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

Thank you for joining us for our next presentation from Scotts Miracle-Gro. Scotts is the leader in the U.S. consumer lawn and garden industry with brands that include Scotts and Miracle-Gro, obviously, as well as Ortho and Roundup. In addition, its Hawthorne Hydroponics segment is a leading supplier to cannabis cultivators, both in North America as well as Europe and across nearly every product category. That said, it's been a rough couple of years for Scotts, some probably understating things, unfortunately. The company has had to navigate a normalization of demand and retailer inventory reductions in its U.S. Consumer segment as well as an oversupply of cannabis on the Hawthorne side. Here to help us all of this out is CFO, Matt Garth, who joined Scotts just a few months ago. So with that, let me hand things over to Matt.

Thank you so much, Joe. Very good introduction from the standpoint of we have been through a lot. But the story is emerging and strengthening. And I think that is why we are all here today. And I thank you all for joining us this morning to go through it. Let me start off, and I think Joe hit the highlights, right? So kind of $3.9 billion in sales in 2022, a down year from what we had experienced during the pandemic. Yes, shifting tectonic plates taking place in cannabis. Also in the consumer, we'll get into that a little bit. But the path that we've been through has actually strengthened us a lot, and I'm going to dig into that as we move through the presentation. We come through market-leading brands. I think you all recognize the brands, the strength of the power of how we go to market, partner with our retailers, and then on through into cannabis, our strong positions there. We'll dig into that also later in the presentation. So why SMG? And Joe hit on it. Kind of a couple of years of significant investment in growth and chasing a market that was moving far faster than our capability to grab dollars, putting in positions to grow with a high-value return, and then the market fell out from underneath us when the pandemic shifted. That's largely cannabis, the story there. And hopefully, everybody knows the cannabis story at this point. A very robust market, north of $100 billion in sales, the shift between legal and illicit and the power play that's taking place in the government and how that's driving different value exchanges between those 2 markets. Well, we sort of play to both. But given the shift in how the market grew on the legal side, it came down very quickly as it didn't seem that the governments were going to be playing on a level playing field or fairly between those 2 markets. Our growth strategy is very much intact, and we'll talk about what those 5 pillars are. We have a project in place that's called Project Springboard, where we are going after margin recovery. I think what we've said is that we have $185 million of savings that we expect to capture sooner. So we expected to capture those in 2024. We're actually going to be run rate achieving those by the end of this year. We do have steady growth in lawn and garden. That goes at GDP-plus. And actually, we're going to spend a lot of time on it in this presentation, talking about how we're activating the consumer, how we're partnering with our retailers, and why this season is different from where we were last season. Hawthorne, again, a very difficult market environment, but we are shaping that business to be a strong value contributor going forward and also maintain its market-leading positions. And then -- and this is important, we do have a very strong capital allocation approach in the company. We are in a place right now where we are paying down debt for the next couple of quarters. Target is to get between 3 and 3.5x net leverage. I'm going to show you a flight path on how we get there, and it starts with strong free cash flow generation. So the 5 pillars. The core, obviously, we talked about it already, very strong brand recognition, extremely strong brand presence. If you go into any lawn and garden center of scale and size, you will see a predominant share of our products in that center. That is a unique position in the market, but it also gives us the burden of helping to grow the market. And that's why when you look to the right, you see us extending into live goods, not only providing solutions to give our customers and their consumers the ability to create beautiful lawns, beautiful gardens through nutrition, know-how, fertilization and great product, but now introducing live plants to have a great gardens, supply those gardens with Miracle-Gro to get them healthy and robust. Omnichannel, moving across, this is a presence for us that is growing. And I think Jim, on the last conference call, went through and talked about 10 new measures that we have to address the omnichannel market. Why is this important? Because people who spend time researching in the lawn and garden market on the Internet through various other channels actually spend about 2x more and visit stores more often. So having a strong omnichannel presence is important for us. And then moving to Hawthorne, you can see Hawthorne. And there's a whole value chain on Hawthorne, but let me do it here. Let's talk about Hawthorne from what it is. Hawthorne is a fantastic business. Why? Because it starts with the genetics of the plant. We are actually -- our team is one of the only teams in the world that is working on genetics in cannabis, hemp. And so we can find and tailor genetics specific to what customers and consumers want. And then we can add growing media to those genetics for the highest quality, the most robust, densest plant that is focused on creating the best flower. So we then have nutrients that are specifically tailored for those plants in that growing media, and we provide the whole hydroponic solution and lights that create the maximum yields. This is a very complete value chain. Again, market a little bit in disarray, but we have an extremely strong position in Hawthorne. Now The Hawthorne Collective, this takes that a next step. This moves down to actually interfacing with the consumer, finding opportunities in high brand capable areas. First quarter for us, I think -- and Joe might want to talk about this later. I think when we came into the first quarter, there were a lot of questions. A lot of open questions about how we were going to perform, what free cash flow was going to be, could we manage against our covenants. Again, we spend a lot of capital going after a very, very high growth trajectory and the market turned on us. So there were valid questions around how we were going to go through that flight path. First quarter proved that we were able to stay within our covenant, 5.9x against a 6.25x covenant. Again, we'll talk about free cash flow, the importance of that moving forward here in a minute. But we also had record December shipments. We saw our U.S. Consumer sales grew 8%. Strong pricing, yes. And really, the price elasticity of raising prices, we didn't really see a significant drop off, and we'll talk about that a little bit more, too. But Hawthorne, 31% down. That is reflective of the market that's taking place there. And then I'm going to go through a little bit of a bridge on what's happening from a margin perspective here in a minute. This is an important slide because this, I think, speaks to exactly where many of your questions are going to lie, $1 billion in free cash flow over 2 years. The underlying free cash flow generation of Scotts Miracle-Gro is about $300 million a year. Now I told you that we've invested for growth that didn't happen. And so we are over-inventoried, and we are now pulling out that inventory. That's about $400 million of inventory over 2 years. So the way I look at this is about $500 million of free cash flow '23 and '24. $300 million of underlying free cash flow, $200 million of inventory release. Pretty simple. Can we do that faster? We're working on it. Can we apportion that differently? We're working on it. Can we grow the $1 billion? That's a stretch target. But yes, we are working on it. If you move to the lower left-hand side, this is that glide path I was talking about. The red line is our max leverage per our agreement with the banks. And you can see there, we do have room seasonally through third quarter of 2024. And you can actually see that red line -- sorry, the green dotted line is how we're looking at our glide path on a net leverage basis. The yellow that's overlaid there is our actual performance. So -- this gives me some comfort that we have the plans in place and that we have the free cash flow generation on the table to be able to meet that glide path. Now at the same time, we are committed to the dividend. We've continued to pay the dividend. That will remain in place. And then the other component to this, and it's really fundamental to the 5 pillars, is continuing innovation, continuing to spend on the things that make us unique, that make us capable of delivering for our customers and also for their consumers on the products that they need. Project Springboard, look, big corporations from time to time get into situations and they have projects to go after cost cutting. This is a unique company. This is a culturally different company. Going through a project at Scotts is like nothing I've seen before. Why? There's accountability that starts at every single level. This is the type of program where we take one of our chief operators, who knows every single dial within the operations is connected tightly with marketing, is connected tightly with sales, and has a strong finance capability and leverage them with going after savings. But not just savings for a period, I've talked about the fact that I believe there is a sticky component to these savings. Our SG&A going forward should be in that 15% to 16% range. That's down significantly. That's sustainable. We've taken out what I would call excess overhead. We have higher leverage within the organization and our efficiencies are growing. So keeping that in place as we move forward is going to be a task but uniquely having a project that is culturally tied from the shop floor to the board room and everybody aligned, that's the power of Springboard. And that's why we're able to achieve the savings ahead of time. The second thing here is, can there be higher savings in Springboard? The answer is yes. But I also have said that I'm going to earmark some of those savings to go after higher innovation, higher consumer initiatives. And those are important, and let's talk about those. But here first, here's that margin bridge I was talking about. You can see here, yes, our margin this year, we're expecting a modest low single-digit decline in gross margin. You can see here on the left-hand side, why that is occurring. Pricing and trade, yes, like I said, we've had a very good pricing program in place. Mix essentially flat is what we are expecting for the year. And then you can see fixed cost leverage, including distribution. We are producing less this year. That inventory position that we have, why add to it? But you're not leveraging your fixed costs the same way. So there's a cost of doing that. But we've offset that cost with the Springboard savings. So the way that you should think about this is when we get through that inventory position, this is leverage that we will get back. And then you can see materials. Yes, $500 million of commodity headwinds over the past 3 years, offset that with pricing, but that's all margin dilutive. So some questions about how commodities are moving, important to us. Commodities are about 1/3 of our overall COGS, used to be about 1/4. So inflation has had an impact, but we can dig into that in Q&A. The U.S. Consumer, the year of the lawn, I mean, every year is a new season for the lawn, right? I mean, hopefully, you all go home and pull up through a beautiful lawn. If you don't, please see me, I'd like to sell you some product. Clearly, it's something that I take great pride in. And I think, hopefully, most of this country and North America does as well, is having a great yard. And so the POS volume in 2022 was down 20%. Now there's a couple of reasons for that. And what we've talked about is, we really didn't address the market the way that we normally would, which is we didn't activate the consumer. And I'm going to go through that here in a minute. But you can see here, yes, growing media mulch, 40% of the business; lawn care, 33% of the business; but Roundup, really strong business for us; and then controls, plant food; and Other. U.S. consumer business in a very strong position, and it's performing right now really well. POS, I'm going to talk about that in a little bit. I already talked about SG&A. Yes, we brought down our SG&A. We found efficiencies in our organization to keep that sustainable. At the same time, one of the lessons learned from last year was we need to activate the consumer. And we didn't do that last year. And during the pandemic, we really didn't need to do that, that much. People were home and they wanted to have a great yard. Well, I think some of that is evening out now. People are figuring out how they're going to work. They're going to return to their yards in the summer, and they're going to want beautiful yards. I think Aimee always tells me, Aimee's our head of IR. She always tells me that people are planning to spend 4% to 6% more time in their backyards this year than last year. I have no idea where that statistic comes from, but I think it's a brilliant statistic. So that just means that you're going to have people demanding product to have a pretty yard, a good yard. So we'll keep this in place in terms of SG&A, but we are going to be focused on activating that consumer. Why does that matter? As I've come into the company, I've learned a few things. And the company uses the term, the violence of the season. If you think about it, we have 16 micro seasons in Scotts. First half of the year is really just building product into the chain. And then as soon as it gets a little bit warm, consumers show up and start ripping that product off the shelves, very tight, seasonal. It's a violent consumer interaction that takes place. And you can see here, 53% of our lawns POS is done by the end of April. It's tremendous. So you have to do all the work to have everything in place. And if you miss that build out, which is why we talk about the importance of the first half, you've missed the opportunity to sell to your consumer. And that means having an extremely strong relationship with your retailers because they need to be bought in too, and they are. You can see here on the right-hand side, there's a lot of exciting things that are happening from a activating the consumer perspective. Daylawn Savings, this is like the best marketing thing ever. You take something -- and I know you guys are going to tell me, Daylight-savings is going away. Yes. Maybe. I don't know. But the point is, you take something that's widely known, alter it a little bit, Lexus' December to Remember event. Well, here, you have Daylawn Savings time. And I'm going to show you a little bit of that promotion in a second. Roundup, I don't know, I'm not going to do a raise of hands because I don't want to embarrass all of you because you should be using Roundup in your properties. Roundup has a new formula out. It's non-glyphosate. So at the end of the day, it's meeting some consumer hurdles, but this product now lasts for 4 months, and it is a excellent product. Martha, we have great partnership with Martha. I think if -- whether you watch any of her vehicles or even when she's on national TV, she will plug our products. And then Scott the Scott for Scotts, another new marketing campaign is actually reviving something that happened about a decade ago when we had this campaign originally, but really fantastic new format for us to go do that. So our March lawns business campaign is ready to roll with Daylawn Savings. I just want to give you a sense of flavor as to what's happening. But more importantly, for those of you who can see this slide. And I don't know how many of you actually go into Home Depot and Lowe's, I buy my product generally from Home Depot. And I'll split from Lowe's now going forward. That being said, I love all of our retailers. That being said, look at that aisle. That's exactly what the aisle looks like. This is an aisle. You go into the garden centers, it is loaded with Scotts product. We are everywhere, on the shelf, across the category. This is powerful. Now I'm supposed to go here, supposed to touch that. Now just feel this. [Presentation]

To me, that's Uber powerful, and why? That was like 10 seconds. But you know you need to go this weekend. Like we said, this is a violent season, activating the consumer, get there this weekend. And by the way, we're incentivizing you to do it. Get your stuff now for the best savings of the season. And then we're going to continue to do things to activate the consumer. This is the power of the U.S. consumer business and what we've done all along to generate free cash flow for the company. Now I have no idea how to get this back into presentation mode. And I'm sure everyone in the audience is going to say press that button. But let's just go this way. Now -- sorry, Aimee. We talk about POS and what's really happening. And I've read the same things, whether Joe is writing it or other analysts or other analysts in retail, no one knows what the consumer is going to do. I get that. Our first half load out, we control. We work with our retailers, that's on us. What happens from there, the consumer showing up being activated, they have on savings, other programs, they're going to come. How do we know? Well, here, Bonus S is our product targeted for warmer markets, that start earlier, that have different grass types. And so that season really has already started. January, February, right? They're starting to get their lawns fertilized, seeded. They're working at that. In the middle of this slide, we had a Bonus S kickoff, Bonus S. We did it 4 weeks earlier this year, 2x the impressions. Actually, what this means is, in the markets where we actually run media versus those where we don't, consumers show up 180% more often. I mean, it's a phenomenal payoff to doing media and getting people in. So you can see there on the Bonus S units, up significantly beyond what we had expected. The grass seed units up. Look at those numbers, Texas, really performing well, big market for us. Big markets for us, Texas, early season markets, Texas and California. Well, California has been washed out, which is a great thing, ultimately, if they can get back to a non-drought position for lawns. Florida also important, and we're seeing great performance there. But again, on the upper right-hand side, connecting with the consumer through our retailers, driving them in and incentivizing them to show up. Hawthorne. Now look, I talked about the value chain of Hawthorne. I also talked about the fact that this was a business that was approaching $1.5 billion in sales. It's probably going to do around 1/3 of that this year. So a dramatic change in the revenue picture for Hawthorne. What has that meant to us? Well, obviously, part of Springboard or not, we are driving towards getting this business back to a profitable position at these sales levels. That means integrating it further into SMG, leveraging our systems, not having unique Hawthorne systems focusing on those brands that are going to win, that consumers and customers care about. Rightsizing our inventory, I'm going to talk about that in a second. And then growing the business and really focusing on those areas that in the intermediate term, are going to drive significant value for us. So legal markets, finding a way to get more commercial, so bigger grows. And then the whole pro-horticulture component to this. And you may not know this, this is not cannabis per se. But all of your peppers, all of your tomatoes that come out looking great all the time, they come from big grow houses across the world. A lot of them here in North America and Canada. And they use the same type of infrastructure as cannabis and their grows. So that business is performing extremely well for us and growing, and it's part of Hawthorne. And then Jim and I both talked about this on the last conference call. And I'll be direct, because this is webcast, and I think I can say it. There's not a lot of value of assets in the cannabis market today. That's clear by what's happened to all the cannabis equity. That being said, companies like Hawthorne, companies like, RIV, have a very strong position, a very strong balance sheet in a zero value asset environment. And the value proposition of how they go to market, how they create real dollar value for themselves and their customers and consumers, that's what's going to win the day. And it leads to smart partnerships. I hate to base it in things like the strong eat the weak. But at the end of the day, being strong right now matters. Building up positions that are sustainable, building brands that are sustainable. Building capabilities, technologies that are sustainable, that's what matters right now, and that's what we're doing. The inventory position here on the Hawthorne side, I love this graph on the left. Why do I love this graph on the left? It absolutely depicts going after a rapidly growing market. And then what you have to do when that market sort of stumbles? And that's what we're doing. So we built an inventory position. You can see there kind of $2.5 billion, now we're ripping out all of that. And sorry, that's Warehouse Space, but you can think of it as inventory. Now we're ripping out all of that Warehouse Space -- that wasn't me. And by the end of 2024, we're going to be back down to the same warehouse position so you can think inventory position that we were kind of in 2020. A lot of work -- a lot has happened over that time frame, but we are working on all of it, and all that is going to lead to a higher level of profitability in Hawthorne. Just like in U.S. consumer, the way that we go to market, the way that we partner with our customers and their consumers very similar. We have a full -- and I talked about the value chain, a full capability offering for our customers. And you can see also moving to high-value areas of the market. Now Chris Hagedorn, who runs the business, often talks about this. And I believe he's a bit of a visionary in cannabis, which you can use that to your own humor if you'd like to, but it actually has a big meaning. Why? Yes, it's a $100-plus billion market. It -- to me, it's a lot like beer and alcohol where you do have mass products. And then there is a whole premium end of the market that exists. Beauty for us is we can play across all of those formats. We can play to open grow, meaning outdoor growers. We can pay to pro-horticulture players. So we're all over the value spectrum in cannabis, and that is a very important part of the Hawthorne offering. Innovation, and I'll speed up here, Joe. I don't even have a clock. Innovation, we're doing more, growing more good. That round up dual action, non-glyphosate, very important for everyone to focus on that and how we are launching that product this year. We're already seeing a strong uptake of that. And given the fact that it lasts for 4 months, so you spray it once and you're not spraying it again till July. A Gro More Good, Flexi packaging, we're taking out, and you see that also in One Gallon Bottle optimization. We are finding ways to reduce costs, bring more value to consumer, and then also working with our retailers. Instead of loading into a bay bottle by bottle, we now send preset packaging that they can just push into a bay and everything is aligned to where they need it, the various products that they would need across our offering. Omnichannel, again, we talked about this a bit. I'm going to focus here on the right-hand side, just to say the omni shopper as I talked about, they make twice the amount of trips and spend more than twice as much as just an in-store consumer. So all of you that are doing your research on how you're going to activate and get your lawns to look good, you're doing that online. That draws you into the store. And then once in the store, you tend to spend about 2x more over the season than you would not doing that first initial fertilization. So strong capability in omnichannel and how it pays off on the Hawthorne side. Again, continuing to focus on all those areas of the value chain that I talked about, bringing unique technologies to help our customers reduce their cost and improve the quality of their products. So we do have significant unparalleled competitive advantages in lawn and garden. You can see with those industry-leading brands, I grew up using those brands. I have a specific point of pride being at this company. I use these products. I do my own lawn. I implore you to do the same. It's a lot of fun. And when you do, use Scotts products. Unrivaled innovation, we are the market leader. We are growing the market. We are bringing new opportunities and ideas to the market, things we need to think about for the future, moving into more drought-resistant type products. Moving into things that have a higher value to our customers as they look into their backyard and enjoy it. In-store execution. This is a unique capability for Scotts, and you probably don't know this. We have, during the season almost 2,000 employees who are working within our retailers to ensure that our product looks good, it's available, and if anyone has questions, to educate them on our product capability. This is powerful. Having someone in the aisle at a big box store -- sorry, at Home Depot and Lowe's. I didn't mean to reduce you to that. But that is extremely powerful. So -- and Aimee just took a note for me to apologize to them. So supply chain, again, a unique capability for the company, outstanding -- really performance. I've walked the floors. I've spent time with the teams. We have a very good supply chain capability to connect with our retailers and get deliveries out faster and more complete and on time. Plus also manage incoming raw materials and work with our suppliers to get them at the lowest cost. So why SMG? I can pull this down too. It's an extremely strong long-term opportunity. But in the near term, Jim, myself, the rest of the executive team, we are acting with urgency to create the highest level of value now, while also managing within our covenants. And thank you for your time.