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| SMG > SEC Filings for SMG > Form 10-Q on 5-Feb-2009 | All Recent SEC Filings |
5-Feb-2009
Quarterly Report
• Results of operations
• Segment results
• Liquidity and capital resources
• Regulatory matters
• Critical accounting policies and estimates
EXECUTIVE SUMMARY
We are dedicated to delivering strong, consistent financial results and
outstanding shareholder returns by providing products of superior quality and
value in order to enhance consumers' outdoor living environments. We are a
leading manufacturer and marketer of consumer branded products for lawn and
garden care and professional horticulture in North America and Europe. We are
Monsanto's exclusive agent for the marketing and distribution of consumer
Roundup® non-selective herbicide products within the United States and other
contractually specified countries. We have a presence in similar consumer
branded and professional horticulture products in Australia, the Far East, Latin
America and South America. In the United States, we operate Scotts LawnService®,
the second largest residential lawn care service business, and Smith & Hawken®,
a leading brand in the outdoor living and garden lifestyle category. Our
operations are divided into the following reportable segments: Global Consumer,
Global Professional, Scotts LawnService® and Corporate & Other. The Corporate &
Other segment consists of the Smith & Hawken® business and corporate general and
administrative expenses.
As a leading consumer branded lawn and garden company, our marketing efforts are
largely focused on building brand and product level awareness to inspire
consumers and create retail demand. We have successfully applied this consumer
marketing focus for a number of years, consistently investing approximately 5%
of our annual net sales in advertising to support and promote our products and
brands. We continually explore new and innovative ways to communicate with
consumers. We believe that we receive a significant return on these marketing
expenditures and anticipate a similar level of advertising and marketing
investments in the future, with the continuing objective of driving category
growth and increasing market share.
Our sales are susceptible to global weather conditions. For instance, periods of
wet weather can adversely impact sales of certain products, while increasing
demand for other products. We believe that our diversified product line provides
some mitigation to this risk. We also believe that our broad geographic
diversification further reduces this risk.
Percent of Net Sales
by Quarter
2008 2007 2006
First Quarter 10.4 % 9.5 % 9.3 %
Second Quarter 32.1 % 34.6 % 33.6 %
Third Quarter 39.3 % 38.2 % 38.9 %
Fourth Quarter 18.2 % 17.7 % 18.2 %
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Due to the nature of our lawn and garden business, significant portions of our
products ship to our retail customers during the second and third fiscal
quarters. Our annual sales are further concentrated in the second and third
fiscal quarters by retailers who increasingly rely on our ability to deliver
products "in season" when consumers buy our products, thereby reducing their
inventories.
Management focuses on a variety of key indicators and operating metrics to
monitor the health and performance of our business. These metrics include
consumer purchases (point-of-sale data), market share, net sales (including unit
volume, pricing, product mix and foreign exchange movements), organic sales
growth (net sales growth excluding the impact of acquisitions, divestitures and
foreign exchange movements), gross profit margins, income from operations, net
income and earnings per share. To the extent applicable, these measures are
evaluated with and without impairment, restructuring and other charges, which
management believes are not indicative of the ongoing earnings capabilities of
our businesses. We also focus on measures to optimize cash flow and return on
invested capital, including the management of working capital and capital
expenditures.
Product Registration and Recall Matters
In April 2008, we learned that a former associate apparently deliberately
circumvented our policies and U.S. Environmental Protection Agency ("U.S. EPA")
regulations under the Federal Insecticide, Fungicide, and Rodenticide Act of
1947, as amended ("FIFRA"), by failing to obtain valid registrations for
products and/or causing invalid product registration forms to be submitted to
regulators. Since that time, we have been cooperating with the U.S. EPA in its
civil investigation into pesticide product registration issues involving the
Company and with the U.S. EPA and the U.S. Department of Justice (the "U.S.
DOJ") in a related criminal investigation. In late April of 2008, in connection
with the U.S. EPA's investigation, we were required to conduct a consumer-level
recall of certain consumer lawn and garden products and a Scotts LawnService®
product. Subsequently, we agreed with the U.S. EPA on a Compliance Review Plan
for conducting a comprehensive, independent review of our product registration
records. Pursuant to the Compliance Review Plan, an independent third-party
firm, Quality Associates Incorporated ("QAI"), has been reviewing all of our
U.S. pesticide product registration records, some of which are historical in
nature and no longer support sales of our products. The U.S. EPA investigation
and QAI review process identified several issues affecting registrations which
resulted in the temporary suspension of sales and shipments of the products
affected. In addition, as the QAI review process or our internal review has
identified FIFRA registration issues or potential FIFRA registration issues
(some of which appear unrelated to the former associate), we have endeavored to
stop selling or distributing the affected products until the issues could be
resolved with the U.S. EPA.
While QAI has completed its review of substantially all of our registrations,
the registration review process has not concluded and we continue to provide the
U.S. EPA with additional follow-up information. At the same time, the second
phase of the QAI review process has commenced with a focus on reviewing
advertising and related promotional support of our registered pesticide
products. We do not expect the results of either of these processes to
significantly affect our fiscal year 2009 sales.
While we believe we have made substantial progress toward completing the FIFRA
compliance review process, the process continues and may result in future state,
federal or private rights of action with respect to additional product
registration issues. Until the U.S. EPA investigation and compliance review
process are complete, we cannot fully quantify the extent of additional issues.
Furthermore, we may be subject to civil or criminal fines and/or penalties or
private rights of action at the state and/or federal level as a result of the
product registration issues. At this time, we cannot reasonably determine the
scope or magnitude of possible liabilities that could result from known or
potential additional product registration issues, and no reserves for these
claims have been established as of December 27, 2008. However, it is possible
that such fines, penalties and/or judgments could be material and have an
adverse effect on our financial condition, results of operations or cash flows.
On September 26, 2008, the Company, doing business as Scotts LawnService®, was
named as a defendant in a purported class action filed in the U.S. District
Court for the Eastern District of Michigan relating to certain pesticide
products. In the suit, Mark Baumkel, on behalf of himself and the purported
classes, seeks an unspecified amount of damages, plus costs and attorneys' fees,
for alleged claims involving breach of contract, unjust enrichment and violation
of the Michigan consumer protection act. Given the preliminary stages of the
proceedings, no reserves have been booked at this time, and we intend to
vigorously contest the plaintiff's assertions.
In addition, in fiscal 2008 we conducted a voluntary recall of most of our wild
bird food products due to a formulation issue. The wild bird food products had
been treated with pest control additives to avoid insect infestation, especially
at retail stores. While the pest control additives had been labeled for use on
certain stored grains that can be processed for human and/or animal consumption,
they were not labeled for use on wild bird food products. This voluntary recall
was completed prior to the end of fiscal 2008.
As a result of these registration and recall matters, we have reversed sales
associated with estimated returns of affected products, recorded an impairment
estimate for affected inventory and recorded other registration and
recall-related costs. The impact of these adjustments was a charge of
$7.6 million for the three months ended December 27, 2008. We currently expect
total fiscal year 2009 costs related to the recalls and known registration
issues to be approximately $20 million, exclusive of potential fines, penalties
and/or judgments.
We are committed to providing our customers and consumers with products of
superior quality and value to enhance their lawns, gardens and overall outdoor
living environments. We believe consumers have come to trust our brands based on
the superior quality and value they deliver, and that trust is highly valued. We
are also committed to conducting business with the highest degree of ethical
standards and in adherence to the law. While we are disappointed in these
events, we believe we have made significant progress in addressing the issues
and restoring customer and consumer confidence in our products.
RESULTS OF OPERATIONS
The following table sets forth the components of income and expense as a
percentage of net sales for the three months ended December 27, 2008 and
December 29, 2007:
THREE MONTHS ENDED
DECEMBER 27, DECEMBER 29,
2008 2007
(UNAUDITED)
Net sales 100.0 % 100.0 %
Cost of sales 73.1 76.9
Cost of sales - product registration and recall matters 0.4 -
Gross profit 26.5 23.1
Operating expenses:
Selling, general and administrative 48.2 46.7
Selling, general and administrative - product registration
and recall matters 2.0 -
Other income, net (0.8 ) (1.0 )
Loss from operations (22.9 ) (22.6 )
Interest expense 5.1 6.2
Loss before income taxes (28.0 ) (28.8 )
Income tax benefit (10.1 ) (10.4 )
Net loss (17.9 )% (18.4 )%
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Net sales for the three months ended December 27, 2008 were $318 million, an
increase of 3.0% from net sales of $308.7 million for the three months ended
December 29, 2007. Higher selling prices and the acquisition of Humax
Horticulture Limited ("Humax") in the United Kingdom favorably impacted sales
growth for the quarter by 8.3% and 0.5%, respectively. The impact of foreign
exchange rates and returns related to product recall matters decreased sales
growth for the quarter by 5.4% and 0.1%, respectively. Organic net sales growth
for the quarter, which excludes the impact of acquisitions and foreign exchange
movements, was 7.8%. In the Global Consumer, Global Professional and Scotts
LawnService® segments, organic net sales growth for the quarter was 13.3%, 17.8%
and 0.5%, respectively. Smith & Hawken® organic net sales declined 22.8% for the
first quarter of fiscal 2009. Net sales for our first fiscal quarter typically
comprise between 9% to 11% of our total year net sales. Therefore, first quarter
net sales trends are generally not indicative of the full fiscal year. We
anticipate fiscal 2009 organic net sales, which excludes the impact of foreign
exchange movements and acquisitions, to increase by 5% to 7% compared to fiscal
2008.
As a percentage of net sales, gross profit was 26.5% of net sales in the first
quarter of fiscal 2009 compared to 23.1% in the first quarter of fiscal 2008.
The gross profit improvement for the quarter was primarily attributable to
increased selling prices and cost productivity improvements net of increased
commodity costs in our Global Consumer and Global Professional segments. The
impact of foreign exchange rates and product registration and recall matters
each unfavorably impacted gross profit rates for the quarter by 40 basis points.
Excluding the impact of product registration and recall matters, for fiscal 2009
we anticipate the gross profit rate as a percentage of net sales to increase by
100 to 200 basis points compared to fiscal 2008, largely due to pricing in
excess of commodity cost increases and cost productivity improvements, partially
offset by lower margin private label products.
Selling, General and Administrative Expenses:
THREE MONTHS ENDED
DECEMBER 27, DECEMBER 29,
2008 2007
(IN MILLIONS)
(UNAUDITED)
Advertising $ 14.2 $ 14.8
Other selling, general and administrative 135.7 125.6
Amortization of intangibles 3.3 3.9
$ 153.2 $ 144.3
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Selling, general and administrative expenses ("SG&A") were $153.2 million in the first quarter of fiscal 2009, an increase of 6.2%, or 10.4% excluding the impact of foreign exchange rates, compared to the first quarter of fiscal 2008. Global Consumer, Global Professional and Corporate spending increased in the quarter, partially offset by a reduction in SG&A expenses in Scotts LawnService® and Smith & Hawken®. The increase in SG&A for the quarter was driven by higher information technology costs, higher compensation-related costs and increased spending for selling, marketing and research and development. We anticipate full-year growth of SG&A to be in the mid-single digits, driven by trends consistent with our first fiscal quarter.
We recorded $6.2 million of SG&A-related product registration and recall costs
during the first quarter of fiscal 2009, which primarily related to third-party
compliance review, legal and consulting fees.
Interest expense for the first quarter of fiscal 2009 was $16.3 million,
compared to $19 million for the first quarter of fiscal 2008. The decrease in
interest expense was attributable to a decrease in average borrowings and the
favorable impact of foreign exchange rates, offset partially by an increase in
weighted average interest rates. Excluding the impact of foreign exchange rates,
average borrowings decreased $136.1 million during the first quarter of fiscal
2009 as compared to the prior year period. Weighted average interest rates
increased by 13 basis points. We anticipate the favorable trend of decreased
interest expense in the first quarter of fiscal 2009 to continue for the balance
of the year, driven primarily by a reduction in weighted average interest rates
and lower average borrowings for the remaining three fiscal quarters.
The income tax benefit was calculated assuming an effective tax rate of 36.0%
for both the three months ended December 27, 2008 and December 29, 2007. The
effective tax rate used for interim reporting purposes is based on management's
best estimate of factors impacting the effective tax rate for the full fiscal
year. Factors affecting the estimated effective tax rate include assumptions as
to income by jurisdiction (domestic and foreign), the availability and
utilization of tax credits and the existence of elements of income and expense
that may not be taxable or deductible, as well as other items. The estimated
effective tax rate is subject to revision in later interim periods and at fiscal
year end as facts and circumstances change during the course of the fiscal year.
There can be no assurance that the effective tax rate estimated for interim
financial reporting purposes will approximate the effective tax rate determined
at fiscal year end.
We reported a net loss of $57 million for the first quarter of fiscal 2009,
compared to a net loss of $56.8 million for the first quarter of fiscal 2008.
The first quarter of fiscal 2009 was unfavorably impacted by product
registration and recall costs of $7.6 million, $4.9 million after tax. This
first quarter loss was anticipated due to the seasonal nature of our business,
in which our sales are heavily weighted in the spring and summer selling season.
Average common shares outstanding increased to 64.7 million for the three months
ended December 27, 2008 from 64.2 million for the three months ended
December 29, 2007, primarily due to common shares issued for stock option
exercises. Furthermore, 0.7 million potential common shares were excluded from
the diluted loss per share calculation for the first quarter of fiscal 2009
because their effect was anti-dilutive.
SEGMENT RESULTS
Our operations are divided into the following segments: Global Consumer, Global
Professional, Scotts LawnService® and Corporate & Other. The Corporate & Other
segment consists of Smith & Hawken® and corporate general and administrative
expenses. Segment performance is evaluated based on several factors, including
income from operations before amortization, product registration and recall
costs, and impairment, restructuring and other charges, which are not GAAP
measures. Management uses this measure of operating profit to gauge segment
performance because we believe this measure is the most indicative of
performance trends and the overall earnings potential of each segment.
The following table sets forth net sales by segment:
THREE MONTHS ENDED
DECEMBER 27, DECEMBER 29,
2008 2007
(IN MILLIONS)
(UNAUDITED)
Global Consumer $ 182.3 $ 166.9
Global Professional 65.5 62.4
Scotts LawnService® 38.8 38.3
Corporate & Other 31.9 41.3
Segment total 318.5 308.9
Roundup® amortization (0.2 ) (0.2 )
Product registrations and recall matters - returns (0.3 ) -
Consolidated $ 318.0 $ 308.7
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The following table sets forth operating income (loss) by segment:
THREE MONTHS ENDED
DECEMBER 27, DECEMBER 29,
2008 2007
(IN MILLIONS)
(UNAUDITED)
Global Consumer $ (35.6 ) $ (38.0 )
Global Professional 13.9 6.4
Scotts LawnService® (7.8 ) (11.5 )
Corporate & Other (32.2 ) (22.6 )
Segment total (61.7 ) (65.7 )
Roundup® amortization (0.2 ) (0.2 )
Other amortization (3.3 ) (3.9 )
Product registrations and recall matters (7.6 ) -
Consolidated $ (72.8 ) $ (69.8 )
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Global Consumer
Global Consumer segment net sales were $182.3 million in the first quarter of
fiscal 2009, an increase of 9.2% from net sales of $166.9 million for the first
quarter of fiscal 2008. Organic net sales growth for the quarter was 13.3%,
which includes the impact of price increases of 6.2%. The acquisition of Humax
contributed 1.0% to the first quarter sales increase, while foreign exchange
movements decreased sales by 5.1%.
Organic net sales in North America increased 17.5%, including a 7.9% increase
resulting from higher average selling prices. Sales of lawn fertilizer products
were the primary driver of the first quarter organic sales increase for North
America, as certain customers took advantage of graduated price increases which
were fully effective January 1, 2009. Sales of our products to consumers at the
retail shelf (point-of-sales) for our largest U.S. customers decreased 1.6% for
the quarter, largely due to a reduction in sales of grass seed, reflecting a
soft finish to the calendar 2008 lawn and garden season. Organic net sales in
Europe increased by 3.4%, as pricing actions and growth in the lawn and weed
control categories were largely offset by declines in the plant food and growing
media categories. From a geographical perspective, net sales increased in France
and Germany, offset by decreases in net sales in Benelux and Austria. U.K. sales
were flat in the quarter. While we are encouraged by the consumer activity in
this quarter, it is important to note that our first quarter typically
represents 7% to 8% of annual net sales for this segment and falls at the end of
the growing season in North America and Europe.
As discussed in "NOTE 12. ACQUISITIONS" to the accompanying condensed,
consolidated financial statements, we acquired Humax, a U.K. company, during the
first quarter of fiscal 2009. With the acquisition, we gained exclusive rights
to harvest and distribute growing media from an existing peat bog for a 17-year
period. Humax net sales were $1.6 million in the first quarter of fiscal 2009.
Global Consumer segment operating loss decreased by $2.4 million in the first
quarter of fiscal 2009 as compared to the first quarter of fiscal 2008.
Excluding the impact of product registration and recall matters and foreign
exchange movements, operating loss decreased by $0.3 million as compared to the
first quarter of fiscal 2008. Higher sales and gross profit in the quarter were
offset by increased spending on media, selling, marketing and research and
development activities.
Global Professional
Net sales for the Global Professional segment in the first quarter of fiscal
2009 were $65.5 million, an increase of $3.1 million, or 5.0%, versus the first
quarter of fiscal 2008. Organic net sales growth for the quarter was 17.8%,
which includes the impact of price increases of 22.6%. Foreign exchange
movements decreased net sales by 12.8% for the quarter. Organic net sales for
the European Professional business and emerging markets increased in the quarter
by 26.8% and 57.8%, respectively. Increased sales in these markets were driven
primarily by pricing actions, in addition to slight growth in volume. Organic
net sales for the North America Professional business declined in the quarter by
30.0%, driven by a decrease in volume.
Global Professional operating income increased from $6.4 million for the first
quarter of fiscal 2008 to $13.9 million for the first quarter of fiscal 2009.
Excluding the impact of foreign exchange movements, operating income increased
by $9.5 million in the quarter, primarily resulting from higher selling prices
and improved gross margins.
Scotts LawnService®
Scotts LawnService® revenues increased 1.3% from $38.3 million in the first
quarter of fiscal 2008 to $38.8 million in the first quarter of fiscal 2009.
Sales increased $0.5 million for the quarter, though average customer count was
down 7.8%, reflecting improved realization rates.
The operating loss for Scotts LawnService® decreased by $3.7 million in the
first quarter of fiscal 2009 compared to the first quarter of fiscal 2008,
driven by field level productivity improvements and lower SG&A spending.
Corporate & Other
Net sales in the first quarter of fiscal 2009 for the Corporate & Other segment,
which pertain to Smith & Hawken®, decreased $9.4 million, or 22.8%, from the
first quarter of fiscal 2008. Smith & Hawken® sales decreased across all
channels. We pursued divesting the Smith & Hawken® business during the first
quarter of fiscal 2009 but were unable to negotiate economically reasonable
terms.
The net operating loss for Corporate & Other increased by $9.6 million in the
first quarter of fiscal 2009 as compared to the first quarter of fiscal 2008,
primarily driven by higher information technology costs, higher
compensation-related costs and an increase in Smith & Hawken® operating loss.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash used in operating activities amounted to $172.3 million and $180 million
for the three months ended December 27, 2008 and December 29, 2007,
respectively. The use of cash in the first fiscal quarter is due to the seasonal
nature of our operations. The first quarter is historically the low point for
net sales, while at the same time we are building inventories in preparation for
the spring selling season that begins in our second fiscal quarter. The decrease
in cash used in operating activities in the first quarter of fiscal 2009 as
compared to the first quarter of fiscal 2008 related primarily to an increase in
net sales for the quarter and improved working capital management.
Investing Activities
Cash used in investing activities was $17.6 million and $14.5 million for the
three months ended December 27, 2008 and December 29, 2007, respectively. We had
. . .
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