Scotts Miracle-Gro Co. — Q2 FY2017 Form 10-Q
Reporting period: The 13 weeks and six months ended April 1, 2017. Unless noted, financial figures are in millions of dollars. The lawn and garden business is seasonal: the second and third fiscal quarters together historically account for more than 75% of annual sales.
Financial performance
| Metric | Three months ended Apr. 1, 2017 | Prior-year quarter | Six months ended Apr. 1, 2017 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $1,203.5 | $1,245.2 | $1,450.3 | $1,439.7 |
| Gross profit | $502.4 | $521.6 | $546.6 | $538.3 |
| Gross margin | 41.7% | 41.9% | 37.7% | 37.4% |
| Income from continuing operations | $165.3 | $225.8 | $101.0 | $146.6 |
| Diluted EPS from continuing operations | $2.73 | $3.64 | $1.65 | $2.35 |
| Net income attributable to controlling interest | $165.1 | $210.1 | $99.8 | $129.0 |
| Income from operations | $301.9 | $369.2 | $231.0 | $271.5 |
Quarterly sales fell 3.3%, mainly from lower U.S. Consumer volume and reduced Roundup-related sales, partly offset by acquisitions and pricing. Six-month sales rose 0.7%; acquisition growth and pricing offset lower volume and unfavorable foreign exchange. Quarterly diluted EPS from continuing operations declined 25%; six-month diluted EPS declined 30%.
Segment sales for the quarter were U.S. Consumer $962.5 million (down 7.4%), Europe Consumer $105.3 million (down 8.4%), and Other $135.7 million (up 49.9%). Other’s growth reflected acquisitions and hydroponic gardening products. U.S. Consumer sales weakened in fertilizer, growing media, grass seed and controls; Roundup for Lawns sales increased.
Cash flow, balance sheet and debt
- Operating cash flow was a use of $497.8 million in the first six months, compared with a $627.8 million use a year earlier. Management attributed the improvement primarily to lower working-capital investment; seasonal receivables and inventory uses remained substantial.
- Investing cash use was $106.1 million, including $77.9 million for acquisitions and $32.8 million in capital expenditures. Financing provided $629.8 million. Cash ended the period at $74.3 million.
- Total debt was $2,096.4 million, including $32.1 million current debt; long-term debt was $2,055.1 million. The reported weighted-average debt interest rate for the six months was 4.3%. Cash less total debt implies net debt of approximately $2,022 million.
- Credit-facility availability was approximately $0.5 billion, subject to covenant compliance. The leverage ratio was 3.20 against a maximum of 4.50; interest coverage was 7.81 against a minimum of 3.00. The company reported compliance with debt covenants.
- Current assets were $2,009.6 million and current liabilities $744.7 million. Accounts receivable of $1,121.3 million and inventory of $658.5 million reflect the seasonal operating cycle.
- Dividends declared were $0.50 per share for the quarter and $1.00 for the six months. The company repurchased approximately 1.0 million shares for $90.6 million in the six-month period.
Material changes and unusual items
- Other segment results included acquisitions, notably Botanicare, acquired in October 2016. Acquired businesses drove substantial Other-segment sales growth, but management said acquisitions diluted consolidated gross margin.
- The company recorded equity-method losses of $24.1 million for the quarter and $37.3 million for the six months from its 30% TruGreen joint-venture interest. TruGreen reported net losses of $80.1 million and $124.1 million for those periods, respectively; Scotts’ share included restructuring and other charges.
- Comparisons were affected by prior-year recoveries: the prior-year quarter included a $50.0 million insurance recovery related to Bonus fertilizer complaints, contributing to a $47.2 million operating-expense recovery. Current-period restructuring and other operating charges were $3.3 million for the quarter. The filing reports cumulative Bonus-related costs of $73.8 million, partly offset by $60.8 million in insurance recoveries.
- Scotts contributed its former Scotts LawnService business to TruGreen in April 2016 for a 30% interest; it is reported as a discontinued operation. The current-period discontinued-operation loss was $0.1 million for the quarter and $0.7 million for the six months.
- After quarter-end, Scotts received a conditional, binding offer to sell specified international consumer lawn and garden businesses for approximately EUR 210 million, subject to adjustments, plus up to EUR 20 million contingent consideration. If it does not accept after the specified French works-council process, a EUR 10 million break fee may apply. The transaction remained an offer, not a completed sale, as of the filing.
Outlook, risks and contingencies
The filing provides no clear numerical full-year revenue or earnings guidance. Management said it expects to remain within leverage and interest-coverage covenant limits during FY2017 under current operating assumptions, while warning that earnings shortfalls, higher debt or other factors could threaten compliance and require a waiver or amendment. The company emphasizes weather sensitivity and seasonality; it also identifies uncertainty around demand for hydroponic products and rapidly changing laws and consumer perceptions affecting potential end uses, including cannabis cultivation.
Contingencies include a bird-food class action certified on March 31, 2017, seeking hundreds of millions of dollars in damages and other relief. The company disputes the claims, intends to defend the case, and recorded no reserve because a probable loss could not be reasonably estimated. Environmental matters had $5.1 million accrued; management said known exposure estimates were adequate, but litigation and other contingencies could still affect results. The company also has ongoing tax audits, with timing and cash settlements uncertain; management did not expect their resolution to cause a material financial impact.
Most important facts for investors to verify
- Whether seasonal sales and collections in the remaining fiscal year convert the first-half operating cash outflow into stronger full-year cash generation.
- Whether U.S. Consumer volume stabilizes and whether acquisition-led Other-segment growth improves profitability without further pressure on gross margin.
- The size and duration of TruGreen-related equity losses and any resulting distributions or additional support needs.
- Debt, covenant headroom, share repurchases and dividends, particularly if earnings weaken or borrowing rises.
- The outcome and terms of the proposed international-business sale, including conditions, contingent proceeds, vendor financing and any break fee.
- Developments in the bird-food class action, Bonus product claims, environmental matters and regulatory exposure affecting hydroponic products.