Business context and reporting period
The Scotts Miracle-Gro Company’s unaudited Form 10-Q covers the three and six months ended March 30, 2019 (fiscal 2019 second quarter and first half), compared with the periods ended March 31, 2018. The company sells lawn and garden products and operates U.S. Consumer, Hawthorne (indoor and hydroponic gardening), and Other segments. Sales are highly seasonal, with most annual sales typically occurring in the second and third fiscal quarters.
Financial performance and key metrics
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $1,189.9 million, up 17.4% | $1,488.0 million, up 20.5% |
| Gross profit / margin | $472.1 million / 39.7%, versus 40.4% | $506.7 million / 34.1%, versus 35.9% |
| Income from operations | $290.2 million, up 24.9% | $205.4 million, up 28.1% |
| Net income attributable to controlling interest | $396.5 million; diluted EPS $7.09 | $316.9 million; diluted EPS $5.67 |
| Operating cash flow | Not separately presented for the quarter | Use of $546.1 million, versus $482.8 million used |
| Debt / cash | Not separately presented for the quarter | At March 30: total debt $2,405.3 million; cash $37.5 million |
Reported earnings include a $259.8 million pretax gain from the sale of the company’s approximately 30% interest in the TruGreen Joint Venture. This gain was recorded in other non-operating income and materially boosted pretax income, net income, and EPS; reported earnings therefore do not solely reflect recurring operating performance. The six-month effective tax rate on continuing operations was 24.7%, compared with (15.0)% in 2018, when results included a one-time tax benefit from U.S. tax reform.
At March 30, 2019, current assets were $1,839.4 million and current liabilities were $1,159.9 million. The company reported $812.3 million of borrowing availability under its credit agreement and $100.0 million under its receivables facility. Its leverage ratio was 3.93, against a maximum of 5.25 for the quarter, and its interest coverage ratio was 5.67, against a minimum of 3.00.
Material changes versus the prior comparable period
- Sales growth reflected acquisitions, volume, and pricing: management attributed 9.0 percentage points of second-quarter growth and 13.2 points of first-half growth to acquisitions, with Sunlight Supply contributing $91.4 million and $163.0 million of Hawthorne sales, respectively.
- Hawthorne sales rose 244.7% in the quarter and 140.3% in the first half, mainly due to acquisitions; the segment moved from losses to profits in both periods. U.S. Consumer sales rose 8.0% in the quarter and 8.1% in the first half.
- Gross margin declined 0.7 percentage points in the quarter and 1.8 points in the first half. Management cited the Sunlight Supply acquisition’s mix, lower Roundup commission income, material costs, and—in the first half—higher transportation costs and unfavorable fuel and resin hedge mark-to-market adjustments. Pricing and fixed-cost leverage partly offset the pressure.
- Interest expense increased to $28.9 million for the quarter and $54.1 million for the first half, attributed to higher average borrowings following acquisitions and higher interest rates.
- First-half operating cash use increased by $63.3 million year over year. Management cited litigation payments, timing of customer rebates and inventory production, higher interest payments, and higher SG&A.
Outlook, management commentary, risks, and unusual items
- The filing provides no specific full-year sales or earnings guidance. Management expected to remain within credit covenant limits through fiscal 2019 under its current operating assumptions, while warning that lower earnings, higher indebtedness, or other factors could threaten covenant compliance and require a lender amendment or waiver.
- TruGreen sale proceeds included $234.2 million for the equity interest and $18.4 million for repayment of related loan financing; proceeds were applied to reduce debt. The company expected to pay approximately $110 million to $130 million of taxes related to the disposition in fiscal 2019’s third and fourth quarters.
- After quarter-end, Monsanto agreed to reimburse $20.0 million for activities connected to the Roundup marketing agreement; the company expected to record it in third-quarter net sales. Also after quarter-end, the company sold its IT&O Joint Venture interest for $36.6 million and expected to recognize an approximately $3.0 million pretax gain in the third quarter.
- Project Catalyst restructuring continued, with $7.6 million of charges in the first half. Management described the initiative as intended to reduce operating costs and capture acquisition synergies.
- The Morning Song bird-food class action settlement had preliminary court approval, with a final fairness hearing scheduled for June 3, 2019. The company reported a $42.5 million accrued probable loss at quarter-end and insurance reimbursements, including $8.4 million recorded as an accrued liability pending settlement finalization. The EZ Seed class action was settled; $0.1 million remained accrued.
- Management stated that environmental and other legal accruals were considered adequate, but noted outcomes could affect results. It also identified covenant compliance and the seasonal nature of the business as relevant considerations. The filing reported no material change in risk factors or market risks from the 2018 annual report.
Important facts for investors to verify
- Separate recurring operating performance from the $259.8 million TruGreen disposition gain when assessing earnings and EPS.
- Track Hawthorne’s organic sales, profitability, and margins apart from Sunlight Supply acquisition contributions.
- Monitor gross-margin pressures, especially acquisition mix, promotional pricing, material and freight costs, and Roundup commission trends.
- Assess seasonal working-capital needs and cash conversion, given $546.1 million of first-half operating cash use and elevated receivables and inventories.
- Confirm debt reduction, covenant headroom, and the timing and amount of the expected $110 million to $130 million tax payments.
- Follow court approval and final settlement accounting for the Morning Song matter, as well as the expected recognition of post-quarter Monsanto reimbursement and IT&O sale proceeds and gain.