Scotts Miracle-Gro Company (The)

Good morning, and welcome to Scott's Miracle-Gro's third quarter 2024 earnings webcast. I'm Amy DeLuca, Head of Investor Relations. With me this morning are Chairman, President, and CEO Jim Hagedorn, and Chief Financial and Administrative Officer Matt Garth. Jim will provide an overall business update, followed by Matt with a review of our financial results. During our review, we will make forward-looking statements and discuss certain non-GAAP financial measures. Please be aware that our actual results could differ materially from what we share today. Please refer to our Form 10-K, filed with the SEC, for details of the full range of risk factors that could impact our results. Following the webcast, Chief Operating Officer Nate Baxter and Hawthorne Division President Chris Hagedorn will join Jim and Matt for an audio-only Q&A session. To listen to the Q&A, simply remain on this webcast. To ask a question, please join via the audio link shared in our press release. As always, today's session will be recorded. An archived version will be published on our website at investor.scotts.com. For further discussion after the call, you are invited to email or call me directly. With that, let's get started with Jim's business update.

Welcome, everyone.

At the start of our fiscal year, we outlined growth targets and financial metrics for fiscal 24. With three quarters of the year behind us, we have greater visibility into how we're performing against them. It's clear we've accomplished almost everything we set out to do this year. Despite an uneven and unsettled weather season, we will improve upon the financial metrics that matter when it comes to driving value and establishing a growth foundation for next year. They include market share, sales and point of sales at consumer level, free cash flow, debt reduction, leverage improvements, gross margin, and EBITDA. We've also held the line on expense control and continue to operate as a leaner, more cost-efficient organization capable of investing strategically to drive volume and sales. To that point, we not only increased our media spend over prior year, but we also efficiently focused those dollars to maximize POS opportunities in response to external factors. The peak of the season is a perfect example. To overcome its sluggish start, we injected 33% more into marketing and sales activities. This contributed to POS growth and profitability in Q3. Inventory is another pain point that we dealt with this year. When we came out of COVID, we were significantly over-inventoried and facing major absorption issues. We committed to drawing down inventory to $600 million this year, and we'll meet that goal. Through Q3, we're just north of that number and below pre-COVID levels when adjusting for inflation. This was a difficult undertaking, but our operating community made it happen. When you look at the totality of our performance, Fiscal 24 is a story of considerable progress. We know we have more work ahead of us to achieve sustained growth, significant margin improvement, and further debt reduction. And I'm holding off declaring full victory in our recovery until we've delivered on each of those things. But I can say with conviction that we're well down the path to getting there. Through the first nine months, U.S. consumer net sales are up 2%, and unit POS growth is plus 10%. We expect a strong fourth quarter and are reaffirming our guidance of 5% to 7% net sales growth for the lawn and garden business. We're also tracking to our company-wide adjusted EBITDA guidance of $530 to $540 million, a significant profitability swing of plus 20% over the last year. Even though we set our sights on a more ambitious EBITDA target this year, it still was a damn good year. Our growth is enabling us to achieve our two-year goal of generating $1 billion in free cash flow by the end of fiscal 24, and we'll pay down at least $350 million in debt for further leverage improvement. Leveraging Q3 was down to 5.5 times adjusted EBITDA, a far cry from the over seven times we faced less than a year ago. By year-end, our leverage will fall below five times. One of our highest priorities has been gross margin recovery. We know it's a multi-year effort to get back to our historic mid-30% range. So far this year, we've improved gross margin by 260 basis points. This compares favorably to our full-year target of 250 basis points. It will also enable us to recoup more than a quarter of the 1,000 basis point margin decline. A big part of our gross margin decline is attributable to deliberate actions we took in the past two years to drive significant sales and free cash flow. We had to build the financial wherewithal to navigate our leverage situation during our financial crisis. Those actions involved trading pricing with retailers in exchange for new promotions, listings, and shelf space to drive volume. This cost us margin points but positioned us for share gains. The moves we made were the right things to do, and the benefits of that strategy are evident in our 2024 performance and the foundation for future growth that we've established. Our share gains in the consumer business are a big part of our recovery story. We knew the trade-off with retailers would bring us lifts in share, but even we were surprised by the level of these gains. In a flat to declining lawn and garden market this year, we captured nearly 700 basis points of share at our biggest retailers. This spans our entire portfolio. And when you exclude mulch, our share gains remain significant at plus 300 basis points. In my entire career with Scott's Miracle-Gro, I have never seen a time in which we took so much share in a single year. And I want to thank our retail partners. This is a testament to our brands and our proven ability to execute and adjust to external factors. No one has what we have in terms of firepower. Our sales, marketing, and supply chain teams are unmatched. And the health of our brands is as strong as ever. A recent study showed that consumer perceptions of trust and safety increased this year with the Scotts and Miracle-Gro brands. Our ability to drive growth through innovation is evident in the new Miracle-Gro Organic Soils line that was supported by a well-received marketing campaign featuring Martha Stewart. At the close of Q3, it was the single biggest driver of our unit POS growth in soils and has been the catalyst for capturing significant market share gains in the overall soils category. Through our retail partnerships, we created success for them and us. Our marketing initiatives and joint promotional efforts brought people into the stores in significant numbers, outperforming tepid retailer foot traffic. We do the advertising, point people to their doors, run joint promotions, and have our salespeople and products on the store floor. Our model works, and no company in Lawn & Garden can match that. Now let's talk about the fourth quarter. We're comfortable with where we're headed. We expect a strong fall supported by advertising centered on higher margin lawn and control products, with targeted price reductions on key grass seed SKUs. Promotional activities will play a key role as well. We'll heavy up on them during the Labor Day weekend. Fourth quarter is also a time when we negotiate with retailers for the spring. Pricing across our portfolio will be a part of that discussion. Inflation has hit everyone hard, and our pricing has not kept pace with our costs. We will be very modest in our approach to pricing next year given the concerns of our retailers and the pressures they have on their own margins. We do expect pricing to contribute at least 1% to net sales in 2025. Longer term, our pricing must keep up with the rate of inflation. Shifting to Hawthorne, the business has been a cash flow contributor and is making money, posting its first profitable quarter in two years. Its strategic move from distributing third-party products to focusing solely on its market-leading brands led to a 6% increase in branded sales year over year and a 144% increase in profit. Hawthorne also continues to develop industry-leading innovation and has just launched three new LED products under the Govita brand. Hawthorne is leading a turnaround in the industry supply side, and we're seeing some fast followers try to mimic our business model. Chris and his team have explored numerous options to create partnerships or separate Hawthorne from SMG. It's been a lot of work on their part, but we've concluded it's better to keep Hawthorne where it is for now, especially when it's profitable, while we create the building blocks for a longer-term solution. At our investor day a few weeks back, we discussed our financial blueprint for the next three years. It's all about getting the company back to operating on all cylinders. You can get the details on our investor website, but here's the abridged version. Matt and Nate built a three-year plan that is grounded on driving an average of 3% annual growth through innovation, pricing, and expansion of our retail and direct-to-consumer channels. We're targeting above 30% adjusted gross margins and adjusted EBITDA of $600 million with further leverage reductions below 3.5 times. These are reasonable goals that will deliver considerable shareholder value, but I believe we can do better. I'm challenging and incentivizing the team to get leverage below three times in this timeframe through further top-line and bottom-line growth and outsized cash flows. We'll increase investments in our business, brands, and capital improvement. Next year, we'll put an incremental $25 million into our brands and innovation. And just this month, we announced that Martha Stewart will be our honorary chief gardening officer to advise us on gardening trends, new gardeners, and products. She'll also be the center of our gardening campaigns in 2025. I view fiscal 24 as the bridge year in the transition from financial strain of the past two years to a state where we can achieve the type of returns that our shareholders deserve. I credit the management team, Matt, Nate, and Chris especially, for working together not only to expedite our progress, but to deliver on our commitments and get us to a great place for next year. I want to thank our associates for their resilience, and our banks, retailers, and the board of directors for their support. The past two years have been the most difficult in the history of Scott's Miracle-Gro, but we're approaching our business with renewed optimism, enthusiasm, and determination. I welcome the opportunity to have you continue with us on our journey.