Good afternoon, everyone, and thanks for being here. I'm Gaurav Jain, Global Tobacco and Cannabis and EU Small and Mid-Cap Companies. With me here is Matt Garth, Scotts' Chief Financial Officer. Thanks, Matt, for being here.
Yeah, thank you, Gaurav.
Thank you. Matt, just to start out, you know, you started with Scotts this year. The company was, it has been highly levered. A lot of investors would say it's a special situation. What attracted you to the opportunity, and what do you see at Scotts?
Yeah. First and foremost, again, thank you for the opportunity. I am an avid gardener, a lawn enthusiast, and that took place over the course of a lifetime. There is a passion and a love interest that people associate with lawn and garden, and I shared that even before Scotts reached out to me. Looking at the situation, probably the way most people see it today, and I know you've written this way a bit, some question marks. I've seen it as a great opportunity with a highly recognizable branded company that has some things we need to contend with, leverage being one of them, margin recovery being another. We have some places that we can improve upon and position for strength in the future.
So if you're kind of a corporate leader and you're sitting back and saying, "I want to be challenged, I want to be excited, and I, I want something that's germane to what I appreciate and I do every day," yeah, Scotts Miracle-Gro, for me, was a, was a home run.
Sure.
So I, to your question, am extremely excited to be here, and for the past 10 months, you know, working with Jim and the rest of the team, getting to know all of our associates across the company, it is a phenomenal place to be with a differentiated culture that I'm now proud to be a part of and represent. So it's been great.
Sure. Thank you. Now, at your Q3 results, there were a number of interesting comments you made on the call. So first of all, the company cut guidance quite significantly this year for EBITDA, and, you know, you highlighted the weakness in consumer, Hawthorne was taking slower to recover. And then you had a lot of interesting markers for next year, and I think you almost highlighted a $3.5-$4 of EPS potential next year. So could you just actually explain to the audience who are not that familiar with Scotts, you know, what exactly has happened this year, and then how do you see massive EPS recovery next year?
Okay, so let's condense a kinda hour-plus conference call into a few sound bites. We came into 2023 expecting growth year-over-year. We expected, one of the things that people talk about is a 10% units growth in our lawns business versus 2022, and that would have been getting back about half of what we lost versus 2021. We expected Hawthorne to also kinda hold its own, and we expected the rest of the portfolio on a unit basis to be flat. What we've seen so far this year is a change in that mix. So right now, I think overall POS is probably down about 1% versus last year. That's a combination of really good performance in gardens and soils and controls, offset by weakness in lawn.
We just didn't see in lawn this year the consumer take-up that we were expecting. So those of you who are looking at your analysis, beginning of the year, first half of the year, really superb execution from the team in every single category. We positioned ourselves extremely well with all of our retail partners. That led to a second half approach where we were locked in. We had media capable to help bring consumers to the marketplace and take stuff off the shelves. Didn't happen, and we talked about on the call, and I think a lot of you have seen in other retail conversations, what's taking place with the consumer, where they're putting their dollars.
They are price sensitive, they are focused on experiences, they are traveling, and for us, that means they're spending more time out of the home, and so therefore away from their lawns and away from their gardens. So that set up kind of a need to readjust our perspective for the second half of the year. And as Gaurav points to, while we were doing that, I put out a marker for 2024 to say, "Well, this was a tough year." I think, and I don't know what your analyst is for... What your estimate is for 2023, I apologize, but consensus, kind of $1-ish. You know, you back out the one-timers, it's probably $1.25. Whether we overdeliver in Q4 or not, I said that on the call, I'll say it here again today. I'm less concerned about.
I am acutely focused, and the rest of the organization is, on delivering the most value in 2024. Now, Gaurav's asking: Okay, what does that mean? It means some modest margin recovery, and we're gonna end the year kind of 23-ish%. We're pointing to a 2024 that would see margins in the 25.5% range. We see some top-line growth coming. I said mid-single digits, but the range that we gave on EPS says that's kind of the range with growth year-over-year and without it. So that explains sort of top line, your gross margin. SG&A, we said, would be down in dollars, and we said we'd be kind of closer to 14-ish% than 15%-16%, which is how we would normally model it.
And so that helps to drive some of the gap, I think, that people were asking about. Lower tax rate, lower interest expense, all delivers higher profitability year-over-year. Now, the question is, that everyone's asking us: Well, you just said you can do $1.25. How are you going to get the $3.50-$4? And it is coming from, again, so expected top line growth, working with our retail partners, extending our positions on topics that are meaningful to us and consumers. Looking at ways to continue to expand margin. We have a lot of those levers in place. We will continue to attack those and then just good old-fashioned blocking and tackling on SG&A. We don't expect that we will need to pick up the spend in SG&A on a year-over-year basis.
Sure. So let's now unpeel a lot of what you have just said in a number of in the next few questions, but let's first start with leverage. That is one of the key topics in the minds of a lot of investors. So leverage right now, you know, I think one thing to keep in mind is that you take last four quarter-
Correct.
Average net debt number, not last quarter net debt number, but you take last 4 quarter net average net debt number and divide it by trailing 12-month EBITDA. That is almost close to 7x, if I'm not mistaken. So what's your deleverage plan going forward? You said on the call that you want to go down to 3.5x as quickly as possible. So how long do you think that will take?
So you're projecting end of the year net leverage in that number?
It was about 7x.
Okay, fine. That's your projection. Got it.
Right.
I'm not going to argue with you. Let's just go with that.
Right.
This is a fireside chat.
Right.
There's heat everywhere.
Right.
So let's just say that's your ongoing assumption.
Mm-hmm.
The math, you're right. It just doesn't move as functionally favorable as we would like it to. So we're going to pay down $300 million in debt this year. We'll pay down $300 million in debt next year.
Mm-hmm.
Because you're averaging in that net leverage calc, doesn't really start to impact you. When we start to talk about the dividend-
Mm-hmm.
The same rationale.
Mm-hmm.
The target ultimately is to get ourselves back down to 3.5 and below.
Mm-hmm.
Timeline to do that, it feels like it's going to be in the 2026 range. Now, that's a while from now. The execution along that pathway includes margin recovery, getting our performance back to where we want it to be, delivering exceptional levels of cash flow-
Mm-hmm.
Turning that into debt paydown. That's what we'll be doing year in and year out. And so the way points, you're right, kind of starting north of 6. We now have renegotiated our banking agreements, our credit agreements. Our banking partners work with us in a very forthright manner. We now have room where we don't need to optimize on a quarter-by-quarter basis. We are looking through the years on a longer-term basis, to make sure that the outcomes deliver the most profitability, the most value, and the most cash flow, so that we can delever faster.
Sure.
I kind of threw out the 26 time frame there. If we can do it faster, we absolutely will.
Mm-hmm.
It comes from, yes, work on the numerator, which is the denominator side, but... I'm sorry, which is the debt side, D. But the averaging of that kind of makes it harder. You really need to drive that EBITDA to deliver on the denominator side.
Sure. So is then the conclusion that the primary focus of free cash flow generation will be for deleveraging and not for M&A, and that the CapEx spend would be almost minimal? Because I don't know what the capacity utilization is right now, but probably in the 70% range.
Yeah.
Your growth, you really don't need growth capital for years to come.
So, a few components of that. One, the overall philosophy that Jim and I have is one of a balanced approach. Certainly right now, with debt being at the levels that it is, we cannot be balanced. We are delivering debt paydown and returns to shareholders. You'll see us kind of year in and year out, generate $300 million in free cash flow. In a normal time period, that's probably going to, you know, half debt paydown or some type of M&A potential and direct returns to shareholders. If there's nothing from a M&A potential, it'll just all go direct returns to shareholders. CapEx, we kind of target around 2% of sales, which means next year we'll be looking around $7 million if you use this year's sales. That seems to be a good place.
We actually have invested a lot over the past couple of years, and so the tail is behind us. We've absorbed the bubble of getting our operations where we want them to be, and as you said, we're right now running about 20% below where we'd want to be in U.S. consumer from a production perspective. So those assets are in a good place. M&A takes on a whole host of different approaches. Are there things out there that Scotts Miracle-Gro should own? Yes. We are an exceptionally well-positioned brand leader. We have an unparalleled distribution network and capability to source, produce, and deliver products that no one in our space, and I think a lot of other competitors in retail, can't match.
We have an unparalleled position with our retailers in terms of depth and meaning of our product category to what their consumers are looking for, deriving that foot traffic, being a part of their long-term solution. So there are a lot of brands and products that fit into that mold that we can look at over the longer term, but for right now, 100% of the free cash flow earmarked for debt paydown. The open question is on Hawthorne. You've heard Jim and I over the last two quarters talk about Hawthorne as the cannabis side of our house, for those of you that don't know, finding a strategic solution for Hawthorne that does not involve a significant cash outlay, we're working through doing that. We have a very strong position in Hawthorne, for those of you who don't know.
When you think of a greenhouse, all of the infrastructure around a greenhouse, being able to develop the genes, the nutrients, and the overall systems to produce the highest quality plants at the lowest possible dens-- or highest possible density at the lowest possible cost. That's what the combination of lighting, consumables, other durables, and a great understanding of genetics does, and that's what Hawthorne is. So that business, again, a very strong position that we can leverage with other partners. Those conversations are ongoing and it centers around doing some type of transaction, cashless in nature, again, where you're combining assets, finding some great commercial arrangement to make the most out of what the situation is, and position that business for optimal value creation as people start to respond to the cannabis space again.
Sure. On the $300 million free cash flow number that you are talking of, so earlier, Scott used to say that $300 million free cash flow is like a per annum number on a longer term basis. But this year and next year, the total free cash flow generation will be almost $1 billion because-
Yeah.
of cash release from inventory.
Yep.
Is that still, like, the $300 million is a long number?
It's $1 billion over 2 years.
Right.
Right? So your underlying free cash flow is about $300 million.
Right.
We came into 2023 with about $400 million of excess inventory.
Mm-hmm.
That's why the production rate is lower.
Right.
and so we're going to eat half of that in 2023, half of that in 2024. And by having a lower production, you're going to sell it through, and so that's what's creating the higher working capital release these two years.
Sure.
Yes, the target, by the way, is still $1 billion over two years.
Sure. And then this flows into the margin expansion question. So, you know, there is clearly, you know, urea prices you have cited. You know, they are- they were at $800 or $900 two years ago, now they're at $350. And, you know, we did this analysis in one of our reports, I think last year, where it was almost like your margins had an inverse correlation to urea prices that, you know, it was always, like, higher highs and higher lows that you had, depending on how the urea cycle went. So first of all, is that correct? It's simplistic, but is that the right way to think that you could actually go beyond prior highs if urea prices remain where they are, number one.
And number two, within that, clearly, cost of what you are selling is less than sell-through right now because of the inventory dynamics. Your capacity utilization is lower, which means that your unit costs are probably higher than what they will be, just as inventory runs down.
Correct.
Can you just explain how much could that lead to margin expansion if your capacity utilization went up to in line with sell-through trends?
Yeah. So there's a, there's a number of ways to explain this dynamic. First and foremost, we took on 1700 basis points of inflationary cost increases over the past couple of years. We fully offset that with pricing. So I know that there's a pricing question here.
Right.
You know, pricing this year will be up mid-single digits, but that's embedded in 17% price increases over the past couple of years. When you get to what's been happening on a net margin impact from these commodity increases versus the pricing, which isn't margin accretive in itself, right? It's just dollar for dollar.
Mm-hmm.
To get the margin back, it's been 500 basis points we've been talking about between where we are now and where we want to get. Part of that bridge back or build back is 500 basis points of additional margin coming out of raw material costs. So that will happen, as you said. One, we're putting in a layer of low-cost inventory now for 2024, that is. That will work itself out. By the back end of 2024, we'll start to see the benefit of that. And in 2025 is when you'll meaningfully see the margins start to accrete higher based on those lower raw material costs.
The utilization rate improvement, that will also happen in effect 25?
Correct.
So, like I-
Which is the other part of how we get back.
Right.
Right? So you're now pointing to a 25, 26, where what we said is target margins for this business are 30+%.
Mm-hmm.
Coming out of this year, 2023, 24%, looking at 25-ish% in 2024. Yeah, you got room to go, but cost has moderated-
Mm-hmm.
-significantly.
Mm-hmm.
We're going to be producing more, which all will accrete to margin expansion.
Sure. So 3.5-4... While the EPS jumps from whatever number of people have, $1, 1.5, I actually have closer to 2, so I need to go back and look at the model.
Uh, right.
But it goes up to 3.5-4. There is still a massive jump which could happen even after that, because the margins, as you are saying, will continue to improve. It's all else being equal, and I know that's a very big statement to make.
All else being equal.
Sure.
Right. So I get this question all the time, which is this is a company that earned $9 and change. You know, how are we now earning roughly $1 per consensus?
Right.
Yeah, I mean, you and I have talked through a lot of the dynamics-
Mm.
-that are happening post-pandemic. We're absorbing a lot of costs. As you can tell by our work on Springboard, we've taken out or will have taken out north of $300 million into 2024. So, we are acting on everything that we can control across the company very rapidly. Is there more to do? Yeah, and we're going after it, right? That was what Springboard 3 was all about. But as we move forward, being leaner, having the proper positions around our brand strength, that will all accrete to a margin level that is consistent where we were, which is—sorry, where we think it should be over the long term. Fair case.
Sure. And now coming to Project Springboard, this is Springboard 3, and, you know, you have already cut a lot of costs. And, you know, and, you know, one time when I had the conversation, I think about a year ago, then, what I learned is that there had been, like, almost a 25%-30% reduction in the number of personnel at the headquarters.
Yeah.
So that is a very high number, and still you have Springboard three. So how lean is the organization now?
Let me give you an indication of what happened, and we said it in the third quarter call, but I've gotten much more comfortable with it over the past couple of weeks. Hawthorne, one example, Hawthorne was a business that was approaching $1.5 billion in sales. It had a distribution, sales, operations network that was built for continued growth, so kind of in excess of $2 billion. This year, Amy will jump out of her chair, but it's gonna end up the year, kind of like $500 million all in, including the ProHort business. That, that's a quarter of what it was built to do. So when we talk about Springboard one and two, which was kind of $200 million-ish, north of half of that all came out of Hawthorne.
Just resetting the network back down, taking out positions that were related to growth that wasn't happening. And so are we leaner? Absolutely. Are we holding back positions now for growth? Not necessarily. I think that there are efficiency optimization, optimizations that we're going after. There is job stacking that is happening, there's responsibility management. There is, what should we be working on versus what we are working on. All of those initiatives are underway to help get further costs out of the system, and that's part of Springboard three.
Sure. Now let's go into each of the businesses, the U.S. consumer business and the Hawthorne business. So the U.S. consumer business, in the pre-COVID, it used to grow 1%-2%. COVID, there was a massive jump. Everyone, including the retailers, over projected growth. We have seen it across industries, and then since then, there has been a COVID unwind. What do you think is the steady state growth of this business? Is it back to 1%-2% growth, or there will be a continuous unwind as more and more work from home happens every year, and the percentage of work from home actually keeps on decreasing?
It's okay. I was hoping that people would work from home more. I love it, but that's counter to anything else you'll hear, I'm sure, from the rest of the senior leadership in this conference. The way I write it on the whiteboard, when Jim and I talk, the business has a opportunity to grow at 2%-3% a year. That has been demonstrated in a 1%-2% growth rate over that time period, pre-pandemic time period that you're talking about. What's the difference? The difference is getting lawns into a position of stability, continuing to grow in gardens, and penetrate more deeply with consumers, which we are, and bringing innovation that should be worth about 100 basis points of growth year in and year out to the table.
So we're not far off from that, that prior trend. We're not expecting 6%-8%, right? But it, it is north of where it was historically. And the solve for lawns, and you heard Jim talk a lot about this, and being a person who's passionate about my lawn, I am a four-step user. I apply minimum four times a year, and I know what I'm doing. The, the next generation, bringing them along, getting them to understand that the care and maintenance and the, the feeling of connecting to a beautiful yard takes a little more, and you're in the midst of that generational change right now. So millennials are coming in, they're all buying homes. They're overwhelmed with costs, and, and yet they're still wanting a lot of outside experiences. That will all moderate over time, right?
So people will look at their yards again, and that will help the lawns business. Gardens, again, people have been, whether it's flowers, vegetables, all through our Bonnie network, into soils and, and having plants that are thriving, in their yards, the business has been performing very well. And then you get into the whole control side. We feel very good about that and the future prospects of that as well. So you, you have this dynamic where get lawns to settle, continue to grow in gardens. That leaves you with a Hawthorne business, which for right now, let's just say you have to assume it's not gonna have any growth.
Sure. Could you talk a bit more about what has happened in the lawns business? You know, it seems you have lost share versus private label. So why have you lost share in lawns and not in gardens? What are the price gaps? How much do you need to close down the performance in lawns?
Yeah, let's make a correction there. Lawns, you need to separate into fertilizers and seeds... In fertilizers, we did not lose share. We actually gained share. If people are going to pull a fertilizer product off the shelf, they were pulling a Scotts bag. We also participate in private label, and we saw our private label business down kind of twice what we saw in our branded products. We have more than just hearsay in understanding what was taking place there. On the seed side of the business, and this goes back to some of the early commentary you and I shared around the sensitivity of the consumer, where they're putting their money, where they're finding value. On the seed side of the house, we had some instances where we were basically kind of 100% higher than a competitive product.
That normal premium should be in the 30%-50% range, so it was kind of 2x what it was historically. So that, that needed to be worked on, and that value needed to be driven back to the consumer. And so the share there are feeling temporarily lost because of the fact that we were kind of mispriced. But you've already seen so far in the second half of the season, there have been price adjustments, and the numbers of earning were favorable to branded products, our products, again, because people know that that's the product that's gonna work.
Right. So as we look ahead now to FY 2024, and in terms of like if you were to separate the volume and price mix dynamic, so is it fair to say that price mix will probably be negative as we look forward into FY 2024, but the volume trends will be much better? So the top line growth might not be much, but there will definitely be sort of a margin expansion which happens, which takes us to this $2.50-$4 kind of EPS number.
Let me, let me do it in my way. I expect, based on the conversations we've been having with our retailers and how the team is motivating around 2024, to see higher volume in 2024. With that will come a decent mix, meaning it should be neutral to slightly positive or negative. So let's call it neutral on a year-over-year basis. Which lends to your last question: What happens with pricing? Pricing, too, what we're seeing right now is, the areas where we are actually lifting price are being offset by price declines. And so outside of some programs which we naturally run, the table speak is kind of flat, but when you get through the programs and how we're moving with our retail partners, you would see pricing down year-over-year, to your point.
Sure. Okay. I want to just open it up to the floor if there are any questions. Otherwise, I have a longer list of questions here. Over.
Matt, can I just, I'm gonna ask a question because something that's kind of hard to have some insight into, but just with the dynamics this year, with some of the, what seem like some supply load earlier in the year to help with some of the debt covenants and whatnot, where you talked about working with retailers to accomplish that, and then kind of the weakness in sales that we've talked about. Can you kind of give us any insight as to what retailer inventories look like, what retailer supply looks like, and what that means, and how you're thinking about that for 2024?
Yeah. Yeah. Gaurav, thank you. Retailer inventories are up right now, and it comes from a few different things. One, Walmart has a higher SKU position, which is beneficial. It's mostly on sort of the control side as we go late into the season. And then as we look at Home Depot, you're seeing that they also, and we talked about this on the call, we had a large load in, kind of like a few days after the quarter. It could have swung in the quarter. So they actually have a higher than what we thought position, but we do believe those are gonna get worked down. You're starting to see that in the order pattern here today.
It is commensurate with ending the overall year down from a retailer inventory perspective, which I think if, you know, earlier in the year, we would have told you it'll be down maybe high single digits. It's probably mid single digits where we're gonna see retailer inventory positions end. What does that mean for 2024? Well, it means you're starting with potentially a higher inventory position going into 2024, which the governor there is what we do on the production side. We're not going to compromise our free cash flow position. We are anticipating that we would bring some selective production back, but we're gonna moderate that basead on where we see retailer positions going into the year.
So, look, coming back to the, you know, overall, you know, question of the enterprise and, and the leverage and, you know, what are the potential options that are there, to reduce the leverage. So, you know, you have spoken about Hawthorne, and you are evaluating strategic options around Hawthorne. But as you know, as you said, you know, Scotts, the core business is a great business, you know, great cash flow dynamics, and you could argue leverage is temporarily high. So if there were to emerge like an opportunity to get an external investor within the core consumer business, is that like something which you are also exploring?
Let me give you the high level answer, and then I'll dig in. One, the work we did with our credit agreement gives us, no one can ever say ample space. Gives us room to maneuver and optimize across the year. Two, gives us room to continue to pay the dividend and make the investments necessary to sustain increasing cash flows in the business. Does that mean that I feel the pressure is off of us from a credit perspective? No, because the numbers tell themselves, to your point. It's a very highly levered position right now versus where this company should be. We recognize that, but it's temporary. Equity is permanent. And I guess it's the same statement on the dividend.
I don't wanna make a near-term, short-term event to solve a short-term issue, but will have a long-term consequence for current shareholders and for the company going forward. So no, I'm not looking at an additional equity raise, nor is Jim. And we believe with the credit agreement that we have in place, the cash flows in the company and our path forward, that we're able to continue to pay the dividend, pay down debt, and return to the type of profitability that investors expect of us.
Sure. Now, you know, you mentioned Hawthorne. You have Hawthorne, and then you also have equity investments in some cannabis entity like RIV Capital, et cetera. So when you're looking at a transaction around Hawthorne, it includes all the cannabis-facing businesses, or it will just be Hawthorne, and you could still continue to own?
It might. Again, there's a lot going on right now that we are in discussions about. I would say it this way, Gaurav, and maybe it was tied to your last question, and I stepped over it, and I didn't mean to. Is the company looking to motivate assets of value into areas where value can contribute back to the company? Of course.
Mm-hmm.
Are those assets valuable? Well, kind of the discussion that Jim and I have been having with you all over the last 10 months has been there's modest value in cannabis, if any. And you saw that return in a heartbeat with the note that was sent from HHS to the DEA on, you know, moving the scheduling of cannabis. These cannabis equities were up 20%-25%, and we participated as well.
Mm-hmm.
There is excitement around that, and so we're continuing to monitor that, and we'll make decisions as we move forward. But ultimately, Jim said it on the last call, the best place for Hawthorne to be is as a separate standalone company.
Sure. And, you know, let's say that, and, you know, last question, and then we'll go to the breakout session. So, you know, there's clearly a lot of focus on immediate issues, you know, within the company, leverage and all. But let's take a long-term view of your gardening business as well. You know, it's a great business, and, and, you know, we keep hearing about a lot of trends around smart gardening, automated gardening. Are you still looking at all those long-term growth optionalities, or the focus is just so much on getting things in order that all those longer term-
No, no, no, Gaurav, that is... It is the opposite of what we're doing. In everything inside the company, we are trying to keep people motivated around the future. The investments in R&D maintain, the investments in our capabilities maintain, understanding the consumer, growing. And so we are doing everything for the lawn and garden of the future that is expected of us because that's our franchise, that's our business. As we talk about lawn and garden, my view, that defines lawn and garden for the consumer. So making sure that we have appropriate positions, appropriate understanding, appropriate innovation, we're going to continue to invest in that.
Sure. Thank you. We are out of time here. Thank you so much, Matt-
Thank you all.
-for your time off.
Yeah, appreciate it.
We'll be going to the breakout session, so please come there, and we'll see you there.
Great.
Thank you.
Thank you.