Scotts Miracle-Gro Company — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended July 2, 2011; filed August 10, 2011. Amounts are in U.S. dollars. The lawn and garden business is highly seasonal, with most sales generated in the second and third fiscal quarters.
Business context
The company sells branded lawn and garden products, primarily in North America and Europe, and operates Scotts LawnService. On February 28, 2011, it sold most of its Global Professional business to Israel Chemicals Ltd. for $270 million; net proceeds were $270.9 million. Global Pro is presented as discontinued operations. The remaining professional seed business is included in Corporate & Other.
Financial performance
| Metric | Three months ended July 2, 2011 | Nine months ended July 2, 2011 | Comparable 2010 period |
|---|---|---|---|
| Net sales | $1,058.7 million | $2,418.5 million | $1,172.6 million; $2,475.7 million |
| Gross profit / margin | $400.1 million / 37.8% | $911.9 million / 37.7% | $481.8 million / 41.1%; $949.6 million / 38.4% |
| Operating income | $192.4 million | $343.5 million | $280.1 million; $407.8 million |
| Income from continuing operations | $111.7 million | $193.6 million | $169.5 million; $233.6 million |
| Net income | $111.6 million | $221.3 million | $175.9 million; $236.7 million |
| Diluted EPS | $1.69 | $3.30 | $2.59; $3.51 |
Quarterly sales declined 9.7%; nine-month sales declined 2.3%. Continuing-operations diluted EPS fell from $2.50 to $1.69 for the quarter and from $3.46 to $2.89 year to date. Nine-month net income includes a $21.2 million after-tax gain on the Global Pro sale. Quarterly operating margin was approximately 18.2%, versus 23.9% a year earlier.
Management attributed weaker results mainly to unfavorable U.S. weather and lower consumer activity, unfavorable sales mix, higher commodity costs, increased trade promotions, and reduced fixed-cost absorption. Excluding registration and recall charges, gross margin declined 320 basis points in the quarter and 60 basis points year to date. Global Consumer organic sales fell 14.2% for the quarter and 4.9% year to date; Scotts LawnService organic sales rose 1.3% and 5.0%, respectively.
Cash flow and liquidity: Nine-month operating cash flow was negative $13.5 million, compared with positive $156.2 million in 2010. Excluding discontinued operations, operating cash flow was approximately $70.7 million versus $170.2 million. Investing cash flow was positive $180.0 million, including $253.9 million in net sale proceeds; capital expenditures were $53.3 million. Financing cash flow was negative $91.8 million, including $218.7 million of share repurchases and $49.4 million of dividends. Cash ended at $164.3 million, up from $77.7 million a year earlier.
At July 2, 2011, total debt was $784.2 million, compared with $690.2 million a year earlier; cash less total debt was approximately $619.9 million. The current ratio was approximately 1.9. A new five-year secured revolving facility provides up to $1.7 billion, with $1.3 billion available at quarter-end, including letters of credit. The company reported compliance with debt covenants; leverage ratio was 1.83 against a maximum of 3.50, and interest coverage was 8.51 against a minimum of 3.50.
Material changes and unusual items
- On June 30, the company refinanced its credit facilities, replacing facilities due to expire in February 2012. Interest expense rose to $14.0 million for the quarter and $37.3 million year to date; a $1.2 million refinancing charge was recorded.
- Impairment, restructuring and other charges were $13.8 million, including a $10.3 million net charge related to settling Turf-Seed acquisition matters and $3.5 million of restructuring costs. Management anticipated total fiscal 2011 restructuring charges of $15 million to $20 million.
- Product registration and recall charges were $6.8 million for the quarter and $11.0 million year to date. The U.S. EPA issued a Notice of Intent to File an Administrative Complaint, and settlement discussions with the EPA and Department of Justice were underway. The company said total potential liabilities could exceed its reserve, possibly materially. Separately, it paid a $245,631 California civil penalty in July and entered a settlement ending further action by that agency regarding the affected products.
- The company repurchased approximately 2.2 million shares for $125.0 million in the quarter. Its board authorized up to $700 million of repurchases through September 30, 2014. On August 8, it announced an increase in the quarterly dividend from $0.25 to $0.30 per share.
Outlook, commentary and risks
For fiscal 2011, management expected net sales to be roughly flat, gross margin to decline at least 50 basis points, and SG&A spending to be essentially flat. It forecast interest expense of approximately $51 million and an 8% to 11% decline in income from continuing operations excluding product registration and recall matters and impairment, restructuring and other charges. Management expected to invest approximately $358 million in share repurchases during the fiscal year. It cited weather, commodity costs, sales mix, promotional activity and fixed-cost absorption as key pressures. The filing states that operating cash flow and capital resources should be sufficient for debt service and working capital, while cautioning that future cash generation and borrowing availability are not assured.
Other disclosed risks include ongoing federal product-registration investigations and potential related claims, environmental matters, asbestos-related lawsuits for which loss could not be reasonably estimated, weather sensitivity, and the possibility that earnings or debt changes could affect covenant compliance. The filing reported no material change in risk factors from the fiscal 2010 Form 10-K. Management stated disclosure controls were effective at the reasonable-assurance level.
Most important facts for investors to verify
- Progress, reserve adequacy and potential financial exposure from the EPA and DOJ investigations and any related claims.
- Whether fiscal 2011 guidance was achieved, particularly sales, margin, adjusted continuing income and interest expense expectations.
- Seasonal working-capital requirements and conversion of earnings into operating cash flow.
- Debt levels, revolving-facility availability, interest costs and covenant headroom after refinancing and shareholder returns.
- Actual restructuring costs, share repurchases and dividend payments relative to management’s stated plans.