Scotts Miracle-Gro Company (The)

Good morning and welcome to the Q4 2022, the Scott Merkle Gold Company Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the Start key followed by 0. After today's presentation, there will be an opportunity to ask a question. To ask a question, you may press Start and 1 on your telephone keypad. To redraw your question, please press Start in Two. Please note this event is being recorded. I would now like to turn the conference over to Kelly Berry. Please go ahead.

Good morning, everyone. Welcome to the Scotts Miracle-Gro Company's fourth quarter earnings conference call. Today's comments from Jim and Dave have been prerecorded. After their comments, we'll take your questions. I want to remind everyone that our comments today We'll 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 may 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 This call is being recorded, and an archived version of the call will be stored on the investor relations portion of our corporate website, gotsmiraclegrow.com. We have a lot of ground to cover, so I'll turn the call over to Jim Hagedorn to begin. Jim?

Thanks, Kelly, and good morning, everyone. I don't think I have to revisit everything we faced this past fiscal year or in the previous two. We're on unusual times. During the pandemic, we responded to the unprecedented challenges with winning strategies to manage all the craziness that came with it. We did so by delivering record results. Now we're in the aftermath of the peak COVID years, facing record inflation, supply chain disruption, war in Ukraine, and a steep downturn in the cannabis industry. It's a messy situation. But here's what I know. We get it, and the leadership team is on it. We have our organization headed in the right direction. My confidence stems from the work we did in the back half of fiscal 22 to improve our cost structure. It also is grounded in our plans for 23. If there is doubt about our willingness to take bold and decisive steps to orient our company to the realities of today, I can assure you we're doing what's necessary to reduce debt and restore acceptable levels of profitability. I'm optimistic we will remain within the bounds of our bank covenants. I know you're looking for guidance. Dave Evans will explain how we see the year shaping up in the U.S. consumer and Hawthorne segments. we're focused on hitting EBITDA and free cash flow targets. In fact, our management incentive program for fiscal 23 is based on leverage-related metrics. For fiscal 22, we finished at six times the debt to EBITDA. We're comfortable with our leverage trajectory to remain compliant for the first six months and have a clear path into the fours by the end of the fiscal year. The personal goal of mine and Mike Lukmeyer is to get to four and a half times, This will position us to move leverage back to our normal levels in the threes by the close of 24. As for cash flow, we continue to project $1 billion in free cash flow by the end of fiscal 24. It's worth emphasizing that much of our leverage improvement is about timing. As the calendar changes, so will our leverage. We will naturally and significantly delever in the intermediate term. Our roadmap this year is based on three major themes. First, We're strengthening the balance sheet, paying down debt, improving free cash flow, and tightly managing operations. We made significant progress with cost outs in fiscal 22, and we're making further reductions in fiscal 23 to give us more room to responsibly manage leverage and move us toward our targets. Second, we're confident in the consumer business. Lawn and Garden is a steady, mature business that historically is a strong cash flow generator. We emerged from fiscal 22 reaffirming the strength of our brands, the power of our retail relationships, and continued high consumer engagement. These represent strengths, and we'll capitalize on them. Third, we're remaking Hawthorne. It's not lost on me that this business has been a drag on earnings. I want to emphasize that we believe in the future of the cannabis industry and its eventual turnaround. There is a huge amount of value that will be unlocked in Hawthorne once this rebound occurs. But I also know that we need to overhaul Hawthorne to adjust to current realities and to protect core SMG from the cannabis downturn. I'll explain shortly how we are integrating Hawthorne into Scott's Miracle-Gro, reconfiguring its lighting portfolio, and revamping its organizational structure. Before I go much further, I have a few comments about our fourth quarter. We did what we said we'd do. We revised our guidance multiple times last year. more than I recall in a single year. But the fourth quarter proved we can be agile enough to make an impact quickly. We made the quarter, we landed within our EPS guidance, we overachieved free cash flow expectations, and we stayed within our leverage threshold. It was a good way to end the year, and I'd like to think that it's the start of a trend. I want to express my heartfelt appreciation for our banks, retailers, and other partners for helping make it happen. It's been an especially hard six months for our associates, and I have a personal message for them as I know many of them are listening to this call. I want to thank you for your commitment and loyalty. Your resilience is outstanding and will go a long way in contributing to our long-term success. Words can't express how much I appreciate your support. And when we get these challenging times behind us, I will not forget all your help in turning around the company. Now let's get back to the themes, starting with the balance sheet and leverage improvement. Our SG&A for fiscal 23 is budgeted to be below fiscal 19. We have minimized capital expenditures and put M&A activities on hold. Our accomplishments thus far can be credited to the cross-functional project springboard team we announced last quarter. The team quickly achieved over $100 million in annualized savings as a result of extensive actions that included reducing our footprints, tightening variable spending, and eliminating hundreds of jobs starting at the highest levels. Our management ranks have been reduced by 35%. In addition, the SpringBoard team executed asset sales and a large sale leaseback of our Hawthorne facility in Vancouver, Washington to generate incremental cash for debt reduction. This year, Springboard's remit is to get our leverage into the fours at the end of fiscal 23 and into the threes by the close of 24. Springboard 2.0, as I call it, will help us further streamline, reduce working capital, and conserve cash. We are taking a hard look at how we operate, what we prioritize, and where we invest. We are driving operational efficiencies to the fullest extent. Among Springboard 2.0's focus areas are inventory reduction, where we expect to realize at least $400 million in cash flow benefit this year by limiting production and selling through current inventory, and another $85 million in cost-outs to be realized in fiscal 23 and 24. The team has so far identified $60 million of this $85 million target. In addition, we believe we have at least $15 million of benefit from commodities as compared to earlier assumptions. The majority of these savings will come from our supply chain, including reducing warehouse space company-wide, enhancing productivity through strategic material substitutions that do not impact product quality, improved labor efficiencies, and resizing Hawthorne operations. These cost reductions can potentially improve our leverage and give us runway to operate, especially given the economic uncertainty. While indications are that the consumer remains resilient and our category is essential to their lives, no one knows where the economy is headed. The greatest economic minds have given wide-ranging predictions on what to expect. But even if the economy goes into recession, history shows that consumers turn to our products. During the recessionary period of 2008 to 2010, we realized year-over-year consumer sales increases of 2%, 15%, and 6%, respectively. I'd sum things up this way. We are leaner, less layered, and higher performing. We are more competitive and focused. We will execute with precision and speed. For those who know me, I refer to a Wall Street Journal article from the 1990s where my family's miracle grow took over Scott's. The gist was how the leadership of the Hagedorn family would bring thriftiness and an entrepreneurial spirit to the new entity. These are elements we are embedding into our culture, and the people who are a part of our company must buy into this approach, and I'm convinced it will be a better company as a result. Now let's talk about my second theme, the U.S. consumer business. The fundamentals of our U.S. consumer business are strong. Our brands are everything. They are iconic and loved by consumers. We have great partnerships with our retail partners. We have the best sales force and field execution in the industry. And we have the leading market share. Compared to the pre-COVID year of 2019, our market share has increased or stayed flat in almost all categories. There are not many brands out there that can boast a brand awareness scores of 70 to 90%. We can. Consumers are engaged and have a high intent to stay. 80% of the 20 million new gardeners who entered the category during COVID continue to be in it. A recent Federal Reserve report on consumer behavior indicated people are emphasizing leisure time, and for many, this includes time at home. Our plan is to capitalize on these strengths. I believe we're being reasonable with this year's sales forecast by assuming we'll be flat in POS units in the U.S. consumer business, with the exception of a 10% hike in units in fertilizer and seed, which were down nearly 20% last year and represent one of our most weather-dependent businesses. Poor weather was a factor in suppressing early season consumer sales last year, in large part due to an unusual polar effect that hit the Midwest and Northeast in March. Current weather models are showing, despite the ongoing dry conditions in the West, more normal conditions in many of our key markets. Now, I don't want anyone to think we're cutting so deep that we're harming the core business. We will respect and protect it. We've heard from our largest investors that this business is as good as they come, and we agree. We will not take any actions that negatively impact its health or integrity. In fact, we're investing in Lawn & Garden. Take innovation, long a tenant of our success. We will continue to drive product development that meets evolving consumer needs, such as drought-tolerant solutions and cost-effective, sustainable ingredients with greater or equal efficacy. We are also continuing to invest in sales and marketing, ensuring our salespeople and consumer facing teams have the tools and resources they need to deliver on our plan. The key to regaining 10% in the more profitable sales mix of fertilizers and seeds is our strategy to engage consumers earlier at the very start of the season. We will front load our marketing and promotional spend to drive early consumer traffic and augment it with execution at the field level and with the cooperation of our retailers. Given the economy, retailers are concerned about foot traffic, especially early in their fiscal year. Lawn and Garden plays a critical role in driving a high percentage of their overall transactions in the spring. Our brands are the catalyst for their early foot traffic and sales. A third of our annual business occurs in March and April historically, confirming it's a critical time to engage with consumers. We also know that consumers who make their first purchase before May spend twice as much in the category. Our retailers are committed to joint promotions, advertising, and other activities. The combination of our media, retailer media, and price promotion has a three- to five-time multiplier effect on POS lift versus promotion or media alone. Look no further than what we did this fall. In a two-week period, we executed joint efforts on our fall fertilizer business with a key retail partner. The result was over a 50% increase in POS units from prior year, a microcosm of what we expect this spring. I want to emphasize that we'll be driving attachment with our brands in live goods, soils, plant food, and controls, too. It's important to remind you that live goods continues to be a key category for us and continues to grow at rates faster than many other lawn and garden categories. When consumers buy plants and add products to their carts, they mostly buy our brands. We will undertake promotions and campaigns on the benefits of gardening too. Inflation is an opportunity for consumers to grow food at home, and anticipated product shortage due to drought can further encourage more DIY planting. I want to address gross margin. Due to a variety of factors in fiscal 22, our margin rate declined for the second consecutive year and is now nearly six points below its historical norm. We expect a further decline in fiscal 23. This is not acceptable. We have line of sight to meaningful margin rate improvement by the close of fiscal 24, and Dave will talk more about this in his comments. We believe we can get gross margin back to historical levels through a softening of commodity costs, supply chain efficiencies, and productivity improvements with trade. But if we still have a gap, we aren't ruling out pricing to get gross margin back where it needs to be. Let's turn to Hawthorne, my third theme. We have a number of strategic levers we could pursue with Hawthorne, but we've put them on hold until cannabis oversupply issues subside. Our first order of business is to return Hawthorne to profitability. knowing that its long-term growth rates are still greater than those of our core business. That's the big reason we got into this business in the first place. But for now, we've given Hawthorne an aggressive profit goal. Given we expect sales to be modestly down for the full year, we will get Hawthorne's profitability back through cost reductions alone. I told you last quarter that I believe we could achieve savings of $65 million in Hawthorne. We started work in fiscal 22 by closing multiple distribution centers, selling assets, and reducing the workforce. More cost efficiency efforts are still underway. Hawthorne will operate as a business unit, much like our lawns, gardens, and control business units. This will allow us to capitalize on the synergies of the parent company and significantly drive operating efficiencies. We will absorb Hawthorne into Scott's Miracle-Gro in a manner that preserves its unique culture and core strengths because we believe in the business model and its long-term potential. Customer-facing teams will continue to work directly with hydro retailers and growers. No other company can do what Hawthorne does. We are the partner to growers. We understand their challenges and we have the products and solutions to help them be more efficient, productive, and successful. We also know as does everyone else in this industry, that things are beyond tough. Many players are just trying to survive. Oversupply, along with inconsistent state regulatory approaches and a lack of federal action on safe banking, 280E, and other issues are contributing to the prolonged downturn. This is what I have to say directly to our Hawthorne customers. We are not abandoning ship. We are tightening up but not giving up. We'll ride this out with you and be ready for the market when it rebounds, and it will. The U.S. cannabis industry matters. Its economic impact on the American economy is nearly $100 billion this year and is expected to rise to $158 billion by 2026. It supports just over half a million full-time jobs, and more people are consuming cannabis with expectations of around 71 million consumers By 2030, more states continue to legalize it in some form. Thinking about the immediate opportunities ahead for Hawthorne, you can expect us to continue to innovate with Govita and capitalize on the upside of the AgriLux WEGA LED technology that we launched in early 22 for the professional horticulture space. In the short time since its launch, The WEGA has delivered over $60 million in new pro-hort sales and catapulted its market share in the LED greenhouse growing space. Tightening up Hawthorne includes rationalizing the lighting brand portfolio. We will exit high-pressure sodium and high-intensity discharge lighting to focus on LEDs, where this industry is moving because of the energy and cost savings. The business community as well as consumers are increasingly focused on sustainability, and this fits with where things are headed. We will also exit the Lux brand as a continuation of the portfolio reduction that began this summer with the sunsetting of Sun Systems. When we acquired Lux, the cannabis market was in a much different place. Our strategy was to expand upon our industry-leading Gevita brand, The Lux team improved our marketing savvy to growers with credible influencers and brought us technologies that can be integrated into our Gavita offering. But we believe the Wega can be the mid-tier option as a replacement to Lux. I'll now address a few elephants in the room. My family is the largest shareholder in this company. This is more than a job for me. This company is my family legacy. I've been part of this business most of my life. and I'll do what it takes to set this company up for ongoing success and long-term shareholder value. You have my commitment. I will and have been making tough choices. I will do what is required. Regarding the dividend, we have no plans to touch it based on what we see today. The truth is that cutting the dividend entirely or even by a percentage does not move leverage that much. We've heard feedback from investors around this topic. Most of our largest shareholders have told us in clear terms that we should not cut the dividend unless absolutely necessary. And here's what I think about issuing more equity. Based on our current view, I do not believe it will be necessary. As always, we will evaluate our options and do what is required. Regarding the concept of selling assets, we've looked at it and will continue to do so. But given the circumstances and other considerations, it's not optimal for our company right now. Our board will explore these kinds of opportunities on an ongoing basis and determine if and when it's in the best interest of our company and shareholders. One final item is an update on our search for a permanent CFO. We have focused on external candidates who are innovative thinkers, have deep experience, and are capable of working with our team. We are close to making a decision. I want to thank Dave for stepping in from the boards. I asked him to serve as interim CFO because he knows our company well and is a talented financial operator. He's brought tremendous value and provided the financial leadership our company needed in this transition period. I know it's come with a great deal of work and stress. Words cannot express my full appreciation for his partnership and support. I'll close with this. We continually talk to our largest shareholders and take what they say to heart. We are making changes across the organization and creating stronger conditions for the success of our core business in addition to reimagining Hawthorne. At the same time, we're highly confident in our brands and that of the consumer. We have embraced our reality and evolved accordingly. Dave, I'll now turn it over to you. Thank you.