Scotts Miracle-Gro Company (The)

Good morning and welcome to the Scott's Miracle-Gro Company's Q2 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. I would now like to hand the call over to Investor Relations Lead for Scott's Miracle-Gro, Amy DeLuca. Please go ahead.

Thank you and good morning. Welcome to the Scotts Miracle-Grove Second Quarter Earnings Conference Call. Joining me this morning are Chairman and CEO Jim Hagedorn, our President and Chief Operating Officer Mike Lutemeyer, Matt Garth, our Chief Financial Officer, and Chris Hagedorn, Group President of Hawthorne. In a moment, Jim, Mike, and Matt will share some prepared remarks and then we'll open the call to your questions. As always, we expect to make forward-looking statements, so I want to caution everyone that our actual results could differ materially from what we relate today. Please refer 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. I've already scheduled time with many of you after the call to fill in any gaps. Anyone who'd like further discussion can call me directly at 937-578-7000. 5621, and we'll work to set up some time as quickly as possible. Also, please note that today's call is being recorded, and an archived version of the call will be published on our website at investor.scotts.com. With that, let's get started. I'll turn the call over to Jim Hagedorn to begin. Jim?

Thanks, Amy. Good morning, everyone. We have plenty to cover, but if I had to narrow it down to a single theme, it would go like this. It's been a hell of a year. As rough as it was, we're in a better place. And we've accomplished it without diluting our shareholders. Considering where we started, we've made progress in several important fronts in a very short period of time. It's a trajectory we expect to continue through fiscal 23 and fiscal 24. The first half of fiscal 23 is a testament to the powerful franchise of our core business. It's a reliable generator of cash that will enable us to materially de-lever, improve cash flow, and invest in growth. Just about a year ago, we were looking at free cash flow of negative $1.2 billion. We reported misses in our sales numbers in the consumer and Hawthorne businesses. We were stacked up with significantly more inventory than we needed. Cost of goods were rising and margin was declining. Without immediate actions, we were facing near certain busting of our bank covenants. It was a tense and cruel time. But our associates responded. They never wavered or lost their way. They stayed engaged and kept their heads up. They've executed upon our plans with grit and determination. It's what we and our people do best. Today, free cash flow is favorable, improving nearly $600 million through our first half. We're reaffirming our guidance of generating $1 billion in free cash flow through fiscal 24. We're living within our credit facility covenants. I do not see leverage compliance issues going forward as we're looking at the low five times range by fiscal year end. I will restate that Mike Lukemeyer and I are pushing to do even better in that timeframe. Cost of goods is improving too. While we expect commodity costs to be up almost $100 million over fiscal 22, this is about 20% less than we projected as recently as the end of Q1. These improvements will not show up in margin rate until we work through our higher-priced inventory. We expect our gross margin rate to fall slightly below last year before achieving more significant margin recovery in fiscal 24. Through the first six months, SG&A was down $44 million due to the cost reduction and efficiency work of Project Springboard, which continues to over-deliver. Our Springboard annual savings target was $185 million by the close of fiscal 24. We're already three-fourths of the way to that target, and by the end of this fiscal year, we expect to exceed $200 million in annual savings. We'll accomplish this without cutting investments in the most important marketing and R&D initiatives. Our efficiency efforts have extended to Hawthorne, where we have significantly reduced its distribution footprint and brands. And overall, we've worked off over $400 million in inventory. We're moving into the transition phase of our recovery. We're creating balance and nearing the inflection point where we can shift from operating in a really constrained environment to having a bit more freedom to operate. Ultimately, this will give us greater flexibility to drive growth and long-term shareholder value. Looking to value creation, Mike Lukemeyer, Matt Garth, and I have agreed on four financial targets that include getting leverage down to 3.5 times or less, achieving sales growth equal to GDP plus 100 basis points, improving total company gross margin to 30% or more, and realizing free cash flow every year of $300 million or more. We also will continue to invest in innovation, marketing, and incremental growth within and outside of our core business. This can range from alternative landscapes and natural and organic products to live goods, as well as strategic investments in Hawthorne. To ensure we prioritize initiatives and approach them in a coordinated and measured manner, Matt is leading a new strategy team that reports to me and will work closely with our business units, brands, management team, and the board. Now that you have a sense of where we are in our transformation, let's revisit the first half. Q2 was the quarter we needed in our U.S. consumer business, where sales were in line with last year's record second quarter. In March, we had our best shipment month ever. Through six months, we're on par with the strong U.S. consumer sales of the same period last year. Despite concerns over consumer spending in general, our retail partners understand the importance of lawn and garden, even in times of economic uncertainty. History shows the consumer still shows up for our category. As a result, our share of shelf makes it obvious we are the market leader. Our collaboration with retailers is tighter than ever. We've developed joint promotional campaigns and backed them with thoughtful planning and aggressive early season execution. Our working media budget is up 23% over last year. The work in Q2 led to early season POS lifts in warm weather markets and product promotion attachment rates that are in excess of historic trends. Where the weather is good, and our promotions are in place, consumers are showing up, and often in bigger numbers. Important early markets like Texas and Florida struggled last year. In Q2, we saw significant POS lifts. Bonus Vest was up nearly 40% in Texas, and branded fertilizers were plus 17% in Florida. Overall, Q2 was a good quarter for our core business. Q3 is off to a solid start, In recent weeks, the weather is opening up in key markets, and with well-timed promotions with our retailers, we're seeing POS gains. In mid-April, we achieved an all-time record POS week with our big three customers at $198 million, breaking our previous record of $193 million in 2021 and eclipsing our peak week of 2022 by over $30 million. Branded lawn fertilizer units across key retailers were positive through April, up 2%, and were taking share. In growing media, the signals are strong. Mulch units are up 10% through April, and Miracle-Gro garden soil units have increased 21% in the same period. Our leadership in non-selective and selective weed control remains unchallenged with share gains at key retailers. In the Northeast and Midwest, Roundup is plus 10%. And Roundup's innovation launch, the new dual action formula, is performing above expectations. It has eclipsed $10 million in POS and has unlocked incremental listings at more retailers. The consumer reviews are category leading. Here's why I'm not worried about the weather early this season. There will be ups and downs. Just in recent weeks, we've seen great weather in the Northeast and Midwest, followed by cold and rain. Consumers ride the ups and downs. California is an example. In Q2, when heavy rains were dominant, branded fertilizer POS was negative 8% year over year. But improving weather has become our friend. In the last four weeks, branded fertilizer POS hit plus 60% in California. In April, California became the number one volume state for Roundup, at plus 67 percent. This is a pattern I expect to play out in other regions as we enter May and June, when the drumbeat of promotional activity will accelerate. We have the bulk of our media and promotional dollars ahead of us, and we'll shift the spend to where we get the most bang for the dollar. Looking ahead, the weather outlook is favorable. We've had three years of La Nina with extreme weather swings. Now we're shifting to an El Nino that is more in line with historic norms. May looks to be relatively normal in temperatures and precipitation. June forecasts are on a similar track, an indication we can extend the peak lawn and garden season deeper into the summer. These projected weather patterns are similar to 2018 when we crushed POS into the summer. I'm going to ask Mike Lukemeyer to jump in here with his thoughts.