10-Q 1 smg-71201710xq3.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________________________
FORM 10-Q
_________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2017
OR
o 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
to
     
Commission File Number: 001-11593
______________________________________________ 
The Scotts Miracle-Gro Company
(Exact name of registrant as specified in its charter)
______________________________________________
OHIO
 
31-1414921
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
14111 SCOTTSLAWN ROAD,
MARYSVILLE, OHIO
 
43041
(Address of principal executive offices)
 
(Zip Code)
(937) 644-0011
(Registrant’s telephone number, including area code)
______________________________________________ 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  o 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
  
Accelerated filer
 
o 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
o 
Emerging growth company
 
o 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o     No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
Class
    
Outstanding at August 4, 2017
 
 
Common Shares, $0.01 stated value, no par value
    
58,411,264 Common Shares
 

1



THE SCOTTS MIRACLE-GRO COMPANY
INDEX

 
 
 
 
 
PAGE NO.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I—FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

THE SCOTTS MIRACLE-GRO COMPANY
Condensed Consolidated Statements of Operations
(In millions, except per common share data)
(Unaudited)
 
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
Net sales
$
1,078.0

 
$
994.1

 
$
2,528.2

 
$
2,433.8

Cost of sales
662.8

 
636.3

 
1,566.5

 
1,532.6

Cost of sales—impairment, restructuring and other

 
0.4

 

 
5.5

Gross profit
415.2

 
357.4

 
961.7

 
895.7

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
172.0

 
151.9

 
488.8

 
466.1

Impairment, restructuring and other
4.1

 
(5.8
)
 
8.8

 
(51.7
)
Other income, net
(6.5
)
 
(5.6
)
 
(12.5
)
 
(7.1
)
Income from operations
245.6

 
216.9

 
476.6

 
488.4

Equity in (income) loss of unconsolidated affiliates
(7.2
)
 
3.5

 
30.1

 
3.5

Costs related to refinancing

 

 

 
8.8

Interest expense
21.8

 
16.9

 
58.9

 
52.3

Income from continuing operations before income taxes
231.0

 
196.5

 
387.6

 
423.8

Income tax expense from continuing operations
79.1

 
69.5

 
134.7

 
150.3

Income from continuing operations
151.9

 
127.0

 
252.9

 
273.5

Income (loss) from discontinued operations, net of tax

 
85.7

 
(0.6
)
 
68.2

Net income
$
151.9

 
$
212.7

 
$
252.3

 
$
341.7

Net (income) loss attributable to noncontrolling interest

 
0.4

 
(0.5
)
 
0.2

Net income attributable to controlling interest
$
151.9

 
$
213.1

 
$
251.8

 
$
341.9

 
 
 
 
 
 
 
 
Basic income per common share:
 
 
 
 
 
 
 
Income from continuing operations
$
2.57

 
$
2.09

 
$
4.23

 
$
4.46

Income (loss) from discontinued operations

 
1.40

 
(0.01
)
 
1.11

Basic income per common share
$
2.57

 
$
3.49

 
$
4.22

 
$
5.57

Weighted-average common shares outstanding during the period
59.2

 
61.1

 
59.7

 
61.3

 
 
 
 
 
 
 
 
Diluted income per common share:
 
 
 
 
 
 
 
Income from continuing operations
$
2.53

 
$
2.06

 
$
4.17

 
$
4.40

Income (loss) from discontinued operations

 
1.38

 
(0.01
)
 
1.10

Diluted income per common share
$
2.53

 
$
3.44

 
$
4.16

 
$
5.50

Weighted-average common shares outstanding during the period plus dilutive potential common shares
60.0

 
61.9

 
60.6

 
62.2

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.500

 
$
0.470

 
$
1.500

 
$
1.410

See Notes to Condensed Consolidated Financial Statements.

3


THE SCOTTS MIRACLE-GRO COMPANY
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In millions)
(Unaudited)
 

 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
Net income
$
151.9

 
$
212.7

 
$
252.3

 
$
341.7

Other comprehensive income (loss):
 
 
 
 
 
 
 
Net foreign currency translation adjustment
5.8

 
(12.3
)
 
3.6

 
(14.8
)
Net unrealized gain (loss) on derivative instruments, net of tax of $0.7, $0.7, $1.1 and $1.7, respectively
(1.2
)
 
(1.2
)
 
1.8

 
(2.8
)
Reclassification of net unrealized losses on derivatives to net income, net of tax of $0.2, $1.1, $1.2 and $3.3, respectively
0.4

 
1.7

 
1.9

 
5.3

Reclassification of net pension and post-retirement benefit loss to net income, net of tax of $0.3, $0.6, $0.9 and $1.0, respectively
0.5

 
0.9

 
1.4

 
1.6

Total other comprehensive income (loss)
5.5

 
(10.9
)
 
8.7

 
(10.7
)
Comprehensive income
$
157.4

 
$
201.8

 
$
261.0

 
$
331.0

Comprehensive (income) loss attributable to noncontrolling interest
(0.1
)
 
0.4

 
(0.6
)
 
0.2

Comprehensive income attributable to controlling interest
$
157.3

 
$
202.2

 
$
260.4

 
$
331.2

See Notes to Condensed Consolidated Financial Statements.


4


THE SCOTTS MIRACLE-GRO COMPANY
Condensed Consolidated Statements of Cash Flows
(In millions) (Unaudited)
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
252.3

 
$
341.7

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Impairment, restructuring and other

 
0.2

Costs related to refinancing

 
2.2

Share-based compensation expense
20.5

 
13.7

Depreciation
41.4

 
40.2

Amortization
18.4

 
14.1

Gain on long-lived assets
(2.5
)
 
(1.2
)
Gain on contribution of SLS Business

 
(142.6
)
Adjustment to gain on contribution of SLS Business
(0.3
)
 

Equity in loss and distributions from unconsolidated affiliates
33.7

 
3.5

Changes in assets and liabilities, net of acquired businesses:
 
 
 
Accounts receivable
(368.6
)
 
(447.8
)
Inventories
(5.5
)
 
(52.6
)
Prepaid and other assets
(24.8
)
 
(27.5
)
Accounts payable
61.3

 
51.1

Other current liabilities
88.0

 
147.2

Restructuring
(15.6
)
 
(9.6
)
Other non-current items
(16.8
)
 
44.8

Other, net
0.9

 
(6.3
)
Net cash provided by (used in) operating activities
82.4

 
(28.9
)
 
 
 
 
INVESTING ACTIVITIES
 
 
 
Proceeds from sale of long-lived assets
5.0

 
2.4

Investments in property, plant and equipment
(42.0
)
 
(35.7
)
Investments in loans receivable

 
(90.0
)
Net (investments in) distributions from unconsolidated affiliates
(0.2
)
 
194.1

Cash contributed to TruGreen Joint Venture

 
(24.2
)
Investments in acquired businesses, net of cash acquired
(89.2
)
 
(161.4
)
Net cash used in investing activities
(126.4
)
 
(114.8
)
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Borrowings under revolving and bank lines of credit and term loans
1,362.8

 
1,882.6

Repayments under revolving and bank lines of credit and term loans
(1,205.3
)
 
(1,762.9
)
Proceeds from issuance of 5.250% Senior Notes
250.0

 

Proceeds from issuance of 6.000% Senior Notes

 
400.0

Repayment of 6.625% Senior Notes

 
(200.0
)
Financing and issuance fees
(4.3
)
 
(11.2
)
Dividends paid
(89.4
)
 
(86.4
)
Distribution paid by AeroGrow to noncontrolling interest
(8.1
)
 

Purchase of Common Shares
(173.8
)
 
(81.2
)
Payments on seller notes
(28.7
)
 
(2.3
)
Excess tax benefits from share-based payment arrangements
4.5

 
4.3

Cash received from the exercise of stock options
3.3

 
9.9

Net cash provided by financing activities
111.0

 
152.8

Effect of exchange rate changes on cash
2.0

 
(3.3
)
Net increase in cash and cash equivalents
69.0

 
5.8

Cash and cash equivalents at beginning of period
50.1

 
71.4

Cash and cash equivalents at end of period
$
119.1

 
$
77.2

See Notes to Condensed Consolidated Financial Statements.

5


THE SCOTTS MIRACLE-GRO COMPANY
Condensed Consolidated Balance Sheets
(In millions, except stated value per share)
(Unaudited)
 
 
JULY 1,
2017
 
JULY 2,
2016
 
SEPTEMBER 30,
2016
ASSETS
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
119.1

 
$
77.2

 
$
50.1

Accounts receivable, less allowances of $7.3, $10.5 and $7.2, respectively
474.3

 
359.7

 
196.4

Accounts receivable pledged
277.8

 
435.1

 
174.7

Inventories
466.6

 
469.9

 
448.2

Prepaid and other current assets
146.5

 
139.2

 
122.3

Total current assets
1,484.3

 
1,481.1

 
991.7

Investment in unconsolidated affiliates
65.7

 
94.4

 
101.0

Property, plant and equipment, net of accumulated depreciation of $653.2, $623.5 and $633.3, respectively
460.8

 
449.6

 
470.8

Goodwill
408.7

 
346.0

 
373.2

Intangible assets, net
806.6

 
750.6

 
750.9

Other assets
121.4

 
131.8

 
115.2

Total assets
$
3,347.5

 
$
3,253.5

 
$
2,802.8

 
 
 
 
 
 
LIABILITIES AND EQUITY
Current liabilities:
 
 
 
 
 
Current portion of debt
$
289.1

 
$
382.5

 
$
185.0

Accounts payable
224.0

 
249.5

 
165.9

Other current liabilities
327.4

 
359.2

 
242.2

Total current liabilities
840.5

 
991.2

 
593.1

Long-term debt
1,419.7

 
1,124.1

 
1,125.1

Other liabilities
344.3

 
306.0

 
350.3

Total liabilities
2,604.5

 
2,421.3

 
2,068.5

Commitments and contingencies (Note 12)

 

 

Equity:
 
 
 
 
 
Common shares and capital in excess of $.01 stated value per share; 58.6, 60.8 and 60.3 shares issued and outstanding, respectively
405.7

 
401.1

 
401.7

Retained earnings
1,043.1

 
938.6

 
881.8

Treasury shares, at cost; 9.5, 7.3 and 7.8 shares, respectively
(610.1
)
 
(409.3
)
 
(451.4
)
Accumulated other comprehensive loss
(108.3
)
 
(117.5
)
 
(116.9
)
Total equity—controlling interest
730.4

 
812.9

 
715.2

Noncontrolling interest
12.6

 
19.3

 
19.1

Total equity
743.0

 
832.2

 
734.3

Total liabilities and equity
$
3,347.5

 
$
3,253.5

 
$
2,802.8

See Notes to Condensed Consolidated Financial Statements.

6


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Scotts Miracle-Gro Company (“Scotts Miracle-Gro” or “Parent”) and its subsidiaries (collectively, together with Scotts Miracle-Gro, the “Company”) are engaged in the manufacturing, marketing and sale of consumer branded products for lawn and garden care. The Company’s primary customers include home centers, mass merchandisers, warehouse clubs, large hardware chains, independent hardware stores, nurseries, garden centers, food and drug stores, and indoor gardening and hydroponic stores. The Company’s products are sold primarily in North America and the European Union.
Prior to April 13, 2016, the Company operated the Scotts LawnService® business (the “SLS Business”), which provided residential and commercial lawn care, tree and shrub care and pest control services in the United States. On April 13, 2016, pursuant to the terms of the Contribution and Distribution Agreement (the “Contribution Agreement”) between the Company and TruGreen Holding Corporation (“TruGreen Holdings”), the Company completed the contribution of the SLS Business to a newly formed subsidiary of TruGreen Holdings (the “TruGreen Joint Venture”) in exchange for a minority equity interest of 30% in the TruGreen Joint Venture. As a result, effective in its second quarter of fiscal 2016, the Company classified its results of operations for all periods presented to reflect the SLS Business as a discontinued operation and classified the assets and liabilities of the SLS Business as held for sale. See “NOTE 2. DISCONTINUED OPERATIONS” and “NOTE 4. INVESTMENT IN UNCONSOLIDATED AFFILIATES” for further discussion. Refer to “NOTE 15. SEGMENT INFORMATION” for discussion of the Company’s new reportable segments identified effective in the second quarter of fiscal 2016.
Due to the nature of the consumer lawn and garden business, the majority of the Company’s sales to customers occur in the Company’s second and third fiscal quarters. On a combined basis, net sales for the second and third quarters of the last three fiscal years represented in excess of 75% of the Company’s annual net sales.
Organization and Basis of Presentation
The Company’s unaudited condensed consolidated financial statements for the three and nine months ended July 1, 2017 and July 2, 2016 are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The condensed consolidated financial statements include the accounts of Scotts Miracle-Gro and its subsidiaries. All intercompany transactions and accounts have been eliminated in consolidation. The Company’s consolidation criteria are based on majority ownership (as evidenced by a majority voting interest in the entity) and an objective evaluation and determination of effective management control. AeroGrow International, Inc. (“AeroGrow”) and Gavita Holdings B.V., and its subsidiaries (collectively, “Gavita”), in which the Company has controlling interests, are consolidated, with the equity owned by other shareholders shown as noncontrolling interest in the Condensed Consolidated Balance Sheets, and the other shareholders’ portion of net earnings and other comprehensive income shown as net income (loss) or comprehensive (income) loss attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Comprehensive Income (Loss), respectively. In the opinion of management, interim results reflect all normal and recurring adjustments and are not necessarily indicative of results for a full year.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted or condensed pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, this report should be read in conjunction with Scotts Miracle-Gro’s Annual Report on Form 10-K for the fiscal year ended September 30, 2016 (the “2016 Annual Report”), which includes a complete set of footnote disclosures, including the Company’s significant accounting policies.
The Company’s Condensed Consolidated Balance Sheet at September 30, 2016 has been derived from the Company’s audited Consolidated Balance Sheet at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes and related disclosures. Although these estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future, actual results ultimately may differ from the estimates.

7


Loans Receivable
Loans receivable are carried at outstanding principal amount, and are recognized in the “Other assets” line in the Condensed Consolidated Balance Sheets. Loans receivable are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. If it is determined that an impairment has occurred, an impairment loss is recognized for the amount by which the carrying value of the asset exceeds the present value of expected future cash flows and recorded within “Operating expenses” in the Condensed Consolidated Statements of Operations.
Interest income is recorded on an accrual basis, and is recognized in the “Other income, net” line in the Condensed Consolidated Statements of Operations. Interest income was $3.0 million and $1.7 million for the three months ended July 1, 2017 and July 2, 2016, respectively. Interest income was $7.8 million and $2.2 million for the nine months ended July 1, 2017 and July 2, 2016, respectively.
Long-Lived Assets
The Company had non-cash investing activities of $2.9 million and $1.9 million during the nine months ended July 1, 2017 and July 2, 2016, respectively, representing unpaid liabilities incurred during each period to acquire property, plant and equipment.
Statements of Cash Flows
Supplemental cash flow information was as follows for each of the periods presented:
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
(In millions)
Interest paid
$
(53.0
)
 
$
(48.1
)
Call premium on 6.625% Senior Notes

 
(6.6
)
Income taxes paid
(72.0
)
 
(52.3
)
Property and equipment acquired under capital leases
(0.9
)
 

During the second quarter of fiscal 2017, Scotts Miracle-Gro’s wholly-owned subsidiary, Scotts Canada Ltd., paid contingent consideration of $6.7 million related to the fiscal 2014 acquisition of Fafard & Brothers Ltd. (“Fafard”).
The Company uses the “cumulative earnings” approach for determining cash flow presentation of distributions from unconsolidated affiliates. Distributions received are included in the Condensed Consolidated Statements of Cash Flows as operating activities, unless the cumulative distributions exceed the portion of the cumulative equity in the net earnings of the unconsolidated affiliate, in which case the excess distributions are deemed to be returns of the investment and are classified as investing activities in the Condensed Consolidated Statements of Cash Flows.
RECENT ACCOUNTING PRONOUNCEMENTS
Debt Issuance Costs
In April 2015, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update that requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the corresponding debt liability rather than as an asset; however debt issuance costs relating to revolving credit facilities will remain in other assets. The Company adopted this guidance on a retrospective basis effective October 1, 2016. As a result, debt issuance costs totaling $6.2 million and $6.0 million have been presented as a component of the carrying amount of long-term debt in the Condensed Consolidated Balance Sheets as of July 2, 2016 and September 30, 2016, respectively. These amounts were previously reported within other assets.
Business Combinations
In September 2015, the FASB issued an accounting standard update to simplify the accounting for measurement-period adjustments by requiring an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, and requiring disclosure of the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this guidance on a prospective basis effective October 1, 2016. The adoption of this guidance did not impact the Company’s consolidated financial position, results of operations or cash flows.

8


Revenue Recognition from Contracts with Customers
In May 2014, the FASB issued amended accounting guidance that replaces most existing revenue recognition guidance under GAAP. This guidance requires companies to recognize revenue in a manner that depicts the transfer of promised goods or services to customers in amounts that reflect the consideration to which a company expects to be entitled in exchange for those goods or services. The standard involves a five-step process that includes identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations in the contract and recognizing revenue when the entity satisfies the performance obligations. The new standard also will result in enhanced disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Subsequently, additional guidance was issued on several areas including guidance intended to improve the operability and understandability of the implementation of principal versus agent considerations and clarifications on the identification of performance obligations and implementation of guidance related to licensing.
The Company has made progress on its evaluation of the amended guidance, including identification of revenue streams and customer contract reviews. The Company has begun the process of applying the five-step model to those contracts and revenue streams to evaluate the quantitative and qualitative impacts the new standard will have on its business and reported revenues. The provisions are effective for the Company in the first quarter of fiscal 2019 and permit adoption under either the full retrospective approach (recognize effects of the amended guidance in each prior reporting period presented) or the modified retrospective approach (recognize the cumulative effect of adoption as an adjustment to retained earnings at the date of initial application). The Company is still evaluating its method of adoption.
Inventory
In July 2015, the FASB issued an accounting standard update that requires inventory to be measured “at the lower of cost and net realizable value,” thereby simplifying the current guidance that requires inventory to be measured at the lower of cost or market (market in this context is defined as one of three different measures, one of which is net realizable value). The provisions are effective prospectively for the Company’s financial statements for the fiscal year beginning October 1, 2017, and are not expected to have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.
Income Taxes
In November 2015, the FASB issued an accounting standard update to simplify the presentation of deferred income taxes by requiring that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The provisions are effective for the Company’s financial statements no later than the fiscal year beginning October 1, 2017. The standard allows for either a retrospective or prospective transition method and is not expected to have a significant impact on the Company’s consolidated financial position, results of operations or cash flows. At July 1, 2017, July 2, 2016 and September 30, 2016, net current deferred tax assets classified within prepaid and other current assets were $60.5 million, $70.4 million and $62.1 million, respectively.
Leases
In February 2016, the FASB issued an accounting standard update which significantly changes the accounting for leases. This guidance requires lessees to recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The provisions are effective for the Company’s financial statements no later than the fiscal year beginning October 1, 2019 and require a modified retrospective transition approach for leases that exist or are entered into after the beginning of the earliest comparative period presented in the financial statements. The Company is currently evaluating the impact of this standard on its consolidated results of operations, financial position and cash flows.
Share-Based Compensation
In March 2016, the FASB issued an accounting standard update that simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The provisions are effective, using a combination of retrospective, modified retrospective and prospective transition methods, for the Company’s financial statements no later than the fiscal year beginning October 1, 2017. The Company is currently evaluating the impact of this standard on its consolidated results of operations, financial position and cash flows.
Cash Flow Presentation
In August 2016, the FASB issued an accounting standard update that amends the guidance on the classification of certain cash receipts and payments in the statement of cash flows. The provisions are effective retrospectively for the Company’s financial statements no later than the fiscal year beginning October 1, 2018, and are not expected to have a significant impact on the Company’s consolidated cash flows.

9


Business Combinations
In January 2017, the FASB issued an accounting standard update that clarifies the definition of a business to provide additional guidance to assist in evaluating whether transactions should be accounted for as an acquisition (or disposal) of either an asset or business. The provisions are effective prospectively for the Company’s financial statements no later than the fiscal year beginning October 1, 2018, and are not expected to have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.
Goodwill
In January 2017, the FASB issued an accounting standard update which removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of the goodwill. The provisions are effective prospectively for the Company’s financial statements no later than the fiscal year beginning October 1, 2020, and are not expected to have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.
Employee Benefit Plans
In March 2017, the FASB issued an accounting standard update which requires entities to (1) disaggregate the current-service-cost component from the other components of net benefit cost (the “other components”) and present it with other current compensation costs for related employees in the income statement, (2) present the other components elsewhere in the income statement and outside of income from operations if that subtotal is presented and (3) limit the amount of costs eligible for capitalization (e.g., as part of inventory or property, plant, and equipment) to only the service-cost component of net benefit cost. The provisions are effective for the Company’s financial statements no later than the fiscal year beginning October 1, 2018, and are required to be applied retrospectively for the presentation of cost components in the income statement and prospectively for the capitalization of cost components. The provisions are not expected to have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.
NOTE 2. DISCONTINUED OPERATIONS
On April 13, 2016, pursuant to the terms of the Contribution Agreement, the Company completed the contribution of the SLS Business to the TruGreen Joint Venture in exchange for a minority equity interest of 30% in the TruGreen Joint Venture. As a result, effective in its second quarter of fiscal 2016, the Company classified its results of operations for all periods presented to reflect the SLS Business as a discontinued operation and classified the assets and liabilities of the SLS Business as held for sale.
During the three and nine months ended July 1, 2017, the Company recognized $0.1 million and $0.8 million, respectively, in transaction related costs associated with the divestiture of the SLS Business. In addition, during the nine months ended July 1, 2017, the Company recorded an adjustment to the gain on the contribution of $0.3 million related to a post closing working capital adjustment. During the three and nine months ended July 2, 2016, the Company recognized zero and $9.0 million, respectively, for the resolution of a prior SLS Business litigation matter, as well as zero and $4.6 million, respectively, in transaction related costs associated with the divestiture of the SLS Business.
The following table summarizes the results of the SLS Business within discontinued operations for each of the periods presented:

THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
(In millions)
Net sales
$

 
$
9.2

 
$

 
$
101.2

Operating costs

 
10.3

 

 
117.4

Impairment, restructuring and other
0.1

 

 
0.8

 
13.6

Other income, net

 

 

 
(1.5
)
Gain on contribution of SLS Business

 
(142.6
)
 

 
(142.6
)
Adjustment to gain on contribution of SLS Business

 

 
0.3

 

Income (loss) from discontinued operations before income taxes
(0.1
)
 
141.5

 
(1.1
)
 
114.3

Income tax expense (benefit) from discontinued operations
(0.1
)
 
55.8

 
(0.5
)
 
46.1

Income (loss) from discontinued operations, net of tax
$

 
$
85.7

 
$
(0.6
)
 
$
68.2


10


The Condensed Consolidated Statements of Cash Flows do not present the cash flows from discontinued operations separately from cash flows from continuing operations. Cash used in operating activities related to the SLS Business was $9.3 million for the nine months ended July 1, 2017 primarily due to the payment of a previously accrued SLS Business litigation matter. Cash provided by operating activities related to the SLS Business was $38.9 million for the nine months ended July 2, 2016. Cash used in investing activities related to the SLS Business was zero and $1.4 million for the nine months ended July 1, 2017 and July 2, 2016, respectively.
NOTE 3. ACQUISITIONS AND INVESTMENTS
Fiscal 2017
On May 26, 2017, the Company’s majority-owned subsidiary Gavita completed the acquisition of Agrolux Holding B.V., and its subsidiaries (collectively, “Agrolux”), for $21.8 million. Based in the Netherlands, Agrolux is a worldwide supplier of horticultural lighting. The purchase price included contingent consideration, a non-cash investing activity, with a maximum payout and estimated fair value of $5.2 million, the payment of which will depend on the performance of the business through calendar year 2017. The preliminary valuation of the acquired assets included (i) $8.0 million of cash, prepaid and other current assets, (ii) $10.0 million of inventory and accounts receivable, (iii) $0.5 million of fixed assets, (iv) $8.6 million of accounts payable and other current liabilities, (v) $6.7 million of short term debt, (vi) $16.3 million of finite-lived identifiable intangible assets, and (vii) $2.3 million of non-deductible goodwill. Identifiable intangible assets included tradenames and customer relationships with useful lives ranging between 10 and 20 years. The estimated fair values of the identifiable intangible assets were determined using an income-based approach, which includes market participant expectations of cash flows that an asset will generate over the remaining useful life discounted to present value using an appropriate discount rate. Net sales for Agrolux included within the Other segment for the three and nine months ended July 1, 2017 were $3.5 million.
On October 3, 2016, the Company, through its wholly-owned subsidiary The Hawthorne Gardening Company, completed the acquisition of American Agritech, L.L.C., d/b/a Botanicare (“Botanicare”), an Arizona-based leading producer of plant nutrients, plant supplements and growing systems used for hydroponic gardening, for $92.6 million. The purchase price included contingent consideration, a non-cash investing activity, with a maximum payout and estimated fair value of $15.5 million, which was paid during the third quarter of fiscal 2017. The preliminary valuation of the acquired assets included (i) $1.2 million of cash, prepaid and other current assets, (ii) $8.4 million of inventory and accounts receivable, (iii) $1.4 million of fixed assets, (iv) $2.3 million of accounts payable and other current liabilities, (v) $53.0 million of finite-lived identifiable intangible assets, and (vi) $30.9 million of tax-deductible goodwill. Identifiable intangible assets included tradenames, customer relationships and non-compete arrangements with useful lives ranging between 5 and 25 years. The estimated fair values of the identifiable intangible assets were determined using an income-based approach, which includes market participant expectations of cash flows that an asset will generate over the remaining useful life discounted to present value using an appropriate discount rate. Net sales for Botanicare included within the Other segment for the three and nine months ended July 1, 2017 were $12.6 million and $33.8 million, respectively.
During the first quarter of fiscal 2017, the Company’s U.S. Consumer segment completed two acquisitions of companies whose products support the Company’s focus on the emerging areas of water positive landscapes and internet-enabled technology for an aggregate purchase price of $3.2 million. The valuation of the acquired assets for the transactions included finite-lived identifiable intangible assets and goodwill of $2.8 million. During the third quarter of fiscal 2017, the Company’s Other segment completed the acquisition of a company focused on the technology supporting hydroponic growing systems for an aggregate purchase price of $3.5 million, which included finite-lived identifiable intangible assets of $3.2 million.
During the fourth quarter of fiscal 2017, the Company’s U.S. Consumer segment made a $29.4 million investment in an unconsolidated subsidiary whose products support the professional U.S. industrial, turf and ornamental market.
Fiscal 2016
On May 26, 2016, the Company, through its wholly-owned subsidiary The Hawthorne Gardening Company, acquired majority control and a 75% economic interest in Gavita for $136.2 million. The remaining 25% interest was retained by Gavita’s former ownership group. This transaction provides the Company’s Other segment with a presence in the lighting category of indoor and urban gardening, which is a part of the Company’s long-term growth strategy. Gavita, which is based in the Netherlands, is a leading producer and marketer of indoor lighting used in the greenhouse and hydroponic markets, predominately in the United States and Europe. The purchase price included contingent consideration, a non-cash investing activity, with an estimated fair value of $2.5 million, the payment of which will depend on the performance of the business through calendar year 2019. The valuation of the acquired assets included (i) $6.4 million of cash, prepaid and other current assets, (ii) $37.9 million of inventory and accounts receivable, (iii) $1.3 million of fixed assets, (iv) $18.7 million of accounts payable and other current liabilities, (v) $5.5 million of short term debt, (vi) $102.6 million of finite-lived identifiable intangible assets, (vii) $83.3 million of non-deductible goodwill, and (viii) $25.7 million of deferred tax liabilities. Identifiable intangible assets included tradenames, customer relationships and non-compete arrangements with useful lives ranging between 5 and 25 years. The estimated fair values of the

11


identifiable intangible assets were determined using an income-based approach, which includes market participant expectations of cash flows that an asset will generate over the remaining useful life discounted to present value using an appropriate discount rate. Gavita’s former ownership group has retained a 25% noncontrolling interest in Gavita consisting of ownership of 5% of the outstanding shares of Gavita and a loan with interest payable based on distributions by Gavita. The loan represented a non-cash financing activity and is recorded at fair value in the “Long-term debt” line in the Condensed Consolidated Balance Sheets. The initial valuation of the loan was $37.7 million. The fair value measurement was classified in Level 3 of the fair value hierarchy. Net sales for Gavita included within the Other segment for the three and nine months ended July 1, 2017 were $39.1 million and $89.8 million, respectively, as compared to $7.0 million during the three and nine months ended July 2, 2016.
During the third quarter of fiscal 2016, the Company completed an acquisition within the Other segment to expand its Canadian growing media operations for $33.9 million. The estimated purchase price included contingent consideration, a non-cash investing activity, with an initial estimated fair value of $10.8 million, of which $6.5 million was paid during the first quarter of fiscal 2017, and the remaining $4.3 million has been adjusted and reclassified to the acquired assets as the Company does not expect to pay out any additional consideration. The valuation of the acquired assets included (i) $4.7 million of inventory and accounts receivable, (ii) $18.5 million of fixed assets, (iii) $9.3 million of finite-lived identifiable intangible assets, (iv) $1.2 million of deferred tax liabilities, and (v) an investment in an unconsolidated joint venture of $0.5 million. Identifiable intangible assets included peat bog lease rights, tradenames, customer relationships and non-compete arrangements with useful lives ranging between 5 and 25 years. The estimated fair values of the identifiable intangible assets were determined using an income-based approach, which includes market participant expectations of cash flows that an asset will generate over the remaining useful life discounted to present value using an appropriate discount rate. Net sales related to this acquisition included within the Other segment for the three and nine months ended July 1, 2017 were $3.2 million and $10.7 million, respectively, as compared to $3.2 million during the three and nine months ended July 2, 2016.
During the second quarter of fiscal 2016, the Company entered into definitive agreements with Bonnie Plants, Inc. (“Bonnie”) and its sole shareholder, Alabama Farmers Cooperative, Inc. (“AFC”), providing for the Company’s participation in Bonnie’s business of planting, growing, developing, manufacturing, distributing, marketing, and selling live plants, plant food, fertilizer and potting soil (the “Bonnie Business”). The Company’s participation includes a Term Loan Agreement from the Company to AFC, with Bonnie as guarantor, in the amount of $72.0 million with a fixed coupon rate of 6.95% (the “Term Loan”) as well as a Marketing, R&D and Ancillary Services Agreement (the “Services Agreement”) pursuant to which the Company provides marketing, research and development and certain ancillary services to Bonnie for a commission fee based on the profits of the Bonnie Business and the reimbursement of certain costs. During the three and nine months ended July 1, 2017, the Company recognized commission income of $2.2 million and recognized cost reimbursements of $0.6 million and $2.2 million, respectively, as compared to commission income of $3.1 million and cost reimbursements of $0.4 million and $0.6 million during the three and nine months ended July 2, 2016, respectively.
These agreements also include options beginning in fiscal 2020 that provide for either (i) the Company to increase its economic interest in the Bonnie Business or (ii) AFC and Bonnie to repurchase the Company’s economic interest in the Bonnie Business. The Company’s option to increase its economic interest in the Bonnie Business (the “Bonnie Option”) is required to be accounted for as a derivative instrument and is recorded at fair value in the “Other assets” line in the Condensed Consolidated Balance Sheets, with changes in fair value recognized in the “Other income (loss), net” line in the Condensed Consolidated Statement of Operations. The estimated fair value of the Bonnie Option was determined using a simulation approach, whereby the total value of the loan receivable and optional exchange for additional equity was estimated considering a distribution of possible future cash flows discounted to present value using an appropriate discount rate. The estimated fair value of the Bonnie Option was $11.8 million as of July 1, 2017, and the fair value measurement was classified in Level 3 of the fair value hierarchy.
The condensed consolidated financial statements include the results of operations for these business combinations from the date of each acquisition.
NOTE 4. INVESTMENT IN UNCONSOLIDATED AFFILIATES
As of July 1, 2017, the Company held a minority equity interest of 30% in the TruGreen Joint Venture. This interest had an initial fair value of $294.0 million and subsequently is accounted for using the equity method of accounting, with the Company’s proportionate share of the TruGreen Joint Venture earnings reflected in the Condensed Consolidated Statements of Operations. In addition, the Company and TruGreen Holdings entered into a limited liability company agreement (the “LLC Agreement”) governing the management of the TruGreen Joint Venture, as well as certain ancillary agreements including a transition services agreement and an employee leasing agreement. The LLC Agreement provides the Company with minority representation on the board of directors of the TruGreen Joint Venture.
In connection with the closing of the transactions contemplated by the Contribution Agreement on April 13, 2016, the TruGreen Joint Venture obtained debt financing and made an excess distribution of $196.2 million to the Company, and the Company invested $18.0 million in second lien term loan financing to the TruGreen Joint Venture. The Company was reimbursed

12


$1.3 million and $35.0 million during the three and nine months ended July 1, 2017, respectively, and had accounts receivable of $8.3 million at July 1, 2017, for expenses incurred pursuant to a short-term transition services agreement and an employee leasing agreement. The Company was reimbursed $5.5 million during the three and nine months ended July 2, 2016, and had accounts receivable of $30.0 million at July 2, 2016, for expenses incurred pursuant to a short-term transition services agreement and an employee leasing agreement. The Company also had an indemnification asset of $6.6 million and $9.8 million at July 1, 2017 and July 2, 2016, respectively, for future payments on claims associated with insurance programs. The Company received distributions from unconsolidated affiliates intended to cover required tax payments of $1.4 million and $3.6 million during the three and nine months ended July 1, 2017, respectively.
The following table presents summarized financial information for the TruGreen Joint Venture for each of the periods presented:
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
(in millions)
Revenue
$
471.6

 
$
401.3

 
$
878.5

 
$
401.3

Gross margin
180.1

 
146.3

 
250.9

 
146.3

Selling and administrative expenses
115.9

 
86.7

 
208.8

 
86.7

Amortization expense
7.9

 
18.1

 
49.8

 
18.1

Interest expense
18.5

 
15.0

 
52.0

 
15.0

Restructuring and other charges
13.6

 
38.2

 
40.2

 
38.2

Net income (loss)
$
24.2

 
$
(11.7
)
 
$
(99.9
)
 
$
(11.7
)
    Net income (loss) does not include income taxes, which are recognized and paid by the partners of the TruGreen Joint Venture. The income taxes associated with the Company’s share of net loss have been recorded in the “Income tax expense from continuing operations” line in the Condensed Consolidated Statement of Operations. The Company recognized equity in income (loss) of unconsolidated affiliates of $7.2 million and $(30.1) million for the three and nine months ended July 1, 2017, respectively, as compared to $(3.5) million for the three and nine months ended July 2, 2016. Included within income (loss) of unconsolidated affiliates for the three and nine months ended July 1, 2017 are charges of $5.0 million and $16.7 million, respectively, which represent the Company’s share of restructuring and other charges incurred by the TruGreen Joint Venture. These charges included $1.1 million for transaction costs, $3.0 million and $10.9 million for nonrecurring integration and separation costs and $0.9 million and $4.7 million for a non-cash purchase accounting fair value write down adjustment related to deferred revenue and advertising for the three and nine months ended July 1, 2017, respectively. The Company’s share of restructuring and other charges incurred by the TruGreen Joint Venture were $17.0 million for the three and nine months ended July 2, 2016. These charges included $10.8 million for transaction costs, $0.6 million for nonrecurring integration and separation costs and $5.6 million for a non-cash purchase accounting fair value write down adjustment related to deferred revenue and advertising for the three and nine months ended July 2, 2016.

13


NOTE 5. IMPAIRMENT, RESTRUCTURING AND OTHER
Activity described herein is classified within the “Cost of sales—impairment, restructuring and other,” “Impairment, restructuring and other” and “Income (loss) from discontinued operations, net of tax” lines in the Condensed Consolidated Statements of Operations.
The following table details impairment, restructuring and other charges (recoveries) for each of the periods presented:
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
(In millions)
Cost of sales—impairment, restructuring and other:
 
 
 
 
 
 
 
Restructuring and other charges
$

 
$
0.4

 
$

 
$
5.5

Operating expenses:
 
 
 
 
 
 
 
Restructuring and other charges (recoveries)
4.1

 
(5.8
)
 
8.8

 
(51.7
)
Impairment, restructuring and other charges (recoveries) from continuing operations
$
4.1

 
$
(5.4
)
 
$
8.8

 
$
(46.2
)
Restructuring and other charges from discontinued operations
0.1

 

 
0.8

 
13.6

Total impairment, restructuring and other charges (recoveries)
$
4.2

 
$
(5.4
)
 
$
9.6

 
$
(32.6
)
The following table summarizes the activity related to liabilities associated with restructuring and other, excluding insurance reimbursement recoveries, during the nine months ended July 1, 2017 (in millions):
Amounts accrued for restructuring and other at September 30, 2016
$
20.8

Restructuring and other charges from continuing operations
8.8

Restructuring and other charges from discontinued operations
0.8

Payments and other
(25.2
)
Amounts accrued for restructuring and other at July 1, 2017
$
5.2

Included in the restructuring accruals, as of July 1, 2017, is $1.3 million that is classified as long-term. Payments against the long-term accruals will be incurred as the employees covered by the restructuring plan retire or through the passage of time. The remaining amounts accrued will continue to be paid out over the course of the next twelve months.
In the first quarter of fiscal 2016, the Company announced a series of initiatives called Project Focus designed to maximize the value of its non-core assets and focus on emerging categories of the lawn and garden industry in its core U.S. business. During the three and nine months ended July 1, 2017, the Company’s Corporate function recognized costs of $4.1 million and $8.8 million, respectively, as compared to (recoveries) costs of $(0.3) million and $2.3 million for the three and nine months ended July 2, 2016, respectively, related to Project Focus transaction activity within the “Impairment, restructuring and other” line in the Condensed Consolidated Statements of Operations. Costs incurred to date since the inception of the current initiatives are $3.4 million for the U.S. Consumer segment related to termination benefits, $2.0 million for the Europe Consumer segment related to termination benefits and $13.4 million for Corporate related to transaction activity.
During the third quarter of fiscal 2015, the Company’s U.S. Consumer segment began experiencing an increase in certain consumer complaints related to the reformulated Bonus® S fertilizer product sold in the southeastern United States during fiscal 2015 indicating customers were experiencing damage to their lawns after application. There have been no costs recognized by the Company related to this matter during the three and nine months ended July 1, 2017. During the three and nine months ended July 2, 2016, the Company incurred $0.5 million and $6.9 million, respectively, in costs related to resolving these consumer complaints and the recognition of costs the Company expected to incur for consumer claims within the “Impairment, restructuring and other” and the “Cost of sales—impairment, restructuring and other” lines in the Condensed Consolidated Statements of Operations. Additionally, the Company recorded offsetting insurance reimbursement recoveries of $5.9 million and $55.9 million for the three and nine months ended July 2, 2016, respectively, within the “Impairment, restructuring and other” line in the Condensed Consolidated Statements of Operations. Costs incurred to date since the inception of this matter were $73.8 million, partially offset by insurance reimbursement recoveries of $60.8 million.
On April 13, 2016, as part of Project Focus, the Company completed the contribution of the SLS Business to the TruGreen Joint Venture. As a result, effective in its second quarter of fiscal 2016, the Company classified its results of operations for all periods presented to reflect the SLS Business as a discontinued operation and classified the assets and liabilities of the SLS Business as held for sale. Refer to “NOTE 2. DISCONTINUED OPERATIONS” for more information. During the three and nine months

14


ended July 1, 2017, the Company recognized $0.1 million and $0.8 million, respectively, in transaction related costs associated with the divestiture of the SLS Business within the “Income (loss) from discontinued operations, net of tax” line in the Condensed Consolidated Statements of Operations. During the three and nine months ended July 2, 2016, the Company recognized zero and $9.0 million, respectively, for the resolution of a prior SLS Business litigation matter, as well as zero and $4.6 million, respectively, in transaction related costs associated with the divestiture of the SLS Business within the “Income (loss) from discontinued operations, net of tax” line in the Condensed Consolidated Statements of Operations.
NOTE 6. INVENTORIES
Inventories consisted of the following for each of the periods presented:
 
JULY 1,
2017
 
JULY 2,
2016
 
SEPTEMBER 30,
2016
 
(In millions)
Finished goods
$
271.5

 
$
299.9

 
$
248.7

Work-in-process
51.2

 
46.6

 
56.9

Raw materials
143.9

 
123.4

 
142.6

Total inventories
$
466.6

 
$
469.9

 
$
448.2


Adjustments to reflect inventories at net realizable values were $14.1 million at July 1, 2017, $15.3 million at July 2, 2016 and $10.8 million at September 30, 2016.
NOTE 7. MARKETING AGREEMENT
The Scotts Company LLC (“Scotts LLC”) and the Monsanto Company (“Monsanto”) are parties to the Amended and Restated Exclusive Agency and Marketing Agreement (the “Marketing Agreement”), pursuant to which the Company has served since its 1998 fiscal year, as Monsanto’s exclusive agent for the marketing and distribution of consumer Roundup® herbicide products (with additional rights to new products containing glyphosate or other similar non-selective herbicides) in the consumer lawn and garden market. Under the terms of the Marketing Agreement, the Company is entitled to receive an annual commission from Monsanto as consideration for the performance of the Company’s duties as agent. The annual gross commission under the Marketing Agreement is calculated as a percentage of the actual earnings before interest and income taxes of the consumer Roundup® business in the markets covered by the Marketing Agreement subject to the achievement of annual earnings thresholds. The Marketing Agreement also requires the Company to make annual payments of $20.0 million to Monsanto as a contribution against the overall expenses of the consumer Roundup® business. From 1998 until May 15, 2015, the Marketing Agreement covered the United States and other specified countries, including Australia, Austria, Belgium, Canada, France, Germany, the Netherlands and the United Kingdom. On May 15, 2015, the territories were expanded to cover additional countries as outlined below.
In consideration for the rights granted to the Company under the Marketing Agreement in 1998, the Company paid a marketing fee of $32 million to Monsanto. The Company deferred this amount on the basis that the payment will provide a future benefit through commissions that will be earned under the Marketing Agreement. The economic useful life over which the marketing fee is being amortized is 20 years, with a remaining unamortized amount of $1.0 million and remaining amortization period of less than two years as of July 1, 2017.
On May 15, 2015, the Company and Monsanto entered into an Amendment to the Marketing Agreement (the “Marketing Agreement Amendment”), a Lawn and Garden Brand Extension Agreement (the “Brand Extension Agreement”) and a Commercialization and Technology Agreement (the “Commercialization and Technology Agreement”). In consideration for these agreements, the Company paid $300.0 million to Monsanto on August 14, 2015 using borrowings under its credit facility.
Among other things, the Marketing Agreement Amendment amends the Marketing Agreement in the following significant respects:
Expands the territories in which the Company may serve as Monsanto’s exclusive agent in the consumer lawn and garden market to include all countries other than Japan and countries subject to a comprehensive U.S. trade embargo or certain other embargoes and trade restrictions.
Eliminates the initial and renewal terms that the original Marketing Agreement applied to European Union (“EU”) countries. As amended, the term of the Marketing Agreement will now continue indefinitely for all included markets, including EU countries within the included markets, unless and until otherwise terminated in accordance with the Marketing Agreement.

15


Revises the procedures of the Marketing Agreement relating to a potential sale of the consumer Roundup® business to (1) require Monsanto to negotiate exclusively with the Company with respect to any potential Roundup® sale for 60 days after the Company receives notice from Monsanto regarding a potential Roundup® sale and (2) provide the Company with a right of first offer and a right of last look in connection with a potential Roundup® sale to a third party. In addition, if the Company makes a bid in connection with a Roundup® sale, the then-applicable termination fee would serve as a credit against the purchase price and the Monsanto board of directors would not be permitted to discount the value of the Company’s bid compared to a competing bid as a result of the termination fee discount.
Requires the Company to (1) provide notice to Monsanto of certain proposals and processes that may result in a sale of the Company and (2) conduct non-exclusive negotiations with Monsanto with respect to such a sale.
Increases the minimum termination fee payable under the Marketing Agreement to the greater of (1) $200.0 million or (2) four times (A) the average of the program earnings before interest or income taxes for the three trailing program years prior to the year of termination, minus (B) the 2015 program earnings before interest or income taxes.
Amends Monsanto’s termination rights and provides additional rights to the Company in the event of a termination, as follows:
delays the effectiveness of a notice of termination given by Monsanto as a result of a change of control with respect to Monsanto or a sale of the consumer Roundup® business to a third party from (1) the end of the later of 12 months or the next program year to (2) the end of the fifth full program year after Monsanto gives such notice;
eliminates Monsanto’s termination rights for a regional performance default, a change of significant ownership of the Company or an uncured or incurable egregious injury (as each is defined in the Marketing Agreement); and
eliminates Monsanto’s termination rights in connection with a change in control of the Company or Scotts Miracle-Gro as long as the Company has determined, in its reasonable commercial opinion, that the acquirer can and will fully perform the duties and obligations of the Company under the Marketing Agreement.
Expands the Company’s termination rights to include termination for a brand decline event (as defined in the Marketing Agreement Amendment) occurring before program year 2023.
Expands the Company’s assignment rights to allow the Company to transfer its rights, interests and obligations under the Marketing Agreement with respect to (1) the North America territories and (2) one or more other included markets for up to three other assignments.
Amends the commission structure by (1) eliminating the commission threshold for program years 2016, 2017 and 2018, (2) setting the commission threshold for the subsequent program years at $40 million and (3) establishing the commission payable by Monsanto to the Company for each program year at an amount equal to 50% of the program earnings before interest and income taxes for such program year.
The Brand Extension Agreement provides the Company a worldwide, exclusive license to use the Roundup® brand on additional products offered by the Company outside of the non-selective weed category within the residential lawn and garden market. The application of the Roundup® brand to these additional products is subject to a product review and approval process developed between the Company and Monsanto. Monsanto will maintain oversight of its brand, the handling of brand registrations covering these new products and new territories, as well as primary responsibility for brand enforcement. The Brand Extension Agreement has an initial term of twenty years, which will automatically renew for additional successive twenty year terms, at the Company’s sole option, for no additional monetary consideration.
The Commercialization and Technology Agreement provides for the Company and Monsanto to further develop and commercialize new products and technology developed at Monsanto and intended for introduction into the residential lawn and garden market. Under the Commercialization and Technology Agreement, the Company receives an exclusive first look at new Monsanto technology and products and an annual review of Monsanto’s developing products and technologies. The Commercialization and Technology Agreement has a term of thirty years (subject to early termination upon a termination event under the Marketing Agreement or the Brand Extension Agreement).
The Company recorded the $300.0 million consideration paid by the Company to Monsanto in connection with the entry into the Marketing Agreement Amendment, the Brand Extension Agreement and the Commercialization and Technology Agreement as intangible assets and the related economic useful life of such assets is indefinite. The identifiable intangible assets include the Marketing Agreement Amendment and the Brand Extension Agreement with allocated fair value of $188.3 million and $111.7

16


million, respectively. The estimated fair values of the identifiable intangible assets were determined using an income-based approach, which includes market participant expectations of cash flows that an asset will generate over the remaining useful life discounted to present value using an appropriate rate of return.
Under the terms of the Marketing Agreement, the Company performs certain functions, primarily manufacturing conversion services (in North America), distribution and logistics, and selling and marketing support, on behalf of Monsanto in the conduct of the consumer Roundup® business. The actual costs incurred for these activities are charged to and reimbursed by Monsanto. The Company records costs incurred under the Marketing Agreement for which the Company is the primary obligor on a gross basis, recognizing such costs in the “Cost of sales” line and the reimbursement of these costs in the “Net sales” line in the Condensed Consolidated Statements of Operations, with no effect on gross profit dollars or net income.
The gross commission earned under the Marketing Agreement, the contribution payments to Monsanto and the amortization of the initial marketing fee paid to Monsanto in 1998 are included in the calculation of net sales in the Company’s Condensed Consolidated Statements of Operations. The elements of the net commission and reimbursements earned under the Marketing Agreement and included in “Net sales” are as follows:
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
(In millions)
Gross commission
$
38.5

 
$
37.4

 
$
86.7

 
$
92.3

Contribution expenses
(5.0
)
 
(5.0
)
 
(15.0
)
 
(15.0
)
Amortization of marketing fee
(0.2
)
 
(0.2
)
 
(0.6
)
 
(0.6
)
Net commission
33.3

 
32.2

 
71.1

 
76.7

Reimbursements associated with Marketing Agreement
18.1

 
18.4

 
56.3

 
55.2

Total net sales associated with Marketing Agreement
$
51.4

 
$
50.6

 
$
127.4

 
$
131.9

NOTE 8. DEBT
The components of long-term debt are as follows:
 
JULY 1,
2017
 
JULY 2,
2016
 
SEPTEMBER 30,
2016
 
(In millions)
Credit Facilities:
 
 
 
 
 
Revolving loans
$
473.7

 
$
404.9

 
$
417.4

Term loans
277.5

 
292.5

 
288.8

Senior Notes – 5.250%
250.0

 

 

Senior Notes – 6.000%
400.0

 
400.0

 
400.0

Receivables facility
250.0

 
348.0

 
138.6

Other
66.5

 
67.4

 
71.3

Total debt
1,717.7

 
1,512.8

 
1,316.1

Less current portions
289.1

 
382.5

 
185.0

Less unamortized debt issuance costs
8.9

 
6.2

 
6.0

Long-term debt
$
1,419.7

 
$
1,124.1

 
$
1,125.1

Credit Facilities
On December 20, 2013, the Company entered into the third amended and restated credit agreement, providing the Company and certain of its subsidiaries with a five-year senior secured revolving loan facility in the aggregate principal amount of up to $1.7 billion (the “former credit facility”). On October 29, 2015, the Company entered into the fourth amended and restated credit agreement (the “credit agreement”), providing the Company and certain of its subsidiaries with five-year senior secured loan facilities in the aggregate principal amount of $1.9 billion, comprised of a revolving credit facility of $1.6 billion and a term loan in the original principal amount of $300.0 million (the “credit facilities”). The credit agreement also provides the Company with the right to seek additional committed credit under the agreement in an aggregate amount of up to $500.0 million plus an unlimited additional amount, subject to certain specified financial and other conditions. Under the credit agreement, the Company has the ability to obtain letters of credit up to $100.0 million. The credit agreement replaces the former credit facility, and will terminate

17


on October 29, 2020. Borrowings on the revolving credit facility may be made in various currencies, including U.S. dollars, euro, British pounds, Australian dollars and Canadian dollars. The terms of the credit agreement include customary representations and warranties, affirmative and negative covenants, financial covenants and events of default. The proceeds of borrowings on the credit facilities may be used: (i) to finance working capital requirements and other general corporate purposes of the Company and its subsidiaries; and (ii) to refinance the amounts outstanding under the former credit facility.
Under the terms of the credit agreement, loans bear interest, at the Company’s election, at a rate per annum equal to either the ABR or Adjusted LIBO Rate (both as defined in the credit agreement) plus the applicable margin. The credit facilities are guaranteed by substantially all of the Company’s domestic subsidiaries, and are secured by (i) a perfected first priority security interest in all of the accounts receivable, inventory and equipment of the Company and the Company’s domestic subsidiaries that are guarantors and (ii) the pledge of all of the capital stock of the Company’s domestic subsidiaries that are guarantors.
At July 1, 2017, the Company had letters of credit outstanding in the aggregate principal amount of $23.5 million, and $1.1 billion of availability under the credit agreement, subject to the Company’s continued compliance with the covenants discussed below. The weighted average interest rates on average borrowings under the credit agreement and the former credit facility were 3.8% and 3.9% for the nine months ended July 1, 2017 and July 2, 2016, respectively.
The credit agreement contains, among other obligations, an affirmative covenant regarding the Company’s leverage ratio on the last day of each quarter calculated as average total indebtedness, divided by the Company’s earnings before interest, taxes, depreciation and amortization (“EBITDA”), as adjusted pursuant to the terms of the credit agreement (“Adjusted EBITDA”). The maximum leverage ratio was 4.50 as of July 1, 2017. The Company’s leverage ratio was 3.03 at July 1, 2017. The credit agreement also includes an affirmative covenant regarding its interest coverage ratio. The interest coverage ratio is calculated as Adjusted EBITDA divided by interest expense, as described in the credit agreement, and excludes costs related to refinancings. The minimum interest coverage ratio was 3.00 for the twelve months ended July 1, 2017. The Company’s interest coverage ratio was 7.98 for the twelve months ended July 1, 2017. The credit agreement allows the Company to make unlimited restricted payments (as defined in the credit agreement), including increased or one-time dividend payments and Common Share repurchases, as long as the leverage ratio resulting from the making of such restricted payments is 4.00 or less. Otherwise the Company may only make restricted payments in an aggregate amount for each fiscal year not to exceed the amount set forth in the credit agreement for such fiscal year ($175.0 million for fiscal 2017 and $200.0 million for fiscal 2018 and each fiscal year thereafter).
Senior Notes - 5.250%
On December 15, 2016, Scotts Miracle-Gro issued $250.0 million aggregate principal amount of 5.250% senior notes due 2026 (the “5.250% Senior Notes”). The net proceeds of the offering were used to repay outstanding borrowings under the credit facilities. The 5.250% Senior Notes represent general unsecured senior obligations and rank equal in right of payment with the Company’s existing and future unsecured senior debt. The 5.250% Senior Notes have interest payment dates of June 15 and December 15 of each year, commencing June 15, 2017. The 5.250% Senior Notes may be redeemed, in whole or in part, on or after December 15, 2021 at applicable redemption premiums. The 5.250% Senior Notes contain customary covenants and events of default and mature on December 15, 2026. Substantially all of Scotts Miracle-Gro’s domestic subsidiaries serve as guarantors of the 5.250% Senior Notes.
Senior Notes - 6.625%
On December 15, 2015, Scotts Miracle-Gro redeemed all $200.0 million aggregate principal amount of its outstanding 6.625% senior notes due 2020 (the “6.625% Senior Notes”) paying a redemption price of $213.2 million, comprised of $6.6 million of accrued and unpaid interest, $6.6 million of call premium and $200.0 million for outstanding principal amount. The $6.6 million call premium charge was recognized within the “Costs related to refinancing” line on the Condensed Consolidated Statement of Operations in the first quarter of fiscal 2016. Additionally, the Company had $2.2 million in unamortized bond discount and issuance costs associated with the 6.625% Senior Notes that were written off and recognized in the “Costs related to refinancing” line on the Condensed Consolidated Statement of Operations in the first quarter of fiscal 2016.
Senior Notes - 6.000%
On October 13, 2015, Scotts Miracle-Gro issued $400.0 million aggregate principal amount of 6.000% senior notes due 2023 (the “6.000% Senior Notes”). The net proceeds of the offering were used to repay outstanding borrowings under the former credit facility. The 6.000% Senior Notes represent general unsecured senior obligations and rank equal in right of payment with the Company’s existing and future unsecured senior debt. The 6.000% Senior Notes have interest payment dates of April 15 and October 15 of each year. The 6.000% Senior Notes may be redeemed, in whole or in part, on or after October 15, 2018 at applicable redemption premiums. The 6.000% Senior Notes contain customary covenants and events of default and mature on October 15, 2023. Substantially all of Scotts Miracle-Gro’s domestic subsidiaries serve as guarantors of the 6.000% Senior Notes.

18


Receivables Facility
On September 25, 2015, the Company entered into an amended and restated master accounts receivable purchase agreement (the “MARP Agreement”). The MARP Agreement provided for the discretionary sale by the Company, and the discretionary purchase by the participating banks, on a revolving basis, of accounts receivable generated by sales to three specified debtors in an aggregate amount not to exceed $400.0 million. The MARP Agreement terminated effective October 14, 2016 in accordance with its terms upon the Company’s repayment of its outstanding obligations thereunder using $133.5 million borrowed under the credit agreement. There were $348.0 million in borrowings or receivables pledged as collateral under the MARP Agreement as of July 2, 2016. The carrying value of the receivables pledged as collateral was $435.1 million as of July 2, 2016.
On April 7, 2017, the Company entered into a Master Repurchase Agreement (including the annexes thereto, the “Repurchase Agreement”) and a Master Framework Agreement (the “Framework Agreement” and, together with the Repurchase Agreement, the “Receivables Facility”). Under the Receivables Facility, the Company may sell a portfolio of available and eligible outstanding customer accounts receivable to the purchasers and simultaneously agrees to repurchase the receivables on a weekly basis. The eligible accounts receivable consist of up to $250.0 million in accounts receivable generated by sales to three specified customers. The Receivables Facility is committed up to $100.0 million during the commitment period beginning on April 7, 2017 and ending on June 16, 2017. The Receivables Facility is considered a secured financing with the customer accounts receivable, related contract rights and proceeds thereof (and the collection accounts into which the same are deposited) constituting the collateral therefor. The repurchase price for customer accounts receivable bears interest at LIBOR (with a zero floor), as defined in the Repurchase Agreement, plus 0.90%. The Receivables Facility expires on August 25, 2017.
The Company accounts for the sale of receivables under the Receivables Facility as short-term debt and continues to carry the receivables on its Condensed Consolidated Balance Sheet, primarily as a result of the Company’s requirement to repurchase receivables sold. There were $250.0 million in borrowings or receivables pledged as collateral under the Receivables Facility as of July 1, 2017. The carrying value of the receivables pledged as collateral was $277.8 million as of July 1, 2017. As of July 1, 2017, there was no remaining availability under the Receivables Facility.
Other
In connection with the acquisition of a controlling interest in Gavita, the Company recorded a loan to the noncontrolling ownership group of Gavita. The fair value of the loan was $40.5 million, $37.7 million and $38.3 million at July 1, 2017, July 2, 2016 and September 30, 2016, respectively.
Interest Rate Swap Agreements
The Company has outstanding interest rate swap agreements with major financial institutions that effectively convert a portion of the Company’s variable-rate debt to a fixed rate. The swap agreements had a total U.S. dollar equivalent notional amount of $1,150.0 million at July 1, 2017, $650.0 million at July 2, 2016 and $650.0 million at September 30, 2016. Interest payments made between the effective date and expiration date are hedged by the swap agreements, except as noted below, respectively.
The notional amount, effective date, expiration date and rate of each of these swap agreements outstanding at July 1, 2017 are shown in the table below:
Notional Amount
(in millions)
 
Effective
Date (a)
 
Expiration
Date
 
Fixed
Rate
$
50

(d) 
12/6/2012
 
9/6/2017
 
2.96
%
200

 
2/7/2014
 
11/7/2017
 
1.28
%
300

(e) 
11/21/2016
 
6/20/2018
 
0.83
%
200

(e) 
11/7/2016
 
8/7/2018
 
0.84
%
150

(b) 
2/7/2017
 
5/7/2019
 
2.12
%
50

(b) 
2/7/2017
 
5/7/2019
 
2.25
%
200

(c) 
12/20/2016
 
6/20/2019
 
2.12
%
(a)
The effective date refers to the date on which interest payments were first hedged by the applicable swap agreement.
(b)
Interest payments made during the three-month period of each year that begins with the month and day of the effective date are hedged by the swap agreement.
(c)
Interest payments made during the six-month period of each year that begins with the month and day of the effective date are hedged by the swap agreement.
(d)
Interest payments made during the nine-month period of each year that begins with the month and day of the effective date are hedged by the swap agreement.

19


(e)
Notional amount adjusts in accordance with a specified seasonal schedule. This represents the maximum notional amount at any point in time.
Estimated Fair Values
The methods and assumptions used to estimate the fair values of the Company’s debt instruments are described below:
Credit Facilities
The interest rate currently available to the Company fluctuates with the applicable LIBO rate, prime rate or Federal Funds Effective Rate and thus the carrying value is a reasonable estimate of fair value. The fair value measurement for the credit facilities was classified in Level 2 of the fair value hierarchy.
5.250% Senior Notes
The fair value of the 5.250% Senior Notes was determined based on the trading of the 5.250% Senior Notes in the open market. The difference between the carrying value and the fair value of the 5.250% Senior Notes represents the premium or discount on that date. Based on the trading value on or around July 1, 2017, the fair value of the 5.250% Senior Notes was approximately $261.6 million. The fair value measurement for the 5.250% Senior Notes was classified in Level 1 of the fair value hierarchy.
6.000% Senior Notes
The fair value of the 6.000% Senior Notes was determined based on the trading of the 6.000% Senior Notes in the open market. The difference between the carrying value and the fair value of the 6.000% Senior Notes represents the premium or discount on that date. Based on the trading value on or around July 1, 2017, the fair value of the 6.000% Senior Notes was approximately $429.5 million. The fair value measurement for the 6.000% Senior Notes was classified in Level 1 of the fair value hierarchy.
Accounts Receivable Pledged
The interest rate on the short-term debt associated with accounts receivable pledged under the Receivables Facility fluctuated with the applicable LIBOR and thus the carrying value is a reasonable estimate of fair value. The fair value measurement for the Receivables Facility was classified in Level 2 of the fair value hierarchy.
Weighted Average Interest Rate
The weighted average interest rates on the Company’s debt were 4.4% and 4.3% for the nine months ended July 1, 2017 and July 2, 2016, respectively. The increase in the weighted average interest rate is due to the issuance of the 5.250% Senior Notes on December 15, 2016.
NOTE 9. RETIREMENT AND RETIREE MEDICAL PLANS
The following summarizes the components of net periodic benefit (income) cost for the retirement and retiree medical plans sponsored by the Company: 
 
THREE MONTHS ENDED
 
JULY 1, 2017
 
JULY 2, 2016
 
U.S.
Pension
 
International
Pension
 
U.S.
Medical
 
U.S.
Pension
 
International
Pension
 
U.S.
Medical
 
(In millions)
Service cost
$

 
$
0.3

 
$

 
$

 
$
0.3

 
$
0.1

Interest cost
0.7

 
1.0

 
0.2

 
1.1

 
1.7

 
0.3

Expected return on plan assets
(1.2
)
 
(2.0
)
 

 
(1.2
)
 
(2.0
)
 

Net amortization
0.4

 
0.5

 
(0.1
)
 
0.4

 
0.4

 
(0.3
)
Net periodic benefit (income) cost
$
(0.1
)
 
$
(0.2
)
 
$
0.1

 
$
0.3

 
$
0.4

 
$
0.1


20


 
NINE MONTHS ENDED
 
JULY 1, 2017
 
JULY 2, 2016
 
U.S.
Pension
 
International
Pension
 
U.S.
Medical
 
U.S.
Pension
 
International
Pension
 
U.S.
Medical
 
(In millions)
Service cost
$

 
$
0.9

 
$
0.2

 
$

 
$
0.9

 
$
0.3

Interest cost
2.1

 
2.9

 
0.5

 
3.3

 
5.1

 
0.8

Expected return on plan assets
(3.6
)
 
(6.0
)
 

 
(3.7
)
 
(6.0
)
 

Net amortization
1.2

 
1.6

 
(0.5
)
 
1.3

 
1.2

 
(0.8
)
Net periodic benefit (income) cost
$
(0.3
)
 
$
(0.6
)
 
$
0.2

 
$
0.9

 
$
1.2

 
$
0.3

NOTE 10. EQUITY
In August 2014, the Scotts Miracle-Gro Board of Directors authorized the repurchase of up to $500.0 million of Common Shares over a five-year period (effective November 1, 2014 through September 30, 2019). On August 3, 2016, Scotts Miracle-Gro announced that its Board of Directors authorized a $500.0 million increase to the share repurchase authorization ending on September 30, 2019. The amended authorization allows for repurchases of Common Shares of $1.0 billion through September 30, 2019. The authorization provides the Company with flexibility to purchase Common Shares from time to time in open market purchases or through privately negotiated transactions. All or part of the repurchases may be made under Rule 10b5-1 plans, which the Company may enter into from time to time and which enable the repurchases to occur on a more regular basis, or pursuant to accelerated share repurchases. The share repurchase authorization, which expires September 30, 2019, may be suspended or discontinued at any time, and there can be no guarantee as to the timing or amount of any repurchases. During the three and nine months ended July 1, 2017, Scotts Miracle-Gro repurchased 1.0 million and 2.0 million Common Shares for $84.6 million and $175.1 million, respectively. From the inception of this share repurchase program in the fourth quarter of fiscal 2014 through July 1, 2017, Scotts Miracle-Gro repurchased approximately 4.0 million Common Shares for $320.8 million.
On August 1, 2017, the Scotts Miracle-Gro Board of Directors approved an increase in the quarterly cash dividend from $0.50 to $0.53 per Common Share.

21


The following table provides a summary of the changes in total equity, shareholders’ equity attributable to controlling interest, and equity attributable to noncontrolling interests for the nine months ended July 1, 2017 and July 2, 2016 (in millions):
 
Common Shares and Capital in Excess of Stated Value
 
Retained Earnings
 
Treasury Shares
 
Accumulated Other Comprehensive Loss
 
Total Equity - Controlling Interest
 
Non-controlling Interest
 
Total Equity
Balance at September 30, 2015
$
400.4

 
$
684.2

 
$
(357.1
)
 
$
(106.8
)
 
$
620.7

 
$
12.4

 
$
633.1

Net income (loss)

 
341.9

 

 

 
341.9

 
(0.2
)
 
341.7

Other comprehensive income (loss)

 

 

 
(10.7
)
 
(10.7
)
 

 
(10.7
)
Share-based compensation
13.9

 

 

 

 
13.9

 

 
13.9

Dividends declared ($1.410 per share)

 
(87.5
)
 

 

 
(87.5
)
 

 
(87.5
)
Treasury share purchases

 

 
(81.2
)
 

 
(81.2
)
 

 
(81.2
)
Treasury share issuances
(13.2
)
 

 
29.0

 

 
15.8

 

 
15.8

Investment in noncontrolling interest

 

 

 

 

 
7.1

 
7.1

Balance at July 2, 2016
$
401.1

 
$
938.6

 
$
(409.3
)
 
$
(117.5
)
 
$
812.9

 
$
19.3

 
$
832.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30, 2016
$
401.7

 
$
881.8

 
$
(451.4
)
 
$
(116.9
)
 
$
715.2

 
$
19.1

 
$
734.3

Net income (loss)

 
251.8

 

 

 
251.8

 
0.5

 
252.3

Other comprehensive income (loss)

 

 

 
8.6

 
8.6

 
0.1

 
8.7

Share-based compensation
25.2

 

 

 

 
25.2

 

 
25.2

Dividends declared ($1.500 per share)

 
(90.5
)
 

 

 
(90.5
)
 

 
(90.5
)
Treasury share purchases

 

 
(175.1
)
 

 
(175.1
)
 

 
(175.1
)
Treasury share issuances
(20.2
)
 

 
16.4

 

 
(3.8
)
 

 
(3.8
)
Adjustment to noncontrolling interest due to ownership change
(1.0
)
 

 

 

 
(1.0
)
 
1.0

 

Distribution declared by AeroGrow

 

 

 

 

 
(8.1
)
 
(8.1
)
Balance at July 1, 2017
$
405.7

 
$
1,043.1

 
$
(610.1
)
 
$
(108.3
)
 
$
730.4

 
$
12.6

 
$
743.0

On November 29, 2016, the Company’s wholly-owned subsidiary SMG Growing Media, Inc. fully exercised its outstanding warrants to acquire additional shares of common stock of AeroGrow for an aggregate warrant exercise price of $47.8 million in exchange for the issuance of 21.6 million shares of common stock of AeroGrow, which increased the Company’s percentage ownership of AeroGrow’s outstanding shares of common stock (on a fully diluted basis) from 45% to 80%. The financial results of AeroGrow have been consolidated into the Company’s consolidated financial statements since the fourth quarter of fiscal 2014, when the Company obtained control of AeroGrow’s operations through increased involvement, influence and a working capital loan provided to AeroGrow. Following the exercise of the warrants, the Board of Directors of AeroGrow declared a $41 million distribution ($1.21 per share) payable on January 3, 2017 to shareholders of record on December 20, 2016. On January 3, 2017, AeroGrow paid a distribution of $8.1 million to its noncontrolling interest holders.
Share-Based Awards
Scotts Miracle-Gro grants share-based awards annually to officers and certain other employees of the Company and non-employee directors of Scotts Miracle-Gro. The share-based awards have consisted of stock options, restricted stock units, deferred stock units and performance-based awards. All of these share-based awards have been made under plans approved by the shareholders. If available, Scotts Miracle-Gro will typically use treasury shares, or if not available, newly-issued Common Shares, in satisfaction of its share-based awards.
On January 30, 2017, the Company issued 0.5 million performance-based award units to certain senior executives as part of its Project Focus initiative. These awards provide for a five-year vesting period based on achievement of specific performance goals aligned with the strategic objectives of the Company’s Project Focus initiatives. The performance goals include a combination of five year cumulative operating cash flow less capital expenditures; five year non-GAAP diluted EPS growth; and dividend yield. The Company assesses the probability of achievement of performance goals each period and records expense for the awards based on the probable achievement of such metrics. Performance-based award units accrue cash dividend equivalents that are payable upon vesting of the awards.

22


The following is a summary of the share-based awards granted during each of the periods indicated:
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
Employees
 
 
 
Stock options

 
444,890

Restricted stock units
109,661

 
74,422

Performance units
487,809

 
56,315

Board of Directors
 
 
 
Deferred stock units
23,853

 
28,103

Total share-based awards
621,323

 
603,730

 
 
 
 
Aggregate fair value at grant dates (in millions)
$
57.7

 
$
16.4

Total share-based compensation was as follows for each of the periods indicated:
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
(In millions)
Share-based compensation
$
5.4

 
$
2.4

 
$
20.5

 
$
13.7

Tax benefit recognized
2.1

 
0.9

 
7.8

 
5.2

NOTE 11. INCOME TAXES
The effective tax rate related to continuing operations for the nine months ended July 1, 2017 and July 2, 2016 was 34.8% and 35.5%, respectively. The effective tax rate used for interim reporting purposes is based on management’s best estimate of factors impacting the effective tax rate for the full fiscal year. There can be no assurance that the effective tax rate estimated for interim financial reporting purposes will approximate the effective tax rate determined at fiscal year end. Final Treasury Regulations under Internal Revenue Code §987 were enacted on December 7, 2016, governing the methodology to be used in calculating deferred translation gain or loss for certain entities treated as U.S. branches for U.S. tax purposes.  The Company has determined that the impact of adopting these regulations is immaterial to the Company's deferred tax balances and financial statements. 
Scotts Miracle-Gro or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. Subject to the following exceptions, the Company is no longer subject to examination by these tax authorities for fiscal years prior to 2014. The Company is currently under examination by the Internal Revenue Service and certain foreign and U.S. state and local tax authorities. The U.S. federal examination is limited to fiscal years 2011 through 2013. With respect to foreign jurisdictions, a German audit closed in the third quarter of fiscal 2017 with no material impact to the financial statements. In regard to the multiple U.S. state and local audits, the tax periods under examination are limited to fiscal years 2011 through 2015. In addition to the aforementioned audits, certain other tax deficiency notices and refund claims for previous years remain unresolved.
The Company currently anticipates that few of its open and active audits will be resolved within the next twelve months. The Company is unable to make a reasonably reliable estimate as to when or if cash settlements with taxing authorities may occur. Although audit outcomes and the timing of audit payments are subject to significant uncertainty, the Company does not anticipate that the resolution of these tax matters or any events related thereto will result in a material change to its consolidated financial position, results of operations or cash flows.
NOTE 12. CONTINGENCIES
Management regularly evaluates the Company’s contingencies, including various lawsuits and claims which arise in the normal course of business, product and general liabilities, workers’ compensation, property losses and other liabilities for which the Company is self-insured or retains a high exposure limit. Self-insurance accruals are established based on actuarial loss estimates for specific individual claims plus actuarially estimated amounts for incurred but not reported claims and adverse development factors applied to existing claims. Legal costs incurred in connection with the resolution of claims, lawsuits and other contingencies generally are expensed as incurred. In the opinion of management, the assessment of contingencies is reasonable and related accruals, in the aggregate, are adequate; however, there can be no assurance that final resolution of these matters will not have a material effect on the Company’s financial condition, results of operations or cash flows.

23


Regulatory Matters
At July 1, 2017, $5.0 million was accrued in the “Other liabilities” line in the Condensed Consolidated Balance Sheets for environmental actions, the majority of which are for site remediation. The amounts accrued are believed to be adequate to cover such known environmental exposures based on current facts and estimates of likely outcomes. Although it is reasonably possible that the costs to resolve such known environmental exposures will exceed the amounts accrued, any variation from accrued amounts is not expected to be material.
Other
The Company has been named as a defendant in a number of cases alleging injuries that the lawsuits claim resulted from exposure to asbestos-containing products, apparently based on the Company’s historic use of vermiculite in certain of its products. In many of these cases, the complaints are not specific about the plaintiffs’ contacts with the Company or its products. The cases vary, but complaints in these cases generally seek unspecified monetary damages (actual, compensatory, consequential and punitive) from multiple defendants. The Company believes that the claims against it are without merit and is vigorously defending against them. It is not currently possible to reasonably estimate a probable loss, if any, associated with these cases and, accordingly, no accruals have been recorded in the Company’s condensed consolidated financial statements. The Company is reviewing agreements and policies that may provide insurance coverage or indemnity as to these claims and is pursuing coverage under some of these agreements and policies, although there can be no assurance of the results of these efforts. There can be no assurance that these cases, whether as a result of adverse outcomes or as a result of significant defense costs, will not have a material effect on the Company’s financial condition, results of operations or cash flows.
In connection with the sale of wild bird food products that were the subject of a voluntary recall in 2008, the Company, along with its Chief Executive Officer, have been named as defendants in four actions filed on and after June 27, 2012, which have been consolidated and, on March 31, 2017, certified as a class action in the United States District Court for the Southern District of California as In re Morning Song Bird Food Litigation, Lead Case No. 3:12-cv-01592-JAH-RBB. The plaintiffs allege various statutory and common law claims associated with the Company’s sale of wild bird food products and a plea agreement entered into in previously pending government proceedings associated with such sales. The plaintiffs allege, among other things, a class action on behalf of all persons and entities in the United States who purchased certain bird food products. The plaintiffs assert: (i) hundreds of millions of dollars in monetary damages (actual, compensatory, consequential, and restitution); (ii) punitive and treble damages; (iii) injunctive and declaratory relief; (iv) pre-judgment and post-judgment interest; and (v) costs and attorneys’ fees. The Company and its Chief Executive Officer dispute the plaintiffs’ assertions and intend to vigorously defend the consolidated action. At this point in the proceedings, it is not currently possible to reasonably estimate a probable loss, if any, associated with the action and, accordingly, no accruals have been recorded in the consolidated financial statements with respect to the action. There can be no assurance that this action, whether as a result of an adverse outcome or as a result of significant defense costs, will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
The Company is involved in other lawsuits and claims which arise in the normal course of business. These claims individually and in the aggregate are not expected to result in a material effect on the Company’s financial condition, results of operations or cash flows.
NOTE 13. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company is exposed to market risks, such as changes in interest rates, currency exchange rates and commodity prices. To manage a portion of the volatility related to these exposures, the Company enters into various financial transactions. The utilization of these financial transactions is governed by policies covering acceptable counterparty exposure, instrument types and other hedging practices. The Company does not hold or issue derivative financial instruments for speculative trading purposes.
Exchange Rate Risk Management
The Company uses currency forward contracts to manage the exchange rate risk associated with intercompany loans with foreign subsidiaries that are denominated in local currencies. At July 1, 2017, the notional amount of outstanding currency forward contracts was $266.2 million, with a negative fair value of $2.1 million. At July 2, 2016, the notional amount of outstanding currency forward contracts was $163.3 million, with a fair value of $0.5 million. At September 30, 2016, the notional amount of outstanding currency forward contracts was $165.8 million, with a fair value of $0.4 million. The fair value of currency forward contracts is determined using forward rates in commonly quoted intervals for the full term of the contracts. The outstanding contracts will mature over the next fiscal year.
Interest Rate Risk Management
The Company enters into interest rate swap agreements as a means to hedge its variable interest rate risk on debt instruments. Net amounts to be received or paid under the swap agreements are reflected as adjustments to interest expense. Since the interest

24


rate swap agreements have been designated as hedging instruments, unrealized gains or losses resulting from adjusting these swaps to fair value are recorded as elements of accumulated other comprehensive income (loss) (“AOCI”) within the Condensed Consolidated Balance Sheets except for any ineffective portion of the change in fair value, which is immediately recorded in interest expense. The fair value of the swap agreements is determined based on the present value of the estimated future net cash flows using implied rates in the applicable yield curve as of the valuation date.
The Company has outstanding interest rate swap agreements with major financial institutions that effectively convert a portion of the Company’s variable-rate debt to a fixed rate. The swap agreements had a total U.S. dollar equivalent notional amount of $1,150.0 million at July 1, 2017, $650.0 million at July 2, 2016 and $650.0 million at September 30, 2016. Refer to “NOTE 8. DEBT” for the terms of the swap agreements outstanding at July 1, 2017. Included in the AOCI balance at July 1, 2017 was a gain of $0.1 million related to interest rate swap agreements that is expected to be reclassified to earnings during the next twelve months, consistent with the timing of the underlying hedged transactions.
Commodity Price Risk Management
The Company enters into hedging arrangements designed to fix the price of a portion of its projected future urea requirements. The contracts are designated as hedges of the Company’s exposure to future cash flow fluctuations associated with the cost of urea. The objective of the hedges is to mitigate the earnings and cash flow volatility attributable to the risk of changing prices. Since the contracts have been designated as hedging instruments, unrealized gains or losses resulting from adjusting these contracts to fair value are recorded as elements of AOCI within the Condensed Consolidated Balance Sheets. Realized gains or losses remain as a component of AOCI until the related inventory is sold. Upon sale of the underlying inventory, the gain or loss is reclassified to cost of sales. Included in the AOCI balance at July 1, 2017 was a loss of $1.0 million related to urea derivatives that is expected to be reclassified to earnings during the next twelve months, consistent with the timing of the underlying hedged transactions.
The Company also uses derivatives to partially mitigate the effect of fluctuating diesel costs on operating results. These financial instruments are carried at fair value within the Condensed Consolidated Balance Sheets. Changes in the fair value of derivative contracts that qualify for hedge accounting are recorded in AOCI except for any ineffective portion of the change in fair value, which is immediately recorded in earnings. The effective portion of the change in fair value remains as a component of AOCI until the related fuel is consumed, at which time the accumulated gain or loss on the derivative contract is reclassified to cost of sales. Changes in the fair value of derivatives that do not qualify for hedge accounting are recorded as an element of cost of sales. At July 1, 2017, there were no amounts included within AOCI.
The Company had the following outstanding commodity contracts that were entered into to hedge forecasted purchases:
COMMODITY
 
JULY 1,
2017
 
JULY 2,
2016
 
SEPTEMBER 30,
2016
Urea
 
78,000 tons
 
34,500 tons
 
40,500 tons
Diesel
 
5,082,000 gallons
 
5,670,000 gallons
 
6,384,000 gallons
Heating Oil
 
1,302,000 gallons
 
1,386,000 gallons
 
1,722,000 gallons

25


Fair Values of Derivative Instruments
The fair values of the Company’s derivative instruments were as follows:
 
 
 
 
ASSETS / (LIABILITIES)
DERIVATIVES DESIGNATED AS  HEDGING INSTRUMENTS
 
 
 
JULY 1,
2017
 
JULY 2,
2016
 
SEPTEMBER 30,
2016
 
BALANCE SHEET LOCATION
 
FAIR VALUE
 
 
 
 
(In millions)
Interest rate swap agreements
 
Prepaid and other current assets
 
$
1.2

 
$

 
$

 
 
Other assets
 
0.2

 

 

 
 
Other current liabilities
 
(1.1
)
 
(4.3
)
 
(3.3
)
 
 
Other liabilities
 
(0.5
)
 
(4.4
)
 
(3.1
)
Commodity hedging instruments
 
Other current liabilities
 
(1.7
)
 
(0.8
)
 
(0.3
)
Total derivatives designated as hedging instruments
 
$
(1.9
)
 
$
(9.5
)
 
$
(6.7
)
 
 
 
 
 
 
 
 
 
DERIVATIVES NOT DESIGNATED AS HEDGING INSTRUMENTS
 
BALANCE SHEET LOCATION
 
 
 
 
 
 
Currency forward contracts
 
Prepaid and other current assets
 
$
0.4

 
$
1.2

 
$
1.2

 
 
Other current liabilities
 
(2.5
)
 
(0.8
)
 
(0.8
)
Commodity hedging instruments
 
Prepaid and other current assets
 

 
0.2

 

 
 
Other current liabilities
 
(0.6
)
 
(0.1
)
 
(0.1
)
Total derivatives not designated as hedging instruments
 
(2.7
)
 
0.5

 
0.3

Total derivatives
 
$
(4.6
)
 
$
(9.0
)
 
$
(6.4
)

The effect of derivative instruments on AOCI and the Condensed Consolidated Statements of Operations was as follows: 
DERIVATIVES IN CASH FLOW HEDGING RELATIONSHIPS
 
AMOUNT OF GAIN / (LOSS) RECOGNIZED IN AOCI
 
THREE MONTHS ENDED
 
NINE MONTHS ENDED
 
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
 
(In millions)
Interest rate swap agreements
 
$
(0.3
)
 
$
(1.0
)
 
$
2.2

 
$
(1.9
)
Commodity hedging instruments
 
(0.9
)
 
(0.2
)
 
(0.4
)
 
(0.9
)
Total
 
$
(1.2
)
 
$
(1.2
)
 
$
1.8

 
$
(2.8
)

DERIVATIVES IN CASH FLOW HEDGING RELATIONSHIPS
 
RECLASSIFIED FROM AOCI INTO
STATEMENT OF OPERATIONS
 
AMOUNT OF GAIN / (LOSS)
THREE MONTHS ENDED
 
NINE MONTHS ENDED
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
 
 
 
(In millions)
Interest rate swap agreements
 
Interest expense
 
$
(0.5
)
 
$
(1.5
)
 
$
(1.7
)
 
$
(4.7
)
Commodity hedging instruments
 
Cost of sales
 
0.1

 
(0.2
)
 
(0.2
)
 
(0.6
)
Total
 
$
(0.4
)
 
$
(1.7
)
 
$
(1.9
)
 
$
(5.3
)


26


DERIVATIVES NOT DESIGNATED AS HEDGING INSTRUMENTS
 
RECOGNIZED IN
STATEMENT OF OPERATIONS
 
AMOUNT OF GAIN / (LOSS)
THREE MONTHS ENDED
 
NINE MONTHS ENDED
JULY 1,
2017
 
JULY 2,
2016
 
JULY 1,
2017
 
JULY 2,
2016
 
 
 
 
(In millions)
Currency forward contracts
 
Other income, net
 
$
(1.7
)
 
$
0.7

 
$
5.3

 
$
(0.4
)
Commodity hedging instruments
 
Cost of sales
 
(0.6
)
 
1.8

 
(0.6
)
 
(2.5
)
Total
 
$
(2.3
)
 
$
2.5

 
$
4.7

 
$
(2.9
)
NOTE 14. FAIR VALUE MEASUREMENTS
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The following describes the valuation methodologies used for financial assets and liabilities measured at fair value on a recurring basis, as well as the general classification within the valuation hierarchy.
Derivatives
Derivatives consist of currency, interest rate and commodity derivative instruments. Currency forward contracts are valued using observable forward rates in commonly quoted intervals for the full term of the contracts. Interest rate swap agreements are valued based on the present value of the estimated future net cash flows using implied rates in the applicable yield curve as of the valuation date. Commodity contracts are measured using observable commodity exchange prices in active markets.
These derivative instruments are classified within Level 2 of the valuation hierarchy and are included within other assets and other liabilities in the Company’s Condensed Consolidated Balance Sheets, except for derivative instruments expected to be settled within the next 12 months, which are included within prepaid and other current assets and other current liabilities.
Cash Equivalents
Cash equivalents consist of highly liquid financial instruments with original maturities of three months or less. The carrying value of these cash equivalents approximates fair value due to their short-term maturities.
Other
Other consists of investment securities in non-qualified retirement plan assets and the Bonnie Option. Investment securities in non-qualified retirement plan assets are valued using observable market prices in active markets and are classified within Level 1 of the valuation hierarchy. The fair value of the Bonnie Option is determined using a simulation approach, whereby the total value of the loan receivable and optional exchange for additional equity was estimated considering a distribution of possible future cash flows discounted to present value using an appropriate discount rate, and is classified in Level 3 of the fair value hierarchy.
Long-Term Debt
Long-term debt consists of a loan provided to the noncontrolling ownership group of Gavita. The estimated fair value of the loan was determined using an income-based approach, which includes market participant expectations of cash flows over the remaining useful life discounted to present value using an appropriate discount rate. The estimate requires subjective assumptions to be made, including those related to future business results and discount rates. The fair value measurement is based on significant inputs unobservable in the market and thus represents a Level 3 measurement. 

27


The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis at July 1, 2017: 
 
Quoted Prices in Active
Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
 
(In millions)
Assets
 
 
 
 
 
 
 
Cash equivalents
$
22.1

 
$

 
$

 
$
22.1

Derivatives
 
 
 
 
 
 
 
Interest rate swap agreements

 
1.4

 

 
1.4

Currency forward contracts

 
0.4

 

 
0.4

Other
15.2

 

 
11.8

 
27.0

Total
$
37.3

 
$
1.8

 
$
11.8

 
$
50.9

Liabilities
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
(1.6
)
 
$

 
$
(1.6
)
Currency forward contracts

 
(2.5
)
 

 
(2.5
)
Commodity hedging instruments

 
(2.3
)
 

 
(2.3
)
Long-term debt

 

 
(40.5
)
 
(40.5
)
Total
$

 
$
(6.4
)
 
$
(40.5
)
 
$
(46.9
)
The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis at July 2, 2016: 
 
Quoted Prices in Active
Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
 
(In millions)
Assets
 
 
 
 
 
 
 
Cash equivalents
$
14.6

 
$

 
$

 
$
14.6

Derivatives
 
 
 
 
 
 
 
Currency forward contracts

 
1.2

 

 
1.2

Commodity hedging instruments

 
0.2

 

 
0.2

Other
11.1

 

 

 
11.1

Total
$
25.7

 
$
1.4

 
$

 
$
27.1

Liabilities
 
 
 
 
 
 
 
Derivatives