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

All right. Good morning, everybody. Thank you for joining us. I'm Joe Altobello, Leisure Equity Research Analyst here at Raymond James, and I'm very pleased to be joined today by members of Scotts Miracle-Gro management, including CFO, Mark Scheiwer; and Vice President of Treasury, Tax and Investor Relations, Brad Chelton. Welcome, gentlemen. Scotts is the unquestioned leader in the U.S. consumer lawn and garden industry with a portfolio of brands that include obviously, Scotts and Miracle-Gro across fertilizer, grass seed, plant food and mulch as well as Ortho and Roundup weed and insect control products. Mark has a few slides you'd like to go through in order to provide a more expanded view or overview of the company, after which we'll move to a fireside chat format. So with that, let me hand things over to Mark.

Thank you, Joe, and I appreciate everyone coming. A little bit of bio by myself. I've been at the company for 15 years. It's about half the time we've been on the New York Stock Exchange. We have a long rich history at Scotts Miracle-Gro. As I said, 30 years on the stock exchange, but it actually started 150 years ago back in Marysville, Ohio with O.M. Scott, who started to sell grass seed and fertilizer out of a little store in Marysville, which today we still operate. That's the Scotts side of the house. So Scotts Fertilizer, Scotts Grass seed and then in the '50s, Horace Hagedorn, Jim, who's our -- Jim Hagedorn, our CEO, his father founded and built Miracle-Gro side of the house, which is plant food and soil. So very long rich history. We then merged as a company in the mid-'90s on the New York Stock Exchange to form Scotts Miracle-Gro. Also during that time, we had subsequent acquisitions. of the Ortho brand and Tomcat. We also do insect and weed control products that I'll touch upon as part of my talking points. If you're new to the story or if you're getting reacquainted, thank you, first of all. We think we have a compelling and exciting story for you that is really refocusing the company on the Scotts Miracle-Gro brand that folks know and love so much. So I have three takeaways for you. We don't -- if you don't listen to anything other than these three takeaways, I think mission accomplished on my side. First, Joe said it, we are the leader in North American consumer lawn and garden. We have powerful brands that are very recognizable with across the country, across every part of the region and that really create a super power for us and give us quite a connection with the consumer that we do not take lightly. Every year, we need to be innovating our products, getting into more naturals and organics and it matters to us our connection. The other area is our superpowers, we call them. We have competitive advantages that we believe in this space that give us a much stronger presence and ability to compete in the marketplace with consumers. It starts with our supply chain team, starts with our field sales team, and Brad will touch upon some of those superpowers a little bit further as we get into the presentation. And the other part of it is we're on an exciting part of our financial journey. Post-COVID, we got over-levered. Our gross margins declined, but we're on an upward growth trajectory. We see our gross margins in the near term getting into the mid-30s, and they can go higher. We feel like our sales growth can get back to, call it, 3% on an annualized basis consistently and potentially exceed it if we deliver on our initiatives, whether it be e-commerce, innovation and then also increasing household penetration and frequency. The other area of our financial growth strategy is our delevering. We're at 4.0 3x this past quarter. We're on our way down to the high 3s. And our target is by fiscal '27 to be in the mid-3s -- below 3.5x leverage. We plan to operate in, call it, the 3 to 3.5x with a very balanced capital allocation strategy thereafter. We think that's a pretty compelling story. I did mention the margins, both gross margins and operating margins. We do expect those to climb. Our midterm goal for gross margin is mid-30s. And again, we think longer term, we can take that higher. On the operating margin front, we're in the low teens today, and we expect to climb that above the mid-teens and into the high teens over the next several years. And again, it's all built on some of our superpowers, which I'll get into. All right. So we have three business lines: Lawns, Gardens and Controls. The Scott side of the house that's in our name is focused on the Lawns business, fertilizer, grass seed and spreaders. Very strong market share. It says #1 up there, very dominant position that we have in the space. There is a lot more green shoots in this area. We think there are opportunities that we can continue to grow this is through increased household penetration and frequency and the newer consumer. The newer consumers, we know want natural products that are safe for their kids and pets. And I will tell you, we haven't always been the best stewards of that messaging. We have outstanding products that deliver some of those outcomes, but we need to get it out to the forefront. Not mentioned on this page, but a year ago, we launched a digital brand called [ OM Scott ]. It's a small brand, call it $5 million of sales last year. It's a natural lawn and grass seed product. We built demand for it online and through Amazon, one of our customers. And now it's getting further distribution across the country. That's an example of building -- through building our product to the consumer needs. The other area is safe for kids and pets. And you'll start to see this in our packaging on our lawn products. We will put more emphasis on safety for kids and pets. Our product, the green bag you see up there is very much safe to be utilized. It's just a fertilizer. And so we can get much more targeted in how we go to market with our consumers in our advertising. Another area that we're competing is on the liquid lawn fertilizer side as well. Folks want different ways to use lawn fertilizer other than just through spreaders, and we can provide those applications. We've got a really strong R&D team that is really good at providing the best applications of use of consumer products. And so we're rolling out some additional liquid products. On the Miracle-Gro side, Gardens, that's another large pillar of our business. It's plant food and garden soils. We are the leaders far and away in this area. We are the national -- we have a national distribution network of 40-plus growing media sites that we can produce and package garden soils. That is -- from a supply chain network perspective is second to none, and it gives us really strong presence. A kind of an interesting campaign we launched 2 years ago on the naturals and organic side is in partnership with Martha Stewart, who's our Chief Gardening Officer, is the organic -- Miracle-Gro organics line. It has done outstanding, well north of $100 million of annual sales, and it's a pink bag you'll see in the stores and online. And then there's other products that go around that Miracle-Gro organics line. Again, tailoring it to the newer consumers that want some of these different products than maybe we've sold in the past. The other area in Q1, we announced it, we mentioned it's done pretty well is our indoor gardening product lines. There are a lot of urban dwellers. Folks love even if you own a home like myself, I got a ton of indoor plants. People love the indoor garden. And we have a whole host of things we can provide for that consumer. And we've rolled out a ton of new products in this area. It's helped with our point-of-sale takeaway in the first quarter. I believe we were up 7% in the first quarter around this category. And that is an area where we're putting more advertising to work as well because it's a year-round business. That's the cool thing about indoor gardening. It's year-round. And so that can help with some of our cyclicality. So there's a lot happening there, a lot of great things that we think will give us a really great growth trajectory. Controls, it's the third business line of ours. It's the Ortho and Tomcat, the brands that we own. We also are a distributor and marketer of consumer Roundup as well. But Ortho takes care of all your insect and weed problems. And then for Tomcat, that was an acquisition, we did a little tuck-in acquisition in 2014. It's a rod and control product. We -- at the time we bought it, it was, call it, the second or third most widely known and sold consumer, rodent control products. It's now #1 in most markets. So it's -- we've been able to grow it -- just grow those sales immensely through our superpowers. Both of these business lines are set up for success in the future. Ortho this year is coming out with a lot of innovation. Probably about -- I would say about approximately 1% of our sales this year, we're shooting for to be innovation type SKUs of growth -- sales growth. And it's going to be -- a lot of it is going to be in the Ortho side of the house. We're coming out with new ant-specific products, mosquito-specific products and flying insect specific products. The cool thing about this innovation as the CFO, we start digitally. We start is the minute that innovation is ready to be sold in market, we'll start it and get it online first, start to build the groundswell of demand from the consumer and then it leads to ultimately then nationwide distribution with our customers as we head into the spring garden season. So a lot of cool newer form factors and innovation happening in Ortho, and we think we can replicate it further. The market share in the insect and weed spaces, while we're still one of the top, call it, 1 or 2 brands, we have opportunities to grow market share. That innovation I just told you about, we have 0% market share today in categories like ant, mosquito. So whatever we grow from here on out, it would be incremental to what we do as an organization. We think we have three outstanding business lines that give us an opportunity to grow sales, call it, that midterm, call it, 3% type CAGR. Longer term, we think it will build itself and allow us to grow even further than that. So now I'll turn it over to Brad, who will talk a little more about our superpowers.

Mark, thanks. So to touch on one of the key superpowers, our integrated supply chain. And I'd highlight a few things for you. One of it is just the unique capability we have from a network perspective to service our customers. So I think I'd call out for you, Mark talked about our gardens business. The growing media facilities we have over 40 across North America, they're uniquely positioned, particularly in the peak of the lawn and garden season to fulfill the customer as their consumer takeaway ramps up. So that is one of our unique capabilities just from a service perspective and where we are geographically located. Also, we've talked a lot publicly about, especially last year as tariff news became part of the headlines, but nearly all of our cost of goods sold are domestically manufactured. So our tariff exposure is minimal. There's a slight headwind that's embedded in our gross margin guidance here in fiscal '26, but very manageable and puts us in a good spot of not having to deal with those headwinds that many of our other consumer packaged goods companies have dealt with. And then the last thing I'd talk about is just from a supply chain perspective is the gross margin improvement is a big part of our company's journey from a financial perspective the last couple of years and will continue to be for a while. Supply chain delivers a big piece of that. We have a long history of generating savings of about 1% of sales historically. Last year, that those savings were outsized. We almost got to about $100 million of savings through our supply chain efforts. This year, our assumption is return to that 1 point of sales savings. And you'll see that really the example I would give you is from a CapEx perspective, we're investing in the business, modernizing our supply chain capabilities, reducing labor costs. And the CapEx, if you go back a number of years, in the range of $50 million to $60 million annually is what we spent. We sweat our assets really hard. We've really -- we stepped up that CapEx. It was $100 million last year, and then we see this year and then the long term to be in the $100 million to $130 million. And that's really -- you see that ultimately come through from a margin rate perspective in the savings from supply chain. If you go to the customer base, our relationships are very strong. I think our public commentary over the years has really been focused on brick-and-mortar and our big three Home Depot, Lowe's, Walmart. That has evolved over the last few years and will continue to evolve in the future. It's really an omnichannel effort now meeting the consumers where they are. And so what does that mean? Obviously, the e-commerce, I'll talk about that more in a minute, has become a bigger part of the journey. You see Amazon on here that's become a much bigger player in lawn and garden. And then other customers like Tractor Supply, Costco, who are also still adding stores as well. So part of our growth journey is evolving with our customer base evolving. And you'll see in our first quarter results in our Investor Relations materials, we started to share POS for our top 15 customers, which really represents over 80% of our total POS. And we'll keep sharing that. We think that's a better indicator of the sales growth of the company. And then I mentioned e-commerce, the journey here. This grown immensely, I go back 6 years, the consumer takeaway or POS, only 2% of it was from e-com 6 years ago. This past year was 10%, we see this year pushing towards 15%. And this will continue into the future again, meeting the consumers where they are. As we look at e-com just for point of clarity, obviously Amazon is a part of this. But so is our, what we called, retailer.com. So a lot of our big brick and mortar customer like Home Depot, Lowe's, Walmart have invested heavily in increasing their e-commerce business. So that's in here as well. So really the makeup of this Amazon.com, retailer.com. There is a slight piece that we do to fulfill our own website so there's D2C commerce we do as well, but it's a small piece of it going through the backs of Amazon and our key retailers. And I'll just wrap up with guidance. The guidance for this year, we -- this is what we shared back in our Q4 '25 call in November. It's -- since then, we have moved our Hawthorne segment to discontinued operations. You saw that in our Q1 results. A couple of weeks ago, we published the recasted financial results of our company going back to fiscal '24, fiscal '25, excluding Hawthorne. All that's to say the guidance that we shared back in November, it's unchanged. So Hawthorne is just such a small part of the company's profitability. And so this remains the same. We're bullish on it. As we get further into the year, we'll revisit this, but just wanted to wrap up here with reiterating our guidance for '26. Joe, I'll turn it over to you.

Thank you, Brad. Thank you, Mark. I appreciate that. I wanted to start on e-commerce. I want to talk about some of the growth drivers you guys laid out in the near term, one of which obviously is e-commerce penetration. It's been growing pretty significantly lately. Last I checked the Internet has been around for a while. So what's changed about your strategy that's helped you to increase that penetration of late?

Having been at the company for 15 years, to me, it's a lot of it is just internal focus as the leader in lawn and garden, you saw the numbers where it was 2% not too long ago. When we stick to an initiative and focus on it, we can really push the category in different ways to raise up an initiative. And at the end of the day, I think a couple of dynamics. Brick-and-mortar obviously has seen their store count start to level off. I think there are a few brick-and-mortar retailers like Tractor Supply and Costco who continue to add store count. And we are growing with those folks from a brick-and-mortar perspective. But from just a pure investment decision dollar perspective, when we look to spend consumer activation dollars or advertising, it's not just about getting foot traffic into a store, especially when the store counts have kind of leveled off. It's about online. And that has become ever more in focus really the past few years. We built a supply chain network that can handle incremental sales volume in this space at a reasonable cost to support our partners that we interact with on e-commerce. And that was done, call it, in fiscal '20 and '21 when we had really outsized sales growth. We were able to invest a little bit in our business at that point. The other areas, I'll just go back on e-commerce. You have to have the right form factors. So product innovation, product differentiation matters, and we are continually working on that in our product lineup. Hence, why you start to see that rate start to go up even more. I think longer term, could it be 30%? I guess it could be of the overall point-of-sale takeaway, but it's going to be through the growth through our partners.

And which products are most prevalent in that channel?

In that channel, it's pretty equally distributed, to be honest with you. I would say each of those business lines I've spoken about do pretty well online. I'll give you a personal example. One of the brick-and-mortar retailers, I purchased about 50 bags of soil on their website, same-day delivery for a $75 delivery fee. You're no longer constrained by the trunk of your car for some of these retailers. So that is a big bag format that is being delivered to your house. It's not the small stuff. Amazon and other retailers are starting to figure out that big bag format. And I had a, like I said, a pallet delivered to my house of product from a retailer. So I think across all those channels, it's definitely present. I would tell you our market share probably in certain of those categories on e-commerce, probably lean, if I was to think of gardens and lawns, we do pretty well. Controls, there's a little bit of an endless aisle in that area where you just have a lot of competition. And so on e-commerce, it gets to be a challenge. But we have great partners, great programs, and we think we can continue to push it.

We have a question from the audience.

The question was, are we limited by chemical laws? In the example of like an Amazon. I would tell you that our products are able to be sold in all 50 states. So that's what we're focused on. And when we put out product information online and what we've been doing in some of our machine learning because we've been trying to develop our own. If you go to our website and play around with it, when you put in a question to it, can I get a product? Can I -- what -- this is my problem or this is the product, you want the right answer. You want to be able to say, okay, in the state of New Jersey, for example, can I use this product? And it needs you to know your location and all that. So we -- in our mind, we want to be the experts from -- of all that to know that, hey, when Scotts gives a recommendation, through one of its retail partners or its website, it's giving you the right legal recommendation. But we focus on 50 states. It's typically -- we try to get 50-state approval out of the gate on our products.

So you've also talked about incremental listings as a growth driver. And I'm sure it's a little bit more complicated than calling Home Depot and asking for more shelf space. And you already have a fair amount of that shelf space to begin with. So how do you convince the retailer to give you more of it?

Yes. So on shelf space, I'll break it down into a couple of different things. With the kind of the less bigger retail partners like a Tractor Supply or somebody that would not be like a Home Depot or Lowe's, there's plenty of ability there to take listing gains, from our perspective. It could mean creating different bag formats. So example, Tractor Supply, they focus on big acreage folks that own property of like 5, 10 acres or more, and they need bigger bag formats. And so the way to get listings in some cases in those areas would be to provide them a different product. On a Home Depot, somewhere like a customer like Home Depot, where we may already have strong market share, you're not going to just be able to displace at this point, just 10% of somebody's shelf space. You can, in certain instances, there are regional players, whether it be in growing media where you can take extra parts of, I'll call it, the soil walls that you walk into. But a lot of it's going to be through in-seasonal promotions. So when we -- our strategy typically is when we go in and ask for pricing, for a customer. We're not afraid to ask for some and then deal back some and try to focus on in-season promotions where you can get a deal at a store with a customer. And we partner closely with all of our big customers for their in-season promotions. And we come up with very specific plans. So if you plan to spend more money in what I'll call consumer activation or customer volume rebates and promotion dollars, the most important thing as a sales exec or finance exec when you interact with them is you've got to have specific programs tangible things you can put your teeth into that are different from the previous year and incremental. And so we always go into the season lining up for those. So I would say in your traditional brick-and-mortar in-store, where you're going to take the listing gains is probably through like an in-season promotion on some of our products. And it's going to be a lot of our higher velocity SKUs where we want to make a difference to the consumer, the products that are safe for kids and pets, the lawn fertilizer, the soil products, the soil bags, that's where we're going to kind of drive sales volume. It's an outstanding products that have high margin. And then the only other area where you typically can take some listing gains is through innovation. You have to have innovation. Even -- it doesn't have to be groundbreaking technology. It's just small little things that you're introducing into the market that can win some of the share space on the shelf.

So you're targeting about 3% sales growth on the U.S. consumer business. Your guidance as we see here is low single digits this year, so it's slightly below that. So, how do we bridge that gap between low single to, let's call it, 3%?

Yes. So for this year, the bridge would be there was some investments we chose to shift. So in connection with some of our biggest retailers, we do have, I'll call it, 10% to 15% of our business that is mulch, branded Scotts mulch and then there's some private label and commodity soils. They're lower-margin products for us. We definitely have done them over the years as a service to our retail partners. And as we continue to reevaluate our investment dollars, we felt like there was an opportunity this year to take some of the investment dollars that we spend in this area and refocus it on our branded products. So we kind of expect to go a little bit backwards in that area on some of these lower-margin products, still produce north of 10% of our portfolio in that area. But we've taken the dollars that we were investing with that -- those retail partners and putting it back into branded products, which to me is awesome because they're higher margin, we create specific programs to drive that sales growth with those customers and then it's brand building for the long term. It's going to have -- those things have long-term brand recognition that will help us, call it, 2, 3 years down the road. So absent that, we would be closer to, call it, that 3% sales growth. I do think that 3%, if you just took a step back, it's going to -- in my view, it's 1% pricing, at least 1% innovation and 1% volume growth. I didn't mention it, but on volume, we do have -- in order to just grow sales, you can't just have a hope that it increases. To me, you got to spend a little bit of money to deliver on that. And we are. And this is our third year in a row of increasing our advertising spend. We are spending more in advertising. Our SG&A rate is staying relatively flat to prior year because we're prioritizing our spend. We're finding areas where it may be less return in our SG&A and reallocating into advertising. And so if you look at our advertising line this year, it should be up again incrementally over prior year. So putting more money to work to drive sales.

We've got a couple of minutes left. One last question for you. Actually, we'll take one from the audience.

The question was how much of our delevering is tied. To our exit of Hawthorne. So the Hawthorne transaction, which we announced with Vireo Growth should close in the next few weeks based on our public comments. We expect to get a minority equity stake, not cash from it. That business, it's been written down quite a bit. The Hawthorne Gardening is the last piece of Hawthorne that we have in our P&L and our balance sheet. And with this transaction, we'll be fully exited from that business. It allows us to potentially monetize it and have optionality 3 to 5 years down the road as that industry gets legalized potentially and that the market -- stock markets get more liquid. So that [ maneuver ] will get equity. So really none of the delevering will be tied to that. It will be tied on EBITDA growth and also debt paydown in the next couple of years. We'll continue to pay down debt through normal free cash flow generation.

Unfortunately, we're just about out of time. So let's wrap it up there. Mark, Brad, thank you. Thank you, everybody, and enjoy the rest of the conference.