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

Yes, that's right.

Just last kind of one on -- and not to -- well, last 2 on lawn and garden. Just any kind of Roundup due in the past year? It seems like a lifetime and a pandemic ago that we were talking about Roundup and litigation in Monsanto and stuff like that. But it seems that you don't hear a whole lot a lot about the business anymore. It seems fairly stable. So any update there would be great.

I'll just start out by saying what the business did. If you look at last year, it was up double digits, consistent with the rest of the business. So the Roundup brand continues to sell through the trade. So things look really good from a shipment and a shipment POS standpoint. Jim, I don't know if you have any other comments, but I think the business is performing well.

Yes, the business performed well, Bill. We've restructured the relationship with Bayer a couple of years ago. So I think we're in a better position there. So the business is -- it's healthy. It's doing fine. We like the relationship. I think we've also put ourselves in a good spot with the investments that we've made in the Ortho GroundClear brand, which have been kind of a nice complement. So at the end of the day, if we saw any consumers who were choosing to move away from the Roundup brand, if they were moving into the Ortho brand, for us, it's moving from one stack to the next. So it's -- we're kind of agnostic about that. But the business has been performing very well. And the [ occupational ] kind of component of the Roundup brand have been very steady as well as something that we look at all the time.

Got it. And then no, I mean, it doesn't sound like there are a lot lingering consumer concerns that really impacted the brand in 2020.

No.

Last one, just because it's timely. How concerned should I be that it was freezing in Texas in the month of February? And -- or someone was happy to point out to me that Pennsylvania had snow on the ground for every day of the month of February for the first time in like 50 years.

Well, if you were planning on planting your tomatoes last week in Dallas, it was a really bad week. So I'll lead with that. No, February -- even in Texas, February is not the time of the year where we sit here and wring our hands about weather. It tends to just push activity from one week to another week or one month to another month or one quarter to another quarter, but it kind of comes full circle to some of your questions on marketing. People who are engaging in gardening are going to garden. If they have to push it out a little bit of time, they're going to push it out a little bit of time. And weather for our business tends to even itself out more years than not. Either by geography or by product category, weather kind of self-corrects. So if we lost 2 weeks in Texas in the middle of April, we might be a little bit more concerned, but losing a couple of weeks in early February or mid-February is not a huge deal.

Got it. Switching over to Hawthorne. Again, looking back, and I still don't fully understand. I mean I understand why Hawthorne is growing so well and doing gangbusters. I don't really understand why when the lockdowns happened last year, it accelerated. And when I say that, and Jim, I think I've asked this with you before, and it was like growing 10%, 20%. And all of sudden, it's growing 50%, 60%, 70%. And while it makes sense that we're locked down and consuming maybe more -- people are consuming more cannabis products, your hydroponics don't spit out gummy bears or other cannabis products. I mean, they're for growers to then create production 6 months down the road. So why did it just hit the market? Any idea looking back?

Yes. Bill, I think if you look back at the growth for Hawthorne, we've been growing at about 70% year-over-year back to June of 2019. So we were seeing that kind of growth before the pandemic hit. And once the pandemic hit, the growth versus the expectations that we have, it continued to go higher, but growth versus the growth we had seen in the previous months, it stayed about the same. So we've been growing at that rate for 18 months now. And there -- I mean, if you look at what happened since the pandemic, we certainly had a strong finish to last year. We're not able to look at what that finish would have been without the pandemic. But I tend to think that it wouldn't have been much different. There is some argument that the consumption of the end product did go up since the pandemic, and that caused some sell-in of our products as growers continue to build out their cultivation operations. There's probably some linkage there. It's tough to draw a straight line to make all that happen. The new markets in Michigan and Oklahoma seem to be hitting their stride right about when that -- right about when the pandemic hit as well. So it could just be the timing of that market hitting or the pandemic.

Well, it seem -- I was also struck that like California in 2020 was up 20%. I mean for a market that's legally or illegally been around for 30 years, and it's certainly the most mature market, any thoughts behind why that was so strong as well or saw a resurgence?

Yes. California was up about 70% last fiscal year. And a lot of this goes back to the changes that happened in '17 that caused some sales downturn for our business back in '18. And now you look at the growth rates that we've had coming out of that '18 year, and they've been really strong in California. A lot of product innovation has allowed for sales to continue to be sold into the cultivators in California as they're upgrading their facilities. Lights, for example, shifting out of older HPS models into newer LED models. There's just been a lot of traditional growers that are still growing and producing in the state of California and just a lot of market conditions that are allowing for our products to continue to be sold in as growth continues to happen in the end product.

And it's going to be, I mean, pretty encouraging. It's like fracking. You're basically finding oil in what you thought were heavily depleted wells and a lot to work. Is that a fair assessment?

Well, that's where innovation plays. We have to continue to look at the innovation that happens in the space with all categories, but lighting is an easy one to make the comparison. Think about televisions, what your TV looked like 5 years ago. The TV could last 20 years, but you're probably still not -- you're not still watching the one that you had 20 years ago because of innovation that's happened from a tube TV through LED to QLED. Lighting is kind of just like that. You're moving through the transition of the lighting fixtures into a more modern fixture, and that's the fixture that we're selling a lot of right now. If you think about our growth, a lot of it is in lighting in the SKUs that are innovative.

And an innovation, Bill, that we've driven, okay? I mean I think that's probably a part of this that people shouldn't overlook. We get a lot of questions these days about how are we different from other players in the space, who people have come to better understand in recent months. And a big part of it is the innovation piece. Just over the last couple of months, we finally opened our R&D facility in Kelowna, British Columbia. It's the only facility in the world that is focused on R&D around cannabis cultivation, okay? And we're testing lights. We're testing nutrients. We're testing the blending of things. So that's an important part of this. And so when you have a technology that gets good enough like LED lighting, that justifies an existing cultivator to go in and retrofit their facility because they can put in very expensive new lights, okay? Those are -- it's a big capital investment. But what it's doing is bringing their utility costs down substantially, which is a big part of the big [indiscernible] and giving them the kind of product yield, plant yields that they still haven't expected. So the innovation piece of this, I think, cannot be missed or understated at all or misunderstood at all. It's a really important part of the growth strategy at Hawthorne.

Yes. And just to add a little more color on that one. If you think of LEDs 2 years ago, we were just launching an LED product that we had sales just at the tail end of Q4 for a few million dollars. And we could do up to $250 million of LED sales this year just in the U.S. alone. So tremendous growth in that area.

Absolutely. Can you just -- just [ packing up ] one of the questions I get and I'm sure you get is, what is the evolution of this kind of a state -- the new state that legalized some things in that market. I mean let's take New Jersey as an example. But even like Georgia, I mean Georgia has passed it from [indiscernible], and they're now bidding out 10 licenses and I think 150 people bidding on it. So -- but how does it work in terms of your business? Like when does the business start to hit its stride in terms of sales?

Yes. I mean, certainly, as new states come online and legalization passes in those states, it's good news for us long term. If you look at the states that have rolled out historically, there's usually a lag of 6 to 18 months before the bill passes until you get through all the regulatory phases to find out who the builders are going to be, of the growth facilities, how those facilities can be grown and then what products they actually put in them. So certainly, we kind of had good news in the East last election cycle. We expect that to be good news for us. We just don't know how much of that good news will happen this fiscal year. It feels like it's likely going to fall into '22 before we see significant good news. And remember, the states that are passing today are smaller states. So I mentioned 2018 before, we had kind of a downturn in '18 because legalization happened in the state of California, and it kind of froze what was happening in California. If you look at the states that are passing today on the East, our base in those states, because of how historically legalization has rolled out, our base is pretty small. And we're kind of protected on the downside because we don't have a lot to lose from an existing sales standpoint. The upside is something that we feel like we can go capture, and we're in a good position to go capture as the build-out of these grows happen. But we do think that is a longer lead time until those grows actually happen and we see those shipments going out that affect our sales.

Bill, let me elaborate on Cory's point to just help illustrate for people. And I use New Jersey because it's real time, right? So first week in November, 65%-35%, I think, was the percentage split, 67%-33% actually. New Jersey residents say, "Make recreational marijuana legal." It took until yesterday for the government apparatus to actually make marijuana legal in New Jersey. It finally was signed and passed yesterday. Now it's got to go into a new kind of pipeline, and now there's got to be a regulatory regime put in place and all the rules and regs around cultivation and marketing and sales and used for a marketplace. That will take another 6 or 8 months to do that, okay? And then you can finally have licenses issued, then people start actually cultivating cannabis. So you see it kind of moving through the snake pretty slowly even when you have a state that overwhelmingly approved moving forward with it. So it just takes time.

Got it. And I think what's least understood by investors is just kind of the -- not supply chain, but just kind of the ecosystem of -- the game-changing moment for Hawthorne was buying Sunlight and being -- which was the largest distributor. And usually, buying a distributor does -- is a game-changing moment. At the same point, you have -- your customers are smaller, midsized kind of commercial retailers that have very small and midsized customers. And so trying to understand like do you expect this to be the way business goes for the next 5 years? Do you expect it to go more commercial and smaller, bigger-type deals, albeit still in state by state? Or how do you expect the market to change over the next few years? And how is Scotts going to position for that change?

Well, I think it goes back to why we did the Sunlight acquisition. Sunlight was a distributor on their own, and they had some brands, but mainly a distributor. And they distributed our brands at the time, Gavita, GH, Botanicare, all were distributed by Sunlight. But we didn't really buy them because they were a distributor. We bought them because of the supply chain network that they had built already. So we had -- I remember having a decision point as like, "Do we build a network and try to compete with them? Or do we go buy this network that's already established and try to tweak it to have more strength for our business?" And obviously, we decided to buy. And as we bought that network, it did a couple of different things. We have systems in place that actually dealt with shipping product to that many customers. We had both like IT systems and processes and systems that allowed goods to actually move. We had just the customers and the contact and the sales force and everybody that, that had been actually calling on those customers. It allowed us to shortcut that process as well and lean on their relationships and the people that Sunlight at the time had in place. And since we've acquired that business, we've done a lot of changes to all those things, but the relationships, the contact to the retail customers, the network that they built were all the things that we leaned on to make sure that as we improve the business and expanded the capacity that the business had, we could continue leaning on that channel and continue pushing our own brands through that network in a harder way than what Sunlight was doing before because they didn't have the same owned brand strength that we had owning that network. So I think that's what the true strength of the Sunlight acquisition did for Hawthorne. And as you look to go forward, we're going to have a lot more distribution points than we do today. When I say distribution points, I mean end product -- end locations where we're going to ship product. And the network allows us to meet the needs that we're going to have in the future more than we could have just by building that network on our own. And as we look for the need to expand the network or increase capacity and focus on more distribution points in the future, those decisions will be made for each location that we're operating in today. But buying the Sunlight business, almost 3 years ago at this point, gave us a giant leap forward in the ability to service the vast number of distribution points that this category, that brings to us.

And just follow-up, do you expect the market to be more commercial in terms of fewer but bigger kind of basket sizes?

I think as legalization continues to roll out state by state, you're going to have several larger growers that are being built in every state. And we're going to look to service those customers in any way we can to make sure that they continue to come for Hawthorne products. If we get to a point where there's federal legalization and interstate commerce happens, I think we're entering a whole new game at that point and more consolidation could happen. One man's opinion, I think that's pretty far off. As Jim said, the time period to make things happen on a state-by-state level is slower than one would expect. I think from a federal standpoint, it's likely to be even slower yet.

And that's not all, I guess, bad for your business model. But is there a legislation out there that would help accelerate this business, I mean that's some banking laws, some stuff like that you see on the horizon?

There are a couple of things, Bill. So not every state can legalize cannabis through the ballot box. So New York is a good example of that, okay? They don't offer ballot initiatives in New York. So that's likely to happen through the legislature. It's actually likely to happen through the budget process in the legislature, which I think most people believe will happen yet this year. So there are a number of other states, where I think you probably will see some legislative activity. You just saw it in Virginia. It could happen in New York. There's further discussion about Pennsylvania. I know there are groups here in Ohio who are thinking about another ballot initiative again here. So I think you're going to see more and more momentum for that to happen at the state level. At the federal level, there are individual bills, for example, to [ say back ], which is really focused on banking that's gained some traction, had gained some traction previously in the House, never really gained any traction in the Senate. There's still an appetite for that, but I'm not sure that you're going to see a narrow bill like that pass the Senate without some broader reforms, which are harder to get in the House than they would have been before even though broader reforms passed the House last year. I'm not sure that they would this year. So that would happen. That still could happen. But you're still going to have, even if you have federal reforms, this transition period of actually having a regulatory framework in place. And I think more and more folks are believing that you're going to see these state regulations be that stop gap for some period of time. If you look at hemp legalization a few years ago, the FDA still has not -- 3 years after the fact, has not put guidelines in place for that market. I think decriminalizing marijuana and then not having some framework to fall back on is not what anybody is looking to do here. So I think the state framework likely stays in place for some period of time, which would be a good thing for us and I think the tens of thousands of cultivators and retailers who have actually been driving a lot of growth and creating a lot of jobs in this industry for the last several years.

Got it. That's -- and then a couple more questions and I'll let you go. One of the questions I get, I think people think of traditional markets where the consumable, be it nutrients, be it other -- is much more that's a recurring revenue base, while your business is more reliant right now on the durable side. So how do you see that? How do you see it changing? What kind of impact does that have on margins as we go forward?

If you look at our business today, we certainly have had a lot of growth in sale -- in the sales of lighting, which has taken our durable percentage of the [ total op ]. We're about 2/3, durables, 1/3 consumables for Q1. I mean, in last year, for the full year, it was a little bit more balanced than that. As the build-out phase continues to roll throughout the East, we expect the durable portion of our sales to continue to remain high. And at that same time, as we're building relationships with those grows and each of the individual grows might become more -- I guess, their sales will become more focused towards our consumable products, we want to capture that business. Consumable products is -- they're very good for us from a margin perspective. Pushing our consumable products through existing grows is a big win from a margin standpoint. But we think that as that kind of happens, what you're seeing in California now will continue to happen throughout the country and throughout the other grows, where our durables are still in demand. So I don't see that we're going to have 2 more years of durables and everything shifts to consumables. I think there's going to be a mix that happens. And then there's also going to be a mix between our signature brands and our distributed brands. If you go back a couple of years, I want to say we sold 64 different brands of nutrients. And certainly, that's too many brands of nutrients for our business to be selling, either owned brands or distributed brands. So we'll continue to have a focus on pushing the owned brands that we have, making sure that the distributed brands that we're working with are large distributed brands that have a place in the market and are the brands that our consumers want out there versus something that we just kind of inherited and keep selling. So the product mix is going to vary as we go through this period of a couple of years, both between consumables and durables, and then within each of the category within distributed and our signature, our own brands. So as it plays out, I think that any door you pick at the end of the road is kind of a good door for us because certainly, our own brands are higher margin. Our consumable products are higher margin for us. And as durables continue to sell, it should be based on products that are new and innovative to the category, which we will be innovating those items to have a higher margin as well. So we're kind of focused on those aspects driving the margin for us as we go forward.

Got it. I could keep going for another hour or so with questions, but I'll just end with the last one that I've been ending all of mines were and with regards to the pandemic, and I'll just change it a little bit because I know it's -- the pandemic has enhanced your growth opportunity. But maybe from an organizational standpoint, if you look back 3 years from now, will you think the pandemic strengthened the organization, weakened the organization or really didn't have that much of an impact on the organization on a go-forward basis and why?

Made us way better. Way better. It was an interesting time, Bill. Most companies were scrambling last March to figure out how to get out the door and how to keep their business operating. We started planning, in fact, last January for this possibility to occur. Think about our business, think about the seasonality of our business and what would have happened to our business had we not been prepared to walk out the door at the break of the season and keep things running, okay? So we were well prepared for it, have been planning for it for a couple of months and I think moved into it in a pretty seamless way. I think the kind of collaboration that's occurred in the company over the last year because of the consumer demand, because of how well the category responded, because of what was happening in Hawthorne, it was -- while we had a good year, it was a hard year, okay? But we did that -- well, Cory and I happen to be in the building today. We're the only 2 people in the building today. And there's nobody that's here these days. But I think it improved our collaboration. I think it improved the morale of the organization. I think it's made us more efficient. And I just think we come out of this as a better company, a smarter company than we were going in. I think it's been beneficial from that perspective. Obviously, it goes without saying, if we could all take it back, none of us would have wanted this to happen. But I think we took a really difficult situation and made the best of it and come out much better and much stronger as a result.

Yes. I agree and I'd add to that. If you go to the beginning of the pandemic, I was in the Hawthorne business at the time. And Hawthorne was very decentralized. We operated like this for the last 3 or so years because our acquisitions had us all over the country. We were in New York, Ohio, Arizona, Canada and out in the state of Washington. So we were really operating decentralized to begin with. And when the pandemic hit and we were forced to operate this way, it wasn't a big change for the Hawthorne side of the business. And I think the flexibility that we had in our work -- actually going through the acquisition process at Hawthorne, there are so many things that Hawthorne leaned on Scotts for. This is one where I actually think Scotts leaned on Hawthorne a little bit, and it allowed for that flexibility to happen in the daily way that we operate our business. And I think we operate in a very efficient manner now. We kind of -- it's straight to business, straight to the decision at hand, and it allowed us to invest in the infrastructure that we needed to continue seeing the growth in our business. And I think that investment that we've made over the last year or so since we've been kind of remote working will help us in years to come. And it's a different mindset that, while we're all doing something different physically and we're in different locations, we overcame that. We focused on the business and we continued to operate the business at -- in what -- hopefully, it's not the record year because I hope that we keep having record years. But for us to hit an existing record year in the middle of all that, I think, says a lot about the way we operate as a business. And Jim was right. It was a hard year, but it was a good year.

That's fantastic. Well, thank you so much for your time. Thanks for being in our consumer symposium. I really appreciate the time and the feedback and the color. So have a great rest of the week.

Yes, Bill. Thanks for having us.

Thank you, Bill.