Business context and reporting period
The Scotts Miracle-Gro Company’s Form 10-K covers the fiscal year ended September 30, 2021, not just the fourth quarter. The company sells consumer lawn and garden products, indoor and hydroponic gardening products through Hawthorne, and international consumer products through Other. Its business is highly seasonal: more than 75% of North American consumer lawn and garden sales typically occur in the second and third fiscal quarters. Fiscal 2021’s first quarter had five extra days and its fourth quarter six fewer days than the comparable 2020 quarters.
Financial performance
Amounts are in millions of dollars except per-share data and percentages.
| Metric | FY2021 | FY2020 |
|---|---|---|
| Net sales | $4,925.0 | $4,131.6 |
| Gross profit / margin | $1,469.0 / 29.8% | $1,347.0 / 32.6% |
| Income from operations / margin | $723.0 / 14.7% | $585.2 / 14.2% |
| Income from continuing operations | $517.3 | $386.9 |
| Net income | $513.4 | $388.6 |
| Diluted EPS from continuing operations | $9.03 | $6.78 |
| Operating cash flow | $271.5 | $558.0 |
| Capital expenditures | $106.9 | $62.7 |
| Free cash flow (non-GAAP) | $164.6 | $495.3 |
- Sales increased 19.2%, driven primarily by volume growth (16.9%), with pricing adding 1.5% and foreign exchange 0.8%. Operating income rose 23.5%; income from continuing operations increased 33.7%.
- Gross margin fell 2.8 percentage points, reflecting higher transportation, warehousing and material costs, and a less favorable mix as Hawthorne grew faster. Pricing and fixed-cost leverage partly offset those pressures.
- By segment, U.S. Consumer sales were $3,197.7, up 10.9%; Hawthorne sales were $1,424.2, up 39.2%; and Other sales were $303.1, up 34.7%. Segment profit rose in each segment, with Hawthorne profit increasing to $163.8 from $111.9.
- Cash and cash equivalents were $244.1 at year-end, versus $16.6 a year earlier. Total debt was $2,315.3, versus $1,531.2. The company reported $1,480.2 of available borrowing capacity under its credit agreement. Its leverage ratio was 2.70 against a maximum of 4.50, and its interest coverage ratio was 10.63 against a minimum of 3.00; it reported compliance with covenants.
Material changes and notable items
- Operating cash flow declined by $286.5, principally due to increased inventory production, higher incentive compensation and tax payments. Inventory rose to $1,126.6 from $621.9. The filing also says payments originally due to several major vendors and Monsanto near fiscal year-end were paid in the first quarter of fiscal 2022.
- Investing activities used $538.6, including $193.1 for convertible-debt investments, $102.3 for the Bonnie Plants joint venture, $127.8 for acquisitions and related rights, and $106.9 for capital expenditures.
- The company issued $500.0 of 4.000% senior notes due 2031 and $400.0 of 4.375% notes due 2032. The proceeds primarily reduced borrowings under its credit facilities.
- Hawthorne acquired Hydro-Logic for $66.7 and Rhizoflora for $33.7; the company also acquired the remaining AeroGrow shares. It formed The Hawthorne Collective and invested $150.0 in a six-year RIV Capital convertible note, plus $43.1 in other minority convertible-debt investments.
- COVID-19-related costs were $29.2 in fiscal 2021, primarily premium pay. The company reported cumulative premium-pay disbursements of nearly $50.0 since the pandemic began.
- Discontinued operations included a $12.2 pre-tax write-down of contingent consideration from the sale of the former International Business. The resulting net loss from discontinued operations was $3.9.
Outlook, management commentary and risks
- Management expects fiscal 2022 capital expenditures to exceed fiscal 2021 levels, citing growth initiatives and infrastructure needs. It expects to remain within debt-covenant limits under its current operating assumptions and believes operating cash flow and borrowing capacity will meet foreseeable needs. The filing does not provide a clear quantified fiscal 2022 revenue or earnings forecast.
- Management said demand for many products remained above pre-pandemic levels, while warning that future demand, operating costs and supply-chain conditions remain uncertain. Raw-material, labor, freight and warehousing cost increases could continue to pressure margins.
- Customer concentration is significant: Home Depot and Lowe’s represented 39% of fiscal 2021 sales and 42% of year-end receivables. The company has no long-term sales agreements with major retail customers.
- Other key risks include seasonal demand and weather variability; supply, transportation and inventory disruptions; competition and retailer bargaining power; environmental and pesticide regulation, including possible effects of PFAS actions; and the legal and regulatory uncertainty around cannabis-related markets and investments.
- The Roundup marketing agreement is an important earnings source. Fiscal 2021 net sales associated with it were $146.8, including $76.0 of net commission. The company declined its opportunity to terminate the agreement for convenience effective September 30, 2022; termination or material deterioration of Monsanto’s consumer Roundup business could reduce earnings and overhead absorption.
- Environmental remediation accruals were $3.6. The company also faces asbestos-related claims, for which it recorded no accrual because it assessed a loss as not probable; management said it did not expect a reasonably possible loss to be material, while noting outcomes cannot be assured.
Important facts for investors to verify
- Whether elevated post-pandemic demand can be sustained and whether pricing can offset input, freight and warehousing cost inflation without further margin compression.
- Whether inventory levels and working capital convert into cash as expected, particularly given the sharp inventory increase and lower operating cash flow.
- Debt repayment capacity, covenant headroom, refinancing needs and the company’s ability to support dividends, repurchases and planned investment while carrying higher debt.
- The performance, valuation assumptions and potential conversion outcomes of the $193.1 in new convertible-debt investments, including exposure to evolving cannabis laws.
- Retailer concentration and the terms, economics and continuity of the Roundup marketing agreement.