Scotts Miracle-Gro Co. — Q1 FY2012 Form 10-Q
Reporting period: Three months ended December 31, 2011; comparisons are with the three months ended January 1, 2011. Amounts are in U.S. dollars. The company manufactures and markets lawn and garden products, operates Scotts LawnService, and sells primarily in North America and Europe. Results are highly seasonal, with sales concentrated in the second and third fiscal quarters.
Financial results and position
| Metric | Q1 FY2012 | Prior-year quarter |
|---|---|---|
| Net sales | $211.2 million | $230.2 million |
| Gross profit / margin | $24.8 million / 11.7% | $49.1 million / 21.3% |
| Operating loss | $100.2 million | $94.5 million |
| Net loss | $73.9 million | $67.9 million |
| Basic and diluted loss per share | $1.21 | $1.02 |
| Cash used in operating activities | $201.1 million | $169.7 million |
- Interest expense increased to $15.3 million from $9.5 million, reflecting higher average borrowings and higher rates.
- At December 31, 2011, cash was $127.8 million; total debt was approximately $1.034 billion, including $8.1 million current and $1.026 billion long-term. Total debt was approximately $856 million a year earlier.
- Total current assets were $1.112 billion and current liabilities $449.1 million. Inventories were $654.8 million, up from $567.0 million a year earlier and $387.0 million at September 30, 2011.
- The company reported $1.05 billion of availability under its senior secured credit facility, was compliant with debt covenants, and reported a 2.09 leverage ratio against a 3.50 maximum. Interest coverage was 6.79 against a 3.50 minimum.
- Capital expenditures were $16.4 million, versus $28.1 million. Financing provided $214.3 million, primarily from net borrowings. The company declared dividends of $0.30 per share, versus $0.25.
Changes and operating drivers
- Sales declined 8.3%; management attributed the decrease mainly to lower volume as customers delayed purchases closer to the lawn and garden season. Pricing contributed 0.9 percentage points, foreign exchange reduced sales 0.2 points, and acquisitions added 0.5 points.
- Global Consumer sales fell 21.0% to $149.1 million; its operating loss worsened to $69.4 million from $55.1 million. U.S. retail point-of-sale declined 5.1%, with weakness in lawn fertilizer, grass seed and control products, partly offset by Roundup.
- Scotts LawnService sales rose 1.3% to $37.6 million, while its operating loss edged up to $4.6 million from $4.5 million. Corporate & Other sales were $24.5 million, compared with $4.3 million, largely reflecting ICL supply-agreement activity.
- Gross margin contracted to 11.7% from 21.3%, primarily due to lower sales and unfavorable product mix, increased material costs, and lower fertilizer sales; higher pricing partly offset these factors. First-quarter margins are seasonally low.
- SG&A fell 14.1% to $123.0 million, reflecting lower severance, compensation, variable compensation and advertising costs. Restructuring charges were $2.6 million, compared with none in the prior-year quarter.
- Operating cash outflow increased by $31.4 million, principally because of working-capital needs and inventory build ahead of the spring season. Management cited higher commodity costs and anticipated stronger FY2012 demand.
Outlook, risks and unusual items
- For FY2012, management expected at least 6% sales growth in Global Consumer and Scotts LawnService, assuming modest category growth, more normal weather, marketing and media investment, innovation and modest pricing.
- Management forecast approximately $80 million of commodity inflation, with about half expected to be recovered through pricing and trade-program adjustments. Advertising could increase by up to $40 million; restructuring savings were expected to contribute about $17 million.
- Management expected interest expense to rise approximately $10–$12 million for FY2012 and targeted leverage of 2.0–2.5 times. It expected a fully diluted share count of approximately 62 million and planned to moderate share repurchases.
- Seasonality and weather can materially affect sales and product mix. Management said fiscal 2011’s unfavorable weather affected higher-margin categories; the FY2012 outlook assumes more normal weather.
- FIFRA matters: On January 25, 2012, after quarter-end, the company and the U.S. Department of Justice filed a plea agreement under which the company agreed to plead guilty to 11 counts, pay a $4.0 million penalty, and make five $100,000 environmental-program payments. Court approval was pending. The existing reserve was stated to cover these amounts, but EPA and state investigations continue; additional claims, penalties and costs could exceed reserves, possibly materially.
- The company also disclosed asbestos-related lawsuits for which it could not reasonably estimate probable loss and had recorded no reserve. It reported $4.0 million accrued for other environmental matters and said ordinary-course legal proceedings were not expected to have a material effect, while noting outcomes remain uncertain.
- Management stated that cash flows and capital resources should meet FY2012 debt-service and working-capital needs, but cautioned that operating cash flow and future borrowing availability are not assured. It also noted that unexpected charges or higher debt could affect covenant compliance.
Most important facts for investors to verify
- Whether the federal court approved the FIFRA plea agreement, and the status and potential exposure from the ongoing EPA and state investigations.
- Whether delayed customer orders shifted into later quarters, and whether Global Consumer sales, retail point-of-sale trends and margins improved during the peak season.
- Actual commodity inflation and the extent recovered through pricing, alongside delivery of the sales-growth and restructuring-savings outlook.
- Debt, interest expense, leverage and covenant headroom as seasonal inventory is converted to sales and operating cash flow recovers.
- How capital returns, including the $0.30 quarterly dividend and planned moderation in repurchases, balance against the company’s leverage target and investment needs.