Business context and reporting period
The Scotts Miracle-Gro Company’s Form 10-K covers the fiscal year ended September 30, 2011; it also reports unaudited fourth-quarter results. The company sells branded lawn and garden products and operates Scotts LawnService. Global Professional was largely sold to Israel Chemicals Ltd. (ICL) in February 2011 and is presented as discontinued operations.
Financial performance and liquidity
- Revenue: Fiscal 2011 net sales were $2.836 billion, down 2.1% from $2.898 billion. Organic sales declined 3.1%; Global Consumer sales fell 4.4%, while Scotts LawnService sales rose 5.1%.
- Profit and margins: Gross profit was $1.003 billion and gross margin was 35.4%, versus 37.1% in 2010. Operating income was $247.0 million, down 32.0%; continuing-operations income was $121.9 million, or $1.84 diluted EPS, versus $200.5 million, or $2.97. Adjusted continuing-operations income was $182.6 million and adjusted diluted EPS was $2.76, both below 2010. Net income of $167.9 million included $46.0 million from discontinued operations, including a $39.5 million after-tax gain on the Global Pro sale.
- Fourth quarter: Net sales were $417.2 million versus $422.3 million in Q4 2010. The company reported a $71.7 million continuing-operations loss and a $53.4 million net loss, compared with losses of $33.1 million and $32.6 million, respectively, in the prior-year quarter.
- Cash flow and investment: Operating cash flow was $122.1 million, down from $295.9 million; continuing-operations operating cash flow was $181.3 million versus $309.4 million. Capital expenditures were $72.7 million. Investing activities provided $153.5 million, including $253.6 million of net proceeds from the Global Pro sale. Year-end cash was $130.9 million.
- Debt and liquidity: Total debt was $795.0 million, up from $631.7 million; working capital was $523.9 million and the current ratio was 1.3. The company had $1.3 billion available under its $1.7 billion revolving credit facility. Leverage ratio was 1.98, below the 3.50 covenant maximum; interest coverage was 7.47, above the 3.50 minimum. The company reported covenant compliance at year-end.
- Shareholder returns: The company repurchased $358.7 million of shares and paid $67.9 million in dividends during 2011. Its quarterly dividend was increased 20% to $0.30 per share in Q4.
Material changes versus the prior year
- Organic sales reversed from 4.8% growth in 2010 to a 3.1% decline in 2011. U.S. Consumer organic sales fell 6.8%, which management attributed primarily to unfavorable spring and fall weather and lower mass-merchant sales.
- Gross margin declined amid higher commodity costs, unfavorable U.S. product mix, increased consumer promotions, and lower fixed-cost absorption. Adjusted operating income fell 13.5% to $337.7 million.
- Operating cash flow fell significantly, reflecting lower earnings, higher working capital, inventory buildup after weaker-than-expected sales, and lower variable-compensation accruals.
- Debt increased, and shareholders’ equity declined to $559.8 million from $764.5 million, alongside substantial share repurchases. The company completed a new five-year credit facility and issued $200 million of 6.625% senior notes due 2020; it also has $200 million of 7.25% notes due 2018.
Outlook, commentary, risks and unusual items
- For fiscal 2012, management expected at least 6% organic sales growth in Global Consumer and Scotts LawnService, assuming more normal weather, modest category growth, increased marketing, innovation and modest pricing.
- Management forecast approximately $80 million of commodity inflation, with about half expected to be recovered through pricing and trade-program changes. Advertising could increase by up to $40 million; restructuring savings were expected to contribute about $17 million. Interest expense was expected to rise about $10 million.
- Management expected a materially larger Q1 2012 loss than in Q1 2011, citing leaner retailer inventories, lower gross-margin leverage and higher interest expense. It expected to moderate share repurchases in 2012, target a diluted share count of approximately 62.5 million, and maintain a 2.0–2.5 times leverage objective.
- Fiscal 2011 included $76.1 million of impairment, restructuring and other charges, $14.6 million of product-registration and recall costs, and $1.2 million of refinancing costs. The charges included impairment associated primarily with the wild bird food business and costs from a workforce and operating-efficiency restructuring. Management expected $20–$25 million of annualized savings from the organizational restructuring.
- FIFRA-related U.S. EPA and Department of Justice investigations remained unresolved; the company said potential total liabilities could not be reasonably estimated and could exceed its reserve. The California regulator settlement was paid for $245,631. Separately, a Pennsylvania environmental agency proposed a $200,000 penalty; the company was formulating its response. The filing also describes asbestos-related claims for which no loss estimate or reserve was recorded.
- Key business risks include weather and commodity volatility, intense competition, and customer concentration: Home Depot, Lowe’s and Walmart represented approximately 30%, 18% and 13% of 2011 sales. The company also identified environmental and pesticide regulation, debt covenant and refinancing exposure, and possible termination of its Monsanto consumer Roundup marketing agreement as risks.
Important facts for investors to verify
- Whether the expected 2012 organic growth, commodity-cost recovery, advertising investment and restructuring savings were achieved.
- The final outcome and financial cost of the FIFRA investigations, including whether reserves require adjustment.
- Whether cash generation and working capital improved after the 2011 decline, particularly given seasonal inventory needs.
- Debt, covenant headroom, interest costs and the company’s ability to balance dividends, repurchases, investment and its leverage target.
- The sustainability of Global Consumer margins and the outlook for the impaired wild bird food business.