Scotts Miracle-Gro Company (The)

Miracle-Gro Company's third quarter conference call. Today's call is being recorded. Mr. King, you may now begin. Good morning, everyone, and welcome to the third quarter earnings conference call. With me this morning are Jim Hagedorn, our chairman and CEO, Randy Coleman, our CFO, Mike Lukemeyer, our president and chief operating officer, as well as Chris Hagedorn, who's General Manager of Hawthorne Gardening Company. I'm sure you've already seen this morning our press release that includes the details of our record third quarter results, updated guidance for fiscal 2020, and the announcement of additional plans to return cash to shareholders. In just a few moments, Jim will share some prepared remarks providing more color on these issues as well as others. Afterward, Randy will drill a little deeper into the numbers and set the table for communicating our year-end results in November, which is also when we will provide guidance for fiscal 2021. After Randy's remarks, we'll open the call for your questions, and both Mike and Chris will also participate in that session. Given the amount of content being covered today, we ask that you help us manage through the time by asking only one question and one follow-up. If we don't get to everyone in the queue, or if you have additional questions we don't cover, please call me directly at 937-578-5622, and I'm glad to give you as much time as needed. Obviously, our comments this morning are going to contain forward-looking statements, so I'm compelled to remind everyone that our actual results could differ materially from what we discussed. A discussion of the risk factors that could impact future results are provided in the press release this morning, as well as within our 10-K, which, of course, is part of the SEC. I want to remind everyone that this morning's call is being recorded, and our conversion call will be being available on our investor relations website. With that, let me clear the stage and turn things over to Jim Hagedorn. Jim? Thanks, Jim, and good morning, everyone. In the late 1990s, we created a commercial that was used for our sponsorship of the American Experience on PBS. The ad copy read as follows. At the Stops Company, we make grass greener, trees taller, and flowers more beautiful. If there's a better business to be in, please let us know. As all of us here reflect on what we've seen over the past several months, the question posed in that PBS spot feels more relevant than ever. What our category does for people's emotional and physical well-being has never been more evident than it has been in 2020. How our brands and products enhance the lives of consumers has never been more important, and our ability to thrive during times of macroeconomic distress and deliver for all of our stakeholders has never been more obvious. This is a great business to be in, and all of us are grateful to be a part of it. The record results we announced this morning are both exciting and humbling. On a full-year basis, we now expect to exceed even our most optimistic expectations. The unprecedented success we're seeing continues in both the U.S. consumer segment and in Hawthorne. We're now in positive territory with every product category in both businesses, and the momentum we've enjoyed does not seem to be slowing down as we enter the final two months of our fiscal year. I want to start by thanking our consumers and cultivators for their support of our brands. I want to thank our retail partners for their support of our category and our business. And most of all, I want to thank the associates with the Scotts Miracle-Gro Company who delivered these results. Our success this year has required a level of dedication, creativity, and collaboration that's been inspiring to see. I'm compelled to say that our shareholders owe associates a debt of gratitude, especially those who work on the front lines in our manufacturing and distribution facilities, as well as the field sales force. As the severity of this crisis has ebbed and flowed, these frontline associates have been there every day, demonstrating a level of loyalty and, at times, even bravery that allowed us to keep up with consumer demand. In the face of our success this year, perspective matters. We know too many Americans are still unemployed, and it's becoming increasingly apparent the economy has a long road ahead in terms of recovery. And, of course, we know that the families of more than 140,000 Americans continue to grieve for the loss of loved ones. We also lost a member of the Scott's Miracle-Gro family to the coronavirus just a few weeks ago. He was just 34 years old. and his passing reminded us of the severity of the crisis. We continue to extend our thoughts and prayers to his fiancée and his family. As we move on this morning, I want to divide my remaining comments into four areas. First, it's important to understand what's driven our results this year. So I'll talk about the successes we've seen in both U.S. consumer and Hawthorne at a high level while allowing Randy to focus on the financials. Second, I want to talk about where we expect to finish in 2020 in the investments we're making for the balance of the year. Third, I want to share some initial thoughts about next year. This is not guidance. It's far too early for us to target specific numbers for either the top or bottom line for 2021. But to some extent, I want this call to provide the roadmap for what we see in 2021. The obvious question on the table this morning is, how do we comp this year's results? And we want to address that issue proactively. Fourth, I want to address our current thinking about our balance sheet, uses of cash, and elaborate on our other announcement this morning of a special dividend of $5 per share, which will be paid in September. That's a lot to cover, so let's dig in and discuss current business trends. I'll start with the U.S. consumer segment, which reported a sales increase of 21% in the quarter and is now up 15% year-to-date. That year-to-date number is expected to improve further, which has probably raised our guidance again for the U.S. consumer business to a range of 20% to 22% compared to the previous guidance of 9% to 11% growth. Entering August, consumer purchases are up 23% on a year-to-date basis at our top four retail partners. When you look at consumer activity more closely, we continue to see gardening as the driving force, even though we are weeks past what would normally be the peak of that season. Consumer purchases of our branded soils are up more than 40% year-to-date, and plant food purchases are up more than 30%. Finding plants in which we have a 25% financial interest has seen an increase in POS up about 50% as edible gardening continues to swell in popularity. The success of Bonnie this year increasingly reinforces our long-held interest in this category and our belief that edible gardening is critical to our strategy in the years ahead. Our controls business continues to see significant increases from last year. Also, outdoor insect control products have seen more than 60% increase in POS, and also indoor insect products are up more than 40%. Most of these gains have come from increased from improved lifting support. Ortho Weed Control products are up about 15%, driven by the continued success of GroundClear, which continues to improve its market share position in the non-selective weed control space. Roundup, which we represent per buyer, has seen an 8% increase in POS on a year-over-year basis. In lawns, GrassFeed continues its multi-year run with POS up nearly 25%. Consumer purchases of lawn fertilizer are up 9%. Across all retailers, our lawns portfolio recently cleared the $1 billion milestone for the first time, and that's with two months still ahead of us. In fact, the severity of this summer and its damaging effects on lawns should bode well for our fall grass-feed business as well. Finally, mulch crossed over into positive territory near the end of June, and POS is now up more than 4% as we enter August. Recall that mulch was still in deep negative numbers entering Q3 and suffered as retailers canceled Black Friday events and other aggressive promotions that used mulch to drive foot traffic into lawn and garden apartments. While mulch isn't a high-margin business, it's a highly strategic one. Retailers began to aggressively reengage in the mulch category beginning in May. If they did, we joined their efforts. we employed a rifle-shot approach to using digital media to drive consumer purchases of mulch in specific markets across the country, which helped clear the inventory from both our distribution points as well as retail stores. The success of that combined effort, again, showed how this product category can create momentum for the entire lawn and garden space. We've seen strong double-digit improvements in every retail chain, in the hardware, club, and farm and fleet channels. Retailers in the home storage channels significantly reengaged in May and June as the economy began to reopen across the country, which allowed them to operate with fewer restrictions. The big picture trends around COVID-19 undoubtedly had a positive impact in our industry and our brands. But it's important to stress that success we had this year didn't just happen. Our marketing team has done an outstanding job all season long adjusting our messaging and campaigns, especially in the digital space. Early in the season, no one was talking to the consumer except us. The team didn't just carry the load for the entire industry, but did so with smart, innovative, and fast efforts to hit the right note at the right time in the right places. Our direct-to-consumer business was also significantly impacted. This is both at-home delivery and curbside or in-store pickup. We've seen more than a 200% increase in volume, growth we've easily absorbed because of the groundwork laid by the team over the last several years. Our sales force did more than just work with our retail partners. They stayed engaged during the peak of the crisis, often adjusting their efforts to work in the middle of the night in order to keep our products in stock while operating in a smart and safe way. And our supply chain has been exceptional. I'm not saying we were perfect. We weren't, and we often employed a bend but don't break mentality, because our teams worked 24-7 to keep up with record demand. At times, service levels fell below our standard. We owned that issue and were working to fix it. However, this team managed an unprecedented level of volatility in the midst of a pandemic. They didn't just keep product rolling through the system, but did so while establishing social distancing and other safety protocols, including regular shutdowns to accommodate deep cleaning activities in more than 50 locations. It may be our most remarkable success story of the entire year. Our supply chain wasn't just challenged to keep up with demand in U.S. consumer, but in Hawthorne as well. Sales in the quarter for Hawthorne were up more than 70% against a nearly 50% comp from a year ago. And with year-to-date sales growth of 59%, we are moving our sales guidance for Hawthorne higher as well and now expect sales growth of 55% to 60% for the full year. We saw third quarter growth in every Hawthorne category in nearly every geography. We were up 129% in lighting, driven by our recently introduced Gevita LED products. We were up 45% in nutrients, 62% in growing media, and 81% in growing systems. In our largest and most established market, California, sales in the quarter were up nearly 80%. Meanwhile, in expanding and recently approved markets like Michigan and Oklahoma, we were up 140% and 190% respectively. On a year-to-date basis, there was not a single negative market in the entire country. The other important storyline here is we're simply running the business better. The shock to the system we experienced in 2018 is a distant memory, but the lessons remain. We have better visibility into the marketplace. more focus on working capital management, and our innovation pipeline continues to improve. This has allowed the team to strike the right balance between driving growth, market share gains, and margin improvement. By the time we complete 2020, we will have exceeded expectations in all three of those measures. The entire Hawthorne team deserves recognition for how they've evolved over the past three years. I was openly critical of this group on one of these calls in 2018. Frankly, at the time, they deserved the criticism. But they've gelled as a unit since then and have established credibility as a true industry leader. They didn't just embrace the idea of remote management. They've excelled at it. Their performance this year gives all of us confidence of what the future holds for this business. The second subject I wanted to cover is where and how we believe we'll finish the year. As you saw, we increased our adjusted EPS guidance for the full year, and I'll leave it to Randy to cover the details. I just want to be straightforward. That range could be higher if we wanted it to be. We're incurring some originally unplanned expenses, however, because we have the flexibility to do so and because it's the right thing to do. For starters, beyond our normal bonus plans, which apply to about 1,500 people, we decided to share some of our upside with a broader group of associates. As I said at the outset of my remarks, the success we enjoyed this year would never have occurred without them. They deserve to share in the outcomes. That's why we plan later this year to make one-time cash payments as well as enhanced retirement contributions to approximately 3,000 hourly and salary associates who do not participate in our variable pay plans. These associates work heroically all season to help us deliver this result, and they are the first people on the list to share in our upside. We also plan to increase our charitable efforts this year, primarily with increased corporate contributions to the Scotts Miracle Grove Foundation. We have also stepped up our support of specific community initiatives close to home in central Ohio, and more broadly, like the 9-11 Memorial and the United Veterans War Council. By the end of the year, we will have more than doubled our planned contributions to charity. Those combined efforts are worth approximately 20 cents per share on an adjusted basis. All of this brings me to my third topic, which is our current viewpoint about 2021. Jim King has told us barely a day goes by when she's not asked about the tough cop we face after this historic year. So we know it's the number one topic on everyone's mind. As a reminder, we're not providing guidance today for next year. We'll look to provide that in November. But I want to address the very big differences for 2021 as it relates to our ability to prompt this year from a sales perspective and then on an earnings perspective. On the top line, let's start with Hawthorne, where the story is relatively simple. If we extrapolate the current run rate of the business into next year, we would expect to see extremely solid double-digit growth in the front half of the year. Given our current order book and view of the market, this seems achievable. Our comps in the second half next year obviously will be a lot harder. So even if we're flat in the second half, and I'm not saying that's the expectation, then we should still be able to hit our long-term targets of high single digit growth. And you as a consumer, we know the societal changes brought on by COVID-19 will begin to normalize at some point. We told you on our last call, The 30% of edible gardening activity came from consumers who were either new to the category this year or returned to the category after stepping away. Since then, we've conducted some additional consumer research, which tells us that lawn care participation increased by 14%, meaning an additional 8 million households used grass seed or lawn food for the first time this year. We also know that 28% of all homeowners said they spent more time on overall lawn and garden activities this year. Keeping all these consumers engaged will be the single biggest key to whether our U.S. consumer segment grows in 2021. I'll start by saying the primary activity that brought these consumers to us in 2020, edible gardening, is a good start. We know that most people who engage in edible gardening don't see it as a chore. It's a passion and a lifestyle choice. and it's been the fastest growing area of lawn and garden for years. We believe most people will do it again next year. To help ensure that outcome, we know we need to strengthen our relationship with these consumers, and that means we intend to stay connected with them. You will likely see us continue to communicate to them throughout the fall and winter, not just about our products, but about the lifestyle around gardening and being out in the yard. We made major improvements to our marketing efforts in 2020. In fact, I believe we're as good as we've ever been. Our team has transformed the way we communicate with our consumers. We know them better than ever before. And we're not simply advertising to them anymore. We're communicating with them in a way that is clearly delivering results. But that doesn't mean we're done. you will see us continue to adapt to the marketplace faster than ever with more creative assets and more ways to deploy them. Come next spring, we also expect a different retail dynamic. Remember that home centers, which generate about 60% of our revenue, had little to no promotional activity this past spring. We expect a step-up of promotional activity, especially early in the season, but not necessarily a return to the way things used to be. Clearly, consumers remained engaged this year with very little promotional activity. We think there's a better balance out there, and we're working in partnership with those retailers to find it. But remember, our retail partners who were in that next tier from a scale perspective had tremendous success in 2020 and clearly saw market share gains. They aren't going to simply roll over in 2021. They're going to work hard to defend their space. So I believe we'll see a much more competitive retail landscape next year. Finally, we would expect to take some pricing next year, pretty much in line with our historical behavior. And that should help the top line as well. We also know even with the big gains we've seen this year, we left some sales on the table due to supply chain constraints during the peak of the season. While we feel good about next year, you should expect for us to be conservative when we set sales guidance in November. If you told me right now we could comp this year and hold our margins, I'd take it. Clearly, we'll incentivize the team to do better than that. And as we've shown this year, we possess an incredible ability to rise to the challenge when we have higher than expected growth. I'd rather do that in 2021 than just have an unrealistic expectation. However, when we think about earnings next year, growth should be far easier. Getting SG&A back to a normal level should be worth at least $70 or $80 million, and that's primarily a variable compensation issue, so we have good visibility to the potential upside there. We'll obviously be in a much better place to share details when we talk in November, but I want you to know that our 2021 upcoming budgeting has become our number one priority, and we're sensitive to the same issues that we know all of you care about as well. The last topic I want to cover is our balance sheet and our current thoughts about uses of cash. When we announced Project Focus in 2015, we said we'd focus on three things. First, to maximize the potential of our U.S. consumer business, and I think we've done a great job there. Second, to reconfigure our company-wide portfolio. That meant divesting some businesses and acquiring others, and that's how Hawthorne evolved to what it is today. And third, we said we'd focus on cash flow and returning cash to shareholders while maintaining target leverage ratio of about 3.5 times debt to EBITDA. We were in the mode of starting to return cash, but pulled back a bit in 2018 after the challenges we faced that year took our leverage ratio higher than we wanted. But once we got back to our comfort zone, we reengaged in our share and purchase activity in 2019 until COVID-19 hit us. We suspended sharing purchases in March out of an abundance of caution, which was the right decision at the time. Now with free cash flow likely to be at its highest level ever and leveraged well below our target, we want to get back to returning cash to our shareholders. A special dividend puts cash back into the hands of our shareholders right away and allows them to decide how they want to invest the money. In my conversation with some of our largest institutional shareholders over the years, I've found most of them to be agnostic about share or purchase versus dividend. So this time, we chose the dividend. Most likely, the special dividend will replace any meaningful share or purchase activity for at least the next several months, though we still have enough flexibility to be opportunistic. We also have ramped up some of our M&A work in recent months and are currently pursuing a couple of small but strategic ideas for both U.S. consumer and software. For obvious reasons, I don't intend to share details this morning, but we still see strategic opportunities to expand our portfolio and better position both businesses for continued success. Before I turn things over to Randy, I want to wrap things up by acknowledging the good fortune that's come our way in 2020. In late March, we issued a press release saying we'd seen a recent surge in business, but also acknowledging we did not know where the season would take us. At the time, we stuck a conservative posture, pulling back on SP&A and suspending our share repurchase activity. We didn't know what to expect. But then consumers stepped up, clearly demonstrating they viewed our category as critical to them as they navigated this public health crisis. The trust consumers and growers put in us, the trust that our retail partners put in us, has not been forgotten by any of the people on this team. We're working harder than ever to strengthen our relationship with them even further in 2021. We're using the strength and flexibility of our financial position to make our company stronger, too. to position us for success, not just in 2021, but in the years that followed. With that, let's switch gears and look at the numbers. Randy? Thanks, Jim, and hello, everyone. It's obvious from our announcement today that our Q3 results greatly exceeded what we expected when we updated our guidance about seven weeks ago. Our momentum throughout June surpassed anything we historically seen and is continuing even as we speak.

So I want to start by joining Jim and thanking our consumers and retail partners, but mostly our associates, for helping us navigate the COVID crisis so effectively in delivering outstanding results.

This morning, I'd like to spend most of my time providing some core commentary on the P&L. I won't go through all of the numbers. I know most of you have already done that.