Scotts Miracle-Gro Company — Form 10-Q Summary
Business context and reporting period
Quarter ended July 3, 2010; results compare the three and nine months ended July 3, 2010 with the comparable 2009 periods. Scotts manufactures and markets consumer lawn and garden and professional horticulture products, operates Scotts LawnService, and serves as Monsanto’s exclusive agent for consumer Roundup products. Sales are highly seasonal: the second and third fiscal quarters generally account for 70%–75% of annual sales. Smith & Hawken was classified as discontinued operations after its stores closed and operations were discontinued.
Financial performance and position
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $1,238.9 million, up 0.6% | $2,664.2 million, up 8.4% |
| Gross profit / margin | $504.8 million / 40.7% | $1,005.9 million / 37.8% |
| Operating income | $290.5 million | $429.2 million |
| Income from continuing operations | $175.9 million | $246.0 million |
| Net income | $175.9 million | $236.7 million |
| Diluted EPS | $2.59 | $3.51 net income; $3.65 continuing operations |
For the nine months, operating cash flow was $156.2 million, versus $3.5 million a year earlier; capital spending was $46.9 million. Cash at July 3 was $78.7 million. Total debt was $690.2 million ($200.0 million current and $490.2 million long-term), down from $1,120.6 million at June 27, 2009. Shareholders’ equity was $834.8 million. The company reported $1.45 billion available under its senior secured credit facilities, including letters of credit, and compliance with borrowing agreements.
Material changes versus the prior comparable period
- Third-quarter reported sales were nearly flat, but the fiscal-calendar shift moved a high-volume spring selling week into the second quarter. Management reported organic sales growth after the calendar shift of 5.6% for the quarter and 5.7% year to date.
- Gross margin rose from 38.6% to 40.7% in the quarter and from 37.0% to 37.8% year to date. Management cited lower input costs and productivity improvements, partly offset by freight costs and, in the first half, older higher-cost inventory.
- Continuing-operations income increased from $150.7 million to $175.9 million for the quarter and from $181.9 million to $246.0 million year to date. Lower SG&A in the quarter and higher sales and gross profit year to date contributed. Interest expense declined to $37.7 million year to date from $45.9 million.
- Operating cash flow improved substantially, helped by earnings and working-capital management. Financing cash flow shifted to a $121.4 million use from a $99.0 million source, reflecting net debt repayments and the issuance of senior notes.
- Global Consumer sales and operating income improved. Global Professional operating income declined year to date, including losses in the U.S. professional seed business. Scotts LawnService sales fell year to date, although quarterly sales rose.
Outlook, commentary, risks and unusual items
- Management forecast fiscal 2010 net sales growth of 5%–7%, gross-margin improvement of 50–80 basis points excluding registration and recall matters, SG&A growth of 2%–4%, interest expense of approximately $50 million, and an effective tax rate near 37.2%. It expected to remain within debt covenant limits during fiscal 2010, while noting this depends on operating results and other factors.
- On August 10, 2010, the board authorized up to $500 million of share repurchases through September 30, 2014 and approved a quarterly dividend of $0.25 per share, double the prior $0.125 rate. The authorization does not guarantee the timing or amount of repurchases. The company also said it was exploring strategic alternatives, including a possible divestiture, for Global Professional.
- EPA and Department of Justice investigations into pesticide product registration issues continued. The company estimated fiscal 2010 registration and recall costs of $8–$10 million, excluding possible fines, penalties, judgments, or litigation costs. No reserve was recorded for those potential liabilities; management said they could be material, and their scope could not yet be reasonably estimated.
- Other matters include environmental proceedings, including a proposed $466,977 EPA penalty concerning the Fort Madison facility, and asbestos-related claims for which no loss estimate or reserve was recorded. Management stated that other ordinary-course claims were not expected to have a material adverse effect, while acknowledging uncertainty.
- Smith & Hawken discontinued-operations losses were $9.3 million year to date, partly offset by an approximately $18 million gain on sale of intellectual property. The company also recorded a $1.9 million tax charge related to changes in the Medicare Part D subsidy tax deduction.
- Management identified weather, seasonal demand, commodity and freight costs, consumer demand, legal and regulatory outcomes, and covenant compliance among factors that could affect results. It stated disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether full-year sales and gross-margin outlooks are achieved, accounting for seasonality and the shifted selling week.
- The eventual scope, cost, and resolution of the FIFRA investigations and any resulting fines, penalties, or litigation; no reserve was established for those potential liabilities.
- Debt levels, facility availability, covenant headroom, and the impact of the 7.25% senior notes due 2018.
- Whether the announced share repurchases and doubled dividend proceed, and how they affect leverage and cash needs.
- The outcome of the Global Professional strategic review and any effect of a potential divestiture.
- Global Professional seed losses and Scotts LawnService’s year-to-date sales and customer trends.