Yahoo Finance The Scotts Miracle-Gro Company (NYSE:SMG) Q2 2024 Earnings Call Transcript
The Scotts Miracle-Gro Company (NYSE:SMG) Q2 2024 Earnings Call Transcript May 1, 2024
The Scotts Miracle-Gro Company misses on earnings expectations. Reported EPS is $-1.45 EPS, expectations were $3.33. The Scotts Miracle-Gro Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning. Welcome to Scotts Miracle-Gro’s Second Quarter 2024 Earnings Webcast. I Aimee DeLuca, Head of Investor Relations. With me this morning our 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 non-GAAP financial measures. Please be aware that our actual result 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. If you wish to participate, 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 An archived version will be published on our website at investor.scots.com.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.
Jim Hagedorn : Good morning, everyone. I'll start with my high-altitude assessment. The state of the company is good. I can't believe we're already halfway through the fiscal year. Everything we've done to get to a better place is happening, just like we projected it would when we laid out our fiscal ‘24 guidance. We told you we would achieve high single-digit growth in the consumer business and $575 million in adjusted EBITDA this year. And we'd do so while generating $1 billion in free cash flow over two years by the close of fiscal ‘24, improving gross margin by at least 250 basis points, and finding a long-term solution for Hawthorne. We've made progress on all these fronts. In fact, through the first six months, we've exceeded plan targets on key financial metrics that support our ability to deliver on our guidance.
Free cash flow is a fabulous story. It improved over $500 million from prior year, exceeding our first half target by $200 million. Our debt levels are down by more than $750 million year-over-year. The most telling sign we're in a better place is our leverage improvement. For Q2, we finished at 6.95x EBITDA, well within our covenant max of 7.7x, and better than Q1. When you consider our leverage limits, Q2 was our tightest quarter. Our banks challenged us to a tougher metric in Q2 to force us to make choices. Nate and Matt worked together to ensure the operating and finance teams navigated it comfortably. I want to thank the banks for their support in a very tough period for our company. Leverage maximums under our bank covenants will come down through ‘24, and we're highly confident we'll manage within them.
We expect to be in the fours by fiscal year end with more improvement in fiscal ‘25. We're also moving in the right direction on gross margin. It was 35.3% in a quarter, 60 basis points better than Q2 of last year. At the end of the year, we expect to be at least 250 basis points improved year-over-year with more gains than ‘25. Tight expense management remains a priority. Through the first half, SG&A was at 15.2% of net sales in line with our guidance and below prior year. Overall, I'm pleased with our performance. It's a testament to the strength of our business, decisive actions, and precise execution. Looking at the Consumer business, here are the positives. Net sales picked up in Q2 as we drove a 2% increase over prior year. Year-to-date, consumer sales were slightly lower than prior year.
This reflects how we are returning to a traditional pre-COVID shipping cadence with retailers versus last year's heavy upfront load -in. Retail inventories are in good shape. POS units through the first half were nearly 15% above prior year and 5% over planned. These lifts were due to the new listings and expanded share of shelf in exchange for investments with retailers. The day-long savings promotion in March outperformed last year's campaign. We told you these would contribute to gains, and they did. Through March, we had POS lifts across nearly all categories. Gardens was up 18%. Controls was plus 12%. Round up plus 9%. Lawns were essentially flat. Price adjustments and promotions led to Q2 year-over-year lifts , up 15% for Bonus S and 28% for Halts.
Both are early-season fertilizers. This year marked the first time in recent years we did awareness-driving advertising around Halts. We've created room for the remainder of the year and accomplished it as a smaller, leaner, more cost-efficient company. Think about what we've done. We cut nearly $400 million in annual operating experience and reinvested $100 million of those dollars back into growth drivers like media and innovation. We're a higher functioning organization moving with speed. The management team has everyone moving in the same direction and our associates have a spring in their step. We're now focused on Q3. We've laid the groundwork for consumer takeaway in this critical quarter that represents 60% of our POS. April started slow but steadily picked up throughout the month.
The sluggishness was due to the late season start in the northeast and a deliberate move on our part and of our major retailers to push high volume spring events and promotions later in the month. This enabled everyone to mitigate the risks of unpredictable early season weather. The shift played out as expected. By late April promotions and retailer events were contributing to POS unit growth. As we look ahead, we have many things going in our favor. Despite inflation, consumer sentiment has improved. They are more confident about the economy and are engaging at higher rates in our category, demonstrating the resiliency of our consumer business in uncertain economic times. Consumers care about their lawns and gardens and we offer a low-cost do-it-yourself option to improve their yard and their home.
Retailers know lawn and garden is critically important to drive in their spring season. Despite tepid retail or foot traffic through the first half, we've outpaced their declines and helped bring people into their stores. We want to thank our retailers for their partnership and their awesome support. Let me talk about what you'll see in Q3. We'll invest 25% more in our brand-focused advertising. It has to be nearly impossible for people not to have seen our ads this year. We're blanketing television and radio nationally during peak news and high-profile sporting events. We're not chasing the fringe consumer. We're laser-targeted on our core consumer, the 30-plus year old homeowner. The Q3 Blitz started with the April launch of Miracle-Gro Organics with Martha Stewart.
In the new dirt nerd spots, Martha shares how she relies on our products in her own gardens. The PR outreach alone surpassed one billion impressions. We're also expanding our Scott for Scotts campaign with actor Kristofer Hivju, who has fully embraced the role and established credibility with consumers. The creative is strong, and Kristofer will lead the launch of a new healthy lawn product, the innovative summer lawn fertilizer and fungicide to combat disease. Without any advertising support, we're already seeing good POS traction with healthy lawn. At the store level, we've expanded fuel sales manager positions by 10% to support in-store activations and collaborate with Bonnie Plants on driving attachment with soils and vegetables. Bonnie's sales are up 12% year-over-year through the first half.
Spring is in full bloom across the country. Retailer programs and our advertising are hitting hard. Weather models look good in May, and we're managing what's within our control. Shifting the Hawthorne, there's progress. We continue to remake the business and strengthen its ability to be a profit contributor. I've challenged the team to achieve a $10 million profit run rate. In the past two years, Hawthorne has gone from 15 distribution centers to two and cut over 1,000 jobs operating today with less than 300 people. In our latest move to improve its economics, we're completing the full transition to manufacturing and marketing our own brands. To make this happen, enhance our ability to invest in our brands, we've exited third-party distribution business where margins were challenged or non-existent.
This was less of a concern when the business was bigger, but we can no longer deploy capital for low-volume, low-margin products. And I doubt competitors such as Hydrofarm can either. We're now focusing on Hawthorne's more profitable, exclusive, and owned brands like Gavita, Botanicare, General Hydroponics, Psycho, Mother Earth, and HydroLogic. These are industry leaders and they stand at 80% of our sales and will increase to 100%, carrying margins on par with our consumer portfolio. As part of this strategic change, we've partnered with BFG Supply to service our smaller retail customers. We believe BFG can deliver a higher service level. The partnership will lower Hawthorne's cost structure throughout the year. We continue to work on the long-term solution for Hawthorne, a valuable, completely legal asset in a cannabis space with tax advantages, the best brands, industry- leading research and development.
At our facilities in Kelowna, British Columbia, Marysville, Ohio, Gervais, Oregon, we're researching genetics, competitive products, cultivation practices, lighting, yields, and more. And we share this with our customers. As this industry consolidates, which is going to happen, Hawthorne will be an important piece of a much larger puzzle. Let me give you a sense of the potential. The cannabis market is estimated at $105 billion annually in the United States, and the overwhelming majority of it is run by illegal operators. Less than $30 billion comes from the legal sector. This is an outrage. What has happened to this industry falls on the politicians in Washington. Their continued inaction on legalization and measures to support a major legal industry is a disservice to Americans.
The cannabis industry is as large as the auto industry, the dairy industry, or the beer industry in the United States. It's five times bigger than the U.S. energy drink market and nine times the size of the U.S. egg industry. It's an economic engine. On top of this, Americans, Democrats, Republicans, and independents favor legalization. In red states like our Ohio, nearly 60% of voters approved of recreational cannabis last November. Today, 38 of the 50 states have legalized cannabis covering three quarters of the United States' population. Yet, cultivators and retailers who take the legal route struggle to make money or raise capital. And they face taxes as high as 80% and a lack of access to financial services. And consumers who shop at legal stores can be hit with product markets of 50% -100% due to some state taxes.
In what world does this make sense? The legal market cannot compete against illicit operators who don't honor or follow the same rules. And consumers across the country are the victims. It's time to level the playing field. I'm calling on federal officials to take immediate action on two proposals. The first is the bipartisan-backed Safer Banking Act in the United States Senate. Senator Schumer needs to bring it to a vote, and Democrats and Republicans who are holding up passage need to vote with the people. The second is cannabis rescheduling. Where does it make sense to have marijuana a Schedule I narcotic? The Drug Enforcement Agency is considering us. This would lessen some penalties for cannabis and ease the tax burden. I call on President Biden to push forth rescheduling, and I call on former President Trump to stand with the majority of Americans supporting cannabis reform.
I call on state officials, including New York Governor Hochul, to strictly enforce laws against illegal cannabis operators circumventing safety, preying on kids, and evading taxes. Until progress is made on these multiple fronts, legally licensed cannabis companies will continue to scrape by or go under. Take California, which has owed more than $700 million in state-backed cannabis taxes. Most of that will never be collected because 72% of the companies are out of business. As you can see, I, like many Americans, I am tired of waiting on Washington to do the right thing. We need action now. I also want to provide an update on our 2021 investment in RIV Capital, the New York cultivator and retail operator that is unlocking value in a cannabis space.
RIV recently opened a flagship adult-use dispenser in White Plains that is far exceeding our expectations. It has also expanded its Chestertown growing operation and is building a new cultivation facility in Buffalo that will double its footprint. What's even more exciting is RIV's potential combination with another cannabis company. While I cannot discuss the details, a deal is in the works. When completed, this business combination would be a transformative moment in our long-term investment strategy in this space. It would reflect movement toward what we intended with RIV, to invest in and help build a multi-state cultivation and retail powerhouse, providing the best cannabis brands. The combined entity would have cultivation and dispenser operations in the most populous states with limited licenses for legalized medical, adult use, or both.
As part of this transaction, we anticipate the convertible note that we now have with RIV to convert to exchangeable shares in the combined business. I'll wrap up with this. We've stabilized and improved the financial flexibility of Scotts Miracle-Gro. Our difficult work over the last 18 months will benefit this company for the next 10 years. We're no longer managing through crises. Looking at the future again, Chris is leading a very exciting effort to recover our investments in the cannabis space and create long-term value. Nate and Matt have been here for a year or more now, and they have a much better handle on where the business should be headed for growth. Matt is developing a long-range financial and strategic plan, and Nate is building a multiyear consumer plan that includes investments in technology, disruptive innovation, and other value drivers.
The board of directors has received an early preview of their plans, which will be fully baked by late summer. We should be ready to share them with you in the fall. I'm excited for their work and their contributions. I want to thank their teams for supporting these efforts. Finally, we're holding an Analyst Day in July at our Marysville headquarters, where you can get an up-close view of how we're positioning Scotts Miracle-Gro for the future. I look forward to seeing you then. Thanks. I'll turn the call over to Matt for financials.
Matt Garth: Thanks, Jim, and hello everyone. For those joining us on video, you can see spring has arrived at Scotts Miracle-Gro headquarters. Hopefully, you are enjoying the early season with great deals on SMG products and the associated mental and physical health benefits of returning to the yard and creating a fantastic lawn and garden. I'm going to begin by reiterating a few points Jim made. First, we are pleased with the first half performance, second, our guidance for the full year is unchanged, and third, we continue to manage what is in our control to drive consumer engagement and deliver our planned results. From a net leverage perspective, we ended the quarter at 6.95x versus the covenant maximum of 7.75x, and remain on track to achieve net leverage in the fours by fiscal year end, giving us much improved financial flexibility heading into ‘25 and beyond.
U.S. Consumer results were strong, with overall unit share through Q2 increasing in line with our plan. We experienced particular strength in growing media on early market home setter promotions. At Hawthorne, we continue to optimize the business to focus on our Signature proprietary brands. Our recently announced distribution partnership with BFG is a major milestone along Hawthorne's strategic path. Now, let's walk through the second quarter in more detail. Listing gains and strong early season engagement and growing media drove U.S. Consumer second quarter net sales up 2% over last year to $1.38 billion, tying our second quarter record with 2022. With outstanding retail partnerships and execution by our teams, U.S. Consumer net sales for the first half were stronger than planned and in just 2% lower than prior year at $1.69 billion.
The first half net sales decline largely reflects our planned shipments phasing, which has returned to a more traditional pre-COVID cadence in alignment with our retailers. Seasonal readiness in stores is excellent. The strong first half shipments and new listings and growing media drove retailer inventory units 3% higher than last year as of the end of March. And as Jim discussed, we exited March with unit POS up mid-teens percentages along with gaining four points of unit share led by mulch and rodenticides. Through April, POS units were up high single digits percentages with dollar POS up low single digits reflective of price reductions and early season mix favoring growing media. Jim stated that Q3 is a critical quarter as it represents 60% of our season.
With the heart of lawn season in front of us and the majority of our new promos yet to run, our high single digits net sales guidance for the U.S. Consumer businesses remains in sight. At Hawthorne, we are meeting the continued industry challenges head on by taking aggressive action to modify our go-to-market approach. While moving away from distributed products will lower Hawthorne's top line. Margins will improve with our focus on our proprietary and industry leading brands, as well as the cost savings from shrinking our distribution network. Hawthorne Q2 net sales $66 million were 28% lower than prior year. Year-to-date net sales were $147 million, a decrease of $78 million, or 35% versus prior year. The declines are driven by lower volumes and price reductions.
For the full year, we now expect Hawthorne's net sales to decline 25% to 30% year-over-year based on the discontinuation of the distributed brands and the challenging near-term industry outlook. Hawthorne's segment loss for the quarter was $3 million compared to a $17 million loss a year ago. Year-to-date segment loss through March was $13 million compared to $33 million for the first half last year. The improvement was driven by favorable product mix and reductions to warehousing costs, headcount, and project spend, partially offset by lower sales volume and pricing reductions. Further improvements are expected in the back half of the year, and we are projecting Hawthorne's contribution to total company adjusted EBITDA to be breakeven or better for the full year, inclusive of investments in sales, marketing, and innovation to drive profitable growth in fiscal 2025 and beyond.
Total company impairment, restructuring, and other charges for Q2 were $77 million. The charges are mostly from non-cash inventory related write-downs of $67 million related to the incremental contraction of the Hawthorne warehouse footprint. On a year-to-date basis, IRO charges were $64 million. Note that these charges are excluded from non-GAAP income. Now let's move to gross margin and cost of goods sold for the total company. The adjusted gross margin rate improved 60 basis points in the quarter to 35.3% versus 2Q a year ago, driven mainly by Project Springboard related distribution cost savings. Material cost favorability in the second quarter was more than offset by unfavorable net pricing and higher manufacturing labor costs. Through the first half, the adjusted gross margin rate declined approximately 30 basis points with distribution cost savings and favorable segment mix more than offset by negative net pricing and fixed cost deleverage from lower volumes.
Material costs were essentially flat year-to-date. With nearly 85% of our commodity inputs now locked, as is typical at this point in the year, we have reasonable line of sight to our full year costs. Other than rising resin and labor costs, we are seeing favorable trends across our commodity basket heading into the back half of the year. Headwinds from resin prices are expected to continue into fiscal 2025. SG&A ended the first half nearly $22 million favorable to the first half last year. As a percentage of net sales, SG&A improved to 15.2% from 15.3% last year and 16% two years ago. The savings are inclusive of more than $11 million of reinvestments in media year-to-date and reflect the durability of our project springboard savings from headcount reduction.
Amortization expense declined by $3 million or 39% in Q2 ‘24 compared to Q2 ‘23 and by $6 million or 44% on a year-to-date basis due to the impairment of Hawthorne and tangible assets recorded in fiscal year ‘23. We maintain our goal of annual SG&A between 15% and 16% of net sales going forward and note that fiscal ‘24 will be at the lower end of the range. Non-GAAP adjusted EBITDA for Q2 was $396 million compared to the prior year's $405 million. On a year-to-date basis, non-GAAP adjusted EBITDA was $371 million versus prior year of $426 million. The year-to-date decline in non-GAAP adjusted EBITDA was driven by the decline in non-GAAP gross margin dollars primarily due to declines in volume and price. Below operating income, our first half results include a $19 million adjusted loss from the Bonnie JV equivalent to the adjusted loss from the JV for the same period a year ago.
Through March this year, Bonnie sales improved 12% versus last year, primarily attributable to increased consumer engagement and improvement in store execution. Year-to-date sales through March represent just 20% of Bonnie's projected full year sales. Also note that Bonnie's fiscal year ends July 31st. Year-to-date interest expense through March was $4 million lower than through the first half last year, a 5% reduction driven by significantly lower debt levels which were partially offset by higher average borrowing rates. As of the end of March, total debt balances were $2.8 billion versus $3.6 billion last year. Utilization of the accounts receivable program contributed $587 million net of discount to the debt pay down. Strong second quarter free cash flow generation delivered the balance of the improvement.
Year-to-date usage of free cash flow improved by over $500 million year-over-year driven by working capital reductions from further inventory improvements, leveraging the AR sale facility, and AP timing. For the full year, interest expense is expected to remain flat as the benefit of lower net debt is offset by higher interest rates. Interest rates are approximately 80% fixed as of the end of the second quarter under a combination of long term fixed rate notes and interest rate swap agreements. Discount cost associated with the AR sale facility is included in other income and expense and was $13 million through Q2. Our adjusted tax rate through the second quarter was 28.6% versus 26.4% for the same period last year. The primary driver of the increase relates to less benefit from stock-based compensation that vested during Q2 and the unfavorable impact of higher non-deductible executive compensation expense.
Share count at the end of the quarter was up by 1.2 million shares versus 2023 due to higher share based payments. Share count is tracking to our guidance of an additional 1.5 million shares issued by fiscal year end. With the first half complete, we are focused on delivering a strong second half performance. This year, we are returning to William Blair's 44th Annual Growth Stock Conference in Chicago where we will share our thoughts on the prospects of SMG and provide an update to our 2024 guidance and outlook that is informed by POS Performance in May. Lastly, as Jim stated, we will host an Analyst Day on July 16th at our Marysville, Ohio headquarters and research center. Our agenda for the day will include opportunities to meet the new management team and experience our new product innovation firsthand.
We look forward to sharing more on our longer term outlook and strategic objectives as we strengthen financial flexibility and our ability to drive shareholder returns. Details will be provided in an upcoming press release and invitation. We can now move on to the Q&A.
See also
20 States with the Highest Percentage of Mobile Homes in the US and
15 States With the Lowest Property Taxes in the US.
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