The O.M Scott & Sons Co.

Background:
The O.M Scott & Sons company was first introduced in 1868 with their main selling product
being weed-free grass seed. Between the 1930s to the 1940s O.M Scott & Sons company grew steadily
reaching 2.7 million in sales. In the next decade, Scott pioneered new products and ultimately increased
sales to 11.4 million in 1955. In the next six years, Scott launched new programs to continue to expand
growth. In 1959 O.M. Scott & Sons pinned a new goal of 25% annual growth in sales and profits for the
upcoming years. O.M. Scott & Sons invested in inventory, followed seasonal financing payment plan but
also created a new trust receipt plan to entice dealers to commit to more inventory. Ultimately, O.M.
Scott & Sons entered financial stress as long term debt and credit line continued to grow to 12.5 million
in parent debt and 4.1 million in subsidiary debt amounting to 16.6 million total in 1961. The amount of
debt held restrained potential growth. In this case, the points that will be taken into account in looking at
O.M. Scott & Sons company are the following dive into the factors that contributed to the growth of the
company, analyze the companys shares, projection of sales for coming years 1962 and 1963, and last a
conclusion on what actions O.M. Scott & Sons should take to improve its internal financial operations.
The many factors that contributed to the growth revolved around the wide range product line,
distribution system, pending competition, inventory system, and lastly dealer payment. Scott had control
of the market, however newly found competition was developing. In response, Scott determined to push
for immediate market penetration and aimed for the 25% increase in annual sales. The leading factor for
national growth was the new inventory system put in place. Inventory that dealers were carrying for
Scott was capping the growth potential. During demand seasons dealers needed to carry more products.
However, inventory needed to be financed by the Scott company itself. Scott produced the inventory
necessary, and introduced a new payment plan of trust receipts. Trust receipts were initiated to secure
inventory and allow dealers to take on more inventory at the expense of O.M. Scott & Sons. This
ultimately lead to the lengthening of account receivables and debt.

Share Price
The stock price of O.M. Scott & Sons increased from an average price per share of $3.80 in
1958 to $19.50 in 1959, or a 413% increase (exhibit 1A). The stock continued to climb 125% to an
average share price of $41.44 in 1960 due to the growth in net income and consequently, earnings per
share. O.M. Scott & Sons average stock price shows a decline in growth from 1960 to 1961. Net
income dropped 12% and earnings per share proceeded to fall 22%. This is scary for investors since all
of their dividends up until this point were all paid in stock rather than cash.

Dividends
In order to help ease the tension with shareholders, O.M. Scott & Sons decided to make a change
to their dividend payout policy at the beginning of 1961 and began paying out a combination of .10 cents
plus 10% stock dividend per share. Although receiving a cash payout may have looked better for
investors, the total value of the dividend had decreased. As shown in Figure 1c, the cash value of the
10% stock dividend in 1960 was equivalent to a payout of $4.14 per share. Once the dividend policy
changed in 1961, the value of the dividend dropped to a value of $2.32 per share. With the value of the
dividend payout declining 44% for O.M. Scott & Sons in 1961, the firm was able to retain more equity
in the company.
 The stock price and dividend payouts show that the company was utilizing all of its retained
earnings to help fuel quick growth through 1958-1960. The company decided to take on more debt than
they should have in 1960 and 1961. The debt O.M. Scott & Sons took on held high interest expenses
which hurt the bottom line of the company, and in turn the earnings per share and stock price. In lieu of
this decline, O.M. Scott & Sons decided to change their dividend payout policy to pay out less equity but
include a small cash dividend. O.M. Scott & Sons should continue with the .10 cent + 5% stock
dividend for the foreseeable future, or until the company feels more confident in their financial position
to begin paying out more cash dividends from the company.

Accounts Receivable
After analyzing O.M. Scott & Sons 5 years of financial statements we have identified some
items of concern. First and potentially the most important issue which needs to be addressed is the AR
collection period. As presented in exhibit (2A) the Net Accounts Receivable Days has increased from 52
days in 1957 to 182 days in 1961. This has caused the companys AR to skyrocket to $21.5MM at the
end of 1961. This increase in AR days has extended the cash cycle which is not good for the company. It
has caused the company to fall behind on interest payments and has put stress on funding operational
expenses.
The root cause of the AR Days extension began in 1959. You will notice in from 1959 to 1960
AR went from $5.7MM to $15.7MM a 175% increase exhibit (2A). Conversely the Inventory amounts
went from 6.9MM to 3.9MM a 43% reduction. This means AR and Inventory were inversely related.
This can be explained by the sales strategy O.M. Scott & Sons had in place. In 1959 they began a large
effort to stock their customer shelves with product in advance. However, this plan resulted in distributors
having overstocked inventories for the current demand levels. Since their customers couldnt sell the
product it ultimately caused them to delay/default on their obligations to pay O.M. Scott & Sons.

Fixed Assets:
In 1959 the company made a substantial investment in fixed assets to produce additional
product/inventory. Net Fixed Assets increased from 1.8M to 6.1MM in 1959 a 239% increase (exhibit
2A). Although this capital investment contributed to the over extension in the company, we do not
believe it was a critical mistake. They appear to have slowed their investment in fixed assets in 1960 and
1961 which makes the 1961 fixed asset turnover ratio of 7.05 more appealing.

Debt:
Over the 5 year period O.M. Scott & Sons has increasingly taken on more debt. The sales plan in
1959 required funding for increased inventory and fixed asset investments. The company used
substantial debt financing to fund these activities including 9MM of subordinated promissory notes in
1960. By the end of 1961 the company has 16.6MM in Interest Bearing Debt which has driven their
average leverage ratio (IBD/NW) to 1.35 (exhibit 2B) and their overall debt to equity ratio to 2.07. These
ratios are high considering the industry standards and may indicate solvency issues later down the road.
On a positive note, the company has a robust Fixed Charge Coverage ratio throughout the 5 years ending
up at 1.54 in 1961. This means they have plenty of cash flow to cover their debt service currently,
however we should note the FCC ratio has declined the last 3 years, which correlates with increasing
debt and interest expense. (exhibit 2C).
Profitability and Growth:
Net profit margin stayed in a tight range between 2.4% and 4.9% over the 5 years, ending up at
3.6% in 1961. Also, gross profit is constant, this is a plus since it means COS is reliable and repeatable,
therefore the company does not have a manufacturing problem (exhibit 2B). However, an issue arises
when analyzing the pivotal year of 1959. The increased sales in 1959 are misleading. The company has
artificially pulled forward revenue by counting the consignment type deals as actual sales. These sales
have turned out to be contingent on the resale of the product by the customer. This artificial spike in
revenue in 1959 created a misleading sustainable growth rate of 25.6% in 1959 (exhibit 2D). In fact, the
sustainable growth rate dropped to 19% and 15% the following 2 years. This demonstrates how investors
can be misled when basing decisions strictly on top line sales and growth rates.

DuPont Analysis:
Decomposing the ROE in 1961 into its component parts reiterates our story of O.M Scott &
Sons Company. We note here that the financial leverage of the company is 3.07 which explains that the
company has raised more debt than equity. This aspect ramifies that the company has also increased their
interest expense which impacted their operating efficiency. The fact that the profit margin is at 3.64%
tells us that they should raise equity as opposed to debt thereby decreasing their interest expenses and
increase their profit margins.

1,570.7 43,140.10 35,739.80

= X X = 3.64% X 1.207 X 3.078 = 13.53%
43,140.10 35,739.80 11,610.00

Projections and their implications:

O.M Scott & Sons Company has had a tremendous record of growth in sales and profits since
World War II. Their constant dissatisfaction that their sales and profits were not up to mark empowered
them to actively identify strategies crucial to their growth. In 1959, the company had estimated the
annual market potential sales of at least $100 million for Scott products. Immediate market penetration
was their most fundamental strategy around which they have been planning to build-up their financial
strength. O.M Scott & Sons Company projected an annual growth rate in sales and profits up to 25% to
achieve the $100 million sales mark. In the Exhibit 3A, we projected the financial statements reflecting
the growth rate of 25%. Note that the company requires additional external funding either by issuing
subordinated promissory notes or by issuing equity worth of about 8.2 million in 1962 and 16 million in
1963.
A sensitivity analysis on the growth rate gives us interesting results. If we consider the growth
rates of sales since 1957, we get an average growth rate of about 23.43%. Applying the rate to the
statements yields the company profits of up to $1.6 million for the year 1962 and $2.3 million for the
year 1963. This projection seems realistic because it assumes every other strategy contributing to the
growth of the company to be constant. A pro forma sensitive to the companys sustainable growth rate
helps us to understand that it could balance the debt to equity ratio and move the business toward
reasonable growth. This projection provides the company with profits of up to $1.4 million in the year
1962 and $1.6 million in the year 1963.
A key implication in running the analysis on the growth rate of sales gives us the big picture;
External Financing. O.M Scott & Sons Company requires an additional external financing of about $8.2
million for the year 1962 and 16 million for the year 1963 (See Exhibit-3B). A growth rate based on
Historical Growth Average requires the company to receive additional funds of about $13.6 million and
$14.7 million for the years 1962 and 1963 respectively. A sustainable rate of growth requires the
company to receive additional funding of about $12.9 million and $15.7 million.
One way the O.M Scott & Sons Company can deal with the external funding is that they can
revamp their strategy of piling up their dealer inventory for seasonal dating. Currently 50% of O.M Scott
& Sons Companys sales account to their debtors. With account receivables turnover skyrocketing to 182
days as of 1961, the company is already potentially increasing their chances of bad or doubtful debts. If
the company accelerates their credit payment by at least 50% of their receivable levying some
considerable incentive to their debtor, they could well be able to offset their requirements for external
funding to a significant extent. They could also pay off their debts as much as possible to bring their debt
to equity ratio to a healthy level which thereby could make the projections in the exhibit 3A & 3B more
realistic. Note the projected Income Statements and Balance Sheets in the Exhibits 3A & 3B does not
capture a detailed distribution of retained earnings to dividend payouts and the companys income
retentions. Had we received the data or the Statement of Shareholders Equity, the scenario of
projections could be influenced. If a question arises as to how the company deals with their seasonal
sales requirements, the company can hold the inventory or reduce the advanced consignment of the
inventory to less days so that they reduce their holding costs and also avoid trusting more on their
dealers.

Recommendations
As the preceding analyses show, Scotts current growth model is not viable as its financial
position is not sustainable. The companys debt to equity ratio grew too large due to lengthening of the
accounts receivable outstanding and aggressive PPE growth to support fabricated demand. This made it
increasingly difficult to settle debts and keep enough cash flow through the books to be internally self-
sufficient.
Based on this, it is our recommendation that Scott & Sons take the following actions. Transition
the current retailer credit programs to more favorable terms for Scott & Sons. At the same time, increase
the current early payment discount to 1%-2% to shorten AR turnover. This should also be done in
conjunction with a switch to a pull based production cycle from the current push based. This will result
in a reduction in inventory and the related inventory costs. However, this reduction will result in a drop
in capacity utilization of the previously acquired PPE assets. As such, it is recommended to liquidate a
portion of those fixed assets so that capacity utilization based on real demand is at a desired and
financially sustainable rate.
Scotts plan to fund its effort to flood the market with inventory in an attempt to gain market
share internally through its retained earnings is not a long-term solution as outlined. As a result, external
funding will be required to achieve 25% real growth. Taking into account Scotts current interest
payments, which have increased 466% between 1957 and 1961, current interest rate levels, and Scotts
D/E, it is our recommendation that Scott issue shares to fund operations and refinance current loans to a
more favorable interest rate.

Exhibits:
Exhibit 1A

Exhibit 1B

Exhibit 1C
Exhibit 2A
Exhibit 2B

Exhibit 2C
Exhibit 2D
Exhibit 3A
Exhibit 3B
References:

Brealey, Richard A., et al. Principles of Corporate Finance. McGraw-Hill Education, 2017.

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