Scotts Miracle-Gro Company (NYSE: SMG) — FY2019 Form 10-K
Reporting period: Fiscal year ended September 30, 2019. The company sells consumer lawn and garden products and indoor/hydroponic gardening products through its U.S. Consumer, Hawthorne and Other segments. Sales are highly seasonal: approximately 75% occur in the second and third fiscal quarters combined.
Financial performance
| Metric | FY2019 | FY2018 |
|---|---|---|
| Net sales | $3,156.0 million | $2,663.4 million |
| Gross profit / margin | $1,019.6 million / 32.3% | $864.6 million / 32.5% |
| Operating income / margin | $409.6 million / 13.0% | $198.9 million / 7.5% |
| Income from continuing operations | $436.7 million | $127.6 million |
| Net income | $460.2 million | $63.7 million |
| Diluted EPS from continuing operations | $7.77 | $2.23 |
| Operating cash flow | $226.8 million | $342.5 million |
| Free cash flow (non-GAAP) | $184.4 million | $274.3 million |
- FY2019 sales grew 18.5%, driven by volume, pricing and acquisitions. Sunlight Supply contributed $231.4 million of sales; Hawthorne sales nearly doubled to $671.2 million, while U.S. Consumer sales increased 8.1% to $2,281.1 million. Other-segment sales declined 2.5%.
- Reported income from continuing operations included a $259.8 million pre-tax gain from selling the company’s approximately 30% interest in the TruGreen joint venture. The company also sold its IT&O joint-venture interest for $36.6 million and recorded a $2.9 million pre-tax gain. These transactions materially boosted reported earnings and provided funds to repay debt.
- Adjusted diluted EPS from continuing operations, a non-GAAP measure, was $4.47, up from $3.71. Adjusted operating income was $422.9 million versus $351.7 million. These measures exclude specified unusual items and are not substitutes for GAAP results.
- Gross margin edged down to 32.3% from 32.5%. Management cited Sunlight Supply’s lower margin profile, higher materials and transportation costs, and Hawthorne promotional pricing, partly offset by price increases and improved volume leverage.
- Operating cash flow fell $115.7 million, reflecting $99.5 million of tax payments related to the TruGreen sale, litigation payments net of insurance recoveries, rebate-payment timing and higher interest payments. Capital expenditures were $42.4 million.
Debt, liquidity and capital allocation
- Gross debt was $1,659.3 million at September 30, 2019, compared with $2,025.7 million a year earlier. Cash was $18.8 million; working capital was $421.2 million and the current ratio was 1.7.
- The company reported $1,326.2 million available under its $1.5 billion revolving credit facility. Its leverage ratio was 3.67, versus a 5.00 maximum then in effect; interest coverage was 5.78, above the 3.00 minimum. The company said it expected to remain covenant-compliant in FY2020, while noting results or debt changes could affect compliance.
- Quarterly dividend increased 5% to $0.58 per share in Q4; full-year dividends were $2.23 per share. No shares were repurchased under the public program in FY2019. Remaining authorization was approximately $285.4 million.
- After year-end, the company issued $450 million of 4.5% notes due 2029 and redeemed its $400 million 6.0% notes due 2023. The redemption premium of $12.0 million was expected to be recognized in FY2020.
Outlook, material developments and risks
- The filing provides no specific FY2020 revenue or earnings guidance. Management expected FY2020 capital expenditures to be consistent with recent spending and, based on current assumptions, expected covenant compliance through FY2020.
- Project Catalyst restructuring continued to target cost reductions and Hawthorne acquisition synergies; FY2019 charges were $13.7 million. Hawthorne returned to segment profit of $53.5 million from a $6.1 million loss in FY2018.
- The August 2019 Roundup agreement revised commissions for 2020 onward to 50% of Program EBIT, changed contribution-payment mechanics and established termination rights and fees. FY2019 Roundup-related net sales were $113.8 million, down from $116.2 million. The company also agreed to sell specified brand-extension assets to Monsanto for $112.0 million plus $3.5 million of inventory, payable January 2020.
- Key exposures include dependence on Home Depot and Lowe’s, which represented 30% and 19% of FY2019 sales, respectively; together with Walmart, the top three represented 57% of sales and 61% of receivables. Other risks include seasonality and weather, raw-material and tariff costs, environmental and pesticide regulation, Roundup-related reputation and contract exposure, and uncertain demand and regulation affecting hydroponics and cannabis-related end markets.
- Legal matters include asbestos/vermiculite claims, which the company said were not probable losses and for which no accrual was recorded; environmental matters, with $3.9 million accrued; and resolved bird-food and EZ Seed class actions. FY2019 included a $22.5 million favorable adjustment and $13.4 million of insurance recoveries related to the bird-food settlement.
- Hawthorne goodwill was $300.0 million; its estimated fair value exceeded carrying value by 5% at the FY2019 test date. A 100-basis-point increase in the discount rate would, according to the filing, have produced an estimated $11.7 million impairment charge.
Important facts for investors to verify
- Separate recurring operating performance from the $259.8 million TruGreen sale gain and other unusual items; reconcile GAAP earnings with the company’s non-GAAP adjustments.
- Review Hawthorne’s underlying demand, profitability and goodwill headroom, given its dependence on an uncertain hydroponic market and acquisition-driven growth.
- Assess FY2020 cash generation after the unusually large FY2019 tax and litigation cash payments, seasonal working-capital needs, dividends and debt service.
- Check covenant headroom as leverage limits tighten, and confirm the effects of the October 2019 refinancing, redemption premium and note issuance on interest expense and maturities.
- Monitor customer concentration, Roundup agreement economics and termination provisions, regulatory developments, and the resolution and potential costs of remaining legal and environmental matters.