Scotts Miracle-Gro Company — Q1 FY2017 10-Q
Reporting period: Three months ended December 31, 2016; comparisons are with the three months ended January 2, 2016. The company manufactures and markets consumer lawn and garden products and has expanded into hydroponic and indoor gardening. Results are highly seasonal: more than 75% of annual sales have historically occurred in fiscal Q2 and Q3, so Q1 results are not necessarily indicative of the full year.
Key financial metrics
| Metric | Q1 FY2017 | Prior-year quarter |
|---|---|---|
| Net sales | $246.8 million | $194.5 million |
| Gross profit / gross margin | $44.2 million / 17.9% | $16.7 million / 8.6% |
| Operating loss | $70.9 million | $97.7 million |
| Loss from continuing operations | $64.3 million; $1.08 diluted loss per share | $79.3 million; $1.30 diluted loss per share |
| Net loss attributable to controlling interest | $65.3 million | $81.3 million |
| Net cash used in operating activities | $209.8 million | $338.6 million |
| Cash and cash equivalents at quarter-end | $88.7 million | $49.0 million |
| Total debt at quarter-end | $1,728.2 million | $1,527.7 million |
Net sales increased 26.9%, led by acquisitions and higher volume. Gross margin improved 9.3 percentage points, reflecting product mix, acquisition contribution, lower input costs, improved fixed-cost absorption, favorable fuel-hedge mark-to-market effects, and fewer prior-year product-claim charges. SG&A rose $5.8 million to $119.1 million, including higher acquisition-related costs and amortization. Interest expense declined to $15.6 million from $16.3 million.
Investing activities used $94.0 million, including $77.9 million for acquisitions and $16.1 million in capital expenditures. Financing activities provided $345.2 million, including issuance of $250 million of 5.250% senior notes due 2026; the proceeds repaid credit-facility borrowings. The company paid $30.0 million in dividends and repurchased $43.4 million of shares. The declared dividend was $0.50 per share.
Material changes and segment results
- U.S. Consumer: Sales rose 10.9% to $125.5 million; segment operating loss improved to $38.0 million from $54.2 million, driven by higher sales, favorable mix and lower distribution and material costs.
- Europe Consumer: Sales fell 5.1% to $24.4 million, affected by foreign exchange, lower pricing and the prior-year exit from the U.K. Solus business. Segment operating loss improved to $8.4 million from $9.2 million.
- Other: Sales increased 74.3% to $96.9 million, principally from acquisitions including Gavita, Botanicare and a Canadian growing-media business. Segment operating income rose to $5.6 million from $0.5 million.
- Acquisitions were the primary source of growth in Other. Botanicare was acquired in October 2016 for $92.6 million, including contingent consideration; its Q1 sales were $9.9 million. The company also completed two smaller U.S. Consumer acquisitions.
- Debt increased from September 30, 2016, partly reflecting acquisition and investment activity and share repurchases. The company terminated its receivables purchase agreement in October 2016 and said it expects credit-facility availability to meet funding needs.
Outlook, risks and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management anticipated a first-quarter net loss because sales are concentrated in spring and summer, and said it expects to remain within debt covenant limits during FY2017 under current operating assumptions.
- At December 31, 2016, revolving-credit availability was approximately $0.8 billion, subject to covenant compliance. The leverage ratio was 3.10 against a maximum of 4.50; interest coverage was 8.25 against a minimum of 3.00. Management cautioned that weaker earnings, increased indebtedness or other factors could threaten compliance and potentially require a lender amendment or waiver.
- The 30% equity-method investment in the TruGreen joint venture generated $13.2 million of equity-method losses, including $9.6 million for the company’s share of TruGreen restructuring and other charges. TruGreen reported a $44.0 million net loss for the quarter.
- The quarter included $5.4 million of other income, including loan interest and royalty income related to TruGreen. Currency-forward contracts generated a $9.2 million gain recognized in other income.
- The company reported $73.8 million of cumulative costs related to complaints about reformulated Bonus S fertilizer, partly offset by $60.8 million of insurance recoveries. No new claim costs were recorded in the quarter. The filing says asbestos-related claims and a consolidated bird-food class action have no reasonably estimable probable loss; no reserves were recorded for those matters.
- Environmental matters, product and general-liability claims, weather variability, foreign exchange and commodity prices remain risks. Management says environmental reserves are believed adequate, but cannot assure that proceedings will not affect future results. Risk factors were reported as not materially changed from the 2016 Form 10-K.
Important facts for investors to verify
- Whether acquisition-driven sales growth and improved gross margin persist through the peak selling quarters, and how acquired businesses contribute to cash generation.
- Seasonal working-capital needs, particularly the buildup and management of inventory, and the company’s ability to convert peak-season sales into operating cash flow.
- Debt levels, credit availability, covenant headroom and the effects of continued acquisitions, dividends and share repurchases on leverage.
- TruGreen’s operating performance and the extent to which restructuring costs or additional losses affect Scotts Miracle-Gro’s equity-method results.
- Developments in Bonus S claims and insurance recovery, as well as asbestos, bird-food, environmental and other legal contingencies.