The Scotts Miracle-Gro Company (NYSE:SMG) Q4 2023 Earnings Call Transcript
The Scotts Miracle-Gro Company (NYSE:SMG) Q4 2023 Earnings Call Transcript November 1, 2023
The Scotts Miracle-Gro Company beats earnings expectations. Reported EPS is $-2.77, expectations were $-2.83.
Operator: Good morning and welcome to the Q4 2023 Scotts Miracle-Gro Company Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Aimee DeLuca, Head of Investor Relations, Scotts Miracle-Gro. Please go ahead.
Aimee DeLuca: Good morning. With me this morning are Chairman, President, and CEO Jim Hagedorn, Chief Financial and Administrative Officer Matt Garth, Chief Operating Officer Nate Baxter, and Chris Hagedorn, Group President of Hawthorne. Jim and Matt will begin our discussion with some prepared remarks. The operator will then open the call to your questions. As always, we expect to make forward-looking statements, so please be aware that our actual results could differ materially from what we share today. Please refer to our Form 10-K, which was filed with the Securities and Exchange Commission for details of the full range of risk factors that could impact our results. For further discussion, after the call, you are invited to e-mail or call me directly at 937-578-5621 and we’ll work to set up some time as quickly as possible.
Lastly, please note that today’s call is being recorded and an archived version of the call will be published on our website at investor.scotts.com.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 going. I'll turn the call over to Jim Hagedorn to begin. Jim?
James Hagedorn: Thanks, Aimee. Good morning, everyone. Today you're going to hear how we closed out Fiscal '23 and the actions we've taken to continue to move forward positively in '24. I'll remind everyone there are many factors that led to our current financial situation impacting our consumer and Hawthorne businesses. Some were macro in nature brought on by post-COVID economy and un-favorable weather, but many were our own doing as we pursued growth. I know this has been a lot for our stakeholders and our associates to deal with. Our mission in Fiscal '23 was to stabilize the business. This put an incredible amount of stress on our people and our operations. It required tough choices and fast actions. As a result of this work, we made legitimate and measurable progress.
We generated $681 million improvement in cash-flow from a year ago and paid down debt by $361 million. We cut expenses north of $200 million and have targeted another $100 million in cost savings. We've reduced inventory by more than $450 million. And thanks to our banks, we have greater financial flexibility. We outperformed the lawn and garden category and took share in a challenging environment. As we enter Fiscal '24, retail inventories are in good shape. Our relationships with our retailers have been tested and are stronger than ever. All of this contributes to what we see as a return to a more normal state of running our business. Our progress can be tied to the strength of our brands, whose awareness and trust among consumers are at all-time highs, and our people, whose resilience in these times has been outstanding.
As for Hawthorne, I stated at the start of '23 that my goal was to restore it to profitability. It reached break-even run rate at the end of Q4, generated more than $100 million in free cash-flow in Fiscal '23, setting the stage for profitability in '24. On top of our achievements, we upgraded talent at the executive and senior levels with next-generation leaders, who bring energy and fresh perspectives. Together, we're building momentum to improve our performance and enhance shareholder value. Matt will explain how we deliver the results for fiscal '23 within or better than the guidance we provided in August. He'll also share our outlook for fiscal '24. We will focus on the final phase of Project SpringBoard, while ensuring we protect and invest in the things that differentiate us.
Those are our brands, our sales force, our innovation, and our supply chin -- supply chain. The team has developed an operating plan for fiscal '24 that is aggressive but well thought out. Elements of the plan include, one, improving gross margin to deliver $575 million in EBITDA. Two, finishing the two-year job of achieving $1 billion in free cash flow by the close of '24. Three, paying down debt by an additional $350 million or more by the end of fiscal '24. And four, getting our leverage ratio into the fours by year-end. The risks to this plan are mostly things outside of our control, the state of the consumer and global events. But when you look at consumers holistically, our core Lawn and Garden consumer is the most stable and healthy.
We and our retailers believe this core consumer will show up in numbers at least to the level they did this past year. Our plan assumes flat on our existing consumer business plus incremental unit growth that we secure from share gains, will drive incremental volume through more promotions, shelf space, and listings that we did not have with last year with major retailers. I'll address this in more detail shortly. I first want to talk about the leadership team that is charged with delivering the plan. The Board and I put an entirely new team in place to empower the leaders who will guide this business for years to come and create opportunities for rising executives to take on more responsibility. It starts with Nate Baxter and Matt Garth. They are the future of our operating and management team.
Nate and Matt are smart, aggressive, and work well with me and each other. They're experienced executives and provide what I need as real business partners. At the close of Q4, I made the decision to accelerate the retirements of Mike Lukmeier and Denise Stump. Both had planned to leave in '24, but it became clear we needed to move more quickly for clarity and to set Nate and Matt up to run the business day-to-day. Nate is responsible for the operations side and Matt has expanded responsibilities beyond the CFO role, shifting almost all administrative functions to Matt positions him and Nate as equal partners. The power and responsibility between them is balanced. We extended the leadership changes to surround Nate and Matt with talent who could step up.
We have a new head of human resources and a new general counsel. We've also set a new direction with marketing and IT by eliminating the chief marketing officer and the chief information officer roles. The teams have been restructured. Marketing is led by Brian VP, Ashley Bachman and Jody Lee. And IT is led by VPs Emily Wall, overseeing IT infrastructure and Syed Nazadi, responsible for digital initiatives. They report to Nate. In marketing, Ashley and Jody will partner with a new creative agency to provide world-class compelling creative that inspires and motivates our consumers. They'll also work with Media Hub, a long time partner for world-class media buying to effectively deploy our media dollars based on our priorities. Now, let's get back to the plan.
Protecting the consumer franchise is paramount. It's what moves the needle. And we must invest heavily in all things that drive our lawn and garden business. Marketing and sales top the list. In fiscal '23, we spent 25% more on advertising than we did in '22. Among my priorities is to further increase our advertising budget this year. We will also shift the majority of this spend into more traditional forms of media to prioritize our core consumer. As I said, our core consumer is the healthiest within the entire consumer base. They are existing homeowners who tend to be higher earners. Their personal debt is low, and they have higher than average savings. We and our retailers see indications they will spend more time at home in '24 than they did in '23.
And this isn't the time to chase a broader base of new consumers. As for retailers, they're focusing on foot traffic. They say lawn and garden is their biggest opportunity to drive more foot traffic. And lawn and garden belongs to us. Together, we will drive powerful promotions and activations aimed at our core consumer. As I said, retailer inventories are in good shape. We expect retailer load to be strong. Last year, there were changes to our sales patterns as we took a short-term, quarter-to-quarter approach to the year. For fiscal '24, the load will follow more historical pre-COVID patterns. Let me walk you through how we intend to grow our volume and share. We took about a third of what would have been our total gross margin rate improvement from fiscal '23 and invested it back into our retailers in the form of trade and modest pricing reductions on certain SKUs to help with elasticity.
In exchange, we will receive increased listings, shelf space and promotions, none of which we had last year. This will strengthen our ability to drive incremental volume growth we need to deliver our plan. And here's some early good news. We've had a great start to the fiscal year. Overall, POS is up 4% in units and 8% in dollars across all brands through the month of October. Our fall lands campaign has yielded 3% plus in units with turf builder plus two at 21%, Bonus-S up 56.5%, gardens and controls are up 4% and 5%, respectively. The biggest ortholine, home defense, is up 19%. Roundup is up 12.5%. Miracle-Gro potting mix is up 9%. We're building momentum for the year ahead. As for Hawthorne, we've made progress on a range of potential solutions that should benefit shareholders and create opportunities for that business to grow.
We're in active discussions to create a leading vertically integrated cannabis Company. I can't share more at this time, but we will provide an update as soon as we can. We are committed to doing what's best for Scott's Miracle-Gro, Hawthorne, and the cannabis industry. In doing so, we can create opportunities for shareholders to participate in the industry's further growth and maximize their returns, hopefully enabling all of us to look back and say it's been a good investment. I'll wrap up with this. For our associates, I know it's felt like a grind, and it feels worse because we're used to winning. All of us need to stay engaged and focused on execution. This will be the year we turn the corner. To all of our stakeholders, we've stabilized the business and accomplished a lot.
Our cost outs by the end of the year will exceed $300 million. We're on track of meeting our goal of $1 billion in free cash-flow over a two-year period, and in that same timeframe, we will pay down over $700 million in debt. We've repositioned our leadership team and brought new faces with diverse experience to our Board. By the end of this year, we will have solved most of our challenges and significantly enhanced our brand power. We're creating a tailwind that will benefit us for the next decade. Thank you. I'll turn it over to Matt.
Matthew Garth: Thank you, Jim, and hello, everyone. As Jim noted, fiscal year 2023 generated significant change within Scott's Miracle-Gro. The immediate outcome of which is every associate is aligned to our strategy and priorities, maintaining market-defining positions and innovations while dRIVing operating margin recovery and increased financial flexibility. Now, let's take a deeper look into our performance in 2023 and the guidance we are establishing for fiscal '24, starting with top-line results, total Company sales decreased 24% for the quarter, ending the year down 10% at $3.55 billion, which was in-line with our fiscal year guidance. U.S. consumer sales declined 33% in the quarter as a result of the previously discussed timing of shipments between the third and fourth quarters.
For the full year, pricing was nearly 5% higher. Total sales fell by 3% on lower shipment volumes and our higher margin, but more weather-sensitive consumer loans business. We ended the year with POS dollars up nearly 5%, driven by the higher pricing. POS units ended the year slightly lower than '23 as poor weather in September prevented the expected volume lift. That said, our fall campaign has taken hold and POS units in the month of October were up almost 5%. Retailer inventory levels entering fiscal '24 are healthy. At our three largest customers, unit inventories ended the year down about 1% on average and are currently down about 2%. The majority of our year-end retailer inventory was related to new, fast- turning, growing media listings and the ramp-up ahead of our fall and road campaigns.
At Hawthorne, sales declined 11% in the fourth quarter and 35% for the fiscal year, with both being in-line with our guidance. We continue to see signs of stabilization in the industry. However, it remains too early to call an inflection point in the top-line. Moving on to total Company gross margin rate for the full year, the rate fell about 260 basis points to 23.7%, with the acceleration of project springBoard savings helping to deliver better than expected results. Now let me break down the margin change for you. Pricing actions and springBoard deliverables drove nearly 600 basis points of year-over-year improvements. Factors that I would characterize as near-term un-favorable, including the impact of lower production aimed at reducing inventory of 380 basis points, higher material costs stemming from COVID-era purchases of 330 bps, and the one-time write-down of excess and obsolete inventory of 130 bps more than offset the gains we drove.
Moving down the income statement, SG&A was managed tightly across the year with savings driven by springBoard actions aimed at creating efficiencies within the organization. We continued to maintain investments in our future through strengthening our brands, our sales force, and our innovation pipeline. For the fiscal year, SG&A came in 10% lower than last year at 15.5% of sales and in-line with our guidance. Operating income for fiscal '23 ended the year at $292 million, or 8.2% of net sales, with accelerated springBoard savings delivering improvements over our guidance of 7% to 7.5%. Adjusted EBITDA was $447 million. Looking below the operating line, the higher interest rate environment has driven a significant increase in interest expense, which ended the year roughly $60 million higher.
SMG average borrowing rates increased 180 basis points in fiscal 2023, and we will see another 80 basis point increase in 2024. As is typical, our free cash-flow generation was weighted to the back half of the year, so debt pay down largely occurred in the fourth quarter. There were several discrete items in our effective tax rate in the fourth quarter that drove the full year rate to 36.6%, which was well above our expectations. In short, we had valuation allowances against our deferred tax assets in certain jurisdictions that meant credits could not be used in the current period. All told, fourth quarter adjusted earnings, which exclude impairment restructuring and other nonrecurring items, were a loss of $2.77 per share versus a $2.04 loss per share last year.
Full year EPS was $1.21. Note, this result includes the one-time impacts of 25 cents related to the U.S. consumer inventory write-down from the third quarter. And moving on to free cash-flow and the balance sheet, we continue to deliver significant improvements with positive free cash-flow of nearly $440 million, of which over $500 million was generated in Q4. Versus prior year, free cash-flow improved $681 million, driven primarily by lowering inventories and other working capital improvements. Inventories fell by over $450 million year over year, and we anticipate a further $275 million decline in fiscal '24. With this cash-flow, we're able to maintain our quarterly dividend and drive debt lower by $361 million. Liquidity is strong, with nearly $1.2 billion in debt capacity as of the end of the fiscal year.
Additionally, we announced today the closing on a new accounts receivable sale agreement with J.P. Morgan that replaces and up-sizes our prior facility. The timing of the closing crossed quarter ends and created a dip in our cash-flow. If we had this program in place at year end, cash from operations would have been $50 million higher in fiscal '23. Note that the discounted cost associated with the AR sales will be reflected in the other income and expense line within operating earnings and is expected to be around $20 million. We ended the year with leverage at 6.57 times adjusted EBITDA versus a covenant maximum of 7.75 times. Recall that adjusted EBITDA for the leverage calculation includes $39 million of allowable increases to reported adjusted EBITDA for nonrecurring E&O and warehouse closure costs that occurred in the third quarter.
Now let's turn to our outlook for fiscal '24. In establishing guidance for the full year, our primary objectives remain generating strong EBITDA and free cash-flow. Our operating plan is aggressive and reflects strong engagement with our retail partners to yield high single-digit growth for the U.S. consumer business. Factors beyond our control may impact consumer takeaway and yield a lower growth trajectory for the year. An improvement in growth margin combined with tight control of SG&A is expected to result in an operating income of 10.5 to 11% of sales. Below the operating line, interest expense will be essentially flat year over year as borrowing costs on average are expected to be higher and debt pay-down will take place in the fourth quarter as is typical.
And lastly, our ETR will be between 29 and 30% and share count will grow by 1.5 million shares. From a net leverage perspective, we now see the second quarter of 2024 as the most acute period in the outlook based on the phasing of seasonal working capital. Note that we have proper headroom to manage any outside swings within our covenant requirements. To sum up, the fundamental advantages of our iconic brands, our supply chain, and innovation capabilities, as well as our talented associates, support our three near-term priorities, margin recovery, the balance of a billion dollars in free cash-flow, and a solution for Hawthorne's future beyond SMG. We are focused on executing with precision. We have a determined path forward, and I'm confident that our trajectory is improving and that we can return to delivering outsized shareholder returns.
With that, I'll turn the call back to the operator so we can answer your questions. Operator?
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