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

Good afternoon, everybody, and thank you for joining us. I'm Joe Altobello, leisure analyst here at Raymond James. And I'm very pleased to have with me today senior management from The Scotts Miracle-Gro, including President and COO, Nate Baxter; and CFO, Mark Scheiwer. Welcome, gentlemen. I'm sure most people in this room are at least somewhat familiar with Scotts as the company is the leader in the consumer lawn and garden space. It also owns a hydroponics business, which is looking to divest and which we'll talk about a little bit later.

With that in mind, I did want to start with your U.S. consumer business. It gapped up during COVID as consumers entered the category, though it's been rather choppy of late. My first question is, what's been driving the recent volatility from year-to-year for what historically has been a fairly steady business?

Yes, I can go ahead and start, and Nate can chime in. I think if you look at the past 2 years, so our fiscal '25 and '24 sales growth in general on U.S. consumer, we've grown over those 2 years, call it, a combined cumulative around 6% to 7%. So that equates to around 3%, 3.5% of annual sales growth. To your point, it's been a little choppy. We got a lot of great listings in '24 in our lawn and garden business, primarily around our soils business, which, as you all know, people love to garden, and that business continues to do some outstanding work. We still have some messages of what I'll call a COVID hangover that have impacted us over the past couple of years. We've continued to see a little bit of retailer deload -- inventory deload that happened over the course of '24 and a little bit in '25. But as we landed this fiscal year, our retailer inventories are very healthy. They're in very good spots. As we work on plans for '26, the plans that we have with our retail partners are very supportive of the initiatives we're trying to achieve. But that's created some volatility as we've navigated. In addition to that, within the quarters, we got as high. Typically, pre-COVID, we were typically a 50-50 sales phasing enterprise. So 50% of the year happened in the first half, 50% in the second half. That got as high as 60% in the first half and 40% in the second half. That's been rightsizing back to post-COVID norms. We got it down to 55% this past year. We'll probably get -- as we look in '26, we expect that shift to happen again a little bit more. We'll probably get into the, call it, the 53% to 54% range. So another, call it, point differential of shifting that is happening and impacting our business. We also did some inventory selling. We had some excess grass seed and fertilizer inventory that was hung over in -- that we sold in '24 that impacted our comparables in '25. So as we come out of '25, I would say our lawn -- our U.S. consumer lawn and garden business is healthy. Retailer inventories are extremely healthy. The thing I get excited about as CFO more than anything is we are continuing to invest in our advertising, invest in our business and our innovation pipeline is picking up steam again. And I would say over the past couple of years, part of that choppiness was some of our innovation pipeline was focused on cost reduction, and Nate can speak a little bit to that. But we've got some really cool stuff coming up over the next couple of years and product lineup changes that Nate can expand upon from an innovation standpoint. But as I see it on the CFO side, as we plan ahead, we view sales growth annually of at least 3%. I think if you look at a longer 10-year perspective, historically, Scotts has grown typically anywhere from 3% to 4% to 5% a year over a 10-year period. And again, it doesn't always happen exactly that way in any one year. But if you look over that time period, that's average -- that's what it averages out to. And it's built on the backs of strong innovation over those years, strong partnership with our retailers and then also a pricing component. But as we look out in the future, innovation, form factors, e-commerce is going to be a big part of that growth driver as we look out into the future.

Yes. I mean I guess I'll add a little color. I think if you take a step back and look at the big brick-and-mortar retailers, they're trying to adjust to the post-COVID world as well. Footsteps are down in brick-and-mortar. Obviously, e-commerce is growing. We've partnered with them over the last few years to really try to drive footsteps. They do use the category. It is a healthy category. And I think a lot of what we saw, especially Joe, with the difference between POS dollars and units was driven by a lot of that investment. So as we sort of clean things up, we're done with any kind of big E&O. We'll divest at some point, hopefully soon, the Hawthorne business. The other big thing that we've talked about is shifting away from the low margin or no margin commodity stuff into the branded products. And I think that's part of our story for '26. When we guide to low single digit, that's really net. And remember, we're going to walk away from some of that low-calorie business, and we're obviously replacing those sales. But we're only going to net to low single digits. But when we look at our branded growth, we're anticipating sort of mid-single digit on the branded growth. So that's a big part of our story moving forward. We've cleaned up our supply chain, taken a ton of cost out of it. We're really now focused on the consumer, and I'm sure I'll have an opportunity to talk a little bit about how we're trying to manage this transition between our core consumer, which is sort of like my parents, and I guess maybe me, I guess I stay here and the next-generation consumer, right? And they shop differently and COVID changed all that, right? They go to market differently. They shop differently. They need both inspiration and education. And so a lot of the investment we're making now and we'll start to actually see in the marketplace in '26 is associated with not ignoring that original cohort and certainly not ignoring the retailers, but recognizing that the growth is double digit in e-com. It's double digit with some of the smaller, more, I'll call it, the club and the large acreage retailers continue to be healthy and grow. And the big retailers are obviously important, but they also see where the puck is going. And if you look at their e-com numbers, they're growing double digits as well. So it's -- I feel like we've cleaned things up. We've done a ton of SKU rationalization. We get past those onetimes. I think starting in '26, we'll be able to build on much more consistency of growth. And we'll get through '26 that transition out of some of these commodities. I've only been here 2.5, 3 years. But over, call it, a decade plus, I would say we've built some bad habits. We're partners with our retailers. We'll give them commodity soils where we're losing money because it's something they want. We'll lean in with them on selling mulch like it's water. And at the end of the day, we had to take a look and say, what's best, right? We've made strong commitments to the Street on not only top line but margin growth, and that's our jet fuel to pay down debt and continue to invest in the business. So this was something Mark, Jim and I very luckily aligned on, and we've made some of those moves this year. We've talked about them a little bit, and I think it will be reflected in the results in '26.

Just going back to your comment earlier about the future growth. I think at your Investor Day in mid-'24, you guys laid out a 3% CAGR on the top line. You mentioned low single-digit growth.

And we negotiated that in front of you, I think.

Indeed. Can you kind of give us the building blocks of that 3% growth? How much is volume? How much is price? And are you assuming any acquisitions and/or market share gains within that number...

Sure. Yes. So I think if you look historically, we've been traditionally be able to deliver at least 1% of pricing annually a year. We offer a broad range of lawn and garden products, both lawn in the lawns category, you have fertilizer, grass seed, in gardens, soils, mulch, plant food and in controls, you have both weed, insect and rodent control. So we offer a wide range of products. So we're able to target and be strategic about what we take on our pricing. We offer good, better, best strategies amongst those categories. So we have a lot of flexibility within our space that we operate. So it's in our DNA, and we are doing that. And you'll see that manifest in '26. The last couple of years, we've been effectively flat to slightly negative on pricing. And part of that was strategies to change foot traffic or frequency in the lawn space or just hold steady our pricing that we have taken since post-COVID. Now we're looking to -- with inflation and commodities. We're not exposed much to tariffs, but we are taking some pricing, and it will be a part of that algorithm this year and beyond. The other aspect of that is, in my mind, is volume. I'd love to see where we can consistently grow 2% in straight of volume growth. It can come on the backs of innovation or what I see another area would be e-commerce. E-commerce sales are not fully all cannibalizable and bring in new consumers, and they are also incremental to some degree. So in my view, that 2% of volume growth to deliver the 3% growth algorithm comes on the backs of innovation, which we have a lot of that coming over the next couple of years and then the continued expansion in our e-commerce participation, both with our retailers and then through some of our own direct sites, not a lot, but some. And then the last mention -- you mentioned the tuck-in M&A. We are the leader in lawn and garden, but there's a lot of outstanding adjacency categories that operate in our space today that we really like. And I think of tuck-in, I think of an M&A that is EPS accretive in year one, that is going to be leverage neutral to potentially help with leverage. We are already partnering with a lot of people in this space. We have good friends out there and partnerships, and it will very much be a part of our playbook. Is it going to be the big multi -- like $200 million, $300 million acquisition? No. Tuck-in acquisitions would be much smaller, call it, $100 million or less and would be in our DNA. It fits into our superpowers. We have outstanding supply chain in lawn and garden, whether it be in the lawn space, in fertilizers and grass seed. We've got outstanding scientists across that category in the soil space. We have 40 growing media sites that are second to none as far as executing in season, and we have great scientists that deliver products across that and controls as well. So there's a ton of opportunity there. And from my perspective, as we kind of go through this journey after coming off of some of the Hawthorne M&A, we'll do it in a measured approach. There will be tuck-in. An example of that, just for your -- all benefit would be Tomcat. In 2014, we acquired Tomcat, the rodent control business. We put it in our distribution sales and marketing engine, and it's done outstanding ever since its acquisition.

Yes. I would just add a little color on that. So we're also looking at channel expansion. I mean e-com is the obvious one, and I would put that at the top. I think when you ask retailers who they're afraid of, it's Amazon for sure. The other is we believe we have a right to win in what I'll call the do-it-for-me Pro space, small Pro space. There are a lot of relatively small businesses out there that use the cheapest product they can get. We've spent some time doing some insights work, building a council, talking to them. And I think -- I don't think there'll be anything material in '26, but we have a thesis and are going to reallocate some resources to go after through loyalty program. I can see over time, as our big retail partners lean more and more into the Pro side of the business, which has not traditionally been so much on the lawn and garden side, I think there's an opportunity to grow with them there as well. And then I think the last comment I'll make is the Hispanic, we put a team together to focus across all channels. We recognize that the Hispanic part of the population, they deeply love brands. It's going to be 50% of the U.S. population is going to have some ethnic background with some -- in sort of Hispanic ethnic background. And so what we're really focused on is how do we genuinely talk to them and how do we make sure that our products are right for them because I think that cohort really cares about quality. They really care about efficacy. So you'll start to hear us talk more about that. And I think it's agnostic of channel. I think when you look at Digital penetration is actually higher with Hispanics, believe it or not. I think there must not be counting social media. There's a lot of opportunities there. So I think between the channel expansion, the innovation, the tuck-in M&A, we're feeling pretty good. Gardening is a very, very healthy category, growing double digits. And then the controls category is one where the pie is expanding. And there are adjacencies that we will get into, whether it's through small tuck-in or doing it ourselves that will not only try to grow the sort of the subcategories we're in today, but also lean into ones that are becoming more important. We've talked about it mosquito, tick, flying insect., Those are areas we don't really play in, and there's a lot of opportunity...

Maybe speak also to the lawns, the frequency...

So yes, so the lawns business is a little different. It's -- first of all, it's probably one of the most important. It's very high margin. I think anybody that goes out and looks at the data knows that -- it's been a declining on a unit basis. It continues to grow as we and our competitors take pricing. But we really believe that there's an opportunity to drive increased household penetration. Today, we stand at about 11%. There's a lot of headroom there. There's a lot of -- what we're learning from our insights is there are -- the vast majority, more than 50% of American households are participating in basic lawn and garden care. So they mow lawn, they water it, but they don't take care of fertilizer. They don't do bug control. So we're really going to focus on education and household penetration, especially as hopefully the housing market warms back up and we see turnover. The other is frequency. I would say we did this to ourselves over many decades. We created -- we're excellent scientists and engineers. We created these all-in-one particles like our triple action that given today's commodity prices are down north of $100 a bag, which is very, very hard to push on a consumer. What we're doing is sort of getting back to basics and just pulling a page from our old playbook, which is let's get back to the 4-step program where you apply 4 times a year. And even if it's most basic, you can apply a base fertilizer with no insecticide, no herbicide, which is very important to an emerging cohort and have a great lawn if you're a patient. You can crowd out weeds as long as the roots are healthy and fed, they'll be more disease resistant. Of course, we're still going to offer our multistep or all-in-one, but we're very much hoping we can get frequency. We did do that last year. We had some commentary in our meeting -- in our quarterly calls, sort of pushing us on that delta between the POS units and dollars, and a lot of that is because we did take pricing. I don't think anybody believed this, but we dealt it all back. And we were very strategic. We put a lot of it into that [indiscernible], that buy 1, get 1 free, get 1 half off. We ran a whole bunch of different promos, really trying to change consumer behavior back to what it was 25 years ago, which is you use 4 steps. So our average application per consumer is about 1.2, and it's basically a huge population of people that barely do one a year and then our shrinking core that still do 4 or 5 a year. So now we're really focusing our messaging on multistep feeding, and we're going to bring a new just straight new formula for it to market this season that's going to have like a $25, $26 price point. It will be something that we can talk about, pet safe, you could interleave it between your weed and feed and your Halts. So that's, I think, where gardens and controls is growing, lawns is the one where we've got to be on the offensive and figure out how to get consumers back in. So between the small Pro and messaging on frequency, I think that's our play there, and I feel pretty good about it because we did see a response by the consumer this last year.

I want to go back to market share because I think there's this perception that during challenging economic times, consumers tend to trade down, right? You guys are the premium branded player in the category. How have your market shares been trending? And have you seen any material trade down to private label, for example?

So on average, I mean, fiscal year '24, we gained 4 points of market share. We netted a point this year. Now there were some puts and takes in there. I think when we look at private label, I mean, it's a complicated relationship. First of all, it's been pretty flat. If you look at across our categories, it's about 15%, maybe a little lower, and that's been pretty consistent. There's been spots of noise, especially in lawn fertilizer. So I don't want to ignore the fact that there's a value gap there or there's a price gap there, but we haven't seen the trade down in our volumes. And I think we've seen some of our big retail partners say that. Now when you look at retailers that may lean into their private label a little bit more, sure, they'll move a few more units of private label, but they'll also lose a massive amount of market share on branded. It was actually an insight that informed us that said, look, we're going to back off a little bit on the commodities, and we're going to ask our retail partners to lean in with us on the branded. And so far, they're doing that. So I mean, look, I came from the Andy Grove at Intel. So I'm always paranoid and it's something we keep an eye on. But it's also something we talk about with our retailers. Our retailers know full well that they can't win alone with private label and the consumers want branded. And we keep a pretty sharp eye on market share in that space.

So going back to e-comm for a second. First, could you tell us how big that business is for you today? And how it breaks down between, let's say, Amazon versus retailer.com?

Let me frame it this way. So if we look at our POS sales, it's about 10% of our POS. It was less than 2% 5, 6 years ago. I expect we'll probably add another 2% or 3% to that. It's growing at double digits. It's really growing fast. Amazon is growing fast, but so are some of our retail partners. And I would just say from the seat I'm in, some are better at it than others. But I think they're all going to have to figure it out. That's really the next frontier. I would say Amazon is probably half of our online sales. Our D2C is a rounding error. It's important, and we're investing it in a little. And actually, the retailers encourage us to because it's all about getting eyeballs on our products. And I'm sort of agnostic of where we sell them as long as we sell them. But there's really valuable 1P data that I'd like to get. So I do want to have that relationship through loyalty and subscription. But it's not a growth strategy. I would never go to market and say that we're going to drive our top line just on D2C. We're going to be there where the consumer needs us, but it will remain a small part. But I think we're seeing retailers -- and it's interesting. It's not just about small form factors, right, concentrates and things that are easy to ship. We have retail partners that are shipping full pallets, and it is doing really well.

Same day, same day full pallets.

And this is a little bit qualitative and not fully quantitative. But when we start to look in certain regions where typically, if you've got a home and you're paying somebody to put mulch down, you buy it in bulk, we've actually seen the cost equation work in our favor where you can have 5 pallets delivered to your driveway next day by depot, and it's less as just including shipping costs and the landscapers like it because they can go lay the bags out and they don't have to shovel much stuff. So what I'm poking at is our insights team, which we've really invested in, is starting to really uncover some little gems that we're following, and I think will all be part of that growth algorithm.

Is same day the kind of secret sauce because I've always looked at your product as very bulky, right? No one's going to buy 20 bags of mulch putting your garage on a Wednesday when you're going to put it down on a Saturday, for example, right? So does same-day kind of solve that issue, I guess?

I don't know. I mean, Sass is our GM. I could get her to come up and comment on it. But here's what I think. I think buying habits differ by region. I think in the Northeast and the Midwest, when the weather in the spring is volatile, you're more likely to have somebody either go pick it up themselves or have it delivered midweek, and then they'll wait for that weather window that we all wait for when we -- in spring in the Northeast and Midwest. In the South, it's different. I think it's pretty much around there, so you can have it delivered and have it instantaneously. I do know talking to our e-com retailers, you've probably seen the headlines. I mean, they've already got sub 30-minute delivery in India, and they're talking about bringing it to the U.S. I think that our retail partners want that for the lawn and garden space as well. So it's going to be interesting to see how this plays out. But my view is we're just going to be available everywhere and figure out how to make sure we're...

I feel like you're unencumbered by the size of your trunk, the amount of visits you make at delivery to your home is pretty neat. And you can probably buy more than you'd expect.

And that's a little bit of the calculus of backing off on the mulch, especially the promo mulch because the attachment rate, our data says that we're not losing customers that you go load your cart with mulch, you're not doing anything else. It's sort of banging on the ground as you leave, and they come back for the other stuff. Well, now if that starts to shift more to being delivered in pallet form, I think that for us was a little bit of, okay, we can back off the promos on the mulch. We can -- I can give [indiscernible] more capacity for higher-margin soils, right? Because if you look at our fiscal '24, I mean, I think it was a record in terms of the amount of mulch. And we're still selling mulch. I mean it's still commodities and mulch is what, about 15% of our total revenue. So it's not like we walked away from it. We just walked away from overpaying trade to promote it and saying, we're just not going to do that. You can go to your regional suppliers and have them do that because it does drive foot store traffic, but we'll still be there with branded mulch. And what will really be is leaning in with really good deals on our high-margin branded products.

Got it. So let's talk about gross margin a little bit. This is, in my view, very much a gross margin story for the stock. If you look at your gross margins, you were mid-30s several years ago. You got down to, I think, below 24% at the bottom, right? And now the goal is to get back to the mid-30s. And you're kind of halfway there, right? So I guess 2-part question here for the benefit of the audience. First, what got you from mid-30s to mid-20s? And what gets you back to the mid-30s?

Yes. So I can start and Nate can add in some color commentary. But what got us ultimately to, call it, the mid-20s from that mid-30s was really our COVID build-out. So during fiscal '20 and '21, we experienced, call it, 10, 15 years of sales growth over a 2-year period. And as part of that, to meet consumer demand, we did have to incrementally add warehouse space, distribution space, capacity in our network. So that build-out obviously created a much larger fixed cost structure. It also left us with some overhang of inventory as our sales started to decline. So after '21 in '22 and '23 in the lawn and garden space, that sales increase we saw over that 2-year period obviously reverted back to more pre-COVID norms. And so if you looked at a sales chart from fiscal '19 to, call it, fiscal '24 and you just drew a line, it would look like a steady climb, but if you actually looked at the year-to-year, there'd be a big mountain in between there. And so that created a lot of inefficiency both on a fixed cost structure. You have bad habits where you're producing at times that are inefficient and creating extra overtime hours. You're conserving cash because your leverage is high. And so you're not building -- prebuilding inventory in optimal time periods. And so your labor is not as efficient as you'd like it. So there's a whole host of reasons because of that COVID activity that obviously created that downstream effect and impacted our gross margins. And also during that time, commodities, as you all know, really spiked. And so urea, for example, which is a big input in our fertilizer products, it got extremely high on a per ton basis. This past year, it was in the 300s. It's sitting in the low 400s today. And that's usually the range that we operate historically. So commodities got very high, and we had to work through a lot of that higher-priced inventory. Generally, it takes us anywhere from 6 to 9 months to work through inventory from purchase to ultimately production and sale to customers. And so that all took time. As we got through '24, we saw some improvements, but '25 was the biggest improvement as we work through the lower cost of inventory. And we got through a lot of the, what I'll call, reducing of the warehouse footprint and some of the capacity issues. As we stand today and we look out to the future, we have plenty of capacity in our supply chain network. And as I think of our path to 35% gross margin or higher, we're sitting at 31% at the end of '25, and we've guided to 32%. I would say the 2 biggest drivers, and I do see upside, I do feel like we can achieve higher than that. But as we navigate that, some areas that -- on the growth to 35% include -- we talked a little bit about pricing. So taking pricing of 1% annually is a part of that growth algorithm of our gross margin rate. Cost savings is another. So we have in our DNA, both pre-COVID and also during the recent cost -- Project Springboard and other cost savings activities. We have a pattern within our supply chain team of just finding different ways to reduce costs, and it can come through just renegotiating prices. Another area, and you'll see it tangibly in our cash flow statement is our CapEx spend. Our CapEx spend is around $100 million this past year. It will get closer to $130 million. It's automation, it's robotics. It's a whole host of things. We're replacing packaging equipment that's 15 years, 20 years old, you're automating and improving your efficiency across your whole factory network. So there's a whole host of things there that allow us to feel confident that we can deliver at least 1% of cost savings annually. So those 2 things will help us mitigate any commodities or tariff costs as we navigate upwards to the 35% rate. The other areas are going to be innovation, incremental tuck-in M&A. And so there's a whole host of those items that we are -- we continue to work on and that we're focused on to hopefully deliver not just 35%, but in the long term, get higher than that. We see where what I'll call our best-in-class consumer products companies are at, and we're striving to attain those. And that's why a lot of these investments in the business that we talk about are super important to help us get up there.

Yes. There's not much to add other than Mark talked about the automation side, and that's most applicable, obviously, to our plants and factories and supply network. And as you said, the CapEx will reflect it. But look, we're sitting in an unprecedented era of just speed of development of technology, AI in particular. And so part of the CapEx spend, we're on a 25-year-old instance of SAP. We've talked publicly over the next 2 years, we're going to transition. It's really not about a new ERP system. It's about making sure that we manage our data in a way that we can use these tools. And I think if you look to the future, whether it's on sort of the back-office stuff, our internal analysts and so on and so forth, we will 100% be able to -- in the future, you'll have an AI agent that you can ask an intelligent prompt to about looking at a slice of P&L and get that data right away. Today, it's like, well, the analyst needs 2 weeks because they're already overburdened. And then I think we're going to see real opportunity on the consumer side where we lean in from a targeted media and creative standpoint, and we're looking at GEO optimization. We're already seeing how we show up in the models. I know there's margin to be gained there by just that targeting. And that's -- none of that's built into our near-term financial model. But it's -- when he and I talk internally about we definitely think we can get higher than 35%, it's a lot of those things. And we're -- we don't have the exact road map yet, but it's coming together pretty quickly.

Well, great. I think we're just about out of time. So Nate, Mark, thank you guys. Thank you, everybody, for joining us, and enjoy the rest of the conference.

Appreciate it. Thank you.