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

All right, everybody, we're going to get started. Thanks for joining us. I'm Jon Andersen, the analyst at William Blair that covers consumer staples, including Scotts Miracle-Gro. Today, we're pleased to have Scott's Chief Operating Officer, Nate Baxter, and Chief Financial Officer, Mark Scheiwer with us to present. Scott is just by far the leading provider of branded do-it-yourself lawn and garden products in the U.S. As most of you know, it participates in a range of categories from lawns to gardens and controls. Over the past couple of years, the company has undergone quite a bit of transformation, which we believe position it for sustainable sales growth, significant gross margin expansion and for a much stronger balance sheet going forward. Company's moat is its -- company has a wide moat, which consists of its brands, its R&D capabilities and its unique go-to-market model. We think this is going to be a pivotal year for the company and its journey to delivering more dependable profit growth. Before handing it over to management, just a couple of quick housekeeping items. Immediately following the presentation, we're going to do a breakout session with the entire team in the Adler room. So join us for that. And last, just to inform you a complete list of research disclosures or potential conflicts of interest can be found on the William Blair website. So with that, I'm going to turn it over to Nate to get started.

All right. Thank you, Jon. I'm going to kick this off a little bit by just giving you some color on the business, our brands, where we're headed, in particular, looking towards the future, some of the transformational changes we've made, and then I'll turn it over to my colleague here, Mark, who will take you through the financials. One of the things that for me joining this company 2 years ago was all about joining an iconic American company, and I believe that to my core. And that's been reaffirmed in the couple of years I've had to work with the team here. We've got great brands, great products. We know people want to get out in Garden and they want to enjoy their green space. I think our challenge is how do we evolve to become more of a lifestyle brand with consumers? How do we provide everything the consumer needs to have that beautiful green space, whether it's in their backyard, whether it's on their patio inside their house. And as we dissect our business, and I was just sharing this with Jon, we've got so much growth opportunity, and I'll take you through that algorithm because I don't think it requires big swings. I think we've got a lot of organic growth just in the existing categories we play in that allows us to drive the margin recovery, and I think will really allow us to hit Jim's targets in a couple of years, puts us what I think is back to our base position where we can start to look at how we want to grow beyond that. So I'll take you through that story a little bit today and then we can talk about it in Q&A. So I hope everybody knows our brands. There's a new brand that on the top right, this O.M. Scott & Sons. It's a legacy brand. It's where we started, and it's an all-natural brand that focuses on natural law and food and seeds. And during Q&A, you can ask John, he's the GM of that business about what that's doing for us. And it's not so much about the dollars at this point, it's about our ability to be agile and launch new brands and do it new channels. This is an e-com play primarily. I think we've got it in a few stores. And that's really going to be the theme when we talk about growth. We know the retailers are crucial to our business. And they are very important partners. But just like them, we know we've got to look for growth channels, and I'll touch that in a few slides. I'd sort of like to say we have a GE model here where we want to be #1 or #2 with all of our brands. But even being #1, we've got an $11 billion TAM, and we plan, call it, $3.5 billion of that. So right there, my thesis of there's plenty of organic growth to go achieve within the existing market with existing consumers I wholeheartedly believe in, and I'll touch on a few things. Lawns in particular, it's part of the reason we brought John. We've got a really good story there where we're not only revamping our product line over the next couple of years, but more importantly, we're really focused on the messaging and the education. We've gotten to a point where our products were sort of once a year applications for many lawn consumers, and this next generation of lawn consumer needs to understand that multiple applications a year is what really drives a successful lawn. It also works towards our sustainability goals because the more you feed the lawn the thicker it is and the less disease and weeds you have. And therefore, the less pesticide and herbicide, you need to put on the product, which, by the way, we're hugely supportive of. It's important for us to look forward to a sustainable future, and I'll talk about that when we get to an R&D slide. But proud of these brands, and I feel like the stewardship of these brands is really what my job is all about. So we've invested heavily in our insights organization as we've rebuilt the company sort of coming out of the last couple of years. We recognize the consumer is changing. I think it's safe to say we've relied heavily on the older homeowner. They're still a very important consumer. They're not going away. We know that housing for younger generation is a challenge. But we also know that those who own homes and invest in their lawns really feel strongly about it, and you can see from the statistics here. Consumers see this as a necessity, and that's a trend that's sort of come out of the pandemic and we're sort of leaning into. We are seeing shift from do-it-for-me to DIY. I think that shift happens every year, but we're seeing more consumers engage and the lesson we're learning there is education. So I'll talk a little bit in a minute about where we're headed. We're going to have a completely new sort of digital interface with the consumer this fall, and it won't be perfect out of the gate, but we're going to consolidate all our websites. We're going to have more of a lifestyle feel. But more importantly, it's not necessarily about directly selling product, although that is part of the goal. It's about educating the consumer. We've got a team that's bringing an AI tool that will come into play even on our existing websites in the form of search, but we'll have a more interactive website that will be coming where we are using, call it, 150 years of knowledge that we've built through science, white papers and consumer experience. And that is proprietary information that we will contain in our large language model, we will leverage that to be able to provide answers to consumers. In a perfect world, there'll be a QR code. We'll have an app. You can -- we codenamed it as Scotty. You can send a picture of a problem or a picture of a grass type, we can help you understand what you need to attack, whether it's an opportunity to grow something or dealing with a problem that you might have. And we feel we're uniquely positioned to do that. And we're going to do it in a way that harmonizes with what our retailers are doing because everybody's got an AI app, but we believe we have a right to be the source of education, and we think that will drive consumer engagement especially as we start to look at these cohorts. This cohorts of older Gen Z and younger millennials that have been really prevented from homeownership, they're big. They are actually bigger than the boomer and Gen X, and they are coming, and it might be 5 to 10 years from now. But part of what we have to do is engage that consumer today. If any of you spend any time on Instagram, you see there's an awful lot on there about house plants and growing on your patio or balcony. We're going to start to lean more into that. Our focus this year in gardens has been getting our organic product line expanded, and I feel like we've done a great job there, but we're now going to start leaning into indoor gardening and engaging those consumers as well as we try to bring them along. And while it's a long play for us, we believe it's important as we look out sort of past 5 years. So I think that's an important statement because as you know, 2 years ago, when I joined, we were very short-term focused and by that, I mean weeks and quarters. We've now put a vision out for 3 years for fiscal '27 to us, that's table stakes, getting back to a financial position, and Mark will talk about that. We're now starting to talk about what's beyond that. And I think that's important. Last comment I'll make is just a couple of quotes here from Ted and Marvin, but our consumer is healthy. They are homeowners. They generally have high incomes, low debt. So I know there was a lot of nervousness, obviously, the last couple of years with inflation, obviously, all of the tariff and consumer sentiment concerns. I wouldn't say we're immune to it. I think people are choosing how to spend their discretionary dollars wisely, but we are largely unaffected. And I think we've been able to manage through that and hopefully, the reaffirmation of guidance that we put out this morning shows that. We're facing a market where volatility in the weather. I know we always talk about weather. It is a factor, but it's not the biggest factor. At the end of the day, it's 1% or 2% and people forget about it. We've gotten more sophisticated about how we manage through it and we can talk about that in Q&A, if you want. And then consumer sentiment, I think, is something that brings everybody down, but we haven't seen an impact in our numbers this year from that. We talked about our superpowers, our brands, our innovation, our supply chain, our sales team. I talked about brands. I'll talk a little bit about innovation on the next slide and supply chain. Sales, I just -- I want to comment on this because a big part of our expense is maintaining a field sales force that is by and far larger than any of our competitors. The reason we do this is the relationships that they build at the store manager level allows us to drive a ton of off-shelf activity. I was actually here in the Midwest talking to our sales leaders here. For one retailer, something like $80 million of our revenue this year was driven completely off-shelf, not part of planograms. And I think that's something we probably don't talk enough about. We talk about going to line reviews, which are happening this time of year. We get fixed on planograms and pricing, but what we don't talk about is the year around sharp elbows trying to make sure we get end caps. And it's a meaningful number for us when we look at our growth. We continue to invest in our brands. Jim talks a lot about that. Don't worry about Tomcat, it's in a really, really good place. We just decided that we were going to allocate our dollars elsewhere, but we have a high commitment to investment in those brands. We will continue to do that and our brand health scores reflect that. So let me take a pause here because I think when we talk about our growth algorithm, I talked about the opportunity for organic growth within the existing TAM, but we also have to drive it through innovation and that innovation has to look to where the consumer is going. Safety, sustainability is important. We're probably the only company in this space and if you look at some of the little notes on the right, we've leaned heavily into organic. It will probably continue to grow and dominate across all of our categories and natural. We're working with big ag partners on biologicals. I have a vision that in 10 years or so, we can say we're going to be in a synthetic free chemical -- synthetic chemical-free company, whether we can really achieve that or not, I don't know. But we sure are going to try, and we know from some of our partners that there are biological and natural formulations that either supplement existing synthetic chemicals, meaning you can use less chemical and be just as effective. And then the ultimate vision would be to replace those. And so I feel we're the only one with deep enough pocketbooks to be able to invest in that. We continue to look at packaging. We talked about -- or I talked about O.M. Scott. That product is now in a fully curb recyclable paper bag. We're very cognizant of the amount of plastic we put out in the world and continue to work on not only packaging but small form innovation. We care a lot about the indoor guarding space, and we're in '26 and '27 going to start to really expand there. On the left, these are just some successes. The top is our exclusive for Costco, our Max line. That came out of the gate last year, really strong. Below that, you see organic line huge, huge gains this year. Just year-to-date, soils for organic line is up 7% in terms of market share gains and our organic plant food is up 3%. We see a consumer that wants more options in this space, and we're going to continue to invest in those. Supply chain. This is what's been making it happen. This is why we've been able to affirm our guidance and our gross margin recovery. We've leaned very heavily into automation. I think we all know we invested heavily in expanding supply chain during the pandemic. That was a bad move. I think a lot of retailers got caught in that position. But what we've done is we've shrink it as we've modernized it. So we're leaning in heavily to automation. We're driving utilization on -- because we're such a peak business, we tend to have very high utilization during certain periods and very low utilization with the others. I came out of semiconductor, where if you're not utilizing your CapEx at as high a rate as possible across the year, you're not winning, and that's where we're going to head with supply chain. And in general, we try to get 1% of COGS, call it, $20 million a year out. We've committed to $75 million this year and $150 million over the total of now through '27, and we are definitely on track, and I'll let Mark talk to that. But a lot of automation as a guy that came out of tech, this is an area that, to me, is really easy, and we're finally making management changes that put in younger leaders who are more tech savvy and we're starting to see the results of that. I wanted to talk about e-com because when we talk about our growth algorithm, we've got to go to where the shoppers are and part of that is the online marketplace. And I talk about that broadly. It's our own D2C, which today isn't huge, but we'll continue to lean into it. When we go through the SKU rationalization, which is something we are going through right now, we know that we have to start to segregate SKUs that are big movers and margin drivers for our retailers. We need to segregate SKUs that are ideal for e-commerce. And by the way, those are both small and large. A big part of our e-commerce platform is now pallet delivery of mulch and growing media and some of these bigger and heavier objects. So that's an important part of that story. And then we've got to figure out how to support the retailers and their e-com. So if you look at where we've come last year, about 8% of our revenues were driven through some form of e-com. We're just under 10% this year. So if I were to predict, I'd say we end somewhere between 9.5% and 10%. To frame that, last year, we shipped about 6 million units direct to the consumer's home on behalf of not only our small D2C business, but also our partners. Year-to-date this year, we're at $12 million. So one of the benefits I inherited of all the investment in the supply chain is a very, very robust network for direct-to-home delivery. Now it's not all about direct-to-home, it's buy online, pick up in store. So there are many flavors and quite honestly, I'm agnostic of it. While I think we need a D2C business, it will probably be that long pallet SKUs that are maybe expert SKUs that don't make sense to push in the retailers, we're going to drive those. So I think with that, I want to turn it over to Mark and let him talk us through the financials, and then we'll address questions in the Q&A.

Sure. All right. Thanks, Nate. Before I jump in to the guidance and our reaffirmation, I at least want to give you a flavor of the employees at Scotts what we believe in. And hopefully, you can get a feel of -- we love the company were consumers at heart. We love the brands. We are a branded consumer company first and foremost. This industry has been around for many years. It's stable. It's consistent. And the thing that I'm excited about that Nate just spoke to is we've got a lot of growth opportunity in the future, both through e-comm channels, through frequency, through getting that -- educating that consumer to use our products more. I started as a homeowner in my mid-20s going to an ACE hardware store, learning the 4-step program, getting educated really by Scotts Miracle-Gro on what it means to take care of my yard. We can do more and more of this and drive frequency. Now I go into all the other retailers, whether it'd be Home Depot, Lowe's, and it's even more exciting now, as Nate talked about the e-com side when it comes to our retail partners. We can deliver pallets of soil and mulch now to customers or to consumers at your home. So we are doing things now that will help us with our growth algorithms, our sales growth in the future. It's what gives us our right to win. Over the past several years, this chart has it up here is a little history of our sales. It shows that we've grown sales. It shows that we've taken listing gains. It shows that we've innovated. And it shows that we can continue to do that. It's very consistent. I would tell you that from a long-term perspective, we set out a target of 3% annually for sales. And we believe in that. It comes through innovation, it comes through pricing. Being the national lawn and garden company, consumer products company that we are, we offer a wider range of products. Nate just spoke to all the brands. But if you look at them in the categories, lawns, we offer fertilizer, we offer grass seed, we offer plant food and gardens. We offer soils, mulch. In the control space, we offer a wider range of insecticides and herbicides, weed killing products. We offer rodenticide products. These are all wide range of things that we offer. And we also offer mulch with a high velocity SKU. Why do I say all that? It allows us to take pricing. It allows us to innovate in all of these areas and it allows us to grow on an annual basis. You'll see here over a 7-year period through last year, we grew our sales about 5%. Where we reaffirmed our sales guidance for this year to be low single digit. So it shows that we have the ability to innovate and to grow our sales. Some of the recent innovation and Nate didn't speak to it, but I'm excited about Miracle-Gro Organics that was launched last year with the Martha Stewart campaign. It's a pink bag. And we've got some other cool things, as he mentioned, through O.M. Scott. Over the years, we've innovated over the past 10 to 15 years and some really cool things like Thick'R in the fertilizer space, which is a grass seed and fertilizer product, that's an all-in-one solution. We've also, in the fertilizer space, have other all-in-one solutions that provide a multitude of outcomes. So I would say, over the years, we've been able to prove that. We have an amazing R&D team. And the reason we're able to continue to grow our sales and I just go back to -- I'll kind of reiterate and it will help us define what we can do on gross margin is our supply chain team. Our supply chain team helps us deliver product quickly in season to customers. We are a national garden -- national consumer products, lawn and garden company, and we can get product to consumers and to our customers quickly, reliably and on time, and that's super important. Jumping to gross margin and EBITDA. We've reaffirmed our targets, which are 30% in the range of $570 million to $590 million. I would just tell you that as we set up for the year, we have made a ton of progress. We kind of almost take it for granted internally on the gross margin side of the house. If you looked at it a couple of years ago, we were in the low to mid-20s. And a lot of that was COVID driven. We had significant peaks and valleys in our sales volumes that caused quite a few fluctuations in our gross margin. And now we're on the road to recovery. If you look at pre-COVID, Scotts has been a mid-30% gross margin company. Now if you talk to Jim Hagedorn, our CEO, he'll push us to high 30s. Do I see a path to that? Potentially. But we got to keep being diligent. We've got to focus on the things we do best. Nate had a slide earlier that talked about cost-outs. So this fiscal year, so just to get everyone grounded, this year, we're expecting 30% gross margin. That's over 370 basis points of improvement versus prior year. About 210 of it is coming from cost savings from a supply chain perspective or about $75 million. About 1/3 of that is commodities driven, but the 2/3 is cost outs. and it can come from a range of things, automating a packaging line, renegotiating prices with vendors, changing formulas, all those things. So we have a history of consistently doing that. So 30% gross margin this year and if you saw through the first half of our fiscal year, what we've reported, we are well on our way to achieving that. And in fact, I feel real confident in what they've been doing in that area. So about 210 of those basis points I talked about are tied to that. Last year, in Q4, we also did an E&O charge tied to our AeroGarden business, which was -- is the kitchen counter, light units that grow plants we took about a $29 million inventory write-off. That will be nonrepeating. So that's an upside, call it, 80 basis points. And then the difference really goes to a couple of things. It's additional overperformance, in the business. It's also Hawthorne doing a lot of strong work there. We didn't mention it here and I'll cover it at the very end around -- briefly around Hawthorne, but they are making a lot of strides on profitability, but it's a lot smaller segment, very much like our other segment now. EBITDA, so with the beginning of the year, the past couple of years, we've given an EBITDA metric. I have -- we have in the press release, introduced EPS back into the fold again, which is traditionally what we used to do pre-COVID, but EBITDA, $570 million to $590 million, if you look at it historically, pre-COVID, we're back to those levels, and we see a strong line of sight to growing that even further for next year. The way we grow that in our gross margin, which is mid-30s for the next 2 years, so '26 and '27, Jim spoke on the past couple of earnings calls and I have as well, about obtaining about $150 million of supply chain cost outs over 3 years. So $75 million this year and then another $75 million in the next 2 years. And again, $75 million over 2 years, it should be probably evenly distributed, but it's around, what, $38 million a year. It is something we can consistently do and we have a history of. The team has already been working on it. We've already been planning for next year, and I'm seeing great progress in that area. So I'm excited about next year and the path forward on achieving the second phase of the $75 million of cost out. Other things, let's see anything else on EBITDA, I don't think so. We can move ahead. All right. So EPS, we've reintroduced EPS. We've put in here a minimum of $3.50 a share. I think if you look at it the past couple of years, we've made outstanding progress. Part of that is tied to the EBITDA improvement I just spoke to, gross margin I spoke to which are driving a lot of that EPS growth. The other piece of it is what I'll call below the operating line. And this is where we've done a lot of hard work as a team on cash flow, debt repayment, and eventually then driving interest expense savings. So that is driving a lot of that improvement below the line. For this year, we do expect cash flows to be about $250 million. And if you look at it, probably pre-COVID, that number was around, call it, on average about $200 million to $210 million. We have started to take a step change up in free cash flow as we look to this year and beyond. Some of the growth initiatives that Nate spoke to as he was going through the presentation, they don't require massive working capital builds. They require just normal CapEx expenditures that we can fill within our normal run rate, which CapEx, in general, is around, call it, 2.5% to 3% of net sales on an annual basis at Scotts. And again, a lot of it is focused on our factories, our supply chain. But I would say some of the newer investments we're making in CapEx are tied to data, to IT and a lot of those insights that Nate spoke to, automating things through that. So a lot more good work to happen. We feel like we can consistently deliver it. And again, I go back to Scott's has been around for many years. We're consistent, stable company. We can deliver consistent, stable cash flow as we look to this year and beyond. The last couple of years, I'll only highlight we're pandemic-driven. So we did get a lot of free cash flow from inventory sell-through. I would just tell you that our inventory levels are very good as we head into the balance of the year. And we would foresee our inventory levels to be, call it, around $600 million at the end of the fiscal year, our -- what we hold on our balance sheet. But I think the thing I'm more excited about, as Nate spoke to, is how do we maybe improve cash flow during the fiscal year and not have such a significant ramp up in our inventory at different times of the year. You can produce inventory at different times. You can get your retail partners to take that over that time period. So we're working on that, and we're excited about it. All right. Long term, I've got this chart in here that talk about the 4, what I'll call, 4 key goals, and that's delivering sustainable net sales growth. Again, if I just showed you that history, we've shown that we have the ability to hit 3% annual sales growth. And that comes in some pretty solid high-margin products. We're not just driving low-margin 20% below our company-wide gross margin SKUs. This is high-margin activity. And the things that we're doing from a growth both in the lawn space and frequency, our soils products, which are high margin and doing the stuff with Martha Stewart there, they all deliver really strong margin. So we have a history of delivering 3% annual growth as you saw on the chart earlier, it comes through innovation. It comes through new platforms. And again, I'm excited about e-commerce. We're growing double digits in e-commerce. So this year, we're growing double digits. So it keeps growing. And the reason we're able to do that, again, supply chain, we can get you the product in season when you need it the most, and that's super important. Be the lowest cost manufacturer, so this is tied to sales at the end of the day in my mind. We have had a lot of listing games. We are the national lawn and garden player. Because of the scale that we have in both our fertilizer production, our grass seed purchasing, our growing media. What I didn't tell you, and you may have seen in prior slides, but growing media has about 40 sites around the country where we produce soils, mulch, that is a strategic and competitive advantage. We're able to get product quickly across the country. And then ultimately then, that allows us to then ultimately get our margins back up to what you've historically seen? And then I think -- and again, for me, as I look out, I think we can achieve above 35%. And the way you get there, again, supply chain savings, pricing because we are an innovative company, we offer a multitude of products across the categories. And then we can grow our sales. And all 3 of those things can provide you the gross margin improvement. And I'll just wrap up and talk about briefly balance of -- the balance sheet and capital allocation. If you look at it as pre-COVID, traditionally, we give our quarterly dividend. We give a share buyback or share repurchase. Those are some of the consistent things that we'll ultimately get back to once our leverage gets to 3.5x and below. We can easily do that we feel like over the next 2 years and then hopefully introduce something like a buyback to you all in about a year or 2. So with that, I'll pause, and we can jump to Q&A.

I think we're going to wrap it there and take it breakdown room at Adler. So thanks again Nate and Mark.