Scotts Miracle-Gro Company (The)

Good day, and welcome to the 2020 Q1 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jim King. Please go ahead.

Good day as well. Thank you, John. Good morning, everyone, and welcome to the Scott Sparrow First Quarter Conference Call. With me this morning in Marysville, Ohio, is our Chairman and CEO, Jim Hagedorn, and our CFO, Randy Coleman. Also present is Mike Lukemeyer, our President and Chief Operating Officer, Chris Hagedorn, the general manager of our Hawthorne Gardening subsidiary, and several other members of the management team. In a moment, Jim and Randy will share some brief prepared remarks regarding our Q1 performance as well as other matters. Afterwards, we'll open the call up to your questions. In the interest of time, we ask that you try to keep to one question and one follow-up. If you have any questions that we don't get to in the call, please call me directly at 937-578-5622, and we'll set up some time to get together as quickly as possible. Before we move on, I'd like to take care of a couple of pieces of housekeeping on the IR front. On March 2nd and 3rd, Randy and I will be attending the Raymond James 41st Annual Institutional Investors Conference at the Grand Lakes Resort in Orlando. We'll conduct one-on-one meetings on both days and conduct a webcast presentation at 2.50 p.m. on Monday the 2nd. We'll be issuing a press release closer to the event. Two weeks later, the week of March 16th, we'll hold one-on-one and small group meetings in several European markets, including London. Those meetings will be coordinated by William Blair & Company. Investors interested in meeting with us at either of these occasions should contact the respective firms directly. With that, let's move on to today's call. As always, we expect to make forward-looking statements this morning, so I want to caution that our actual results could differ materially from what we say. Investors should familiarize themselves with the full range of risk factors that could impact our results, and those are filed for their Form 10-K with the FCC. I want to remind everyone that today's call is being recorded, and an archived version of the call will be available on our website.

So let's get started, and to do so, I'll turn it over to Jim Hagel. Thanks, Jim. Good morning, everyone. If you've had a chance to review the first quarter results we announced this morning, it's evident the momentum we enjoyed in fiscal 2019 carried into the early months of fiscal 2020 as well. Not only did we see strong performance in Q1, but the early weeks of Q2. Because of strong cash flow, we've reinitiated our share repurchase activity. So, we're feeling good about the strong start to the year and have a high degree of confidence in our full year guidance. It's easy to look at the results, though, and get carried away. So, I just want to remind everyone that Q1 constitutes less than 10% of the year. While the growth rates we reported in both the U.S. consumer and Hawthorne units were well ahead of our full year guidance, it's important to remember we expect to return to more normal growth rates in the months ahead. I'll keep things brief this morning, but I want to start by focusing on Hawthorne, which grew 41% in the quarter. Obviously, the engine of Hawthorne business is the United States hydroponics and indoor growing businesses, which was up 66%. Better yet, the growth in the quarter was completely driven by organic growth. Hawthorne continued to see strong growth in nearly all product categories. Lighting sales for the entire segment grew by 27%, driven by sales in the United States, which increased more than 100%, from 2019 levels. While lighting sales declined 30% in our European professional horticulture business, that decline was baked into our full-year expectations due to the timing of some lighting installations in 2019 that we knew would not repeat this year. We still expect this business to grow on a full-year basis. On the consumable side of the business, we reported 36% growth in nutrients and a 78% increase in growing media sales. The geography of our U.S. sales is also encouraging. California was up 58%, and Colorado grew by 57%. When you move east, Michigan more than doubled, as did Illinois, Florida, New Jersey, and Alabama. On average, our top 11 markets grew by 64% in the quarter. It's worth adding that Hawthorne team also pulled off a successful launch of SAP during the quarter at what was Sunlight Supply. This is no small feat. In fact, it was probably the most complex SAP implementation we've ever undertaken. Sunlight has thousands more SKUs than our U.S. consumer segment as they were both manufacturers of their own product lines as well as distributor of dozens of others. Now that we have every one of the Hawthorne acquisitions using the same platform, we see opportunities to significantly improve our service levels, consolidate SKUs, and take more costs out of the business. Hawthorne also posted sharply higher profits in Q1, keeping us on track to achieve our goal of at least a 10% operating margin on a full year basis. Before I move on, I think it's fair to provide some context around Hawthorne's first quarter. Remember that the business was still in recovery stages this time last year from the challenges we experienced in 2018. That means we had a pretty easy comp in Q1. Regardless, the momentum we've seen over the last year has been outstanding. While we expect the growth to moderate in the months ahead, Randy will discuss the details, we feel really good about the progress Hawthorne is making and the success it's had in positioning itself as the clear industry leader. As we look longer term, we continue to be optimistic about the potential of the overall marketplace. We believe as many as 10 states could hold ballot initiatives this year to create new or expanded state-authorized cannabis markets. One of those markets is New Jersey, where Senate President Steve Sweeney Perhaps the most thoughtful politician in America on this issue is leading the effort. And in New York, Governor Cuomo is once again pushing for adult use legalization of cannabis through the budget process that's being managed by the state legislature. It's impossible to know which states will be open and when. But what I do know is no one is better positioned than Hawthorne to take advantage of these opportunities when they present themselves. Okay. Let's switch gears and focus on the U.S. consumer segment. We reported 8% sales growth in the quarter. On a real-time basis entering February, consumer purchases are up 5% from the same period last year driven primarily by lawn care and gardening products. However, controlled products, especially weed control, while down slightly on a year-to-date basis, has been extremely strong in the past month in the early breaking markets. even against double-digit comps from last year. I'll let Randy take us through the details, but the same issues that drove our growth in fiscal 2019 are still playing through the business in Q1. More importantly than our absolute performance in Q1 was the work being done to ready ourselves for the upcoming season. As it relates to our outlook for the U.S. consumer business this year, I think it's important to understand why our initial guidance for this business is higher than it's been in several years. I want to start with the relationship with our key retailers. In a word, fantastic. The home centers continue to see this as a primary traffic driver in the spring, and they are positioning themselves for another great season. They are leaning into this category and our brands with aggressive and creative program support that we believe will continue to drive the entire industry. It may sound trite to say our relationships in this channel have never been better, but it's true. In the mass retail channel, our major customers continue to return to a strategy of using our brands to drive their lawn and garden business. Over the past two years, we've taken big steps to be a better partner. I've personally been engaged in that effort. Together, we continue to believe there is meaningful growth on the table, and we're working collaboratively for the benefit of both parties. We also expect strong performance out of the hardware channel again in 2020. Merchants in this space have had tremendous success with our brands over the last several years. We've become one of the most important vendor partners for them, and the strength of the relationship should allow us to build upon our momentum again this season. We don't often talk about our retail partners outside of the big four, but this group will be critical in our plans for 2020. We expect at least a full point of our growth in the U.S. consumer segment this year will come from increased listing support in both the club channel and farm and fleet. In every traditional retail channel, I believe our retail partners are increasingly seeing lawn and garden as a strategic opportunity to differentiate themselves from retailers who are operating exclusively online. That's made us more important and a more strategic partner in driving their success. That's not to suggest we're ignoring our partners who operate online. The highest growth rates in the U.S. consumer continue to come from those relationships. While some of our products don't play well on the online space, we've been able to modify our approach in recent years to capture those consumers who prefer to shop online. and we'll continue to evolve our direct consumer efforts in 2020 to take advantage of what will clearly remain a strategic opportunity for years to come. I want to pivot for a moment because we're also optimistic about future developments on the new product front. Product stewardship, especially in the pesticide category, is something we have always taken seriously here and have shown the flexibility when we believed it would help alleviate consumer confusion or concern. Lawn and garden consumers are not chemists. They are homeowners with kids and dogs who don't worry about the products that they use to create a beautiful and healthy lawn and garden outdoor space. Over the last 20 years, we have reformulated our fertilizers, improved our application devices, some of our pesticide formulations and sometimes even walked away from certain active ingredients. We sometimes did this even when the scientific findings showed the products were safe for use and not harmful to the environment when used as directed. It was our direct relationship with the consumer and understanding of our role as an industry leader that drove those decisions. There is not a single one of those actions that I regret, even though some of them didn't fit well with others in our industry and didn't make good economic sense in the short term. But those kind of actions are exactly what's necessary to instill a deeper level of trust with all of our stakeholders, not just consumers and retailers, but NGO and government leaders as well. That approach to product stewardship is why we created a new formulation using our GroundClear brand last year. The product, which works fast and is listed for use around organic gardens, exceeded our sales expectations in 2019. We remain bullish on the opportunity around GroundClear again in 2020, which is why we're expanding the product offering and marketing support for this season. We're also entering year two with Performance Organics, and the storyline here is very similar. This new technology, groundbreaking technology, gave consumers expanded choice when it was successfully launched last year. We see more opportunities for performance organics in 2020 as we continue to see this as one of the most important new products we've ever introduced. With these products, as well as much of the rest of the portfolio, we will continue to rapidly evolve our approach to marketing. Our investment in television advertising continues to decline and the percentage of dollars being spent on digital outreach continues to increase. But it's how we're evolving our digital efforts that matter the most. I expect us to have literally thousands of pieces of creative this spring to better leverage weather, retail promotions, even quirky news events to more narrowly target the right consumers at the right time. We made big strides in this area in 2019, mostly in support of GroundClear. This year, the effort will be more widespread. You'll likely see us ramp up the visibility of our company too. Scott's Miracle-Gro is an organization driven by a set of values that we believe is shared by our consumers. We know our story goes beyond just our brands, and it's time we share that story with a wider audience. I can go on all morning about our plans for the year, but what will matter the most is our execution. Assuming unforeseen issues and extended weathers doesn't get in the way, I feel extremely confident in the plans we have in place, not just for 2020, but in the years to follow.