Scotts Miracle-Gro Company — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2018, compared with the periods ended July 1, 2017. Amounts are in millions except per-share data. The company makes branded lawn and garden products and operates U.S. Consumer, Hawthorne (indoor and hydroponic gardening) and Other segments. Results exclude the International Business, sold in August 2017, which is reported as discontinued operations.
Financial performance
| Metric | Three months ended June 30, 2018 | Prior-year quarter | Nine months ended June 30, 2018 | Prior-year period |
|---|---|---|---|---|
| Net sales | $994.6 | $973.4 | $2,229.5 | $2,265.4 |
| Gross profit | $347.6 | $383.4 | $790.9 | $884.6 |
| Gross margin | 34.9% | 39.4% | 35.5% | 39.0% |
| Operating income | $185.7 | $236.1 | $346.1 | $459.5 |
| Continuing-operations income | $125.5 | $144.6 | $258.2 | $240.6 |
| Net income (including discontinued operations) | $82.8 | $151.9 | $210.6 | $252.3 |
| Diluted EPS from continuing operations | $2.23 | $2.41 | $4.50 | $3.96 |
| Total diluted EPS | $1.47 | $2.53 | $3.67 | $4.16 |
- Quarterly sales rose 2.2%, but nine-month sales fell 1.6%. Acquisitions and foreign exchange supported sales; pricing and volume were drags over the nine-month period.
- Gross margin declined 4.5 percentage points in the quarter and 3.5 points year to date. Management cited transportation costs, product mix, higher customer rebates, acquisition mix and restructuring charges.
- Quarterly operating income fell 21.3%; nine-month operating income fell 24.7%. Lower SG&A partly offset lower gross profit and higher impairment and restructuring costs.
- Nine-month continuing income increased despite lower operating income, principally reflecting the lower effective tax rate: 8.3% versus 35.1%, including a $45.9 tax benefit from revaluing deferred tax liabilities under the Tax Act. Quarterly continuing income declined.
Segments and cash flow
- U.S. Consumer: Quarterly sales were $810.9, up 1.2%; nine-month sales were $1,857.1, down 2.4%. Segment profit was $243.1 for the quarter and $491.4 year to date, down 1.3% and 5.8%, respectively.
- Hawthorne: Quarterly sales were $74.2, up 2.5%; nine-month sales were $192.8, down 1.2%. Segment profit was a loss of $3.6 for the quarter and $6.6 for nine months, versus profits of $10.3 and $26.5 in the comparable periods. Management cited lower gross margin and higher SG&A.
- Other: Quarterly sales rose 9.9% to $109.5 and nine-month sales rose 7.1% to $179.6, supported by Canada. Segment profit was $13.1 for the quarter and $10.6 year to date.
- Operating cash flow was a use of $3.4 for nine months, versus cash provided of $91.6 in the prior-year period. Investing cash outflow was $562.3, including $492.9 of net acquisition payments and a $35.3 post-closing payment related to the International Business sale. Financing provided $475.8, primarily reflecting increased borrowings.
- Cash was $29.6 at June 30, 2018, down from $120.5 at September 30, 2017. The business is seasonal, with more than 75% of sales typically in its second and third fiscal quarters.
Debt, liquidity and capital allocation
- Total debt was $2,297.5 at June 30, 2018, including $314.5 current and $1,975.4 long-term debt (net of issuance costs). Total debt was $1,409.7 at September 30, 2017. Interest expense for the nine-month period rose to $63.6 from $58.5.
- At June 30, the company reported $493.3 of availability under its former credit agreement, subject to covenant compliance, and $0.7 available under its receivables facility. Receivables pledged under that facility were $316.7, supporting $285.0 of borrowings.
- On July 5, 2018, after quarter-end, the company replaced its credit agreement with a five-year facility totaling $2.3 billion: a $1.5 billion revolving facility and an $800 million term loan. The company reported a 3.96 leverage ratio versus a maximum of 5.25 and interest coverage of 5.81 versus a 3.00 minimum at June 30; management expected covenant compliance through fiscal 2018 under current assumptions.
- The company repurchased $310.3 of shares during the nine months and declared dividends of $1.59 per share. The credit agreement limits restricted payments unless the resulting leverage ratio is 4.00 or less, or subject to annual caps.
Acquisitions, unusual items, outlook and risks
- On June 4, 2018, Hawthorne acquired Sunlight Supply for an estimated $459.1, including $23.4 paid in company shares and contingent consideration. The acquisition added $23.5 of quarterly sales. Purchase accounting remains preliminary.
- Project Catalyst, launched alongside the acquisition, is intended to reduce costs and capture Hawthorne synergies. Continuing-operations charges were $30.4 in the quarter and nine-month period, including a $17.5 non-cash impairment of previously acquired customer relationship intangibles.
- A $65.0 pre-tax probable-loss charge for the Morning Song Bird Food class action was recorded in discontinued operations, contributing to the reported discontinued-operations loss. The plaintiffs seek substantial damages; the company disputes the claims and plans to defend the case. A separate EZ Seed matter resulted in a $10.2 charge, with settlement subject to court approval and a claims process.
- Tax Act accounting remains subject to measurement-period adjustments. The company estimated a $14.0 transition tax, substantially offset by foreign tax credits, and said no cash payment was expected for that amount. Certain international-tax and other provisions were not yet reasonably estimable.
- No quantified full-year financial guidance is stated in the provided filing text. Management cited weather sensitivity, seasonality, acquisition integration and restructuring execution as relevant factors; it expected to remain within credit covenants based on current operating assumptions.
- Other exposures include environmental matters, asbestos-related claims, ordinary-course litigation, interest-rate and foreign-exchange movements, and potential covenant pressure if earnings fall or indebtedness rises. Management stated that risk factors had not materially changed from its 2017 Form 10-K.
Important facts for investors to verify
- Whether Sunlight Supply integration delivers the expected cost savings and improves Hawthorne profitability, and whether final purchase accounting changes materially.
- Cash generation, seasonal working-capital needs, debt levels and availability under the new credit facilities and receivables financing.
- Developments in the Morning Song and EZ Seed cases, including whether recorded accruals are sufficient and whether further charges arise.
- Final tax effects of the Tax Act and any revisions to the company’s interim tax estimates.
- Whether margin pressure, pricing and volume trends, and Project Catalyst charges evolve as management expects.