Business context and reporting period
The Scotts Miracle-Gro Company filed this Form 10-K for the fiscal year ended September 30, 2010. It manufactures and markets consumer lawn and garden products, professional horticulture products, and U.S. lawn-care services. The business is highly seasonal: 70%–75% of annual sales typically occur in the second and third fiscal quarters. Smith & Hawken was closed and presented as discontinued operations; management was exploring strategic alternatives, including a possible sale, for Global Professional.
Financial performance and position
| Metric | FY2010 | FY2009 |
|---|---|---|
| Net sales | $3,139.9 million | $2,980.7 million |
| Gross profit / margin | $1,147.3 million / 36.5% | $1,057.6 million / 35.5% |
| Operating income / margin | $384.6 million / 12.2% | $297.6 million / 10.0% |
| Income from continuing operations | $212.4 million | $154.6 million |
| Net income | $204.1 million | $153.3 million |
| Diluted EPS from continuing operations | $3.14 | $2.34 |
| Operating cash flow / free cash flow | $295.9 million / $212.5 million | $264.6 million / $189.2 million |
| Debt at year-end | $631.7 million | $810.1 million |
Sales increased 5.3%; organic sales growth was 4.6%. Gross-margin improvement reflected supply-chain productivity, lower average commodity costs, favorable mix, and higher Roundup commissions, partly offset by pricing declines, particularly in Global Professional. Interest expense decreased to $46.8 million from $56.4 million, primarily as average debt fell. FY2010 included $18.5 million of non-cash brand impairment charges and $8.7 million of product-registration and recall costs.
Cash and cash equivalents were $89.1 million, working capital was $313.7 million, and the current ratio was 1.4 at September 30, 2010. The company reported $1.5 billion of availability under its senior secured facilities and was in compliance with debt covenants. Its leverage ratio was 2.0 and interest coverage ratio was 9.4. The $200 million 7.25% Senior Notes issued in January 2010 mature in 2018; the senior secured credit facilities mature in 2012.
Segment and quarterly details
- Global Consumer: sales of $2,649.7 million, up 6.6%; segment operating income of $504.1 million, up 17.2%. It represented approximately 84% of worldwide sales.
- Global Professional: sales of $266.9 million, up 0.6%; segment operating income fell to $12.1 million from $18.6 million, partly due to sales of older, higher-cost inventory at lower prices.
- Scotts LawnService: sales declined 3.0% to $224.1 million, while segment operating income rose to $24.3 million from $19.0 million.
- Fourth quarter: net sales were $475.7 million and income from continuing operations was a loss of $33.6 million, versus a $27.3 million loss in FY2009’s fourth quarter. FY2010’s fourth quarter was five business days shorter.
Material changes versus the prior year
- Operating income rose 29.2%, continuing-operations income increased to $212.4 million from $154.6 million, and operating cash flow rose by $31.3 million.
- Gross margin expanded by 1.0 percentage point. Organic sales growth slowed to 4.6% from 8.4% in FY2009.
- Debt declined by $178.4 million; the company issued $200 million of Senior Notes and used proceeds to reduce revolving borrowings.
- Inventory fell to $403.6 million from $458.9 million, contributing to stronger operating cash flow.
- Smith & Hawken generated a discontinued-operations loss of $8.3 million, compared with $1.3 million in FY2009. FY2010 closure costs were partly offset by an approximately $18 million gain on sale of its intellectual property.
Outlook, risks, contingencies, and unusual items
- FY2011 outlook: management forecast sales growth of 4%–6%, gross-margin expansion of 70–100 basis points, and diluted EPS growth of 10%–13%. SG&A was expected to rise slightly less than sales, while interest expense was expected to be approximately $60 million.
- Management expected the FY2011 first-quarter pre-tax loss to widen by approximately $20–$25 million versus FY2010, with year-over-year pre-tax improvement anticipated in each of the remaining quarters.
- FIFRA investigations: U.S. EPA, U.S. Department of Justice, and California investigations concerning pesticide product registrations remained open. The company expected another $8–$10 million of FY2011 registration and recall costs, excluding possible fines, penalties, judgments, or litigation costs. No reserve had been established for those potential liabilities, whose amount could be material.
- Other matters included $2.6 million accrued for non-FIFRA environmental actions; a settled Iowa RCRA matter requiring a $148,388 penalty and environmental projects; an unresolved New York proposed penalty of $695,000; and asbestos-related lawsuits for which a probable loss could not be estimated and no reserve was recorded.
- Key business risks include weather and seasonal demand, raw-material prices, regulation and product liability, strong competition, reliance on a few large retailers, foreign-exchange exposure, and refinancing the senior secured facilities due in 2012. Home Depot, Lowe’s, and Walmart accounted for approximately 28%, 17%, and 15% of FY2010 sales, respectively.
- The company doubled its quarterly dividend to $0.25 per share in the fourth quarter and authorized up to $500 million of share repurchases over four years; approximately $25 million was repurchased in FY2010’s fourth quarter. Dividend payments are subject to credit-facility restrictions.
- The auditor expressed an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal control were effective at year-end.
Important facts for investors to verify
- Progress, potential penalties, and total costs from the ongoing FIFRA investigations, including whether any new reserve or sales restrictions become necessary.
- Timing and terms of refinancing the 2012-maturing secured facilities, covenant headroom, and the effect of higher borrowing costs.
- Delivery of FY2011 sales, margin, EPS, and interest-expense guidance, particularly given seasonal and weather-related variability.
- Any decision to sell or otherwise restructure Global Professional and the resulting effects on earnings, cash flow, and debt.
- Retailer concentration and the durability of Global Consumer growth, along with the company’s ability to fund dividends, repurchases, and planned investment.