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| SMG > SEC Filings for SMG > Form 10-Q on 6-May-2009 | All Recent SEC Filings |
6-May-2009
Quarterly Report
OVERVIEW
Management's Discussion and Analysis ("MD&A") is organized in the following sections:
· Executive summary
· Results of operations
· Segment results
· Liquidity and capital resources
· Regulatory matters
· Critical accounting policies and estimates
EXECUTIVE SUMMARY
The Scotts Miracle-Gro Company ("Scotts Miracle-Gro") and its subsidiaries (collectively, together with Scotts Miracle-Gro, the "Company"), "we" or "us" 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 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 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 retailers' 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 foreign exchange movements and product recalls), 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 conducted 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.
QAI has completed a review of substantially all of our registrations, advertising and related promotional support of our registered pesticide products. While we do not expect the results of the QAI review process to significantly affect our fiscal year 2009 sales, the registration review process has not concluded, and we continue to cooperate with the U.S. EPA and U.S. DOJ in their related investigations.
While we believe that the FIFRA compliance review process is substantially complete, the U.S. EPA and U.S. DOJ investigations and the review process continue and may result in future state, federal or private rights of action including fines and/or penalties with respect to known or potential additional product registration issues. Until the U.S. EPA and U.S. DOJ investigations and the compliance review process are complete, we cannot fully quantify the extent of additional 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 potential liabilities have been established as of March 28, 2009. However, it is possible that such liabilities, including 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 accruals have been recorded, and we intend to vigorously contest the plaintiff's assertions.
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, and we do not expect any material impact to our fiscal 2009 financial condition, results of operations or cash flows as a result of such recall.
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 pre-tax charges of $8.0 million and $30.8 million for the three-month periods, and $15.6 million and $30.8 million for the six-month periods, ended March 28, 2009 and March 29, 2008, respectively. Although we have begun to reduce our need for third-party professional services related to the recall and registration matters, we nevertheless expect to incur $10 to $15 million in additional charges, exclusive of potential fines, penalties, and/or judgments, related to the recalls and known registration issues, including those associated with more aggressively addressing impacted inventory as permitted by the U.S. EPA.
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- and six-month periods ended March 28,
2009 and March 29, 2008:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 28, MARCH 29, MARCH 28, MARCH 29,
2009 2008 2009 2008
(UNAUDITED) (UNAUDITED)
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 62.4 63.9 65.1 67.1
Cost of sales - product registration and
recall matters 0.3 2.4 0.3 1.8
Gross profit 37.3 33.7 34.6 31.1
Operating expenses:
Selling, general and administrative 22.4 21.8 28.9 27.8
Selling, general and administrative -
product registration and recall matters 0.6 0.1 0.9 0.1
Other income, net - (0.1 ) (0.2 ) (0.3 )
Income from operations 14.3 11.9 5.0 3.5
Interest expense 1.7 2.4 2.5 3.4
Income before income taxes 12.6 9.5 2.5 0.1
Income taxes 4.6 3.4 0.9 0.0
Net income 8.0 % 6.1 % 1.6 % 0.1 %
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Net sales for the three months ended March 28, 2009 were $960.1 million, essentially flat compared to net sales of $958 million for the three months ended March 29, 2008. Net sales for the first six months of fiscal 2009 grew 0.9% versus the comparable period of fiscal 2008. Foreign exchange movements decreased sales growth for the second quarter and six months ended March 28, 2009 by 4.9% and 5.0%, respectively. Additionally, product returns related to recall matters in 2008 had the impact of decreasing net sales, thereby increasing sales growth for the second quarter and six months ended March 28, 2009 by 2.1% and 1.6%, respectively. Organic net sales growth, which excludes the impact of foreign exchange movements and product recalls, was 3.0% and 4.3% for the second quarter and first six months of 2009, respectively. In the Global Consumer segment, organic net sales grew by 5.5% and 7.0% for the second quarter and first six months, respectively, primarily due to an increase in sales in North America. Global Professional organic net sales declined by 10.6% for the second quarter, and were essentially flat year-to-date compared to the same period in fiscal 2008. Organic net sales growth for the Scotts LawnService® segment was 1.2% and 1.3% for the three and six months ended March 28, 2009, respectively. Smith & Hawken® organic net sales decreased by 22.1% and 22.4% for the second quarter and first six months of fiscal 2009, respectively.
In recent years, consolidated net sales for the first six months have typically comprised 42% to 45% of our total fiscal year consolidated net sales. However, there can be no assurance that a similar sales trend will apply to fiscal 2009. On a consolidated basis, we anticipate fiscal 2009 organic net sales to increase by 5% to 7% compared to fiscal 2008.
As a percentage of net sales, gross profit was 37.3% for the second quarter of fiscal 2009 compared to 33.7% for the second quarter of fiscal 2008. For the first six months of fiscal 2009, our gross profit percentage increased to 34.6% from 31.1% in the comparable period of fiscal 2008. Excluding product registration and recall matters, gross profit for the second quarter and first six months of fiscal 2009 increased 150 and 190 basis points, respectively. The fiscal 2009 second quarter and year-to-date gross profit rate increases were driven by cost productivity improvements and increased selling prices net of increased commodity costs. 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 nearly 200 basis points compared to fiscal 2008, consistent with trends from the first half of the year.
Selling, General and Administrative Expenses
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 28, MARCH 29, MARCH 28, MARCH 29,
2009 2008 2009 2008
(IN MILLIONS) (IN MILLIONS)
(UNAUDITED) (UNAUDITED)
Advertising $ 46.1 $ 49.7 $ 60.3 $ 64.5
Other selling, general and administrative 166.9 154.8 302.6 280.4
Amortization of intangibles 2.9 3.9 6.2 7.8
$ 215.9 $ 208.4 $ 369.1 $ 352.7
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Selling, general and administrative ("SG&A") expenses increased $7.5 million, or 3.6%, to $215.9 million for the second quarter and $16.4 million, or 4.6%, to $369.1 million for the first six months of fiscal 2009. Excluding the impact of foreign exchange rates, SG&A expenses for the second quarter and first six months of fiscal 2009 increased 7.5% and 8.7%, respectively. Lower advertising expense year-to-date was largely attributable to increased media efficiencies in the Global Consumer business. We expect full-year advertising expense to reflect increased spend in the North America Consumer segment, offset by lower media spending in the International Consumer segment, primarily due to media efficiencies. The increase in other SG&A for the second quarter and year-to-date was primarily driven by increased estimates for full-year variable compensation and retention costs, investments in research and development and technology, and increased pension costs. We continue to expect full-year growth of SG&A expenses in the mid- to high-single digits, with the largest incremental driver being variable compensation, which is linked to our results.
We recorded $5.5 million and $11.7 million of SG&A-related product registration and recall costs during the second quarter and first six months of fiscal 2009, respectively, which primarily related to third-party compliance review, legal and consulting fees. For both the quarter and six months ended March 29, 2008, we recorded $1.2 million of SG&A-related product registration and recall costs.
Interest expense for the second quarter and first six months of fiscal 2009 was $15.9 million and $32.2 million, respectively, compared to $23.5 million and $42.5 million for the second quarter and first six months of fiscal 2008. The decrease was primarily due to a decline in our borrowing rates, as well as the favorable impact of foreign exchange rates and a reduction in average debt outstanding. Weighted-average interest rates decreased by 88 basis points during the first six months of fiscal 2009 as compared to the same period of fiscal 2008. Average borrowings also decreased by $160.7 million.
Income tax expense was calculated assuming an effective tax rate of 36.0% for the first half of both fiscal 2009 and fiscal 2008. The effective tax rate used for interim reporting purposes was 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.
Diluted average common shares used in the diluted net income per common share calculation were 65.8 million for the second quarter of fiscal 2009 compared to 65.6 million for the same period a year ago. Diluted average common shares used in the diluted net income per common share calculation were 65.7 million for the six months ended both March 28, 2009 and March 29, 2008. Diluted average common shares included 0.9 million equivalent shares for the second quarter and year-to-date periods in fiscal 2009 to reflect the effect of the assumed conversion of dilutive stock options, restricted stock and restricted stock unit awards. For the second quarter and first six months of fiscal 2008, diluted average common shares included 1.2 million and 1.4 million equivalent shares, respectively.
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 generally accepted accounting principles 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 SIX MONTHS ENDED
MARCH 28, MARCH 29, MARCH 28, MARCH 29,
2009 2008 2009 2008
(IN MILLIONS) (IN MILLIONS)
(UNAUDITED) (UNAUDITED)
Global Consumer $ 833.7 $ 820.5 $ 1,016.0 $ 987.4
Global Professional 74.5 99.5 140.0 161.9
Scotts LawnService® 32.8 32.4 71.6 70.7
Corporate & other 19.3 24.8 51.2 66.1
Segment total 960.3 977.2 1,278.8 1,286.1
Roundup® amortization (0.2 ) (0.2 ) (0.4 ) (0.4 )
Product registrations and recall matters - returns - (19.0 ) (0.3 ) (19.0 )
Consolidated $ 960.1 $ 958.0 $ 1,278.1 $ 1,266.7
The following table sets forth operating income (loss) by segment: THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 28, MARCH 29, MARCH 28, MARCH 29,
2009 2008 2009 2008
(IN MILLIONS) (IN MILLIONS)
(UNAUDITED) (UNAUDITED)
Global Consumer $ 199.3 $ 179.2 $ 163.7 $ 141.2
Global Professional 8.0 16.3 21.9 22.7
Scotts LawnService® (16.1 ) (18.5 ) (23.9 ) (30.0 )
Corporate & other (43.2 ) (27.9 ) (75.4 ) (50.5 )
Segment total 148.0 149.1 86.3 83.4
Roundup® amortization (0.2 ) (0.2 ) (0.4 ) (0.4 )
Other amortization (2.9 ) (3.9 ) (6.2 ) (7.8 )
Product registration and recall matters (8.0 ) (30.8 ) (15.6 ) (30.8 )
Consolidated $ 136.9 $ 114.2 $ 64.1 $ 44.4
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Global Consumer
Global Consumer segment net sales were $833.7 million for the second quarter and $1.02 billion for the first six months of fiscal 2009, an increase of 1.6% and 2.9% from the second quarter and first six months of fiscal 2008, respectively. Organic net sales growth for the second quarter and first six months of fiscal 2009 was 5.5% and 7.0%, respectively, including the favorable impact of price increases of 8.9% and 8.2%. Foreign exchange movements decreased net sales by 3.9% and 4.1% for the second quarter and first six months of fiscal 2009, respectively.
Organic net sales in North America increased 8.2% and 9.6% for the second quarter and first six months of fiscal 2009, respectively. Organic net sales growth includes the favorable impact of higher selling prices, which increased North American sales by 9.1% and 8.6% for the second quarter and first six months of fiscal 2009, respectively. Sales of our products to consumers at retail (point-of-sales) for our largest U.S. customers increased by 18.0% and 10.9% for the quarter and year-to-date, respectively, primarily driven by sales in lawn fertilizers, growing media and plant foods. Organic net sales in Europe decreased by 7.1% and 3.6% for the second quarter and first six months of fiscal 2009, respectively, primarily driven by delayed purchasing by our retailers. All European regions, except for Germany and Central Europe, were unfavorably impacted by the delayed purchasing. Pricing actions in Europe increased net sales by 8.0% and 6.6% for the quarter and year-to-date, partially offsetting the decline in volumes.
Global Consumer segment operating income increased by $20.1 million and $22.5 million in the second quarter and first six months of fiscal 2009, respectively. Excluding foreign exchange movements, segment operating income increased by $25.7 million and $26.0 million in the second quarter and first six months of fiscal 2009, respectively. The increase in operating income was driven by the increase in net sales accompanied by improvement in gross margin rates of 170 basis points for both the second quarter and first six months of fiscal 2009. The increase in gross margin rates was the result of cost productivity projects, as well as the net impact of pricing in excess of commodity cost increases. The improvement in net sales and gross margin rates were partially offset by increases in SG&A spending, primarily related to higher research and development costs and increased variable compensation.
Global Professional
Global Professional segment net sales were $74.5 million for the second quarter and $140.0 million for the first six months of fiscal 2009, a decrease of 25.1% and 13.5% from the second quarter and first six months of fiscal 2008, respectively. Organic net sales, which excludes the effect of exchange rates, decreased by 10.6% for the second quarter and were essentially flat for the first six months of fiscal 2009. Pricing actions increased net sales by 11.3% and 16.1% for the second quarter and first six months of fiscal 2009, respectively. The decrease in net sales for the second quarter was driven primarily by volume declines in North America resulting from a decline in category demand and a reduction in grower and distributor inventory.
Global Professional segment operating income decreased $8.3 million in the second quarter of fiscal 2009, or $6.1 million excluding the impact of foreign exchange rates. The decrease in operating income was primarily driven by declines in gross margins. Operating income decreased by $0.8 million for the first six months of fiscal 2009, and increased by $3.2 million excluding the impact of foreign exchanges rates. The increased operating income for the first six months of fiscal year 2009 was driven by improved year-to-date gross . . .
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