Scotts Miracle-Gro Co. — Form 10-Q Summary
Reporting period: Fiscal 2012 second quarter and six months ended March 31, 2012; comparisons are to the three and six months ended April 2, 2011. Amounts are in millions except per-share data. Scotts sells branded lawn and garden products and operates Scotts LawnService. Results are seasonal, with sales concentrated in the second and third fiscal quarters. Global Pro was sold in February 2011 and is presented as discontinued operations.
Key financial results
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $1,173.5, up 3.9% from $1,129.6 | $1,384.7, up 1.8% from $1,359.8 |
| Gross profit / margin | $462.8 / 39.4%, versus $462.7 / 41.0% | $487.6 / 35.2%, versus $511.8 / 37.6% |
| Operating income | $218.2, versus $245.6 | $118.0, versus $151.1 |
| Continuing-operations income | $127.2; diluted EPS $2.05, versus $148.6 and $2.20 | $53.3; diluted EPS $0.86, versus $81.9 and $1.21 |
| Net income | $127.2, versus $177.6 | $53.3, versus $109.7 |
Prior-year net income included discontinued-operations income of $29.0 for the quarter and $27.8 for the six-month period, primarily from the Global Pro sale. Higher input costs, increased advertising and marketing, and higher interest expense weighed on current-period earnings. Pricing and volume partly offset these pressures. Material inflation and unfavorable product mix reduced gross margin.
Cash flow, debt and liquidity
- Operating cash flow was a use of $620.4 in the first six months, compared with a use of $604.0 a year earlier. Management attributed the increase in cash use, excluding discontinued operations, to lower continuing earnings and greater working-capital needs, including seasonal receivables and inventory.
- Investing cash flow was a use of $25.2, versus a source of $205.5 in the prior period, which included $249.8 of net proceeds from the Global Pro sale. Capital expenditures were $25.7.
- Financing provided $635.7, including $673.2 of net borrowings under revolving and bank lines. Cash ended at $122.4.
- Total debt was $1,469.0, including $227.8 current and $1,241.2 long-term; this included $222.5 borrowed under the receivables purchase agreement. Cash was $122.4. The filing reports $837.4 of availability under the senior secured credit facility, including letter-of-credit availability.
- The company reported compliance with debt covenants: leverage ratio 2.51 against a maximum of 3.50; interest coverage 5.80 against a minimum of 3.50. Management said cash flows and capital resources should meet needs, while cautioning that future cash generation and borrowing availability are not assured.
- Quarterly dividends declared were $0.30 per share, up from $0.25. The company repurchased 0.4 million shares for $17.5 in the six-month period.
Business trends and material changes
- Second-quarter sales growth reflected volume, pricing, favorable year-over-year weather, marketing and a shift in retailer orders from the first quarter. Six-month sales were nearly flat in Global Consumer; Scotts LawnService sales increased 5.3% for the six months, while Corporate & Other sales rose with ICL supply-agreement activity.
- Global Consumer operating income declined 8.0% for the quarter and 15.6% for the six months, mainly due to material costs and increased advertising. Scotts LawnService’s operating loss narrowed versus the prior periods.
- Advertising expense rose $19.6 in the quarter and $17.6 year to date. Fiscal 2012 advertising investment was expected to be approximately 6% of net sales.
- Fiscal 2012 share repurchases were expected to be moderated. The company’s longer-term capital allocation target was one-third of operating cash flow for shareholder returns and two-thirds for organic and acquisitive investment, while targeting debt leverage of 2.0–2.5 times.
Outlook, risks and unusual items
- Management expected fiscal 2012 sales growth of 6%–8%, supported by modest category growth, more normal weather, marketing, innovation and modest pricing.
- Management forecast approximately $70 of commodity inflation and an approximately $85 increase in product costs, with only part expected to be recovered through pricing and trade-program changes. Planned advertising increases were up to $40; variable compensation was budgeted at $30–$35. Restructuring savings of about $17 and higher interest expense of about $10 were also anticipated.
- For the six months, continuing-operations effective tax rate was 37.1%, versus 35.9%. Fiscal 2012 fully diluted share count was expected to be about 62.0 million.
- On March 13, 2012, a court accepted the company’s guilty plea to 11 FIFRA violations; sentencing was delayed. The plea agreement provides for a $4.0 penalty and $0.5 in environmental-program payments. EPA and state investigations continued, and the company said additional claims, fines or costs could exceed its accrual. Product-registration and recall charges were $3.8 for the six months; related accrued costs were $10.6 at March 31.
- Other exposures include environmental matters ($4.1 accrued), asbestos-related claims for which no reserve was recorded because loss could not be reasonably estimated, and ordinary-course litigation. Weather, commodity prices, seasonal working capital, debt covenant compliance and the Roundup marketing relationship are also relevant risks.
- Management reported disclosure controls effective at a reasonable assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether seasonal sales and receivable collections convert into operating cash flow as expected, and whether inventory builds align with demand.
- Progress toward fiscal 2012 sales, cost-inflation, advertising and earnings expectations, particularly given the first-half margin and earnings declines.
- Final sentencing and outcomes of the EPA and state proceedings, and whether further product-registration liabilities require additional accruals.
- Debt, receivables-agreement borrowings and covenant headroom, especially if earnings or working capital weaken.
- Execution of the capital allocation plan, including dividend capacity, reduced buybacks and the targeted leverage range.