SCOTTS MIRACLE-GRO CO annual report, FY2015

Business context and reporting period

The Scotts Miracle-Gro Company’s Form 10-K covers the fiscal year ended September 30, 2015. The company sells branded lawn and garden products through its Global Consumer segment and provides lawn, tree, shrub and pest-control services through Scotts LawnService. Results are highly seasonal: more than 75% of annual sales occur in the second and third fiscal quarters combined.

Financial performance and position

FY2015 adjusted income from operations was $386.1 million versus $365.6 million in FY2014; the company excluded $91.5 million of impairment, restructuring and other charges in FY2015. Adjusted measures are non-GAAP and should be considered alongside reported results.

Global Consumer sales rose 5.8% to $2,701.0 million; Scotts LawnService sales rose 9.7% to $288.5 million. International sales were $508.0 million, or 16.8% of consolidated sales. In the fiscal fourth quarter, sales were $483.2 million and the company reported a $24.6 million loss from continuing operations, including restructuring and Bonus S-related charges.

Material changes versus the prior year

• Consolidated sales increased 6.2%, driven by acquisitions and higher volume, partly offset by unfavorable foreign exchange and pricing. Acquisitions contributed 4.9 percentage points and volume 4.4 points; foreign exchange reduced growth by 2.7 points.
• Reported operating income declined $20.0 million, while adjusted operating income increased 5.6%. Gross margin fell 1.0 percentage point, reflecting product mix, acquisitions, lower pricing and higher grass seed and growing-media costs.
• In FY2015 the company paid Monsanto $300 million for expanded Roundup marketing rights, brand-extension rights and access to technology and commercialization opportunities. It also acquired General Hydroponics and Vermicrop, growing-media businesses, and Action Pest.
• Debt increased by $379.0 million year over year, reflecting the Monsanto payment and acquisitions, among other financing needs. Operating cash flow was broadly stable; investing activities used $536.4 million, including the Monsanto payment and acquisitions.
• FY2014 included a $2.00-per-share special dividend; FY2015 dividends paid were $111.3 million. The recurring quarterly dividend was raised to $0.47 per share in August 2015.

Outlook, commentary, risks and unusual items

Management expected FY2016 capital expenditures to be consistent with recent spending and allocations, and stated it expected to remain within credit-facility leverage and interest-coverage requirements based on current operating assumptions. The filing does not provide a clear numerical FY2016 revenue or earnings guidance figure. Management cited weather, consumer demand, acquisitions and cost leverage as important influences on performance.

• Bonus S claims: Consumer complaints concerning the reformulated fertilizer, sold in the southeastern United States, led to $62.4 million of FY2015 costs, including expected claims; $4.9 million of insurance reimbursements had been received. The company had paid $42.7 million to its third-party administrator for lawn repairs. Additional insurer recoveries and ultimate claim costs remain uncertain.
• Debt and liquidity: The company reported a 2.63 leverage ratio against a 4.50 maximum and 9.34 interest-coverage ratio against a 3.00 minimum. It reported $861.0 million of availability under the former credit facility at year-end. Subsequent to year-end, it entered a $1.9 billion credit agreement, issued $400 million of 6.000% notes due 2023, and gave notice to redeem its $200 million 6.625% notes; these are subsequent events, not year-end balances.
• Customer concentration: Home Depot, Lowe’s and Walmart represented 63% of Global Consumer sales and 54% of accounts receivable. The company has no long-term sales agreements with major retail customers.
• Roundup dependence: The Monsanto relationship generated $67.9 million of net commission income and $131.2 million of total sales associated with the agreement in FY2015. Termination could materially reduce earnings and overhead absorption, although the 2015 amendments expanded rights and protections.
• Other risks and contingencies: Risks include seasonality and adverse weather, raw-material prices, foreign exchange, pesticide and environmental regulation, integration of acquisitions and litigation. Environmental liabilities accrued were $5.6 million. Asbestos-related claims and consolidated wild-bird-food class actions had no recorded reserves because probable losses could not be reasonably estimated; the company disputes the claims.

Most important facts for investors to verify

• Track Bonus S claim volume, total costs, insurance reimbursements and any effect on subsequent-period results.
• Reconcile reported earnings with adjusted results, especially the $91.5 million of FY2015 charges and their cash versus non-cash components.
• Assess whether acquisition-led growth and the $300 million Monsanto investment generate returns sufficient to support margins and debt service.
• Monitor debt, seasonal borrowing needs, covenant headroom and the effects of the post-year-end refinancing and note redemption.
• Evaluate exposure to the three largest retailers and the continuing economics and termination provisions of the Monsanto agreements.