Scotts Miracle-Gro Company — FY2016 Form 10-K
Reporting period: Fiscal year ended September 30, 2016, including fourth-quarter results. Scotts sells branded lawn and garden products and is expanding into hydroponics and indoor gardening. Figures below are in U.S. dollars.
Financial performance
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $2,836.1 million | $2,728.0 million |
| Gross profit / gross margin | $995.4 million / 35.1% | $908.0 million / 33.3% |
| Operating income | $459.3 million | $262.1 million |
| Continuing-operations income | $253.3 million | $137.8 million |
| Diluted EPS from continuing operations | $4.09 | $2.23 |
| Net income | $314.8 million | $158.7 million |
| Operating cash flow | $237.4 million | $246.9 million |
| Capital expenditures | $58.3 million | $61.7 million |
| Total debt | $1,316.1 million | $1,157.6 million |
Adjusted diluted EPS from continuing operations, a non-GAAP measure, was $3.90 versus $3.17. Cash and cash equivalents were $50.1 million; working capital was $398.6 million and the current ratio was 1.7. Operating cash flow declined despite higher earnings, principally reflecting working-capital movements. The company reported $1.2 billion of availability under its revolving credit agreement and was compliant with debt covenants. Leverage was 3.10 against a maximum of 4.50; interest coverage was 7.88 against a minimum of 3.00.
Material changes and notable items
- Sales rose 4.0%. Acquisitions and volume supported growth, while foreign exchange reduced sales by 0.8 percentage points. Gross margin improved 1.8 percentage points, with lower input and distribution costs, pricing, and Roundup-related income contributing.
- U.S. Consumer sales increased 2.1% to $2,187.4 million. Europe Consumer sales fell 10.0% to $274.2 million, including the impact of exiting the U.K. Solus business and unfavorable currency. Other-segment sales increased 33.0% to $374.5 million, driven largely by indoor-gardening acquisitions.
- Reported operating income and earnings benefited from a $55.4 million net recovery associated with insurance reimbursements for Bonus S fertilizer claims, compared with substantial charges in FY2015. The filing reports $39.5 million of impairment, restructuring and other recoveries from continuing operations in FY2016. Adjusted measures were lower than reported results.
- On April 13, 2016, Scotts contributed Scotts LawnService to a TruGreen joint venture for an approximately 30% interest. The transaction generated a $131.2 million pre-tax gain; discontinued operations reported $61.5 million of income, including the gain. Scotts received a $196.2 million distribution and retained an $18.0 million second-lien loan investment. It recognized $7.8 million of equity-method income from the venture.
- Acquisitions included a 75% economic interest in Gavita for $136.2 million and a Canadian growing-media operation for an estimated $33.9 million. The company also made a $72.0 million loan to Bonnie Plants/AFC at a fixed 6.95% coupon. After year-end, on October 3, 2016, it acquired Botanicare for an estimated $90.0 million.
- Fourth-quarter continuing-operations loss was $20.2 million, with diluted loss per share of $0.33; the business is highly seasonal, with more than 75% of annual sales generally in the second and third quarters.
Outlook, risks and contingencies
Management expected FY2017 capital expenditures to be consistent with recent spending and expected to remain within financial covenants under its current operating assumptions. The filing provides no specific FY2017 revenue or earnings guidance. Management’s strategy emphasizes growing core U.S. brands and newer categories, extracting value from non-core assets, and generating cash for investment and shareholder returns.
- Customer concentration is significant: Home Depot, Lowe’s and Walmart together accounted for 61% of FY2016 sales and 56% of year-end receivables. Sales are seasonal and exposed to weather, consumer demand, retail inventory decisions and competition.
- Debt increased year over year. Covenants, variable-rate exposure and the company’s ability to generate seasonal cash flow are important; $185.0 million of debt was current at year-end. The $400 million 6.000% senior notes mature in 2023.
- Roundup is an important earnings and cost-absorption source, and the company’s marketing rights depend on its agreement with Monsanto. The filing identifies termination of that agreement as a material risk.
- Bonus S claims and insurance recoveries have been significant and are not necessarily recurring. The company reported cumulative costs of $73.8 million and reimbursement payments of $60.8 million through FY2016.
- Unresolved litigation includes asbestos-related claims associated with historic vermiculite use and putative class actions concerning recalled wild bird food. Losses could not be reasonably estimated and no reserves were recorded for these matters. Environmental remediation accruals were $4.0 million.
- Other disclosed risks include pesticide and environmental regulation, raw-material and fuel costs, foreign exchange, acquisition integration, emerging-market regulation, and pension funding. The company increased its quarterly dividend 6% to $0.50 per share and raised its repurchase authorization by $500 million; remaining authorization was $854.3 million at September 30, 2016.
Investor verification priorities
- Reconcile reported earnings with adjusted results and identify the effects of Bonus S insurance recoveries, restructuring items and the TruGreen contribution gain.
- Assess cash conversion, seasonal working-capital needs, debt maturities, revolver availability and covenant headroom.
- Track the performance and integration costs of Gavita and other indoor-gardening acquisitions, plus the economics and collectability of the Bonnie and TruGreen-related investments.
- Review customer concentration, Roundup agreement terms, and the status of Bonus S claims, asbestos litigation and the bird-food class actions.
- Confirm whether FY2017 capital spending, dividends and share repurchases remain consistent with cash generation and leverage targets.