Scotts Miracle-Gro Co. — Q1 FY2018 Form 10-Q
Reporting period: Three months ended December 30, 2017. The company manufactures and markets lawn and garden products and indoor/hydroponic gardening products. Results are highly seasonal: management says more than 75% of annual sales typically occur in the second and third fiscal quarters. The International Business was sold in August 2017 and is presented as discontinued operations; comparisons below generally concern continuing operations.
Financial results and liquidity
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $221.5 million | $207.4 million |
| Gross profit / margin | $34.0 million / 15.3% | $36.8 million / 17.7% |
| Operating loss | $71.9 million | $61.8 million |
| Loss from continuing operations | $20.0 million | $58.1 million |
| Net loss | $21.2 million | $64.9 million |
| Diluted loss per share | $0.37 | $1.09 |
| Cash used in operating activities | $210.5 million | $209.8 million |
| Cash used in investing activities | $164.8 million | $94.0 million |
- Sales rose 6.8%, but the increase was driven by acquisitions (+12.2%) and foreign exchange (+2.1%); pricing (-0.9%) and volume (-6.6%) weighed on growth.
- Gross margin fell 2.4 percentage points, primarily from unfavorable Hawthorne product mix, lower pricing and reduced Roundup-related sales; acquisitions partly offset the decline.
- Q1 loss from continuing operations improved largely because of a $45.9 million estimated tax benefit from revaluing deferred taxes after U.S. corporate tax reform, as well as improved equity-method results. The company reported a 76.9% effective tax rate for continuing operations, versus 35.7% a year earlier.
- Cash and cash equivalents were $54.5 million at December 30, 2017, compared with $120.5 million at September 30, 2017. Current assets were $982.9 million and current liabilities were $471.1 million.
- Total debt was $1.791 billion, up from $1.410 billion at September 30, 2017. Long-term debt was $1.697 billion. Interest expense was $17.8 million, up from $15.3 million.
- Credit-facility availability was $778.5 million, subject to covenant compliance; the separate receivables facility had only $0.1 million available. The reported leverage ratio was 3.11 against a maximum of 4.50, and interest coverage was 7.32 against a minimum of 3.00.
- Quarterly dividend declared was $0.53 per share, up from $0.50. The company repurchased approximately 1.0 million shares for $96.6 million.
Material changes and segment performance
- U.S. Consumer sales were $125.9 million, essentially flat year over year; segment loss narrowed slightly to $37.9 million from $38.5 million.
- Hawthorne sales increased 20.4% to $76.7 million, helped by acquisitions and currency movements, but volume declined 24.9%; segment profit fell to $1.7 million from $6.6 million.
- Other sales grew 8.0% to $18.9 million, while segment loss widened to $4.0 million from $2.3 million.
- Acquisition spending included $73.9 million for Can-Filters and $69.2 million to acquire the remaining Gavita interest, plus contingent consideration. The company also invested $5.3 million in loans to an unconsolidated affiliate.
- The company stopped applying the equity method to TruGreen in Q1 FY2018 after its investment and advances were reduced to zero; it reports no contractual obligation to fund further TruGreen losses. A $21.9 million liability represents distributions received in excess of the investment balance.
Outlook, commentary, risks and unusual items
- No specific sales or earnings guidance for fiscal 2018 is provided in the filing. Management anticipated a first-quarter loss because of the business’s seasonal sales pattern and said it expects to remain within debt-covenant limits during fiscal 2018 under current operating assumptions.
- The estimated deferred-tax revaluation benefit and transition-tax accounting are provisional under SEC staff guidance and may be adjusted within the measurement period. The company estimated $14.0 million of federal transition tax, offset by foreign tax credits; it expected no cash payment, with state tax expense estimated to increase by $0.1 million. Effects of certain tax-law provisions remained under evaluation.
- Management identifies weather, seasonality, earnings shortfalls, increased debt, floating interest rates and covenant compliance as risks. The company uses interest-rate, currency and commodity hedges; its weighted-average debt interest rate was 4.7%, compared with 4.3% a year earlier.
- Material litigation includes the EZ Seed class action, which continued as a class action after the court narrowed claims; the Second Circuit denied an interlocutory appeal request in January 2018. The company says it cannot reasonably estimate a probable loss and has recorded no accrual. The filing also discusses asbestos-related claims and the Morning Song bird-food class action, with no loss estimate or accrual for those matters.
- Environmental liabilities accrued were $4.3 million. Management considers the accrual adequate, but notes that outcomes and defense or remediation costs could affect results.
- Disclosure controls and procedures were assessed as effective at a reasonable-assurance level; no material change in internal control over financial reporting was reported for the quarter.
Investor verification priorities
- Track whether Hawthorne’s steep volume decline persists and whether recent acquisitions generate profitable growth.
- Separate recurring operating performance from the substantial one-time tax benefit; monitor final U.S. tax-law measurements and the company’s effective tax rate.
- Monitor debt growth, interest costs, seasonal borrowing needs, receivables-facility capacity and covenant headroom.
- Assess working-capital and cash-flow trends as inventories build ahead of the peak selling seasons.
- Follow developments and potential financial exposure in the EZ Seed, Morning Song, asbestos and environmental matters; the filing does not quantify probable losses for several cases.