Net sales:

                                

Garden Products

   $ 215,429     $ 228,568     $ 510,571     $ 535,385  

Pet Products

     129,686       145,863       376,989       420,381  
    


 


 


 


Total net sales

   $ 345,115     $ 374,431     $ 887,560     $ 955,766  
    


 


 


 


Income (loss) from operations:

                                

Garden Products

   $ 19,645     $ 16,716     $ 40,311     $ 40,680  

Pet Products

     16,532       19,654       39,448       46,214  

Corporate

     (3,598 )     (4,628 )     (17,042 )     (17,235 )
    


 


 


 


Total income from operations

     32,579       31,742       62,717       69,659  
    


 


 


 


Interest expense—net

     (5,426 )     (4,870 )     (14,540 )     (13,112 )

Other income

     1,563       1,665       1,893       1,935  

Income taxes

     (11,486 )     (10,596 )     (20,028 )     (22,342 )
    


 


 


 


Net income

   $ 17,230     $ 17,941     $ 30,042     $ 36,140  
    


 


 


 


Depreciation and amortization:

                                

Garden Products

   $ 1,297     $ 1,463     $ 3,947     $ 4,193  

Pet Products

     3,048       2,968       8,970       8,822  

Corporate

     128       261       380       610  
    


 


 


 


Total depreciation and amortization

   $ 4,473     $ 4,692     $ 13,297     $ 13,625  
    


 


 


 


 

    

September 27,

2003


  

June 26,

2004


     (in thousands)

Assets:

             

Garden Products

   $ 281,679    $ 335,798

Pet Products

     208,703      232,402

Corporate

     338,716      374,628
    

  

Total assets

   $ 829,098    $ 942,828
    

  

Goodwill (included in corporate assets):

             

Garden Products

   $ 105,681    $ 165,040

Pet Products

     117,099      145,520
    

  

Total goodwill

   $ 222,780    $ 310,560
    

  

 

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Table of Contents

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, 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 income 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 was issued for his arrest. According to press reports and other information, he has subsequently been arrested in Germany. It is anticipated that the United States Attorney’s office will seek to extradite Herbert Axelrod from Germany to the United States of America. 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 and included in “Deferred Income Taxes and Other Assets” 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

 

9


Table of Contents

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 class action lawsuit has now been settled as to all parties, and has received Court approval. As part of the settlement, Central’s liability insurers paid $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 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 June 26, 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

Interpet PLC

Matthews Redwood & Nursery Supply, Inc.

New England Pottery LLC

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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Table of Contents

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 June 26, 2004

(in thousands)

(unaudited)

 

     Parent

   

Guarantor

Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 118,775     $ 277,963     $ (22,307 )   $ 374,431  

Cost of products sold and occupancy

     85,210       193,908       (22,612 )     256,506  
    


 


 


 


Gross profit

     33,565       84,055       305       117,925  

Selling, general and administrative expenses

     30,816       55,367               86,183  
    


 


 


 


Income from operations

     2,749       28,688       305       31,742  

Interest – net

     (4,913 )     43               (4,870 )

Other income

     774       891               1,665  
    


 


 


 


Income (loss) before income taxes

     (1,390 )     29,622       305       28,537  

Income taxes

     521       (11,003 )     (114 )     (10,596 )
    


 


 


 


Net income (loss)

     (869 )     18,619       191       17,941  

Equity in undistributed income of guarantor subsidiaries

     18,810       —         (18,810 )     —    
    


 


 


 


Net income (loss)

   $ 17,941     $ 18,619     $ (18,619 )   $ 17,941  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Three Months Ended June 28, 2003

(in thousands)

(unaudited)

 

     Parent

   

Guarantor

Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 112,711     $ 252,842     $ (20,438 )   $ 345,115  

Cost of products sold and occupancy

     82,944       180,351       (20,387 )     242,908  
    


 


 


 


Gross profit

     29,767       72,491       (51 )     102,207  

Selling, general and administrative expenses

     24,964       44,664               69,628  
    


 


 


 


Income (loss) from operations

     4,803       27,827       (51 )     32,579  

Interest – net

     (5,363 )     (63 )             (5,426 )

Other income

     1,005       558               1,563  
    


 


 


 


Income (loss) before income taxes

     445       28,322       (51 )     28,716  

Income taxes

     (177 )     (11,329 )     20       (11,486 )
    


 


 


 


Net income (loss)

     268       16,993       (31 )     17,230  

Equity in undistributed income of guarantor subsidiaries

     16,962       —         (16,962 )     —    
    


 


 


 


Net income (loss)

   $ 17,230     $ 16,993     $ (16,993 )   $ 17,230  
    


 


 


 


 

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Table of Contents

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Nine Months Ended June 26, 2004

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 314,463     $ 706,945     $ (65,642 )   $ 955,766  

Cost of goods sold and occupancy

     228,950       499,983       (65,189 )     663,744  
    


 


 


 


Gross profit

     85,513       206,962       (453 )     292,022  

Selling, general and administrative expenses

     82,016       140,347       —         222,363  
    


 


 


 


Income (loss) from operations

     3,497       66,615       (453 )     69,659  

Interest – net

     (13,221 )     109       —         (13,112 )

Other income

     413       1,522       —         1,935  
    


 


 


 


Income (loss) before income taxes

     (9,311 )     68,246       (453 )     58,482  

Income taxes

     3,628       (26,153 )     183       (22,342 )
    


 


 


 


Net income (loss)

     (5,683 )     42,093       (270 )     36,140  

Equity in undistributed income of guarantor subsidiaries

     41,823       —         (41,823 )     —    
    


 


 


 


Net income (loss)

   $ 36,140     $ 42,093     $ (42,093 )   $ 36,140  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS

Nine Months Ended June 28, 2003

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 287,168     $ 656,577     $ (56,185 )   $ 887,560  

Cost of goods sold and occupancy

     212,134       468,421       (55,510 )     625,045  
    


 


 


 


Gross profit

     75,034       188,156       (675 )     262,515  

Selling, general and administrative expenses

     72,814       126,984       —         199,798  
    


 


 


 


Income (loss) from operations

     2,220       61,172       (675 )     62,717  

Interest – net

     (13,655 )     (885 )     —         (14,540 )

Other income

     825       1,068       —         1,893  
    


 


 


 


Income (loss) before income taxes

     (10,610 )     61,355       (675 )     50,070  

Income taxes

     4,245       (24,543 )     270       (20,028 )
    


 


 


 


Net income (loss)

     (6,365 )     36,812       (405 )     30,042  

Equity in undistributed income of guarantor subsidiaries

     36,407       —         (36,407 )     —    
    


 


 


 


Net income (loss)

   $ 30,042     $ 36,812     $ (36,812 )   $ 30,042  
    


 


 


 


 

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Table of Contents

 

CONSOLIDATING CONDENSED BALANCE SHEET

June 26, 2004

(in thousands)

(unaudited)

 

     Parent

   Guarantor
Subsidiaries


   Eliminations

    Consolidated

ASSETS

                            

Cash and equivalents

   $ 12,195    $ 6,016    $ —       $ 18,211

Restricted investments

     15,307      —        —         15,307

Accounts receivable

     59,097      139,519      (11,256 )     187,360

Inventories

     59,536      183,436      —         242,972

Prepaid expenses and other

     2,554      7,681      —         10,235
    

  

  


 

Total current assets

     148,689      336,652      (11,256 )     474,085

Land, buildings, improvements and equipment, net

     8,932      92,828      —         101,760

Goodwill

     310,560      —        —         310,560

Investment in Guarantors

     331,458      —        (331,458 )     —  

Deferred income taxes and other assets

     51,597      4,826      —         56,423
    

  

  


 

Total

   $ 851,236    $ 434,306    $ (342,714 )   $ 942,828
    

  

  


 

LIABILITIES

                            

Accounts payable

   $ 59,844    $ 57,653    $ (11,256 )   $ 106,241

Accrued expenses and other current liabilities

     32,794      43,635      —         76,429
    

  

  


 

Total current liabilities

     92,638      101,288      (11,256 )     182,670

Long-term debt

     288,450      —        —         288,450

Other long-term obligations

     4      1,560      —         1,564

Shareholders’ equity

     470,144      331,458      (331,458 )     470,144
    

  

  


 

Total

   $ 851,236    $ 434,306    $ (342,714 )   $ 942,828
    

  

  


 

 

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

Shareholders’ 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

Nine Months Ended June 26, 2004

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net cash provided (used) by operating activities

   $ 79,792     $ 6,059     $ (42,093 )   $ 43,758  

Expenditures for land, buildings, improvements and equipment

     (1,394 )     (9,109 )     —         (10,503 )

Businesses acquired

     (122,926 )     —                 (122,926 )

Restricted investments

     (15,307 )     —                 (15,307 )

Investment in guarantor subsidiaries

     (49,649 )     7,556       42,093       —    
    


 


 


 


Net cash provided (used) by investing activities

     (189,276 )     (1,553 )     42,093       (148,736 )
    


 


 


 


Borrowings (repayments) under lines of credit, net

     (51,823 )     —         —         (51,823 )

Proceeds from long-term debt

     91,823                       91,823  

Payments on long-term debt

     (750 )     (27 )             (777 )

Proceeds from issuance of stock

     6,075       —         —         6,075  
    


 


 


 


Net cash provided (used) by financing activities

     45,325       (27 )     —         45,298  
    


 


 


 


Effect of exchange rates on cash

             287               287  
    


 


 


 


Net increase (decrease) in cash and equivalents

     (64,159 )     4,766       —         (59,393 )

Cash and equivalents at beginning of period

     76,354       1,250       —         77,604  
    


 


 


 


Cash and equivalents at end of period

   $ 12,195     $ 6,016     $ —       $ 18,211  
    


 


 


 


 

CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS

Nine Months Ended June 28, 2003

(in thousands)

(unaudited)

 

     Parent

    Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net cash provided (used) by operating activities

   $ 13,392     $ 14,848     $ (405 )   $ 27,835  

Expenditures for land, buildings, improvements and equipment

     (1,500 )     (10,015 )     —         (11,515 )

Investment in guarantor subsidiaries

     (38,719 )     38,314       405       —    
    


 


 


 


Net cash provided (used) by investing activities

     (40,219 )     28,299       405       (11,515 )
    


 


 


 


Borrowings (repayments) under lines of credit, net

     (33,992 )     (25,983 )     —         (59,975 )

Proceeds from long-term debt

     250,000       —                 250,000  

Payments on long-term debt

     (125,035 )     (15,843 )     —         (140,878 )

Loan fees and financing costs paid

     (7,700 )     —         —         (7,700 )

Proceeds from issuance of stock

     6,943       —         —         6,943  
    


 


 


 


Net cash provided (used) by financing activities

     90,216       (41,826 )     —         48,390  
    


 


 


 


Net increase in cash and equivalents

     63,389       1,321       —         64,710  

Cash and equivalents at beginning of period

     10,080       804       —         10,884  
    


 


 


 


Cash and equivalents at end of period

   $ 73,469     $ 2,125     $ —       $ 75,594  
    


 


 


 


 

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Table of Contents

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, Kent Marine, Zodiac, Pre-Strike, Altosid, Nylabone, TFH, Four Paws and Interpet. 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, New England Pottery, GKI/Bethlehem Lighting, 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, New England Pottery, Interpet and KRB Seed Company 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 May 2004, the Company acquired substantially all of the assets of KRB Seed Company, LLC (dba “Budd Seed”), a leading provider of high-quality grass seed brands under the “Rebel” and brand for approximately $18 million in cash. The acquisition has been accounted for as a purchase. The purchase price exceeded the fair market value of the net tangible and intangible assets acquired by approximately $9 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Budd Seed from the date of acquisition.

 

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 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 $20 million, which was recorded as goodwill. The consolidated financial statements include the operating results of Interpet from the date of acquisition.

 

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 $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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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.

 

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 meantime, we continue to disclose stock compensation expense in footnote 2 to our consolidated financial statements in accordance with SFAS 123. 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 policies, estimates and assumptions or the judgments affecting the application of those accounting policies since our Annual Report on Form 10-K for the fiscal year ended September 27, 2003.

 

Results of Operations

 

Three Months Ended June 26, 2004

Compared with Three Months Ended June 28, 2003

 

Net sales for the three months ended June 26, 2004 increased $29.3 million, or 8.5%, to $374.4 million from $345.1 million for the three months ended June 28, 2003. Pet Products’ net sales increased $16.2 million, or 12.5%, to $145.9 million for the three months ended June 26, 2004 from $129.7 million in the comparable fiscal 2003 period. Garden Products’ net sales increased $13.1 million, or 6.1%, to $228.5 million for the three months ended June 26, 2004 from $215.4 million in the comparable fiscal 2003 period. Our branded product sales increased $24.5 million and sales of other manufacturers’ products increased $4.8 million. . Our Pet Products’ branded product sales increased $12.8 million due primarily to $9.7 million from our recent acquisitions of Kent Marine and Interpet. Our Garden Products’ branded product sales increased $11.7 million due primarily to $17.2 million of sales from our recent acquisitions of New England Pottery and Budd Seed, partially offset by a decline in grass seed sales of approximately $7 million due to unseasonable weather conditions impacting demand at the retail level and a strong comparable 2003 quarter season making for a tough comparison for the most recent quarter.

 

Gross profit for the three months ended June 26, 2004 increased $15.7 million, or 15.4%, to $117.9 million from $102.2 million for the three months ended June 28, 2003. Gross profit increased $8.9 million in Garden Products and $6.8 million in Pet Products.

 

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Gross profit as a percentage of net sales increased to 31.5% for the three months ended June 26, 2004, from 29.6% for the three months ended June 28, 2003, as both Garden Products’ and Pet Products’ margins improved. The margin improvements were due primarily to the contributions from our recent acquisitions and margins for our wild bird feed products returning to more normal levels offset by a decline in margins for our grass seed sales.

 

Selling, general and administrative expenses increased $16.6 million, or 23.8%, from $69.6 million for the three months ended June 28, 2003 to $86.2 million for the three months ended June 26, 2004. As a percentage of net sales, selling, general and administrative expenses increased to 23.0% for the three months ended June 26, 2004, compared to 20.2% in the comparable prior year period.

 

Selling and delivery expenses increased $9.2 million, or 23.1%, from $39.8 million for the three months ended June 28, 2003 to $49.0 million for the three months ended June 26, 2004. The increase was primarily attributable to $5.3 million from recent acquisitions and $3.5 in increased marketing expenses, including consumer advertising programs.

 

Facilities expense increased $0.4 million to $2.9 million for the three months ended June 26, 2004 from $2.5 million for the three months ended June 28, 2003. The increase was primarily related to our recent acquisitions.

 

Warehouse and administrative expenses increased $7.0 million, or 25.6%, from $27.3 million for the three months ended June 28, 2003 to $34.3 million for the three months ended June 26, 2004. Approximately $4 million of the increase was due to our recent acquisitions and approximately $1 million to increased professional fees for unrealized acquisitions and increased accounting fees related to Sarbanes-Oxley compliance.

 

Net interest expense for the three months ended June 26, 2004 decreased $0.5 million, or 9.3%, to $4.9 million from $5.4 million for the three months ended June 28, 2003. The decrease was due primarily to $0.4 million in fees and expenses incurred in the prior year quarter in connection with the refinancing of our senior credit facility. Although total long-term debt was $27.5 million higher compared to the prior year quarter, the related interest expense was offset by a slightly lower effective interest rate, due to converting half of our fixed rate 9- 1/8% senior subordinated notes to a floating rate.

 

Other income increased $0.1 million to $1.7 million for the quarter ended June 26, 2004 from $1.6 million for the quarter ended June 28, 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 June 26, 2004 was 37.1% compared with 40.0% for the quarter ended June 28, 2003. The decreased rate reflects estimated state tax decreases and the impact of non-US tax rates at our U.K. based subsidiary.

 

Nine Months Ended June 26, 2004

Compared with Nine Months Ended June 28, 2003

 

Net sales for the nine months ended June 26, 2004 increased $68.2 million, or 7.7%, to $955.8 million from $887.6 million for the nine months ended June 28, 2003. Pet Products’ net sales increased $43.4 million, or 11.5%, to $420.4 million for the nine months ended June 26, 2004 from $377.0 million in the comparable fiscal 2003 period. Garden Products’ net sales increased $24.8 million, or 4.9%, to $535.4 million for the nine months ended June 26, 2004 from $510.6 million in the comparable fiscal 2003 period. Our branded product sales increased $45.8 million and sales of other manufacturers’ products increased $22.4 million. Our Pet Products’ branded product sales increased $31.2 million due primarily to a $9.9 million increase in sales of aquarium products and $11.9 million from our recent acquisitions. Our Garden Products’ branded product sales increased $14.6 million due primarily to $22 million of sales derived from our recent acquisitions, partially offset by a $7 million decline in grass seed sales. Grass seed sales were impacted due to unseasonable weather conditions impacting demand at the retail level and a strong comparable 2003 season making for a tough comparison for the current nine month period.

 

Gross profit for the nine months ended June 26, 2004 increased $29.5 million, or 11.2%, to $292.0 million from $262.5 million for the nine months ended June 28, 2003. Gross profit increased $15.4 million in Garden Products and $14.1 million in Pet Products. Gross profit as a percentage of net sales increased to 30.6% for the nine months ended June 26, 2004, from 29.6% for the nine months ended June 28, 2003. The margin improvements were due primarily to the contributions from our recent acquisitions and restoration of wild bird feed product margins to more normal levels.

 

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Selling, general and administrative expenses increased $22.6 million, or 11.3%, from $199.8 million for the nine months ended June 28, 2003 to $222.4 million in the nine months ended June 26, 2004. As a percentage of net sales, selling, general and administrative expenses increased from 22.5% for the nine months ended June 28, 2003 to 23.3% for the nine months ended June 26, 2004.

 

Selling and delivery expenses increased $12.4 million, or 12.1%, from $102.3 million for the nine months ended June 28, 2003 to $114.7 million for the comparable fiscal 2004. The increased expenses were primarily attributable to increased sales and our recent acquisitions.

 

Facilities expense increased $0.7 million to $8.4 million for the nine months ended June 26, 2004 from $7.7 million for the nine months ended June 28, 2003. The increase is due primarily to our recent acquisitions and the shutdown costs of a pet manufacturing facility.

 

Warehouse and administrative expenses increased $9.5 million, or 10.6%, from $89.8 million for the nine months ended June 28, 2003 to $99.3 million for the nine months ended June 26, 2004. The increase was due primarily to $5.5 million from our recent acquisitions and $1.8 million in professional fees incurred as acquisitions being pursued did not materialize.

 

Net interest expense for the nine months ended June 26, 2004 decreased $1.4 million, or 9.8%, to $13.1 million from $14.5 million for the nine months ended June 28, 2003. The decrease was due primarily to loan fees and financing costs in fiscal 2003 related to the refinancing of our convertible subordinated notes and lines of credit. The impact of the increase in total long-term debt during fiscal year 2004 was offset by a slightly lower effective interest rate due to converting half of our fixed rate 9- 1/8% senior subordinated notes to a floating rate.

 

Other income remained flat at $1.9 million for the nine months ended June 26, 2004 and June 28, 2003. Other income represents income from equity method investments.

 

Our effective income tax rate for the nine months ended June 26, 2004 was 38.2% compared with 40.0% for the nine months ended June 28, 2003. The decreased rate reflects an expected lower effective state tax rate and the impact of non-US tax rates at our U.K. based subsidiary.

 

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 provided by operating activities increased from $27.8 million for the nine months ended June 28, 2003 to $43.8 million for the nine months ended June 26, 2004. A smaller accounts receivable and inventory build-up from our existing business increased cash provided by operating activities approximately $33 million, as compared to the prior year period. This increase was partially offset by approximately $13 million change in income taxes, as income tax payments were made of approximately $8 million in the current

 

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year period while income tax refunds of approximately $5 million were received in the prior year period. Net cash used in investing activities increased $137 million due to $123 million paid for acquisitions and $15.3 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 decreased $3.1 million. In the current year period the amounts provided by financing activities were due primarily to borrowings on our line of credit to finance our acquisitions while in the prior year period the amounts were provided by increased long-term borrowings, as a result of the recapitalization of our long-term debt, in anticipation of future acquisitions.

 

At June 26, 2004, our total debt was $289.5 million versus $262.0 million at June 28, 2003, due to borrowings on our line of credit to finance our 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 to include 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 requiring maintenance of minimum levels of interest coverage 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 June 26, 2004. This facility also requires the lenders’ prior written consent to any material investments in or acquisitions of a business. The balance outstanding at June 26, 2004 under the $125 million revolving credit facility was $40.0 million, and the remaining available borrowing capacity was $77.7 million, with $7.3 million outstanding under certain letters of credit.

 

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 % 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 June 26, 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 been 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, except for borrowings under our senior secured credit facility to finance acquisitions and the interest rate swap discussed above in Liquidity and Capital Resources.

 

Weather and Seasonality

 

Historically, our sales of lawn and garden products have been influenced by weather and climate conditions in the markets we serve. 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.

 

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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

 

Not applicable

 

Item 3. Defaults Upon Senior Securities

 

Not applicable

 

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

 

Not applicable

 

Item 5. Other Information

 

Not applicable

 

Item 6. Exhibits and Reports on Form 8-K

 

  (a) Exhibits

 

  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 June 26, 2004.

 

  a. On April 2, 2004, Central filed a Form 8-K relating to a press release announcing it had agreed to acquire substantially all of the assets of Interpet Limited.

 

  b. On May 19, 2004, Central filed a Form 8-K relating to a press release announcing it had acquired substantially all of the assets of KRB Seed Company, LLC.

 

The following current report on Form 8-K was furnished during the quarter ended June 26, 2004:

 

  a. On May 7, 2004, Central filed a Form 8-K relating to a press release announcing its financial results for the quarter ended March 27, 2004.

 

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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: August 10, 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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