The Scotts Miracle-Gro Company (NYSE:SMG) Q1 2023 Earnings Call Transcript

The Scotts Miracle-Gro Company (NYSE:SMG) Q1 2023 Earnings Call Transcript February 1, 2023

Operator: Good day and thank you for standing by. Welcome to The Scotts Miracle-Gro First Quarter Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advise that today’s conference is being recorded. I would now like to hand the call over to Aimee DeLuca, Senior Vice President, Investor Relations. Please go ahead.

Aimee DeLuca: Thank you and good morning. I am Aimee DeLuca and I would like to welcome you to The Scotts Miracle-Gro first quarter earnings conference call. I have recently stepped in to lead Investor Relations after 21 years at Scotts and other finance and strategy roles. It’s been a pleasure meeting many of you already and I look forward to meeting many more of you over the coming months. Joining me this morning are our Chairman and CEO, Jim Hagedorn; our new CFO, Matt Garth; as well as Mike Lukemire, our President and Chief Operating Officer; and Chris Hagedorn, Division President of Hawthorne. In a moment, we will share some brief prepared remarks from Jim and Matt. Afterwards, we will open the call for your questions. I see that we already have quite a few people in the queue.

In the interest of time, please stick to one question and one follow-up. Matt and I have additional time with many of you today to fill in some of the gaps and I invite anyone else who would like to set up some follow-up time to reach out to me directly. With that, let’s move on to today’s call. As always, we will be making some forward-looking statements, so I want to caution everyone that our actual results could differ materially from what we shared this morning. Investors should familiarize themselves with the full range of risk factors that could impact our results. Those can be found in our Form 10-K, which is filed with the Securities and Exchange Commission. Please be aware that today’s call is being recorded. An archived version of the call will be available on our Investor Relations site at scottsmiraclegro.com.

With that, let’s get started and I will turn things over to Jim Hagedorn.

Jim Hagedorn: Thanks, Aimee. Good morning, everyone. I talked in our last call about the challenges of fiscal 2022, and the hard choices and aggressive actions we took to return the company to acceptable levels of profitability. I stated that our leadership team was on it and that we had full confidence in our ability to right-size the business and drive value for our shareholders. This brings me to today. For Q1, we exceeded our total net sales goal on the strength of the U.S. consumer business and the scrappiness of Hawthorne to find opportunities within a struggling cannabis market. Record consumer shipments to retailers resulted in strong load-in, an indicator of confidence in the consumer this lawn and garden season. I will sum up Q1 this way.

There is light ahead. We are moving in the right direction. We have more work to do. And once again, we are on it. Our Q1 results reflect the transformation within Scotts Miracle-Gro. We are operating as a very different company than a year ago. We have reoriented our business. We are leaner but more focused on driving the greatest value. We have strengthened our financial position. We are demonstrating discipline. Most importantly, our entire company across all functions is performing to the highest levels. Let me provide context. For Q1, we are working against tough comps in the U.S. consumer segment, where in 2022 we posted a profitable first quarter for only the second time in our history. Consumer engagement remained high ahead of a year that ultimately was impacted by retailer shipments not keeping pace with demand.

What our current Q1 numbers do not show is the exceptional performance of our Scotts Miracle-Gro associates in a much more challenging environment. They never blinked and they have approached 2023 with grit and a winning attitude. They are making our operating plan a reality. Here’s a snapshot of what our hard work accomplished against our internal targets. Net sales that beat the plan by nearly $25 million, gross margin improvement of almost 300 basis points against our plan, EBITDA of $21 million against an internal forecast of zero, net leverage of 5.9 times debt-to-EBITDA comfortably within the covenant maximum of 6.25. We are ahead of schedule and overachieving on Project Springboard, tracking to exceed the original cost savings guidance for the year.

We are guiding to mid single-digit decline in SG&A versus fiscal 2019. Overall, I am pleased, but it’s too early to declare outright victory. As I said, there’s still more work to do. We are reaffirming our outlook for the U.S. consumer business and how we see it performing for the full year. There has been a massive company-wide effort in Q1 to make the lawn and garden season a success. Hawthorne continues to operate in a tough market. We are committed to increasing its return level, bringing it to profitability by year end. This is less about sales, although, the team is working hard on this front, and more about unwinding the overbuild supply chain and excess inventory. So far, we have achieved a 40% reduction in warehousing costs, and reduced SG&A and inventory by a third.

Additional optimization and operating efficiencies are in the works. I want to provide more color around our core business as there are two dimensions to it. First, building momentum and making sure retailers are fully loaded and all in with us. We accomplished this in Q1. Second, motivating and energizing the consumer to visit stores browse and shop online and to load up with our products. This is our focus in Q2 and Q3. We will attack both quarters with the same result as we did in Q1. Early engagement is critical. As we know consumers who make their first lawn and garden purchases before May, spend twice as much in the category. I told you last quarter that despite our cost reductions, we would not stop making high value investments to enable growth.

This year, we are increasing investments in marketing and promotions, doubling our lawn spend over last year. Overall, our total working media spend is nearly 25% higher than in fiscal 2022 and it will be more efficient and targeted. Total media spend this year will be even higher than the pre-pandemic year of 2019. As you know, the early season has already started in the South. Omni-channel campaigns, radio, television and digital activation are already underway. We are seeing positive POS growth in the South where in the past two weeks, Bonus S is up 68% in Florida and 54% in Texas. We are also seeing strength in grass seed during the same period with plus 24% in Florida and plus 65% in Texas. In March, we will launch a National Early Season Lawns Campaign.

Miracle-Gro is partnering with Roku and Martha Stewart to support her new show, Martha Gardens. And this month, we will begin the largest product launch in Roundup’s history with the introduction of a new dual action non-glyphosate formula. These are just a few examples of what’s coming. Our investments are being coordinated with retailers, who are increasing their spend on joint media promotions and in-store activations. Lawn and garden is the leading driver of foot traffic early in the year and our combined efforts can have a 3 times to 5 times multiplier on POS. I stand behind our operating plan. In a few moments, Matt Garth, who became our CFO on December 1st, will elaborate on the Q1 numbers and our fiscal 2023 outlook. First, I want to revisit our long-term strategy.

Although we are managing our business quarter-to-quarter, we are starting to do so with a view toward growth. In fiscal 2021, we unveiled a five-pillar growth strategy. I am reaffirming the strategy. Three of the five pillars relate to the consumer business and the others to Hawthorne. On the consumer side, the lawn and garden pillar is a mature, steady generator of cash. The bulk of the new gardeners who entered our category during the pandemic are still with us. We see sustainable growth with our brands and continue to engage consumers through marketing, innovation and packaging, formulations and products. This includes drought tolerant solutions to create living landscapes that work in concert with the environment. The second pillar is direct-to-consumer, a component of category growth that includes our e-commerce and retailer.com sites.

A strong online presence enhances brick-and-mortar POS, direct-to-consumer platforms are used to learn and shop for products. The lawn and garden omni-channel shopper, one who shops online and in store, spend 2 times as much in our category than an in-store-only shopper. With this in mind, we have improved our online product content and visibility, and last month, we migrated to a new e-commerce platform for improved efficiency and enhanced marketing and personalization tools across 10 brand sites. The third pillar live goods is a natural gateway for consumers in their lawn and garden journey. Consumer purchases and vegetables and herbs have remained steady over the past two years and almost 60% of edible gardeners intend to plant more over the next two years.

We are strong believers in growth opportunities through Bonnie Plants where we will execute with enhanced precision at growing stations and retail stores, as well as invest in innovation to inspire more consumers to grow their own. I will now shift to Hawthorne, where our strategy is two-fold. Number one, we will retain Hawthorne’s competitive advantage in the cannabis non-plant touching space and professional horticulture. We are the leading solution provider for growers, which differentiates us from those who are primarily distributors. Number two, through our investment in RIV Capital, we will position ourselves to become a key player in the consumer and retail cannabis space in New York, projected to be the second largest cannabis consuming state behind California.

Digging deeper into Hawthorne, I have explained how we integrated back office functions and are optimizing our network. We are windowing our focus. Just as importantly, we are innovating. Our scientists in Kelowna, British Columbia, the first R&D facility in North America devoted the cannabis research are running trials on lighting, nutrients, genetics and other technologies to improve yields, quality and energy efficiency. Similar work is underway on hemp in Oregon, Florida and Ohio where we opened a controlled environment facility to supplement our greenhouses. R&D’s work led to the launch of the market’s most advanced and efficient LED ever, the Gavita 2400e. We have continued to innovate with the WEGA LED lighting portfolio for indoor growers of vegetables, fruits and flowers.

WEGA is expected to surpass last year’s unit sales in Europe and North America and is now one-sixth of Hawthorne’s business. We capitalized on the trend toward indoor agriculture, an industry but by some accounts is about $40 billion annually in the U.S. with a projected annual growth rate of 13.5% through 2030. Additionally, by modifying the light spectrum for the WEGA, we can make it an excellent no-frills LED option for cannabis growers. One final point on the cannabis industry, when it does recover and it will, growers will be ready to invest in CapEx. We will be there to support the turnaround. Consolidation is happening in the industry and we see opportunities for high-value no-cash partnerships to further strengthen Hawthorne’s ability to provide value-added and innovative solutions to growers.

I will shift to the consumer side of cannabis through our convertible loan to RIV, an integrated cultivator and retail in New York that owns the Etain cannabis brand. RIV holds one of 10 vertically integrated licenses that includes a growing and processing operation and four dispensaries, is developing a state-of-the-art indoor growing facility in Buffalo. From a regulatory perspective, New York has tripped over itself in developing and implementing rules, which has prevented the market from reaching its near-term potential. But let me make this clear, New York will become a monster market and we will see it through. There is progress in value in our investment with RIV. To summarize, we have adjusted the speed, which we are moving forward in our strategic pillars.

We have shifted from an accelerated pace to a prudent but steady investment approach that strengthens our ability to grow and drive shareholder value. When we are able, we will shift back to a more aggressive shareholder-friendly bias. We remain focused on cost control, EBITDA and free cash flow. When we spoke last quarter, we committed to $185 million of annualized savings across the two phases of Project Springboard by fiscal 2024. We will achieve the full $185 million in savings by fiscal 2023 and now have line of sight to additional savings in excess of that commitment. Reflecting on the year, times like these illuminate the resiliency and strength of our business, and the determination of our associates. We have exceptional leadership and talent.

We are bringing rigor to our financial processes, forecasting and capital allocation at an important time in our transformation. It’s been a real pleasure to work with the leadership team and the Board of Directors, which has been a great partner to me and the executive team. I also want to thank our retail partners and banks. Their support and commitment has been invaluable and will contribute to our mutual success. Thank you. I will close with this. Consumers have emotional connections to their lawns and gardens, which is reflected in our vision statement. We help people of all ages express themselves on their own piece of the earth. This comes to life in our leading brands, innovation and products to meet diverse needs. Through good times, pandemics and recessions, people consistently turn to us to enhance their lives.

I have often said there’s no better business to be in and this is true today as ever. Thank you. Now I will turn this call over to Matt.

Matt Garth: Thank you, Jim, and hello, everyone. I would like to begin by noting my excitement with being a part of The Scotts Miracle-Gro family. I have long been a consumer of the company’s products and have firsthand knowledge in achieving a great lawn, applying Turf Builder 4 times a year and creating a productive garden using Miracle-Gro soil and plant food. I have been warmly welcome to the company and was transitioned expertly by Dave Evans as he wound down his interim CFO role. Since joining, I have immersed myself in operations, marketing, sales, human resources, and of course, the finance practice. To summarize my experience so far, we have an outstanding team that every day reinforces the open, transparent and accountable culture created by Jim and his team.

As this quarter proves, the collective effort to improve the company’s financial strength through Project Springboard is delivering. The discipline focused on improvements and savings will continue, while we also invest in our future and innovation to extend our leading positions and create significant long-term value. Now let me turn to the first quarter performance. Record December shipments in our U.S. consumer business delivered Q1 segment sales, 8% higher year-over-year and combined with the robust savings from Project Springboard that Jim referenced, more than offset early softness in Hawthorne. We now expect to achieve the $185 million of annualized Springboard savings by the end of the fiscal year, well ahead of our prior commitment.

Springboard actions and the continued urgency of our team will create additional upside as we move into 2024, with potential savings above $185 million that we can direct towards innovation, consumer activation and growth. Net leverage at the end of the quarter was 5.9 times adjusted EBITDA, comfortably within our covenant maximum of 6.25 times. Let me move on to the P&L beginning with sales. Net sales on a company-wide basis were down 7% versus Q1 last year. Sales growth in U.S. consumer reflected the strong partnership with our retailers for the early season build-out. The sales and supply chain teams were outstanding in their execution and coordination in delivering on customer expectations, including getting some Q2 volumes out in Q1. For the first half, we still expect the load-in to be aligned with our original plan and slightly higher than the first half of last year.

First quarter POS at our four largest customers was in line with our expectations, ending down 19% in units and 8% in dollars. The POS unit declines are consistent across our key customers and categories. As we discussed last quarter, we still expect full year POS units in fertilizers and grass seed to grow by 10% and unit volume and other product categories to remain essentially flat versus fiscal 2022. Early season performance in our Southern markets indicates that we are tracking well against our expectations. We call that Q1 represents less than 15% of the full year and our focus is appropriately shifting to our peak season in Q2 and Q3. As we entered the year with retailer inventory units slightly down versus prior year, a strong Q1 load-in and the expected decline in POS have brought retailer units slightly higher.

Replenishment orders in the second half will be driven by consumer takeaway and the inventory management actions by retailers. Our plans align with our retail partners year-end target inventory positions and we are monitoring the consumer condition to ensure we act quickly to align production with any changes in demand levels. Turning to Hawthorne. Continued industry-wide challenges yielded a 31% topline decline year-over-year. This result was driven by lower retail and professional grower activity stemming from oversupply, and general uncertainty on when the market will become more balanced. Our original guidance estimated Hawthorne sales would be flat to down low-single digits for the full year. Given the soft start for the business and the state of the industry as a whole, we now expect Hawthorne sales to decline 20% to 25% year-over-year.

There are many reasons to be excited about the future of Hawthorne. We are taking the appropriate prudent actions to achieve run rate profitability by the end of the year, while also strengthening our position for the future. For the full company, we previously guided to low single-digit sales growth for the full year. We now expect that a low single-digit sales decline in fiscal year 2023 is a more reasonable expectation given the market challenges Hawthorne is facing. Gross margin for the quarter was 20%, down 90 basis points versus last year. Strong U.S. consumer volume and pricing, better segment mix and sooner than expected progress against our Springboard targets largely offset lower Hawthorne sales and higher conversion and commodity costs.

We continue to expect that gross margin will decline slightly in fiscal 2023 as the impact of lower Hawthorne volume will be offset by Springboard savings. As explained on the last quarterly call, commodities are now about one-third of our total cost of goods sold due to historic inflation levels. At this point, we are about 65% locked on our total commodity costs and north of 70% locked on total COGS, so we have a fairly good visibility for the rest of the fiscal year. We are seeing some bright spots in international freight rates, resins and pallets, while our larger inputs like diesel and urea continued to move with underlying energy related commodities. The team has executed well in working with our customers to manage inflationary costs and delivering pricing to largely cover our dollar exposure.

Our progress on Project Springboard is most evident on the SG&A line, which is down $26 million or 17% versus last year. We guided for full year SG&A to be below fiscal 2019 levels, and given our first quarter results, we now expect a mid single-digit decline from fiscal 2019. Moving further down the P&L, interest expense is up mainly due to increased borrowings and higher interest rates, call that we guided to additional interest expense of up to $40 million in 2023. Given the move in SOFR and our spread at current leverage levels, we now expect incremental interest expense to be closer to $60 million for the fiscal year. The adjusted effective tax rate in the quarter was 25.5% and we anticipate the full year ETR will be between 26% and 27%.

I will also note here that we anticipate fully diluted shares will increase by approximately 0.5 million shares through the end of the fiscal year. That brings us to the bottomline where our net loss for the quarter on a GAAP basis was $65 million or $1.17 per share compared with a loss of $50 million or $0.90 per share last year. On an adjusted basis, which excludes impairment, restructuring and other non-recurring items, we reported a loss of $56 million or $1.02 per share, compared with a loss of $49 million or $0.88 per share a year ago. On a total company basis, the overall year-over-year decline was completely driven by non-operating factors, mainly higher interest and tax expense. In fact, adjusted EBITDA improved to $21 million this year versus a loss of $1 million last year.

Adjustments to arrive at non-GAAP adjusted EBITDA from our net GAAP operating loss in the quarter are detailed in the press release financials and include $19 million related to our ongoing restructuring efforts, including Hawthorne, integration costs and other projects Springboard initiatives. We are modifying our full year adjusted EBITDA guidance given lower than expected depreciation expense, mainly due to the timing of capital expenditures and Hawthorne impairments. We now expect the full year increase in adjustments to be less than $20 million, resulting in low single-digit growth in full year adjusted EBITDA. Now let me turn to an update on our capital allocation approach. We face no near-term refinancing risk and ended the quarter with over $800 million in undrawn revolver capacity.

We expect to manage the seasonal working capital build through this year and stay within our financial covenants. We will direct our free cash flow to debt pay down, targeting a net leverage ratio below 4 by the end of fiscal year 2024. We are deploying CapEx of $100 million in 2023 funding maintenance requirements and high return, short payback projects. Our outlook also includes continued support for our quarterly dividend. In sum, we will maintain tight capital discipline and drive leverage down, while ensuring we fund the innovation and capability to deliver long-term growth at SMG. Please keep in mind the guidance that I have provided is not without risk. We are diligently managing what is within our control. Performance in the back half of our fiscal year is largely driven by consumer engagement.

We have an aggressive and creative plan that is in lockstep with our customers to activate the consumer early and throughout the season. I also shared Jim’s excitement about the long-term prospects for Hawthorne and the potential for growth and value creation in the business. And let me close by putting the first quarter into proper context. Q1 is typically less than 15% of our full year. The peak of our year is fast approaching and I have confidence in the plans we have put in place and the ability of Mike Lukemire and his team to execute. With that, I will conclude and return the call to the Operator so we can take your questions. Thank you.

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Q&A Session

Operator: Thank you. Our first question comes from Jon Andersen with William Blair. Your line is open.

Jon Andersen: Hi. Good morning, everybody. Thanks for the question.

Jim Hagedorn: Hey.

Jon Andersen: I wanted to ask first on the U.S. consumer business. There are two parts. One, can you talk a little bit more about any early season reads that might kind of enhance your confidence in, I guess, particularly the lawns business and the recovery that you anticipate in the lawns business in 2023? And the second part is, I’d love to hear a little bit more about the marketing plans. You are talking a lot about kind of leaning in and activating consumers early in the season across the country and how important that is. Have you taken that approach in the past, has it been successful, what are some of the details around that? Thank you.

Jim Hagedorn: Okay, John. Hagedorn here. I have been — I tell people I am not going to like to try to answer all the questions, but this is a good one. The — first, let’s start with the budget we put in, and I think, it — people can say, well, you are sandbagging or whatever. We think we are pretty conservative by putting basically flat, and remember, lawns was down 20% last year. And our view is almost entirely on weather. California, Texas, Northeast, Midwest, which I don’t need to go through that again, it sucked . The — so we are plus 10 with lawns, zero for everything else. So we don’t think we have a particularly challenging number, because I think, many of us who have been in the industry a long time said, it was just a very challenging weather year for us and I think the same is true in agriculture. So anybody who’s following, I think, knows that we speak the truth here. The early season numbers on lawn actually look pretty good. I don’t know, Mike?

Mike Lukemire: Yeah. No. I mean, the last two weeks are up 57%, 64% and where we apply promotion. It is really — it’s moving.

Jim Hagedorn: So we need lawns to — I mean, we do need lawns to work. In addition, I think, Bonnie is seeing similar kind of like very positive numbers, early season. So I think the early season — it’s conservative numbers and I think this early part of the season look pretty good so far. So I’d say that, Patti, you want to talk about — like Patti runs the brands.

Patti Ziegler: Good morning.

Jim Hagedorn: You want to — no. You can’t.

Patti Ziegler: Okay. The team, the SBU leaders and the marketing partners, we are really excited about the season and we are, particularly, pleased with our early season activity, which we have already seen in the South, working well with our bonus product offering and we have a program in partnership with the retailers. We are launching in the very early season to reflect Jim’s comments earlier about how we know that early season consumer pays — spends more in the category. And the program is named the Lawn Savings , and we are doing that in partnership with our retailers and getting out even ahead of their Black Friday promotions. So we will continue to support this consumer, get them in the category early and we are excited about the potential of the program and what it’s going to do to stimulate it.

Jim Hagedorn: And the spend is real high.

Matt Garth: Yes. Very high.