Business context and reporting period
The Scotts Miracle-Gro Company’s unaudited Form 10-Q covers the three and nine months ended July 1, 2017, compared with periods ended July 2, 2016. The company sells consumer lawn and garden products, operates indoor and hydroponic gardening businesses, and earns commissions under its Monsanto Roundup marketing agreement. Sales are highly seasonal, concentrated in the second and third fiscal quarters.
Results are presented on a continuing-operations basis following the April 2016 contribution of Scotts LawnService to the TruGreen joint venture, in which Scotts retained a 30% interest.
Financial performance
| Metric | Three months ended July 1, 2017 | Three months ended July 2, 2016 | Nine months ended July 1, 2017 | Nine months ended July 2, 2016 |
|---|---|---|---|---|
| Net sales | $1,078.0 million | $994.1 million | $2,528.2 million | $2,433.8 million |
| Gross profit / margin | $415.2 million / 38.5% | $357.4 million / 36.0% | $961.7 million / 38.0% | $895.7 million / 36.8% |
| Income from operations / margin | $245.6 million / 22.8% | $216.9 million / 21.8% | $476.6 million / 18.9% | $488.4 million / 20.1% |
| Income from continuing operations | $151.9 million | $127.0 million | $252.9 million | $273.5 million |
| Diluted EPS from continuing operations | $2.53 | $2.06 | $4.17 | $4.40 |
| Net income | $151.9 million | $212.7 million | $252.3 million | $341.7 million |
Third-quarter sales rose 8.4% and continuing-operations income rose 19.6%. For the first nine months, sales rose 3.9%, while continuing-operations income fell 7.5%. Prior-year net income was boosted by discontinued-operations income, including the gain on the SLS contribution; it is therefore not directly comparable with 2017 net income.
Segment sales and profit (loss) for the three and nine months, respectively: U.S. Consumer sales were $792.2 million and $1,880.1 million, with segment profit of $246.6 million and $522.5 million; Europe Consumer sales were $93.2 million and $222.9 million, with segment profit of $13.3 million and $23.2 million; Other sales were $192.6 million and $425.2 million, with segment profit of $23.8 million and $44.5 million. Segment profit is a non-GAAP measure.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow was $82.4 million, versus cash used of $28.9 million a year earlier. The company attributed the improvement principally to lower working-capital use. Capital expenditures were $42.0 million, compared with $35.7 million.
- Investing activities used $126.4 million, including $89.2 million for acquisitions. Financing activities provided $111.0 million; the company paid $89.4 million in dividends and spent $173.8 million repurchasing shares.
- Cash was $119.1 million at July 1, 2017, versus $77.2 million a year earlier. Total debt was $1,717.7 million, up from $1,512.8 million; current debt was $289.1 million and long-term debt was $1,419.7 million.
- The company reported $1.1 billion of availability under its credit agreement, subject to covenant compliance. Its receivables facility had no remaining availability and expires August 25, 2017. At July 1, the leverage ratio was 3.03 against a maximum of 4.50; interest coverage was 7.98 against a minimum of 3.00. The company reported compliance with debt covenants.
- Average debt interest rate was 4.4% for the nine-month period. The company had $250 million of 5.250% senior notes due 2026 and $400 million of 6.000% senior notes due 2023.
Material changes and outlook
- Third-quarter sales growth reflected acquisitions, pricing and higher volume; the Other segment’s sales rose 36.4%, mainly from acquisitions and hydroponic product volume. Nine-month U.S. Consumer sales declined 1.5%, while Europe Consumer sales declined 5.9%.
- Gross margin improved in both comparison periods, supported by pricing, product mix and lower fertilizer input costs. Acquired businesses weighed on margin. Nine-month operating income was lower partly because prior-year restructuring and other recoveries did not recur, while SG&A and interest expense increased.
- Interest expense rose $4.9 million in the quarter and $6.6 million year to date, reflecting higher average borrowings and, in part, the issuance of the 5.250% notes. Acquisitions and share repurchases contributed to higher borrowings.
- On July 5, 2017, the company accepted an offer to sell consumer lawn and garden businesses in specified international markets. Expected consideration is approximately EUR 210 million, subject to adjustment, plus up to EUR 20 million contingent on performance. Closing was expected in the fourth quarter of fiscal 2017, subject to conditions and approvals; the agreement also provides for a EUR 25 million vendor-financing loan.
- Management expected to remain within leverage and interest-coverage covenant limits through fiscal 2017 under its current operating assumptions, but warned that weaker earnings or higher debt could threaten compliance. The filing gives no specific earnings or revenue guidance.
- Risks include seasonal and weather-sensitive demand, foreign-exchange movements, commodity prices, and contingencies. The company disclosed asbestos-related claims and a certified class action concerning recalled wild bird food; it said probable losses could not be reasonably estimated and recorded no accrual for these matters. It also reported environmental accruals of $5.0 million.
Important facts for investors to verify
- Whether the international-business sale closed on expected terms, including final proceeds, contingent consideration, and required approvals.
- Whether seasonal cash generation, working capital and operating performance support debt service and continued covenant compliance; particularly the status of the receivables facility after its August 2017 expiry.
- How acquisition-driven growth and margins develop in the Other segment, and whether U.S. Consumer volume weakness persists.
- The financial impact, if any, of the bird-food class action, asbestos claims, environmental matters and outstanding tax audits.
- Capital allocation following $175.1 million of year-to-date share repurchases: the board raised the quarterly dividend from $0.50 to $0.53 per share on August 1, 2017.