Scotts Miracle-Gro Company — Form 10-Q summary
Reporting period: Fiscal third quarter and first nine months ended June 30, 2012; comparisons are with the three and nine months ended July 2, 2011. The company sells branded lawn and garden products and operates Scotts LawnService. Sales are seasonal, concentrated in the second and third fiscal quarters.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $1,062.2 million | $1,058.7 million | $2,446.9 million | $2,418.5 million |
| Gross profit | $366.5 million | $400.1 million | $854.1 million | $911.9 million |
| Gross margin | 34.5% | 37.8% | 34.9% | 37.7% |
| Operating income | $168.0 million | $192.4 million | $286.0 million | $343.5 million |
| Continuing-operations income | $95.0 million | $111.7 million | $148.3 million | $193.6 million |
| Net income | $93.3 million | $111.6 million | $146.6 million | $221.3 million |
| Diluted EPS from continuing operations | $1.53 | $1.69 | $2.39 | $2.89 |
| Interest expense | $16.6 million | $14.0 million | $49.8 million | $37.3 million |
- Cash from operations was $115.1 million for the first nine months, compared with cash used of $13.5 million a year earlier. Management attributed the improvement primarily to lower working-capital use, especially lower period-end receivables.
- Investing activities used $45.5 million; capital expenditures were $39.0 million. Financing activities used $68.9 million. Cash at June 30 was $132.3 million, including $123.1 million held by foreign subsidiaries.
- Total debt was $771.2 million, including $90.8 million classified as current and $87.5 million under the receivables purchase agreement. The company reported $1.4 billion of availability under its credit facility. It was covenant-compliant: leverage ratio 2.86 versus a 3.50 maximum; interest coverage 4.89 versus a 3.50 minimum.
- Quarterly dividends declared were $0.30 per share. On August 9, 2012, the board announced an increase to $0.325 per share.
Changes and operating drivers
- Sales were nearly flat in Q3 and up 1.2% year to date. Higher U.S. mulch and controls sales and lawn-service growth were partly offset by weaker European and grass-seed sales and unfavorable foreign exchange.
- Gross margin fell 3.3 percentage points in Q3 and 2.8 points year to date. Management cited higher packaging and fertilizer input costs, adverse product mix, increased distribution costs from an early-season demand surge, and low- or no-margin ICL supply-agreement sales.
- Global Consumer operating income declined 18.2% in Q3 and 16.8% year to date, reflecting higher costs and increased marketing spending. Scotts LawnService sales rose 6.6% in Q3 and 6.0% year to date; its operating income was flat in Q3 and higher year to date.
- Net income comparisons are affected by discontinued operations: prior-year nine-month results included the Global Pro sale gain, while 2012 includes a $1.7 million tax estimate adjustment related to that sale. Continuing-operations income is a more comparable operating measure.
- Shares used in diluted EPS calculations declined, primarily because of share repurchases, supporting EPS relative to the decline in earnings. Nine-month repurchases totaled $17.5 million; cumulative repurchases under the program were $401.2 million.
Outlook, risks and unusual items
- Management said consumer demand and Global Consumer sales growth fell materially short of expectations despite increased advertising and holding customer prices flat amid rising commodity costs. It now expects fiscal 2012 operating income to decline from fiscal 2011, revising its earlier expectation of relatively flat operating income. It is planning actions, including price increases, to recover part of the decline; no specific earnings guidance value is provided.
- The company recorded $7.8 million of impairment, restructuring and other charges year to date, including a $5.3 million impairment related to product commercialization issues, plus restructuring costs. Q3 included a $0.4 million benefit from resolving certain international restructuring activities.
- FIFRA product-registration investigations remain ongoing. The company’s guilty plea to 11 counts was accepted in March 2012; sentencing remained pending. The agreement provides for a $4 million penalty and five $0.1 million environmental-program payments, which were included in the company’s accrual. EPA and state matters continue, and additional liabilities could exceed accrued amounts; the total possible exposure is not reasonably estimable.
- Other disclosed exposures include environmental remediation and asbestos-related lawsuits for which no probable loss was estimable and no accrual was recorded. Management said ordinary-course proceedings were not expected to be material, while noting outcomes cannot be assured.
- Management believed operating cash flow and capital resources would cover fiscal 2012 debt service and working-capital needs, but cautioned that cash generation and future borrowing availability are not assured. It expected to remain within covenants under current assumptions; adverse earnings or debt changes could threaten compliance.
Most important facts for investors to verify
- Whether planned price increases and cost actions restore margins after the sharp gross-margin and Global Consumer profit declines.
- Whether the weaker-than-expected category demand persists, particularly in Europe and key consumer product lines.
- Final sentencing and resolution of EPA, state and other product-registration matters, including whether liabilities exceed current accruals.
- Seasonal working-capital needs, foreign-held cash availability, and debt-covenant headroom if earnings weaken.
- The effect of the announced dividend increase and ongoing repurchases on liquidity and capital allocation.