Scotts Miracle-Gro Company (The)

Good day and welcome to the Scotts Miracle-Gro Company's fourth 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.

Good morning to all of you and welcome to the Scotts Miracle-Gro fourth quarter conference call. By now, you've likely seen our fourth quarter and year-end press release in which we announced record four-year results as well as our initial guidance for fiscal 2022. We have a lot of ground to cover this morning with prepared comments from Chairman and CEO Jim Hagedorn, CFO Corey Miller, as well as Hawthorne Division President Chris Hagedorn. After their comments, we'll take your questions, and for the Q&A session, we'll be joined by President and COO Mike Lukemeyer. In the interest of time, we request that you ask only one question and one follow-up. I will be available after the call and throughout the days ahead, to answer any questions that we don't have time to address or need further follow-up. I want to remind everyone that our comments today will include forward-looking statements, and so our actual results could differ materially from what we discuss. I'd refer you to our Form 10-K, which is filed with the Securities and Exchange Commission, so that you might familiarize yourself with the full range of risk factors that could impact our results. This call is being recorded, and an archived version of the call will be stored on the Investor Relations portion of our corporate website ScottsMiracleGo.com. Without further delay, we'll get started, and I'll turn the call over to Jim Hagedorn to begin. Jim?

Thank you, Jim, and good morning. For the last month, I've been thinking about the key themes I wanted to cover today, and I also spent a lot of time thinking about who exactly I wanted to target with my remarks. I won't spend a lot of time focusing on a quarter or the past year, but it is worth pointing out that we just finished our third straight record year and remain extremely optimistic. And it's worth pointing out that our 11% growth in U.S. consumer was against a 24% comp and a 39% growth in Hawthorne was against a comp of 64%. I know there are obvious questions to address. Our stance on pricing, the commodity outlook, excess inventory in the cannabis market, and our thoughts about capital allocation. We'll cover all of these topics as well as share our thoughts about fiscal 22. But I've been a public company CEO for 20 years now, and too often I've seen the market's focus with short-term issues overwhelm the bigger picture. So I want to spend most of my time focused on more than our current results. Frankly, there are a lot of great things happening at the company right now. Some of them I can't share with you, but they're very exciting. Our business is an important inflection point, one that could transform what we look like five years from now. We have the opportunity to make this company stronger, to make the moat around our business wider and deeper, and to empower a new generation of leaders to shape it through their eyes, not just mine or my executive team. We also see the current volatility in the market as an opportunity. If you're willing to lean in during times like this, there is potential to capture opportunities that others can't and an opportunity to further strengthen your competitive advantages. And leveraging those advantages, it's what drives long-term shareholder value. So I want the real takeaway from today to be a better understanding of the journey we're on. And I'll be honest, my target audience is pretty narrow. To our sell-side friends, I appreciate the need to get your models refined and to share that information with your clients. We're committed to giving you what you need, but my comments are not aimed at you. My comments are also not aimed at short-term investors. I'm not going to get pulled into a rabbit hole about our quarterly splits, the spot market price of commodities, or a bridge to year-over-year SG&A. I do, however, want to speak to those investors who see the long-term opportunity in SMG shares. I want you to know where we're headed and why we're confident our efforts will create shareholder value. I won't ignore the key questions about fiscal 22, but weave them into a broader context of how we're operating the business rather than the confines of how it impacts the P&L. In order to look ahead, I need to look backwards for just a moment. For the five-year period we completed on September 30th, Our strategic plan assumed a relatively mature core business and enterprise growth of roughly 4% to 6%, driven by the higher growth at Hawthorne. We sought to achieve a consistent shareholder return of 10% to 12% by leveraging the P&L, repurchasing shares, maintaining a roughly 2% dividend yield. We also set a five-year target of cumulative free cash flow of $1.5 billion. We exceeded each of those goals. While we are proud of the achievement, we know that the strategy has run its course because the opportunities are different now. And we're different, too. And so, the next step in our evolution will reflect these realities. We've defined five distinct pillars of growth for the next five years. Three of the five are related to the U.S. consumer business. The other two are related to Hawthorne. we see a higher level of sustainable growth with our existing brands in our core business based largely on our ability to reach a new generation of consumers. Second, further growth of our direct-to-consumer efforts is there for the taking if we invest in people, brands, partnerships, and infrastructure. Third, live goods remains a meaningful growth vehicle and a gateway for a more direct relationship with gardeners. Our goal remains the same. for consumers to see us as a gardening company, not a gardening supply company. Fourth, to support Hawthorne's future growth, we must continue to put the commercial grower at the center of everything we do. This means further strengthening a model driven by innovation and technical solutions. And fifth, there is no doubt the cannabis industry will continue to evolve and grow. And there's little doubt that those companies, creative and courageous enough to wade into that pool early, have the potential for a first mover advantage. We've shown our willingness to do this when we created Hawthorne, and as I'll describe later, we intend to do it again. As we pursue these pillars, we are strengthening our team, focusing on succession planning and ensuring our ESG efforts are embedded into our operations and also better understood by our key stakeholders. We debated as a team and with our board whether to pursue all these opportunities at once. We all agreed we had to. But we recognized that succeeding against all these pillars requires us to reorganize and empower a new generation of leaders. While there are no plans for me or any member of the current team to step away, nearly every member of my team has made changes to their organizations. The level of oversight needed to succeed against these efforts requires Mike Lukemeyer to spend more of his time on the strategy and implementation of the fastest growing areas of the business. He has reshaped his organization so that each of these pillars reports directly to him. Therefore, he's given up most of his day-to-day responsibilities in the U.S. consumer segment to Josh Peeples and Dave Swihart, who will effectively serve as co-leads of that business. On the corporate side, Corey has fortified his leadership team with an infusion of outside talent. And Denise Stump and Jim King have realigned their teams to better meet the needs of the business. In addition, most of the M&A opportunities we're pursuing include a management team that can further strengthen our own. If every opportunity we see manifests itself, we could double the size of Scott's Miracle-Gro within five years. That's not the goal necessarily. We want smart growth, not growth simply for the sake of it, but the magnitude of the opportunity could be game-changing. Let me briefly tell you how we expect to execute against these pillars. Where I can, I'll talk about them in the context of our expectations for next year. Between the first two pillars, we believe the U.S. consumer segment can achieve sustainable long-term growth of 2 to 4 percent annually. Our previous strategic plan assumed growth of 0 to 2 percent. If we can sustain growth at this higher level, those added two points carry significant P&L leverage and improved cash flow. It's worth noting that the guidance we set for next year assumes flat to slightly declining growth in the U.S. consumer segment. This is based on an assumed reset of the business in a post-COVID world. Specifically, we're planning for a decline in unit volume offset by pricing. You'll remember from our Q3 call that we took roughly five points of pricing effective in August. In recent weeks, we've communicated to our retail partners a second price increase effective in January. This more targeted increase will range from mid-single to low double digits, depending on the product line. In total, we now expect pricing in 22 to be on the high single-digit side, with the goal of covering commodity prices. While we believe our sales assumption for 22 is a prudent way to plan, the trends suggest a better outcome. Here's why. Consumer POS in units in fiscal 21 was six points higher than in 2020. More importantly, it was 21 points better than fiscal 19, and actually got stronger later in the year. Consumer volume during the fourth quarter of fiscal 21, while down seven points from last year's record performance, was 35 points higher than the same period in fiscal 2019. Consumers are showing us that lawn and garden is an essential part of their lives. Every cut of the data tells us they have stayed with the category and our brands throughout this past season. Those trends have continued in October. While it's a relatively small month, it's an important conclusion to the season, especially in the Midwest and Northeast. POS and units were up 4% in October compared to last year's record result and up 42% compared to fiscal 2019. As we enter the off season, the POS numbers won't tell us much until February. And obviously, we won't know until next summer how much of the COVID bump we retained. But I'm confident we'll have a significantly higher base to grow from. We continue to invest with that in mind. Millennial homeowners clearly have become a demographic tailwind and are more than offsetting baby boomers who are leaving the category. This group of consumers care more about gardening than their parents, and see the category as more rewarding and purpose-driven as well. A 30-year-old couple buying a home today and entering our category for the first time has the potential to stay with us for 20 years or longer. We must operate with that time frame in mind. We don't want our marketers to worry about hitting a target for Wall Street. Their job is to drive consumer engagement, brand loyalty, and market share. And we're going to give Josh Peoples and his team the tools to get that done. The same holds true for our direct-to-consumer pillar. This area is approaching 10 percent of our U.S. consumer sales and will only grow higher. When we think about direct-to-consumer, it goes well beyond selling items on our website. It also means collaborating closely with our retail partners to support their online efforts. It also means finding new partners who can help us boost the appeal of gardening and have their own digital platforms that we can leverage. Patty Ziegler is one of our brightest and most creative leaders and directs our direct-to-consumer effort. In addition to the efforts I've already mentioned, she and her team have launched native online brands like Green Digs, Knock Knock, and Instead. But one of their greatest successes has been with AeroGrow. Thanks to Patty's leadership and with the infusion of our R&D and marketing capabilities, we took a declining business, and tripled its sales since 2019 to nearly $100 million. Patty's been a champion for the potential of our direct-to-consumer platform since day one and continues to reimagine the future of this business. Succeeding in our direct-to-consumer effort also requires improving our IT and supply chain infrastructure. Dave Swihart, whose role has recently been expanded to lead both supply chain and R&D, is driving toward that goal. we need to improve our ability to ship directly to consumers, especially in categories like live goods, which has significant online potential. Until recently, our direct-to-consumer efforts didn't warrant your attention, but that's changed. While it remains too early to gauge the ultimate potential of this pillar, it will be a significant contributor to growth as we go forward. I'm equally convinced our third pillar, live goods, will be even more important. Live goods are the gateway to lawn and garden category, but historically have been highly regional, poorly marketed, and highly commoditized. We believe we can do better. We've got a great start with Bonnie and its leader, Mike Sutterer, and we're working with Bonnie's other owner, Alabama Farmers Co-op, or AFC, to pursue other growth opportunities that hold significant potential. Like us, AFC has a vision to create a national branded business across several categories of live goods. Together, we believe we can better meet the needs of gardeners and our retail partners through innovation, marketing, and supply chain. We've already made tremendous progress improving the Bonnie business, and even there, we've only scratched the surface. The other two pillars are related to Hawthorne. Chris will spend more time discussing the current environment, but I want you to know I'm not obsessing about the sales in Q4 or what we think about Q1. I believe Chris and his team have a good handle on the current environment. More importantly, I believe they're navigating the choppiness in the market while keeping their eye on the long-term opportunity. If the market is challenged for a couple of quarters, expect them to take advantage of it. We won't chase sales, but we will take an aggressive stance to further solidify Hawthorne and strengthen its market position. So expect us, for example, to further enhance our innovation efforts. I finally visited our new R&D facility in British Columbia last week. It's amazing. I've recently visited field stations in Oregon, Florida, and of course, Ohio. What's been the takeaway? That the work we're doing on hemp and cannabis research is changing the industry. From lighting to nutrients to growing media, our research is not just focused on continuing to improve our product offerings, but more importantly, to help growers get a better and more cost-effective outcome. Our unique understanding of plant science and the nuances of indoor cultivation is unmatched. Not only is no one in the industry doing what Hawthorne is doing, our competitors can't even try to replicate that model. I think you should keep that in mind. We also are likely to use this period as an opportunity to step up our M&A efforts. We continue to be disciplined in our M&A efforts, but the economics of some of our deals have become more attractive recently. The final pillar of our strategy is embedded into the recent creation of a new subsidiary called the Hawthorne Collective. I've been alluding for months about the opportunities to invest in emerging areas of the cannabis industry, but this is my first opportunity to discuss the effort in detail. It starts with our recent investment in Riv Capital, a Canadian-based publicly traded company that owns or invests in a series of cannabis-related businesses. we share a common vision with the other major investors at RIV to create a fully integrated business based on the acquisition of licenses for cultivation and distribution. From there, RIV can partner with some of the most well-managed brands in the cannabis industry. There's a lot of speculation regarding the potential for new brands to prosper as the market expands into categories like beverages. However, too few people are focused on existing brands in traditional categories. This is already a multi-billion dollar market with brands operating in the silos of individual states. We're convinced there is tremendous potential for some of those brands to flourish more broadly as the market expands. And our investment in RIV reflects that belief. We believe that our unique level of expertise in the cannabis industry gives us the right to win in areas beyond our existing portfolio. However, today, we cannot make direct investments in those areas. In fact, we can't even have a direct ownership stake in a company that does. But we can create an ownership option, which is what our convertible loan to RIV capital reflects. In the near term, we do not expect to see an impact from the investment in RIV on our P&L. And the amount of capital we've employed, $150 million, does not impact our ability to invest in other areas or return cash to shareholders. In the intermediate term, it is possible RIV may seek further capital infusions. We could be interested depending on the opportunities. I'm not going to speculate on how much we might invest. The honest answer is it depends. But just as we did when we purchased General Hydroponics, Botanicare, Goveda, and Canfilters, we're willing to make investments others might avoid until there is more clarity about the future. If you're a short-term investor, you may not like it. That's fine. But the long-term potential is real and it's significant. Ultimately, if we convert our financial interest in RIV into equity, which is definitely the goal, it may prompt us to reassess our current capital structure. Many of you have asked if we'd break Hawthorne off as a separate company. I've said we'd only consider doing that for strategic reasons and not to chase valuation, and that's still true. Over the past year, we've worked to understand what a potential separation would require, and I believe we're capable of pulling the trigger on such a move if we decided it made sense. Let me be clear. We have no near-term plans to do this. But could it become a viable option? I think the possibility is growing. As I transition to Corey, I want to emphasize that I'm just as confident about our near-term plans as I am about our long-term strategy. The U.S. consumer business is performing well, and our consumers continue to demonstrate how important they see this category in their lives. At Hawthorne, while we continue to expect top-line pressure through Q1, I'm confident in our team's ability to power through it, and we still expect sales growth on a full-year basis. I appreciate your patience this morning as I know my prepared remarks are longer than normal. Are there more challenges out there right now than a year ago? Yes. Am I thrilled with the equity price right now? No. But we're on a path to build a better and stronger business, and we won't be distracted by the noise around us. I mentioned earlier that we exceeded all the financial targets we set with our previous strategic plan. and the goal is to remain on a path that allows shareholders to continue benefiting from the opportunities I outlined in our new plan and the pillars that I discussed. The confidence we all have is part of our decision to increase our share repurchase efforts. I told you last quarter we had allocated $250 million for that purpose. We now expect to add another $100 million to that total, and we hope to acquire as many of those shares as possible in the next two quarters. There's still a lot to cover this morning, so I want to step aside for now. Corey, why don't you pick it up from here?