Scotts Miracle-Gro Company — Q2 FY2023 Form 10-Q
Reporting period: Fiscal quarter and six months ended April 1, 2023. The company manufactures and markets lawn and garden products and indoor/hydroponic gardening products. Results are seasonal, with sales concentrated in the second and third fiscal quarters. Dollar amounts below are in millions unless noted.
Financial results
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $1,531.5; down 8.8% year over year | $2,058.1; down 8.3% |
| Gross margin | $412.7; 26.9% of sales, versus 35.1% | $508.4; 24.7% of sales, versus 31.5% |
| Operating income | $206.2, down 46.8% | $164.4, down 53.4% |
| Net income / diluted EPS | $109.4 / $1.94, versus $276.5 / $4.94 | $44.7 / $0.80, versus $226.4 / $4.02 |
| Interest expense | $48.3, versus $28.3 | $91.0, versus $52.1 |
Lower sales volume and margin, higher restructuring charges, and increased interest expense drove the decline. Pricing partly offset lower volume. For the six-month period, sales fell 16.7% from volume and mix, partly offset by 8.7% pricing; foreign exchange reduced sales by 0.6%.
- Segments, quarter: U.S. Consumer sales were $1,357.4 (down 1.6%) and segment profit was $397.4 (down 7.3%). Hawthorne sales were $92.7 (down 54.2%) and segment loss was $16.8, versus $3.3 profit. Other sales were $81.4 (down 15.2%) and segment profit was $14.6 (up 39.0%).
- Cash flow, six months: Operating cash use was $566.9, compared with $1,142.6 used a year earlier; investing cash use was $20.6, versus $255.8; financing provided $525.3, versus $1,171.3. Cash ended at $25.0. Operating cash flow benefited from vendor payments extended into the third quarter and a $37.0 seller-financing repayment was classified as investing cash flow.
- Debt and liquidity: Total debt was $3,593.5, including $435.4 current and $3,138.0 long-term. Cash was $25.0; current assets were $2,842.4 and current liabilities $1,372.5. Revolver availability was $852.5. Average credit-facility borrowing rates, excluding swaps, were 7.0% for the six months, versus 1.8%.
Material changes and unusual items
- Impairment, restructuring and other charges totaled $140.5 for the quarter and $159.2 for six months, compared with $5.4 and $7.1, respectively, in the prior-year periods. These included inventory write-downs, employee termination benefits, facility closure costs, and asset impairments.
- The company announced closure of four additional Hawthorne distribution centers, sold its non-core Hurricane fans business for $5.0, and began accelerating inventory reductions. It reported $216.5 of cumulative restructuring costs through April 1.
- Goodwill and intangible assets were $254.3 and $565.5, respectively, compared with $688.1 and $799.9 a year earlier. The filing reports significant Hawthorne restructuring and prior-period intangible impairment; investors should review the related impairment disclosures and carrying values.
- Convertible debt investments had a fair value of $84.8 against an amortized cost basis of $224.0, with $139.2 of gross unrealized losses. The company attributed the decline to conversion-option values, said it believed it would recover cost, and reported no intent to sell or convert.
Outlook, risks and contingencies
- Management raised its expected annualized restructuring savings target to at least $200, up from $185, and expects to substantially complete remaining actions by fiscal year-end. It said savings should improve gross margins and SG&A.
- Management expects continued adverse effects from cannabis oversupply on Hawthorne, and expects inflation, volatile commodity costs, high manufacturing and logistics costs, and higher interest rates to persist through fiscal 2023. No numerical full-year sales or earnings guidance is provided in the supplied filing text.
- The company was in compliance with debt covenants at April 1 and expected to remain compliant over the following 12 months. Its leverage ratio was 6.01 against a 6.50 maximum for the quarter; the maximum tightens over time to 4.50 beginning in the third quarter of fiscal 2024. Interest coverage was 3.66 versus a 3.00 minimum. Management warned that a covenant breach could accelerate debt and trigger cross-defaults; it stated it lacks sufficient cash or available liquidity to repay the relevant $3,192.5 of credit-agreement and senior-note debt in a default. Contingency options include further cost reductions, lender discussions, and financing that could include equity, with no assurance of success.
- The receivables facility expires August 18, 2023; borrowings were $380.0, secured by receivables with a $422.2 carrying value. The seasonal commitment period ends June 16, 2023.
- Management considered recorded accruals for legal and environmental matters adequate, but noted outcomes and defense costs could affect results. It recorded $2.4 of environmental liabilities. Asbestos-related claims were not accrued because loss was not considered probable; the company said it was vigorously defending them.
Most important facts for investors to verify
- Whether operating cash flow improves after the seasonal receivables build and the delayed vendor payments, and how much cash is available after seasonal borrowing needs.
- Progress on Hawthorne inventory reduction, distribution-center closures, restructuring charges, and delivery of the at-least-$200 annualized savings target.
- Quarterly covenant calculations and headroom as leverage limits tighten, including the availability and feasibility of contingency financing if performance weakens.
- Hawthorne demand and margins amid cannabis oversupply, and the persistence of inflation, interest costs, and consumer-volume pressure.
- The recoverability and valuation assumptions for convertible debt investments and other impaired or potentially at-risk assets.