Scotts Miracle-Gro Company (The)

Good day and welcome to the Scots Miracle-Gro Company's Third Quarter Earnings Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Jim King. Please go ahead, sir.

Good morning, everyone, and welcome to the Scots Miracle-Gro Third Quarter Conference Call. Joining me this morning is our Chairman and CEO, Jim Hagedorn, our Interim Chief Financial Officer, Corey Miller, as well as our President and Chief Operating Officer Mike Lukemeyer and Chris Hagedorn, Group President of Hawthorne. In a moment, Jim and Corey will share some prepared remarks and then we'll open the call to your questions. In the interest of time, we ask that you keep to one question and one follow-up. I've already scheduled time with many of you after this call to fill in the gaps. Anyone else who wants to set up some Q&A time can call me directly at 937-578-5622, and we'll set up some time as quickly as we can. One quick bit of housekeeping. Corey and I will be participating in the Raymond James Consumer Conference on September 14th, which will be held virtually. We'll publish more details related to the time and date a couple of weeks in advance. With that, let's move on to today's call. As always, I'll remind you that we expect to make forward-looking statements, so I want to caution you 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. Those are filed with our Form 10-K, which is filed with the Securities and Exchange Commission. I also want to remind everyone that today's call is being recorded, and an archived version of the call will be available on our website. With that, let's get started, and so I'll turn the call over to Jim Hagenhorn. Jim?

Thanks, Jim, and good morning, everyone. This is an important call today, perhaps the most important call with the investment community over the past year. It has nothing to do with the fact that we've posted another strong quarter and remain on pace for a record year. It's because we're finally at the inflection point everyone knew was coming. Yes, we're starting to run up against tough comps in both businesses. Yes, we're starting to see consumers get back to their normal routines. And yes, Like a lot of consumer companies, the cost pressures we're seeing from commodities are starting to feel unrelenting. But as I take a deeper look at our business, I can't help but feel positive. If you only look at a quarterly P&L, you can't possibly understand what's happening here. You have to dig, you have to analyze, you have to find the answers to questions you've never even thought about asking in the past. For more than a year, I've been telling anyone who would listen that I believe Scott's Miracle-Gro would exit COVID as a fundamentally stronger company. And the deeper we dig, the more we analyze, the more I'm convinced that is exactly what's happened. Our consumer base today is vastly bigger and more engaged than prior to the pandemic. Our relationship with those consumers is stronger and more personal than ever, thanks to the overhaul of our marketing programs. Our ability to engage on their terms is better today due to the vast improvements in our direct-to-consumer initiatives. And our ability to provide them the best possible outcomes has been made even easier by an innovation team that continues to turn out important new innovation. Our growth engine Hawthorne continues to outperform the market and is positioning itself for long-term success. We've built competitive advantages that others in the industry can't match. We brought science-based innovation to this industry, and we continue to embrace a vision that is driving us to explore new and creative opportunities for growth. In addition to the strength of our businesses, our balance sheet gives us more financial flexibility than we've had in a decade. We have opportunities to invest in immediate growth, and we'll pursue those. We have opportunities to invest in long-term growth, and we'll pursue that, too. and we have the opportunity to return cash to shareholders, which we'll also pursue, especially given the recent pullback in our share price. We're not doing everything perfectly here, but when I look for major weaknesses, I just don't see them right now. We've taken full advantage of the unique opportunity that presented itself over the past 18 months and have put ourselves in a great position. And so that's the context of how I want to frame up five distinct topics I want to cover this morning. First, I want to discuss the continued strength of our U.S. consumer business. Consumer engagement remains strong, and by the time we navigate through the next year, we expect to have retained nearly all of the growth we captured in 2020. I'm not sure many other CPG companies can say that. Second, Hawthorne. Again, the trends are extremely strong. We were up 48% in the quarter, and we continue to expect growth of 40% to 45% on a full year basis. Third, M&A. This morning we announced a small but strategic bolt-on acquisition for Hawthorne. We continue exploring opportunities that are bigger in scope, and we are increasingly committed to finding creative ways to invest in other areas of the cannabis industry. Fourth, I'll share some early thoughts about our view of next year. We're not providing fiscal 22 guidance today, but we do have a working thesis about next year, and I believe long-term shareholders will like what they hear. And fifth, I want to touch on our evolving thoughts about returning cash to shareholders. Let's start with U.S. consumer. Clearly, we've done a better job on the top line than we expected coming into the year. Consumer engagement exceeded our expectations and allowed us to call up our numbers twice this season. Of course, a lot of that benefit, in excess of a dollar a share, has been offset by commodity pressures that every company in the consumer product space is trying to navigate. I'll let Corey dive deeper into those details. I want to focus my time on the strong underlying foundation of the business. The most critical takeaway is this. Consumer engagement remains extremely high. Entering the season, our research suggested about 85% of consumers who came into the category last year would return. We believe the actual number was probably closer to 75%. However, we're confident we've benefited from a higher overall level of participation, as one-third of all consumers said they increased their participation in our category this spring. When we subtract consumers who did less gardening this year from those who did more, our data suggests participation was up 8%. And that aligns pretty well with consumer purchases for our products at our largest retail partners. Entering August, POS dollars at our largest four retail partners were up 4%. In units, the number is 8%. There's a story here, and it's important to understand. In most years, the gap between units and dollars is negligible. In 2020, however, retailers did almost no promotional activity, so POS dollars far outpaced units. This year, retailers promoted more than in 2020. The change in their behavior meant the difference between POS dollars and units swung back in the other direction. In our soils business, where 4 for 10 and 5 for 10 promotions were reintroduced, POS dollars are up 5% year-to-date, but units, a more accurate reflection of our shipments as well as consumer activity, are up 8%. In mulch, dollars are up 11%, and units up 20%. And there are other branded categories where the year-over-year impact of promotional activity is less pronounced, like lawn fertilizer, weed control, and grass seed. POS dollars were up 3%, 8%, and 14%, respectively. This is the third straight year we're seeing double-digit growth in grass seed. So across all categories, the numbers we're posting would be good in any year. So we're extremely pleased given the tough comps. Still, we've given up a lot of the POS gains we reported on the last call when the year-to-date number was plus 20. Most of the reduction was expected because of the difficult comparisons. However, We believe the result would have been better if it had not been for the weather challenges that undoubtedly drove the number lower in May and June. On Mother's Day weekend, historically the largest weekend of the gardening season, it snowed in some key markets. Memorial Day brought record cold through most of the Midwest and Northeast. Father's Day was not much better. In fact, June as a whole was extremely wet in much of the Midwest. And of course, the record heat and drought conditions in the western U.S. have not helped either. We believe the impact from weather was magnified this year. Last year, when people were working from home, we saw a lot more POS happening on weekdays than we were accustomed to seeing. So if the weekend weather was lousy, it wasn't a big deal because more people were shopping on weekdays. But this year, because weekday foot traffic was closer to normal, the weekends have become much more important again. So lousy weather is more difficult to overcome this year, and we've seen a lot of it. This is not an excuse. It's a reality. Weather can impact the business, and it was a significant headwind this year. By September 30th, I suspect weather will have cost us at least two points of growth in fiscal 21. Nonetheless, consumer engagement remains encouraging. Our third quarter historically accounts for about 55% of full-year POSs. In the 13-week period from April through June, POS was down 1% this year compared to 2020, but it's up 24% in those same weeks compared to 2019. If we look only at the last nine weeks of that period, that's when we started to hit tougher comps. POS was down 12% from 2020 levels. However, it's up 30% from 2019 during that same nine-week window. If we extrapolate the current trends for the balance of the year, we expect full-year POS dollars to be up slightly from last year. POS units are likely to be up low to mid single digits. Compared to 2019, we expect POS for 2021 to be up more than 25%. The current consumer trends, combined with planned higher retail inventory levels, give us a high degree of confidence in our full-year sales growth guidance for the U.S. consumer business, which we set at the range of 7% to 9%. Behind the numbers, there are a lot of great stories. I'd love to share details on all of them, but I'm going to turn the page and share some of the highlights from Hawthorne, where we continue to see strength across the board. Through June... Sales are 60% higher on a year-to-date basis as the business continues to build on its market-leading position. In Q3, our lighting business grew 77%. Within that number, our market-leading Kavita brand grew at more than twice that rate. We continue to see new growth facilities come online across the country, and the retrofit market remained an important part of the story in legacy markets in the western United States. Our success in lighting continues to be led by innovation. In particular, we continue to see great success with our new LED lighting products that provide growers a one-for-one replacement for existing high-pressure sodium lights. Outside of lighting, we continue to see strength in the consumable category as well, which is a more accurate reflection of growth in the actual cannabis market. Nutrient sales were up 54% in the quarter, and growing media was up 32%. Our signature brands significantly outperformed the overall category. General Hydroponics grew roughly 30 points more than the total nutrient portfolio, and our Mother Earth and Botanic Air brands grew three times faster than the rest of our growing media business. The across-the-board strength led to the 48% growth we saw in the quarter, which ended with our largest sales month ever in June. The growth rate we expect for the full year is a little more than two times higher than our initial guidance. The upside this year allowed us to upgrade our talent, enhance our innovation efforts, and improve our marketing. We expect those investments will help drive the business again next year and the years that follow. Obviously, another opportunity to drive growth is through M&A, so let me touch on the deal we announced this morning. The acquisition of Hydrologic is pretty straightforward. This is an easily integrated bolt-on deal that is highly strategic. Hydrologic is a leading provider of products and systems related to water filtration and purification. That makes it a strong complement to our existing irrigation supply business in a high margin category. We continue to have more M&A opportunities in the pipeline in both business segments than we can digest right now. The challenge for Hawthorne is that many of the targets are small to medium-sized businesses. You might think that small deals are easy to get done. In most cases, it's just the opposite. The lack of sophisticated IT systems and financial controls makes the due diligence process harder and more time consuming. And we're not going to rush the deal just to get it done. But I will tell you, we're making good progress. Separately, we remain committed to putting capital to work in areas of the cannabis industry that are closer to the end consumer and to the grower and within the bounds of current federal law, as well as the requirements of our lenders. After months of work by an internal task force, we've created a process that will allow us to make non-equity investments in other entities that invest in cannabis brands and operations. In fact, we've been in discussions with potential partners to bring this strategy to life and hope to see significant movement in the near future. We've developed a highly successful business in Hawthorne based on the current state-authorized marketplace. Even though we've never been involved with plant touching activities, We understand the space as well as anyone, perhaps better than anyone. Our evolving vision is to create the optionality to have an early mover advantage in the broader U.S. cannabis market when federal law allows. There is little doubt this industry is poised for significant growth. And given our track record, I believe we have an absolute right to win here. I look forward to sharing more details in the months ahead. Speaking of the months ahead, I realize everyone wants to know what's in store for fiscal 22. So let me change gears and share some high level thoughts. The easy part of this equation is Hawthorne. The run rate of this business segment remains strong. We just completed an acquisition and hopefully there are more on the horizon. We continue to extend our leadership in the overall marketplace. We continue to face the same challenge we've had for several years. We enter fiscal 22 against pretty tough comps. But based on everything we're seeing, it's hard to imagine growth being below 10% to 20% next year. I know that feels like a conservative estimate to many. Perhaps it is. And perhaps our guidance range will be different. But taking a conservative approach has worked for us over the past several years and will continue down that same path. I'm not going to overcommit to growth here. The more challenging questions for next year are related to the growth in the U.S. consumer business and the continued pressures from higher commodity costs. I'll cover the first part. Corey will cover the second. First things first, we still have two months to go in the year, so Mike and I are working to keep the team focused all the way to the finish line. As it relates to next year, there are a lot of moving parts, so we're not going to be overly specific this morning. That said, I like where we are. I told you a year ago I'd be happy if we could keep the growth we captured in 2020 in our U.S. consumer segment. That remains my view. We're probably going to continue to feel some top-line pressure through next April because of the difficult comps. So to some extent, fiscal 22 will be a mirror image of this year, a tough start that should get easier as the year goes on. Right now, I believe it's prudent to plan for the U.S. consumer business to decline slightly next year. Some of you have models suggesting a double-digit decline. We're hoping to do better than that, given the expected benefits from pricing, but it's still too early to tell. Obviously, we won't really know until this time next year. But our consumer business picked up nearly a decade's worth of growth in the last year, and it feels pretty sticky so far. Coupled with the changing demographics of the lawn and garden market and a red-hot real estate market, it leaves us in a far stronger position in a post-COVID world. That's why we've been investing so hard in our brands this season and why we'll do so again next year. That's a point of view right now, not guidance. We have a lot of work to do over the next 90 days and our thoughts could change. We are still finalizing listings and programs with some major retailers for next year. We also may take a second price increase in January, depending on what happens with commodities. And of course, we need to get through the fall season to understand what retail inventory picture looks like as we prepare for next season. So we'd expect to give you a much clearer picture when we talk again in November. I said at the outset that it's tough to understand the business by just looking at the P&L. And I hope it's clear that we're feeling bullish, and it's in that vein I want to briefly cover one more subject, returning cash to shareholders. As we look at the pullback in our equity price since early June, it's clear that the uncertainty about next year is creating a drag on our value. I've said repeatedly that I think about this business with a long-term perspective, and I don't worry about quarter-to-quarter fluctuations. I like our strategy. I like how we're set up to execute, and I believe in this team. And though I've hinted at the possibility of a special dividend multiple times this year, I'm a big fan of buying our shares at these prices. I told Corey I'm comfortable allocating upwards of $250 million to share repurchase in the months ahead under our existing authorization. So look for us to do that. Before I turn things over to Corey, I just want to add one last bit of perspective. I was walking around our campus in Ohio last week and came across a group of our R&D associates. Plant scientists conducting field research. Their enthusiasm for their work and their belief in what it could mean for our future was inspiring. It reminded me of why I love working here. There's an optimism here that I don't think you'll find at many other companies. It's what carried us through the early days of COVID and has helped us drive the record results we've been posting every quarter since. So we aren't worried about the difficult comps we continue to face. or the fact that we're likely to see a couple negative quarters coming up. And we aren't worried that our consumers will disappear when the world goes back to normal. We believe in our vision here. We believe in the mission we're executing against. We believe our business does make the world a better place. And we believe the opportunities have never been more plentiful and that the future has never been brighter. With that, let me turn things over to Corey for a brief overview of the numbers and to share some of his own early thoughts about next year.