Scotts Miracle-Gro Company — Q3 FY2014 Form 10-Q
Reporting period: Quarter and nine months ended June 28, 2014; filed August 7, 2014. The company makes and sells branded lawn and garden products and operates Scotts LawnService. Results are seasonal, with most sales in fiscal Q2 and Q3. The wild bird food business is reported as discontinued operations.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net sales | $1,116.4 million | $1,137.1 million | $2,387.0 million | $2,340.1 million |
| Gross profit | $423.3 million | $440.3 million | $891.0 million | $848.1 million |
| Gross margin | 37.9% | 38.7% | 37.3% | 36.2% |
| Operating income | $200.9 million | $249.0 million | $328.3 million | $329.0 million |
| Income from continuing operations | $120.7 million | $147.7 million | $180.6 million | $178.6 million |
| Net income | $121.7 million | $148.2 million | $181.7 million | $180.5 million |
| Diluted EPS | $1.95 | $2.37 | $2.90 | $2.89 |
- Q3 sales declined 1.8%, primarily from lower Global Consumer shipments as retailers received product earlier in the season. Nine-month sales increased 2.0%, supported by pricing, acquisitions and foreign exchange.
- Q3 net income fell about 18%, with lower sales and gross margin and a $33.7 million Ortho brand impairment among the drivers. Nine-month net income was broadly flat; increased sales, gross margin and lower interest expense were largely offset by impairment, restructuring and refinancing costs.
- Nine-month operating cash flow was $34.3 million, down from $143.1 million. Management attributed the decline principally to a $137.8 million increase in cash used for working capital, including higher inventory production and receivables.
- Nine-month investing cash outflow was $121.1 million, including $68.5 million of capital expenditures and the $60.0 million Tomcat acquisition. Financing provided $100.1 million, including net borrowings, while the company paid $81.3 million in dividends and spent $89.5 million on share repurchases.
Balance sheet, debt and liquidity
- At June 28, 2014, cash was $147.2 million; total debt was $829.2 million, comprising $200.5 million current and $628.7 million long-term debt. Cash less debt was approximately $682 million.
- The $829.2 million total debt includes $425.1 million of revolving loans, $200.0 million of 6.625% senior notes and $190.3 million under the accounts receivable purchase agreement. The company redeemed its $200 million 7.25% notes in January 2014.
- The $1.7 billion revolving credit facility had $1,251.6 million of availability, including letter-of-credit availability, and expires December 20, 2018. The company reported compliance with covenants: leverage ratio 1.91 versus a 4.00 maximum; interest coverage 7.39 versus a 3.50 minimum.
- Cash and cash equivalents included $137.3 million held by controlled foreign corporations that the company said it intended to keep indefinitely reinvested.
Material changes and unusual items
- Q3 operating expenses included a $33.7 million noncash impairment of the Ortho brand. Restructuring and other charges totaled $39.2 million for the quarter and $45.6 million year to date, including U.S. personnel restructuring and turfgrass biotechnology monitoring/remediation costs.
- Nine-month refinancing costs were $10.7 million, associated with redeeming the 7.25% notes. Interest expense declined to $38.7 million from $47.9 million for the comparable nine-month period.
- The company acquired the Tomcat consumer rodent-control business for $60.0 million in cash; it contributed $18.7 million of nine-month sales. It also sold its U.S. and Canadian wild bird food business, recording $1.1 million of nine-month discontinued-operations income, net of tax.
- Q3 Global Consumer sales were $1,012.8 million, down 2.7%; its reported segment income measure was $244.5 million versus $260.5 million. Scotts LawnService sales were $92.8 million, up 3.2%, while its segment income measure declined to $20.7 million from $22.3 million.
Outlook, risks and contingencies
- No specific full-year earnings or revenue guidance is provided in the supplied filing text. Management expected approximately $125 million of additional one-time shareholder payments in Q4 FY2014, subject to credit-agreement restrictions.
- Management expected operating cash flows and borrowing capacity to fund debt service, working capital, capital expenditures, dividends and share repurchases, and expected covenant compliance through FY2014. It cautioned that lower earnings, higher debt or other factors could threaten covenant compliance and require a waiver or amendment.
- Management cited seasonal shipment timing and unfavorable weather as factors affecting quarterly results. Risks also include working-capital swings, the loss or reduction of Monsanto Roundup marketing-agreement earnings, interest rates, foreign exchange and commodity prices.
- Environmental remediation liabilities of $5.6 million were accrued. The company reported asbestos-related claims and consolidated wild-bird-food litigation, for which it had recorded no reserves; it said losses could not be reasonably estimated in the latter matters. Tax examinations and claims were ongoing, with no material impact anticipated by management.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the Q3 sales softness reflected shipment timing alone or weaker underlying consumer demand, and whether the timing shift reversed in Q4.
- The assumptions behind the $33.7 million Ortho impairment and any future brand impairment risk.
- Working-capital conversion, particularly receivables and inventory, and the sustainability of operating cash flow.
- Debt and covenant headroom after the planned approximately $125 million Q4 shareholder payment, including the status of the accounts receivable purchase agreement.
- Potential financial exposure from asbestos, bird-food litigation, environmental matters and tax audits, which the filing says cannot all be reliably estimated.