The Scotts Miracle-Gro Co (SMG) Q2 2019 Earnings Call Transcript

A lot of folks have started asking me if I am contemplating a slower pace or maybe even retirement. The truth is I haven't had this much fun at work in years and my level of engagement is actually increasing, not decreasing. The reason I suspect is twofold. First, the issues we're working on, the evolution of Hawthorn, changes in how we communicate with consumers, the challenges regarding Roundup, our commitment to improving cash flow, the development of our next-generation of leaders are critical to our success in both the near and long term.

And second, frankly, I'm just energized by what we're trying to do. All of our efforts are paying off so far this year. So I'll just hit a few of the highlights. Sales to retailers in US consumer are up 8%. Five in the last six months at Hawthorne have been up double-digits on a comparative basis and we have once again been able to get our leverage ratio below 4 times. Someone will probably ask the question later, so I'll just say it upfront. Yes, we are running better than we expected entering May, and no, we're not changing our guidance at this time.

While there is a lot of optimism flows through the building right now, it's May, we've been here too many times to declare victory at this point. There's a lot of season ahead of us and we have to stay focused, all the way through to the finish line. Like I said, I don't want to dwell on the numbers, what I'd rather do I'll focus on the real efforts that allowed us to deliver those numbers. A year ago there wasn't much celebrating going on here. We had a terrible start to the season and changes to California cannabis laws (inaudible) on the hydroponic space.

It would have been easy to panic as the stock price fell and some investors questioned our strategy. We could have scrambled to restructure, pull back on innovation or said investments in marketing could wait for a better day. We actually may have done some of those very things a decade ago. But this is a different company today and we didn't do any of that. Instead we stayed focused on the play we called and kept executing. In fact, while we were sitting on this call a year ago talking about the challenges of the 2018 season, our teams were head down already focused on the 2019 season and that approach is evident in the results we announced this morning, both in our US Consumer segment and in Hawthorne.

Look at our lawn fertilizer business where POS is up 10% entering May. The biggest drivers in this category are products that didn't even exist three years ago. A decade ago this category was in a deep slide. We took the time to understand why that was happening. We found new ways to engage with the consumer, created trade programs that rallied our retailers and launched products that exceeded our expectations. One of those products, the Scotts Triple Action, which feeds your lawn, kills weeds and even prevents crab grass or controls bugs, depending on the regionally specific product that you buy. Another example is Scotts Thick'R, which contains soil enhancements, fertilizer and grass seed, all in a single bag.

It's been blowing the doors off with consumers. Grass seed is up 35% this year and was one of our high performing categories last year as well. Over 90% of the online reviews for Thick'R carry a 5-star rating, further proof that the innovation we're bringing to the market is driven by understanding and adapting to consumer needs. The way we're talking to consumers also continues to evolve. We're not just investing more heavily this year, we're evolving our approach and the actions we've taken so far are just the tip of the iceberg. A decade ago I spoke at the Analyst Day Meeting in New York and criticized our digital marketing efforts. Yes, we were doing a great job with TV and radio, but our digital efforts were way behind the curve. We were doing almost nothing with social media and our online commerce efforts were not existent.

Today, our digital efforts are greatly improved and I want to acknowledge our team for their work. But the digital marketplace is ever changing and if we were lagging in the space in the past, I want us to be leading in the future. More of our spending needs to move to digital, but our efforts have to be focused on inspiring the consumer. We have to be clever, provocative and innovative. We also have to be willing to challenge your own thinking. That's why we've enhanced our internal efforts through the engagement this year with Gary Vaynerchuk, an acclaimed online influencer who has become one of the country's most sought after digital marketing authorities. He and his colleagues at VaynerMedia have helped us launch our successful new Ortho GroundClear campaign and have been heavily engaged with our team on using our social media presence more creatively.

I mentioned Gary's work with us, not just in the context of marketing, but through the lens of creating long-term value. Consumers are changing fast and if we hope to enjoy a relationship with them in the future, we have to change too. I'm committed that revolutionizing our approach to marketing is positioning both our Company and our brands in a way that instills trust with the next generation of gardeners and allows them to see us as a relevant and necessary part of their lives, season after season.

Speaking of being relevant, I want to spend a few months -- not few months, it feels like it -- moments talking about what's happening with the launch of our new GroundClear product and also provide an update on Roundup. First on the Roundup front, you saw in the press release the POS is up more than 20%, that's obviously good news and we're particularly thankful for the strong retailer support the brand is continuing to receive. On the past two calls, I've hinted that we were talking to Bayer about the structure of our relationship with them and we've made tremendous progress in recent weeks.

First, you may recall, we entered into a JV with Monsanto a couple of years ago that resulted in Scotts's acquiring a 51% stake in a professional non-selective weed control product business. In recent weeks, we sold our interest back the Bayer and have exited that business. It negatively impacts the P&L by a few cents per share, but the cash proceeds of $37 million will go straight to paying down debt.

Additionally, we've already reduced our debt by about $140 million using the proceeds from our sale of our minority interest in TruGreen. These two transactions have allowed us to get below 4 times leverage in the quarter and we should remain at that level through to the end of the year. If we stay in our current path, we would expect to get back to about 3.5 times leverage next year. This would allow us to get back to one of our major pillars of Project Focus to return cash to our shareholders.

A second development is that Bayer has agreed to a $20 million reimbursement this year. We have been anticipating this payment for several months as reimbursement for investments we didn't anticipate entering fiscal 2019. In other words, I would caution you against adding this to your models. Our counterparts to Bayer have been committed to working with us. We've been working collaboratively to further make amendments to our agency agreement that gives us more flexibility going forward. I'm cautiously optimistic and we'll obviously have more to say as things move along.

As for GroundClear, it's the story behind the story that I think matters the most here. We brought this innovative herbicide to the market in less than a year, that's unheard of in the pesticide world. Nearly every major function in the Company touched this product and the process ran with near-perfection.

GroundClear serves two important purposes. First, it provides an alternative to consumers who might have otherwise decided to leave the category. But this is also our first armory-listed non-selective weed control so it can be used around organic gardens and it is extremely effective and fast. This opens up an entirely new segment of audience for us and allows us to expand in the category. In fact, if you look at the non-selective category in total, as Roundup and the entire GroundClear line, consumer purchases are up nearly 30% entering May. GroundClear is an example of turning the organization on its head and getting something done with urgency.

Sometimes the process doesn't work like that. Sometimes bringing a product to market takes patience and that's what we demonstrated with Miracle-Gro Performance Organics.