The Scotts Miracle-Gro Company (SMG) Earnings Call Transcript & Summary

Okay. Well, hello, everyone. Thank you for joining us. My name is Joe Altobello, equity research analyst here at Raymond James, covering the household, personal care and leisure industries. We are very pleased to have with us today the senior management team from Scotts Miracle-Gro, including Chief Financial Officer, Randy Coleman; and Chief Communications Officer, Mr. Jim King. Scotts is the unquestioned leader in the U.S. consumer lawn and garden product sector. While its Hawthorne hydroponics business has been on fire, no pun intended, driven by the expanding legalization of and demand for cannabis globally. We're going to employ a bit of a hybrid format today, with Randy kicking things off with an update on current trends. Hopefully, everyone saw the press release that Scotts issued last night in which they raised fiscal '20 guidance once again. At which point, we'll then move into a fireside chat format. So with that, let me hand things off to Randy for some remarks.

Thank you, Joe. And I trust that you can hear me?

Yes.

Well, I think you cannot see me?

No, unfortunately.

All right. So we're having a little technology glitch, which my kids would tell you, is not to be unexpected with me, but we'll carry on anyway. We do not have a presentation for today, but we do have a few scripted dots to share with everyone before we get to Q&A. So given that, I think it's certainly been a challenging time for the world and our country this year, but we've been very fortunate to be in the businesses that we're in, as they're considered essential, and we've performed extremely well under the circumstances, with strong focus, execution and agility. As you know from the press release last night, we caught up our numbers again to over 30% sales growth and about $7.25 of EPS for 2020. Total company sales growth assumes almost a 25% increase for the U.S. and about 60% for Hawthorne. We also expect free cash flow, which we define as operating cash flow with less CapEx, to now approach $500 million for the year, as we've struggled to build our inventory since practically everything we buy and make is being shipped out as soon as possible. The word unprecedented is probably being overused right now, but it's also accurate for us. We've struggled in predicting how high is high this year, and let me provide some context on the reasons why. In the U.S. business, we started the year well, even before COVID began to affect the country. Our Q2 POS was up about 20%. April was down 8%, as home centers were careful about ordering and driving traffic in the weeks after COVID hit the U.S. Then business picked up in May, as consumers became more accustomed to working from home, and focused on their yards, and May was up 44%. We expected June to slow down as we always, at least until this year, see a big drop-off in consumer activity after mid-June. But this year, it was different. Our string of $100 million weeks continued until the end of the month, and June POS was up 50%. While the POS curve has returned to normal since then, the year-over-year increases are still almost 40% in Q4. So we clearly underestimated the continued strength of POS and consumer engagement over the last few months. The more recent impact on our U.S. sales relates more so to retailer attitudes. Across the board, retailers continue to push lawn and garden and are gearing up for a huge fall season, and there are no obvious constraints on inventory or ordering. As a result, we now expect year-end inventories to be at least 20% higher than last year on September 30. This retail inventory build was not anticipated in our guidance in late July. This also creates a line of sight to a big Q1 and even beyond Q1 until we begin to comp big numbers in Q3 of next year. We're optimistic about U.S. consumer next year for several reasons: first, continued consumer engagement and a work-from-home environment; Scotts' marketing focus on one-to-one relationships with consumers throughout the entire year; strong retailer push in our category, including anticipation of a more promotional approach in 2021; SMG has continued to support of our retailers' e-commerce platforms as well as our own; and we're building inventory to improve service and capture sales that we believe we missed out on in 2020. Switching to Hawthorne. Q4 sales continue to grow versus a year ago, and we now expect September to be our largest sales month ever. We'll be at the top end of our sales guidance from late July, and we'll exceed our 10% operating margin rate for 2020. Looking ahead to next year for Hawthorne, we remain bullish given the consistent wholesale and retail prices in the marketplace, our growth and expected sustainability in consumer demand and our belief in significant market share gains during the year. While it still remains too soon to provide specific guidance today regarding next year, we are optimistic about the continued commercial opportunities for both of our major businesses through March of '21. Our service performance this year was below our expectations and retailer expectations at certain points in the year for both of our segments, and we believe we left about $200 million of sales on the table by just not being able to keep up. We also know we have about $1 per share of expense tailwinds in 2021 from incentives and P&L investments that we made over the last few months of fiscal '20. I'll provide specific P&L line item guidance when we have our Q4 earnings call on November 5. After talking about the numbers, I also want to emphasize how well we've taken care of our people this year. We added 50% premium pay for frontline workers during the onset in the first couple of months of COVID, and we continue to pay 50% premium in [ hired ] spots. We also initiated to maintain enhanced cleaning protocols, and we manufactured and gave away face shields to organizations across the country. And more recently, we decided to pay annual bonuses to hourly associates, who are not typically eligible for our annual bonuses, and we're also dramatically increasing our charitable giving in our communities. We're grateful for the support from our consumers and retailers this year, and we know we're fortunate to be in fast-growing categories, when much of the country is still struggling. So thanks for listening today, and I'll ask Joe to kick off the Q&A. Thanks a lot.

Great. Thank you, Randy. That was very helpful. So I want to begin by asking about 2000 first. It's, obviously, been an unusual year to say the least. But for Scotts, financially, I think it might be your greatest year ever. If someone were asleep for the past 6 months, and were -- and then they woke up to see their -- your U.S. consumer sales up 25% and Hawthorne up 60%, I'm not sure they'd believe it, but here we are. So could you help us understand what's been driving that growth since it is so much above what you've historically done in the past? Is it people spending more time at home? Is it the fact that your retailers were deemed essential and were able to remain open? Is it a combination of those things? So help us understand what's been driving this super growth in 2020?

Sure. So I'll start with the U.S. business. And like I said in my prepared remarks, we started off the year really strong. We knew we had listing gains within and beyond the Big 3. We had a little bit of pricing that's going to be about 1 point for the year. So we had a lot of optimism coming into the year. But things did change quite a bit once COVID hit the country. April, I think everybody pulled back a bit. I know definitely that the home centers did, and they were trying to do the right thing, be respectful, take care of their associates and not flood their stores with a lot of people. I think once everybody got a little more comfortable with the environment, the push became a little more normalized in May and June. And then the fourth quarter has been, like I said, up 40%. So some of this has been COVID-related, but I think a lot of the people who have joined the category, we have a lot of reasons to believe that they'll remain in the category and be sticky. About 30% of our consumers who are engaged in edible gardening this year were new consumers or lapsed users from recent years. And in the lawns category, we believe there's about 8 million new users this year. So our belief is once people join the category, it helps them with their mental and physical health. They've made an investment. They're happy with how it goes. Even if they were to go back to work at a more normalized level, and I doubt the whole world goes back to 5 days a week in the office. But we think people will continue to engage in our category, and we have a lot of reasons to believe that, that's going to continue on. And then switching over to Hawthorne, we expect to have a really terrific year this year. We'd started out planning for mid-teens externally, but had internal expectations to do better. We, certainly, didn't see 60% growth. But again, I think we benefited a bit from people staying at home, engaging in the category. We've taken a tremendous amount of market share. And again, I think once those consumer behaviors take hold, I'd be surprised if we really give anything back going forward. So time will tell, but we have a lot of optimism by Q1. We feel good all the way through the first half of the year. And then I think we'll have to reassess, but we have a lot of good reasons to believe.

You mentioned that of old gardening. I'm curious how big that is of a business for you right now. And what's driving that? Is it people concerned about the food supply? Or they just want the freshest vegetables, for example?

Yes. Sorry, Joe, I'm trying to get my video on. It's so hard do that.

And so -- I'll jump in a little bit here at the beginning, and then Randy can add some color. So edible gardening has been the fastest-growing segment of lawn and garden in general for the last several years, particularly popular with new homeowners, millennial homeowners. They index really strongly in this space. So we've been seeing a lot of momentum in that space for some time, which is why several years ago, we took a minority interest in Bonnie Plants, which is the largest provider of edible plants, live goods in the retail space today. So this year, we just saw more of that momentum picking up. And we saw it early in the spring. And actually, it continued all-season long. You saw people planting vegetable gardens well into the summer, normally way later than they -- or way later than they typically do. So a lot of momentum as a result of that. That helped, not just our investment in Bonnie, but our growing media business. Our soils business this year is up well over 40%. And we've been seeing in that space, in particular, as quickly as we could get products manufactured and through our line, we're getting them on the truck and getting them to retail, and they're getting taken off the shelf. So that's where the real demand has been. I think part of our plan going forward, to keep those people engaged, is to kind of build a relationship with them based on the successes that they had as gardeners this year. So you're seeing a lot of communication these days from the Miracle-Gro brands, talking to people about their harvest, what to do with their harvest, how to freeze it, how to yard, how to cook with it, maybe what to do with surplus. And I think you're going to see that brand, in particular, work really hard through the off-season to remind people of the benefits of edible gardening, and why they got in the category to begin with, and hopefully bring them back in next year. So we're really bullish on that part of the segment.

And how big is that business for you, Jim?

So the buying business is more than a $300 million business. Those sales don't run through our P&L. And then our growing media business is well in excess of $650 million now, and a big part of that is dedicated to edible gardening.

Okay. Now normally, we'll been talking about the weather, right? And that would be the difference between, let's say, U.S. consumer up 1 versus U.S. consumer up 3. Clearly, we've had other factors this year to overwhelm that. But just curious, has weather been a positive or a negative, generally speaking?

I think it's probably been fairly -- if you -- I think the way that we tend to look at it is that weather tends to normalize itself over the course of the year, Joe. And there's nothing in any over the entire country, that's probably true again this year. I think, in the Northeast, again, in particular this year, weather caused us to get off to a slightly slower start, but then came back really nicely. So I don't think weather has been necessarily a tailwind, but I don't think it's been much more than neutral on a total company basis over the course of the year.

And Joe, to add a little more color to that. If you look at our sales by region, and we break our business down into the West, the South, the Midwest and the Northeast, everyone is circling around 25%, give or take a point. And that's on a year-to-date basis. When we look at results every month and every week, they're also very, very tight. So I really don't think anything going on this year is really related to weather. It's more just about national engagement and then lawn and gardens. People have spent more time at home, and learned to enjoy working out in the yard.

You mentioned earlier, the $8 million-or-so roughly new lawns customers this year that entered the category. I guess 2 questions there. First, why weren't they in the category to begin with? And two, maybe more importantly, how do you keep them in the category next year?

As far as why they were not, some are lapsed users. When we look at our business, the most important consumers we have are the ones that -- what we call the weekend warriors, that year in, year out, are going to show up. And if it does rain on 1 week, they're going to come back the next week. They're going to plant their garden every year. They're going to take care of their yard. And that's really the bread and butter for our business. I think over time, as we look at what's happened in about the last 10 years, we have seen a decline in units in our lawns business, I think, just because people a little more focused on other things. I think they get consumed with their telephones and their devices rather than being on the yard. And I think we've been able to see a shift back towards people wanting to be outside and get out of their homes as it works from home. So again, I think we're encouraged about what that's going to look like. And we're using things like Bonnie Plants, that Jim mentioned, to stay engaged with consumers all year long. It's really encouraging to me to see that the retailer is gearing up for a big fall, and we're going to continue to market for those same people all the way through the winter. And when you can see in our 40% growth rates in months like July and August when it's hot outside, and I'm not just talking about Ohio or New York, I'm talking about Arizona and Florida and the South is still up 40%. To me, that's a really encouraging sign.

So if we look forward to next year, and I think, Randy, you touched on this a little bit in your prepared remarks. Hopefully, we're not in the same situation from a COVID standpoint. People are able to get out and about and go on vacations and play travel sports and go to camps and things like that. So could we talk about how you will lap this year next year? I mean obviously, again, you're probably not going to see the POS numbers that you've seen in a post-[ Father's Day ], let's call it, next year. So how should we think about your ability to anniversary this? What is largely COVID-driven relative to 2020?

Right. So I would expect the momentum we have right now to continue. It's been a bit of a frustration for us internally, and that we did expect things to slow down once we got past mid-June. And clearly, it hasn't. So at this point, I don't see any reason to think it will slow down, even if there were a vaccine tomorrow. And if that were the case, I'd still think people will want to find the right balance between working from home and working from the office. And again, when they're working from home, they look out the window, like I am right now, and they want to make sure that the yard looks nice and it's enjoyable for their family. So that's the largest thing. Again, our marketing focus has changed quite a bit from -- historically, the great majority of our advertising would be on TV. And we've really engaged much more on social media with different agencies this year, and talking to consumers directly, practically all the time, and we continue to do that all the way through the winter with what we call our 365 marketing campaign now. The retailers are going to be, I believe, a lot more competitive and a lot more promotional, especially in March, April and May versus what we saw this year. And I think e-commerce, not just in 2021, but beyond that, is really going to take hold and be a bigger part of our business. So whether we're talking about our own websites, whether we're talking about e-commerce more broadly, or whether we're talking about our largest customers and their buying online and pick up curbside initiatives, I think we're best positioned from national brands and national infrastructure and service to be able to fulfill all the needs related to that. So -- and then the final thing is, we've been trying to build inventory in the fourth quarter. We haven't really been able to and expect in the year about flat in our own inventory, but we're going to have plenty of inventory in our barns in the front part of next year to make sure that we're not missing out. And then we'll have to reassess about halfway through the year and see where we are. But a lot of optimism, especially for the first half. And then I think we're doing all the right things that make those consumers sticky beyond that.

Joe, if I can just elaborate on the marketing piece a bit. Randy mentioned what we're doing with digital. I think it's important for people to understand that this is way more complex than simply buying ads on Facebook or buying ads on Instagram or banner ads on websites. So part of what we've really been working on is understanding the demographics of who've been -- who's been buying and engaging in the products this year, what platforms they're using, what demographically they look like, where they shop, where they live, whether do they have kids, understanding that the creative that may appeal to me may not appeal to you. The creative that appeals to you probably doesn't appeal to your wife. So moving away from kind of a simple approach where handful of pieces of creative are what we use to drive activation and moving towards a place where literally, we're talking about tens of thousands of pieces of creative that change every day, really kind of understanding what's happening real-time with these consumers so that we can talk to them in relevant ways and keep them engaged. So it's a very, very different approach. And anything that we have done. It's been working extraordinarily well with us. We'll be working more closely with our retailers going forward as well. And we've seen a lot of success in using that sort of activation to also drive specific foot -- specific consumers and specific retailers for specific product promotions. So a lot of reasons to be really bullish about the marketing approach that we've taken. And I think it's just important for people to understand exactly what we're talking about.

Is that an internal initiative for you, Jim? Or have you partnered with an outside [ party ]?

We've been partnering with an outside firm, people who are kind of social media users may know the name, Gary Vaynerchuk. Gary has been working very closely with us. His firm, VaynerMedia, has been working pretty side-by-side with us for a couple of years. We've really ramped up our efforts with Gary and Nick and that team this year. We're going to go further next year. And over time, Joe, I think the goal here is to build more of an internal skill set as well. But certainly, the learnings from Gary and his team have been really helpful to us over the last 2 seasons this year, in particular.

And you mentioned earlier that pricing probably added 1 point, let's call it, to U.S. consumer sales this year. Is pricing going to be a part of the equation as well next year?

What is a point for our U.S. business and probably a little bit more than that this year for Hawthorne as well. Looking forward to next year, there will be some pricing in our P&L. Exactly how much? We're still in the process of determining. And we typically kick off-line our dues April, May, and we finalized them September, October. So we'll have answers by November 4 on -- and we can be a lot more specific about pricing, but there will be pricing in our P&L next year.

Okay. One of the things that you guys have benefited from this year is a lack of promotion for [ Hawthorne ], which is that you and your retail partners really didn't have to do much of it. How do you see the promotion environment playing out next year? It sounds like we're going to see a bit of an uptick on that next year, but probably not back to what we were, let's call it, in 2019. And what's the impact on the P&L? Could that offset the price increases you guys have planned or probably not that big?