Skip to content
  • Boyar Family of Companies

    Boyar Family of Companies

    Whether uncovering a new idea for our research subscribers, managing pension funds, or handling accounts for individual investors, our research-driven insights help both professional and individual investors pursue their investment goals. 

    Boyar_Logo_Asset_Management-May-31-2023-08-39-05-3251-AM

    Boyar Asset Management focuses on investing in the equity securities of intrinsically undervalued companies.

    Boyar_Logo_Research-1

    Boyar Research was established in 1975 to provide independent research utilizing a business persons approach to stock market investing.

  • Insights

    Blog

    Read the latest news and insights from the team at Boyar Value Group.

    Understanding Dividends: How Companies Allocate Money

    The Boyar Value Group’s 4th Quarter Letter 2023

    The Boyar Value Group’s 4th Quarter Letter 2023

  • Podcasts

    Podcast

    "The World According to Boyar podcast brings top investors, best selling authors, and market newsmakers to show you the smartest ways to uncover value in the stock market." 

    Anthony Scaramucci on resiliency, cryptocurrencies, and much more.

    Guy Spier, Portfolio Manager of the Aquamarine Fund and Author of the Education of a Value Investor

    Patrick Doyle, Executive Chairman of RBI on: increasing Domino’s share price by 23x; his vision for Tim Hortons and Burger King; and his thoughts on 3G Capital.

  • Media Appearances

    Media

    Check out the latest media appearances from the team at Boyar Value Group.

    Understanding Dividends: How Companies Allocate Money

    Comcast, Atlanta Braves, and 3 Other Forgotten Value Stocks With Potential to Grow

    Will Small Caps Stand Out In 2024?

  • Team
  • Contact
  • Schedule a Meeting

James Hagedorn, CEO and Chairman of the Board Scotts Miracle-Gro CEO on the tremendous opportunity in the cannabis space, potentially spinning off the fast-growing Hawthorne division and more...

Share it on:  Share on twitter  Share on linkedin 

The Interview Discusses: 

  • How their cannabis division Hawthorne has grown over 100% over the past two years.
  • Why he decided to enter the cannabis business.
  • His thoughts on the current regulatory environment for cannabis and what he believes needs to change.
  • Where the biggest money will be made in a post cannabis “prohibition” world and where they are investing.
  • The logic of potentially spinning out the Hawthorne business.
  • The demographic shift that is greatly helping their traditional consumer business.
  • A meeting he had with Henry Kravis in ~2007 and what he did in response to that meeting.
  • Why Scotts has been a “pandemic beneficiary.”
  • His thoughts on inflation.
  • How they have changed their marketing to target millennials.
  • Their innovative weather partnership with IBM that could greatly enhance their marketing.
  • Why he believes private label is not a threat to his consumer business.
  • How they incentivized employees during the pandemic.

About James Hagedorn:

Jim became chief executive officer of Scotts Miracle-Gro in 2001 and was named chairman of the Board of Directors in 2003. Prior to this, Jim helped to orchestrate Miracle-Gro’s merger with The Scotts Company in 1995, creating the leading consumer lawn and garden business in the world. He held the role of president from May 2001 to December 2005 and from November 2006 to October 2008. Jim also served in the United States Air Force for seven years, where he was a captain and an accomplished F-16 fighter pilot.

Jim is a graduate of The Harvard Business School Advanced Management Program and holds a degree in aeronautical science from Embry Riddle Aeronautical University, where he is a member of the Board of Trustees.

Please click here to download the Scotts Miracle-Gro report.

Click Below to Read the Interview Transcript

 

Important Disclosures. The information herein is provided by Boyar’s Intrinsic Value Research LLC (“Boyar Research”) and: (a) is for general, informational purposes only; (b) is not tailored to the specific investment needs of any specific person or entity; and (c) should not be construed as investment advice. Boyar Research does not offer investment advisory services and is not an investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”) or any other regulatory body. Any opinions expressed herein represent current opinions of Boyar Research only, and no representation is made with respect to the accuracy, completeness or timeliness of the information herein. Boyar Research assumes no obligation to update or revise such information. In addition, certain information herein has been provided by and/or is based on third party sources, and, although Boyar Research believes this information to be reliable, Boyar Research has not independently verified such information and is not responsible for third-party errors. You should not assume that any investment discussed herein will be profitable or that any investment decisions in the future will be profitable. Investing in securities involves risk, including the possible loss of principal. Important Information: Past performance does not guarantee future results.  

Transcript of the Interview With James Hagedorn:

[00:00:00] [music]

Jonathan: Welcome to The World According to Boyar, where we bring top investors, best-selling authors, and business leaders to show you the smartest ways to uncover value in the stock market. I’m your host, Jonathan Boyar. Today’s guest is Jim Hagedorn, chairman and CEO of the Scotts Miracle-Gro company. Jim became chief executive officer of Scotts in 2001 and was named chairman of the board of directors in 2003. Prior to this, Jim helped to orchestrate the Miracle-Gro’s merger with Scotts company in 1995, creating the leading consumer lawn and garden business in the world.

Jim also served in the United States Air Force for seven years where he was a captain and accomplished F16 fighter pilot. Jim, welcome to the show.

Jim: Hey, thanks for having me.

Jonathan: I’m super excited to have you on The World According to Boyar. Scotts is a company that Boyar research began following in 2011 when shares were trading around $50 per share. We’ve owned it in certain accounts for almost a decade and one of the characteristics we look for in companies are ones that have great consumer franchises and the Scotts Miracle-Gro with its Coca-Cola-like market share, certainly fits the bill. We also like investing in companies, operated by people with skin in the game, as they make decisions that are in the best interests of long-term shareholders and not simply to meet wall street short-term targets.

You and your family owned about 30% of the company and have in our opinion, done a great job for shareholders utilizing a mix of dividends, buybacks and special dividends. Most importantly, though, you’ve invested in the business. In less than a decade, you created a division called Hawthorne that today is the world’s largest vertically integrated hydroponics company serving primarily the cannabis industry and generates about a billion and a half dollars in sales in fiscal year 2021 and grew revenues almost by 40%.

I first would like to talk about Hawthorne and the traditional [00:02:00] business, but first, you were a fighter pilot until at least the pandemic hit you live primarily on Long Island and actually flew yourself to Ohio each day to go to work. What was that like? I imagine it gave you a lot of time to think.

Jim: I love being in a metal tube by myself. The answer is, if you want to think about stuff, I’m not sure the FAA would want to hear all this, but it’s a great place to read. Yes, prior to COVID, I traveled back and forth on a daily basis from Long Island, Farmingdale to Marysville, Ohio, which is a couple of miles from the office here. They were early days, be home in time for dinner. We had a tragedy, lost a 24-year-old daughter who was killed and our family became unstable enough that coming home at night was important to maintaining the survivor family. Once I did that for a year, I actually liked being able to come home at night. I fly a single engine citation jet single pilot is a really great place to reflect on the business and think and read.

I get to be able to read all the papers, send a lot of emails to my team on that hour and a half each direction, back and forth. Not really from a time-wise much different from commuting into Manhattan. I really liked it. Now since COVID, I get to take that commuting time, mostly spend it on a treadmill running. Lately, I’ve been coming out here once or twice a week, and we’ve been running the business via Google Meeting used to be a Hangout. It’s been a really interesting couple of years. By the way, in regard to Hawthorne, it’s up 100% in two years, not just 40%. It was 60% in 2020 and 40% last year.

Jonathan: The business is on fire. It’s a fantastic business, which I definitely want to talk about. I don’t know if it’s true. I read in my research, 1994, SC Johnson offered your family a [00:04:00] lot of money to buy the company. Instead, you decided to buy Scotts, which was six times the size of Miracle-Gro. It got about half the value, but you took it in equity and warrants. Obviously, things turned out more than fine. Looking back at it, was this a crazy decision?

Jim: I put myself in the slightly, from a personality point of view, unusual. This would’ve been 1994 I think it was. Sam Johnson wants to meet with my dad. I wasn’t invited. Miracle was making about 100 million. Sub S company, we didn’t pay federal tax. It was great because it was Reagan time, where it was 28% federal rate and they were on the pay $400 million for call it 100 million of pre-tax earnings. My father said, “It was great meeting you, we’re not for sale.” My father went on vacation to Europe and people brought me in Scotts the big dog in this space. We had spies, so we had a bunch of people who work for Miracle-Gro who are ex-Scotts people.

We always wanted to see the retail programs where if we could get intel on programs that Scotts was offering, it kind of gives us some insights on how they operate. This is back to early days. This is when CompuServe and AOL. I went on the AOL and checked Scotts stock price. Remember SEJ offered 400 million for Miracle-Gro. Scotts’ market cap at the time, $600 million of sales compared to our $100 million. We make $40 million just so be clear. Made $40 million, they offered us $400 million. Top Line was about $100 million. Scotts’ market cap was $265 million. My father was traveling, my father was the right-hand man with his dad in the Virgin Islands.

I said to myself, “We’re worth more than Scotts is?” We didn’t know anybody. We didn’t know any lawyers or anything in this kind of world. I called my father’s estate lawyer [00:06:00] at Skadden, a guy named Bob Vincent. He was the chairman or something at Barclays. I said, “Hey, Bob, if Miracle-Gro was worth more than Scotts, I wonder if we could just take over Scotts?” There was no real shareholder and that had been a LBO from Clayton Dubilier and when they went public on the Nasdaq, first Boston and Goldman took them back public again out of Clayton Dubilier, [00:06:25] it really had no shareholding.

There was like a bunch of inside ownership because of the LBO and Singapore, completely passive investor only 10%. That was it, there was no concentration of the shareholdings and the company had not performed. When the two or so years that they’ve been public since Clayton Dubilier took them public again, they never made the number, not once. You miss call 10 quarters in a row, people just get discouraged and say, “XXXX this,” and analysts stop covering the stock and that’s where Scotts was. He said, “I think maybe you could take them over.” He said, “What you need is an investment banker.” The guy running First Boston’s Investment Bank is a guy named Allen Wheat.

Bob introduced me to Allen Wheat and he says, “I think it’s definitely possible.” Remember they took Scotts public again out of Clayton Dubilier and he said, “The banker who did that work is a guy named Brian Finn. Now Brian Finn is on our board today. One of the really fabulous strategic bankers I think in the world ever is Brian Finn. We met with Brian and he and I came up with a script. Now, I met my father. He came back on the QE2 or whatever the hell it was back in the day. I picked them up in the hand and said, “Dude, if I told you we could take over Scotts but the currency would be Miracle-Gro.”

He just looked at me and said, “I am in.” That was it, “I’m In.” Our script was [00:08:00] pretty simple. This is to Scotts, “Miracle-Gro is not for sale, if it was for sale, you couldn’t afford it. Good news is we would be willing to merge the companies but it will have to be pooling as opposed to purchase accounting.” Now we didn’t end up doing that because my old man at the last minute, said he wanted to leave and that’s where he set up his charity. If you go back two years and go forward one year, Miracle-Gro people were there in about 42% of the combined equity and it’s pretty consistent over time.

We would make a suggestion, we pull, we get 42% of the equity and we don’t want any cash. We ended up with a little bit different deal because late in the transaction, my old man comes into my office and he says, “I’m out,” and this is how I think about age. My father was probably this most powerful like 75, which makes you wonder why people leave so early but seriously, I’m a student of my dad’s, I would say the most powerful intellectually as a business person at probably 75. At this point, he was probably 79 and he said, “I’m out,” and I said, “What do you mean?” My mother had died of cancer, he remarried this excellent woman who’s also gone now named Amy. He said, “Amy and I are starting a new business.”

Now, I’m thinking to myself, “What the XXXX does my old man know? Does he want to compete with me?” This is all going through my head in a second before he told me the answer. I said, “Oh, what do you mean?” and he said, “Amy and I are going to start a new business, we’re going to be co-CEO’s and it’s going to be giving away every single dollar I have, 100%, everything I’m going to give away. My father was not a usual charitable person. My father would love to give $20,000, $50,000, $100,000, be on the board, participate. It wasn’t a big giant check where he gives all his money away.

It’s lots of bets where [00:10:00] he participates, and Amy participated. At that point, he gave me a number and said, “This is what it’s going to cost.” Now probably I’ll argue with my own man. We didn’t actually pay for business we got. When my mother got cancer, my father wanted to step up the basis of Miracle-Gro so he gave 100% of it to my mother, with the idea you step up the basis to whatever the current value was, but she had to live a year for that to work. She didn’t. He basically renounced my mother’s estate, and it went to the kids. He maintained 20% of the business, 40% of the voting stock.

What you do when your old man says, “This is what it’s going to cost.” I called our lawyers at Skadden, really great guys and women. I told him. I said, first of all, he’s XXXX this whole deal up, we’re going to lose the pooling, and we’re going to go purchase accounting and they just said, “Dude, what are you going to do? It’s your own man, get a grip. He’s given it away.” I was like, “Fine.” We established a preferred equity to pay the dividend and that dividend was used to buy my father out. Prior to the deal, he gave his equity to the New York Community Trust, and then they had a capital stake that we closed out two or three years ago.

A couple of things. My wife during the whole thing, because the company is in Ohio, we live in New York. My wife’s like, “What the hell are you trying to build, Jim?” I said, “I want to create Procter & Gamble’s of Lawn & Garden. She said, “What the hell’s that mean?” I said, “Anything of value I want.” That effectively was the vision. My brother Peter, he was on board. This is my older brother, 12 years older than I am. He’s like, “What’s the plan here?” I said, “Peter, this is the truth. I’m not exaggerating. It’s not going to sound great, maybe to you,” but I said, “Peter, I can take Scotts,” and he said, “You sure it’s the right thing?”

I said, “No, but my urge to hunt here is so high that I feel like I have to take them [00:12:00] and I want to do this.” We made that presentation in Pittsburgh airport because my father was like, “No, we don’t want to do it in Columbus, we don’t want to do it in New York, we’ll go in between.” We agreed we’re going to meet a club in Pittsburgh. The first time we came here, I never been discussed before in Marysville. We drove in the parking lot and Tad Seitz, the chairman of the board is driving the car. My father is in the front seat. My father’s partner, John Kenlon, president of Miracle-Gro is in the backseat and me, the two of us in the back.

We’re driving the parking lot and this is like a 600-acre campus here, manufacturing R&D, office complex built when ITT was in conglomerate phase. I looked at John and said, “This is going to be ours?” The weird thing is, nobody ever said, “No.”

I had this view of noses in, fingers out. I think that’s a terrible idea. For one reason, I am the leader that the board could wake up and say, “Are you kidding me? What did he say and all this XXXX? What’s he up to?” Let’s just say you’re a merchant for Home Depot and you said, “I think you should make this product.” If I say yes, you know what? You’re going to carry the XXXX out of it because it’s your project.

If I let the board engage in management of the business, they’re much more comfortable with what I’m up to. I run the board way different than I used to. We meet more frequently now, six-plus times per year, we do all the nonsense, which is important and a lot of it the committee’s. We do that during the week, but before the board meeting by telephone, or video now. When we show up in person, we’re strictly talking about the business. Now the board, especially my chairman, I’m much more involved in business so there’s not this educational process that has to occur all the time and I have a board that is really functional.

The problem is I got pretty high tenure, Mike and I are getting pretty [00:14:00] old and so there’s change afoot, not because anybody’s threatening to leave or anything like that but both from the board, especially if we say this, another board going to have to happen for Apollo. I got a whole new leadership I got to groom, it’s taken up a lot of time. Our last board meeting– I’m not making this up. I’m usually pretty happy when my board speaks with this foul language as I do, but we had a subject item on this schedule at our meeting where it was like, “If you’re going to do all this XXXX, your five pillars, this was the subject, you would want XXXXing army.”

That’s taking up a lot of our time right now, especially complicated if you say maybe SMG today is two businesses with two boards, two management teams, and do you have the people to do this? We’re in a very expansion-centric mode right now too so it’s a really cool time.

Jonathan: Your traditional consumer business which produces fertilizer, grass seed, et cetera has unbelievable brand recognition, as I said earlier, Coca Cola-like market share, and anyone who gardens know your product. You were a huge pandemic beneficiary, and as your son, Chris, who also works in the business said on a conference call, we joked when all this started, not that it’s a joking matter, but you got to find levity where you can, that what were people going to do when quarantine hit the whole country is they’re going to go sit at home and smoke pot and garden.

I think in all seriousness, there’s a lot of truth in that statement. One of the reasons you were a pandemic beneficiary was millennials moving to the suburbs. How big of a deal has been the exodus from the city to the suburbs been for your business?

Jim: It’s been huge. We had these dark fears, the weirdness about the financial community, the investor community, particularly short-term investors, there was a lot of discussion about work, people are going to move inside the beltway, have condos, no lawns, and that’s what young people wanted. [00:16:00] We weirdly started to believe that, that maybe the growth is done in consumer lawn and garden. I had this conversation with Craig Menear, from Depot, who’s a good friend and a fabulous CEO. Craig said, “Do you think anybody knows homeowners better than we do, Jim? We spent a lot of money on research, and I think you’re completely wrong. If you look at the demographics, there’s a huge bubble of young people who are now having families.”

He said, Jim, “Our research shows that when they have kids, they want a home, a yard, a dog, or a pet. They want all the things that people traditionally wanted.” Even before COVID, we started to become very much believers that if you look at the huge number of our kids, this is my age kids. I’m 66. They’re all buying homes, and even before COVID, buying a home around here in central Ohio, you better do it quick because there’s going to be bidding wars on it, and there’s just a lack of supply here. Homes are just being built and sold. There’s a big article today in the Journal on homeownership and where it’s headed and what the numbers are looking like, but clearly benefited from low-interest rates.

I think generally, a lack of supply and a big group of people who want to be homeowners that are bigger even than people like us that are retiring and downsizing. Even before we were very positive that lawn and garden was a business particularly if we kept up, meaning, innovate market to people the way they want to be marketed to that we could grow that business, at least kind of a GDP. That was where we’re at. Unlike Peloton, who I think is struggling hard right now, that was a big issue for us coming out of COVID, what are people going to do? [00:18:00] We saw a double-digit increase in consumer sales last year, in ’21.

Our fiscal year ends at the end of September, on top of growth 23 or 24%, in ’20. A 33% increase in two years on a business that we viewed is pretty mature. It gets back to the demographics wanting to have a home, a yard, and garden. What happened during COVID was this issue, we didn’t know what was going to happen. This issue of essentiality– remember that whole argument, only essential businesses could be open, you only could go out to do something essential. People early on said gardening is essential, and not every state agreed. There were two states that didn’t. Michigan and Vermont, both said, “Really? Buying plants? That’s essential?”

Consumers argued the point, and both those states had to back up and say, “We agree, lawn and garden is essential.” For us, having a business– and the same was true with the cannabis business. People both from a medical point of view and most states recreationally, it was deemed to be an essential business. That, to me is some kind of confirmation that we’re not on the wrong track, that people say, “Your business is essential.” Last year was not– if you live in New York, it was not a fabulous weather year. Mother’s Day sucked, Father’s Day sucked, Memorial Day sucked, and Fourth of July sucked. Even with no brakes on this sort of Midwest, Northeast weather, we were still up 10%.

We didn’t lose anything coming out of that. I think it’s a real positive for the business. We also got an opportunity to do because when COVID hit, retailers didn’t want to advertise. I think everybody was pretty happy if their store was deemed to be essential. [00:20:00] They didn’t want to advertise and be criticized. You’re bringing people together and you’re going to get people sick. They didn’t promote at all. What happens then? First of all, retails went up by at least 10%. Meaning, everything that would have been promoted wasn’t, so the actual price that the consumers went up double digits and take away was up a quarter call it.

They weren’t afraid of a little bit higher prices, which I think is important right now, but also because they wouldn’t market because the retailers didn’t want to be criticized, we started taking over and doing a lot of work with this guy, Gary Vaynerchuk. I don’t know if you know Gary. Gary’s at VaynerMedia. We basically said, “Look, we’re on our own. We’re going to take the money that we would have given the retailers to market. We’re going to market ourselves.” That really gave us a lot of confidence that we could change how we market. Remember if you say, “To do this, we can’t be the old company we were, we’re going to have to innovate. We’re going to have to sell to that younger group that they do want a garden.”

That’s what the research tells us. They just don’t want to be a slave to it like their parents were. How many people actually watch TV commercials these days on commercial TV, unless it’s sports or news? I think not much. Therefore, we’ve got to figure out how to use social media and influencers. We’ve made a ton of progress on how do we communicate to younger people today. COVID, I think both on the Hawthorne side and then on the consumer side, in spite of the tragedy that I think it was for America, in the world, it was very gratifying to know that this is business that people actually, when this XXXX was happening people said, “I’m going to garden.”

Jonathan: You actually did something that was really interesting. You have something with the weather channel or Watson, you’re able to advertise more when the weather is predicted to be more favorable for gardening, is that something?

Jim: Yes, [00:22:00] this was a criticism. If you look at how marketing happen in lawn and garden pre-COVID, it was falling apart. I’m not sure the retailers agreed with me on this. I thought it was falling apart, that if you looked at, call it, the marketing hit rate, let’s just say you had three or four Black Friday events throughout the lawn and garden season. I’ll bet you, 70% of your marketing and promotional dollars get spent against that. They want to get out early. The retailers want to get out early to get the lawn and garden consumer in, because if they buy certain things on Black Friday events, they tend to buy a bigger basket of stuff. This may be a global environmental change that’s happening, which is we tend to have really good weather up through March.

Then it becomes unstable April, May and then summer hits and you have a decent normal season. We were seeing 80% miss rate on weather. If it’s cold and raining and you go into a Home Depot or Lowe’s when the weather sucks and it’s cold and wet, it’s like crickets in there. This is nobody there. We know the phasing of how people buy stuff. It tends to be because it’s a good promotional item, lawn fertilizer, and grass seed. Then you get into the bug season, pesticides and weed killers. We know the flow of it, but what’s the value of advertising when the weather sucks?

The business we’re in is a t-shirt business. If it’s not going to be t-shirts and people are in a down jacket, don’t expect them to be in a store. Can we pull the advertising either forward up to maybe two weeks or push it back based on weather forecasting? The weather channel data part of it is owned by IBM and it’s a big data deal. I don’t know that they can predict the weather a year in advance, but they can predict the weather two or three weeks in advance pretty well. If [00:24:00] you know you’re going into a weekend, just don’t advertise, push it off or pull it forward.

What we’re learning is if you promote into good weather where you have the promotions, the inventory, the weather, all in your favor, it’s just so much easier to have good business. Yes, we’re pretty careful on the data and learning how to be flexible to move promotions. Now, retailers, it’s harder because the retailers are doing Black Friday events a year out and getting the merchant teams to say, “But you got to be flexible just plus, or minus a week or two. If you’re flexible, then we’ll just promote in a good weather.” It turns out we think weekends are important and they are, but good weather, in season, even if the middle of the week is okay.

We’re trying to run our sales and our advertising, have the weather on our back, not blowing and freezing cold in our face.

Jonathan: One of things I think about in your consumer business– it’s obvious you have a fantastic product but I think about, let’s say the food industry as an example, were over let’s say, a past decade roughly, many of the supermarkets and other places where people purchased food, decided to compete against the established brands with decently high-quality private label brands and they took away market share. I know you do have some private label business, but what gives you the confidence that that’s not going to happen in lawn and garden?

Jim: Well, we start by saying experience. First of all, if you look at dollars spent and units sold, they’re different and you said 50% of the units and 68% of the dollars are the brands, but 50% of the units are private labels. Without private label, it’s going to be very challenging for retailers to make money in lawn and garden. Private label is key to it and we don’t resist that. We try to manage that alongside the retailers. I think that [00:26:00] makes it helpful. Chuck Berger, that was the CEO before me. He’d always tell me, “Don’t tell me what you think. Jim, tell me what you know.”

This is a little bit what I think, I think if you go to store managers and maybe you’ve done that, I know some of our analysts do. I think they’d say, Scotts and maybe Behr paint are the best vendors in the chain. They are some of the very few vendors that a store manager will give his personal cell phone number because they trust us. We’re all about helping them. I think that what you get with Scotts is not only access to very integrated private label programs. By the way, just so headline, we’re not losing share at private label and we haven’t over the last decade, but it’s a very integrated program where we’re delivering everything on the same trucks, which remember, a Depot doesn’t have a lot of bays.

A lot of times you’re just pulling stuff off in a parking lot. When you can reduce the number of trucks arriving by half by integrating private label with this national brand, that is a big benefit to them. We service the product, we counsel on the weekends. Meaning, we have thousands of people in these stores. We own the concrete. I think that the difference between food to some extent and lawn and garden is lawn and garden is a once or twice a season purchase. It’s not something you’re doing every day. Personally, I’m a brand freak. I don’t buy a lot of unbranded food.

I think we’re doing our job to innovate on the branded side especially, offer competitive programs on the private label side, but really try to reserve our big innovation for the branded product, at least initially. I think it’s working out pretty well. I’d start by saying, we are very much believers that a blended program of private label and national brand matters. To the extent we can and be competitive, we want to do both.

Jonathan: [00:28:00] The brand is clearly your biggest competitive advantage but you did spend a lot of money on your supply chain and you have one of the best ones out there. Clearly, for most businesses, they’re experiencing issues, but I can’t help, but wonder is it as bad of a problem as people say it is? Or is this an excuse for companies really just to kind of raise prices?

Jim: I’m going to talk to you the way I talk which is, it’s pretty up out there, seriously. Commodities, we don’t see much easing a little bit, I think right now. I think mostly in plastics and other things, it’s just a really tight supply and there’s no choice. Certain stuff we buy; bags and some containers. We’re a major customer, but they’ll say, “It’s a courtesy call, dude. This is what’s happening with pricing. If you don’t like it, I’m moving down the phone list and I’ll call the next person. Everything’s going to be sold. This is what’s happening with the price.” If you look at our Q3 call, our last third-quarter call, we ate XXXX on that call.

I think it was like for 500 basis points of margin decline in a quarter. I don’t think people were happy with my view on pricing. I think that everybody would’ve been happy if I’d taken 10 but I said 5. It was largely because I was believing this transitory nature of what the Fed was saying. I was hopeful. Now we told retailers, “If it ain’t transitory, we’re coming back,” but I don’t think the street heard that. I think they looked at margins. I think the view of the pot industry as being a little bit oversupplied at the moment and freaked out, but is it bad out there? Yes, I would say it’s pretty bad.

It was The Journal or The Times yesterday, the question is, is there easing happening right now? It’s this whole discussion of, you go from famine to feast. I don’t know if you saw that article yesterday. I think that’s probable, but if you look at right now, that was another thing. We’ve gone from half a billion of free cash flow to 165, I think, we ended last year at– [00:30:00] A couple of things. We had a great year in ’20, so we paid our incentive out at the beginning of ’21. That cost $100 million right there. Inventory is probably up $500 million. That’s us making sure we have the product.

Now, we thought we lost. I think the number we use publicly was $200 million, but I think reality is we think we lost in ’20, business we couldn’t fulfill, $300 million.

Jonathan: Just from not having enough supply?

Jim: Correct. Probably $100 million in Hawthorne, maybe $200 million in the consumer side. We didn’t want that to happen again because people accepted it because it was ’20 and everybody was screwed up then. Going forward, we can’t live like that. It’s not just that, we paid premium pay here during COVID and we didn’t get beaten into this.

We led with this. Meaning, from day one, we said people who have to work in hazardous areas, which we defined as infection rates of more than 45 per 100,000, we’re going to pay a 50% premium. What did we learn a year into it, was that people were tired.

They were working 12-hour shifts, because anybody gets sick, the whole shift goes bananas, and you end up where you have got three shifts, but you never could really feel three shifts. We’re working two shifts, 12 hours, and you do that for months and months, it doesn’t matter people getting paid a lot.

We just couldn’t operate basically on the margin like that. We’re going to burn out the people in our machinery and everything else. We had the investment inventory and then we had a $100 million in cost increases just based on cost of goods. You got $100 million there, $500 million, plus another– it’s about $700 million of investment, called $600 million if you pull out the incentive that was from ’20, that got paid in ’21.

[00:32:00] That’s the way of solving the issue right now is very much a dull instrument of a lot more bullXXXX so that you don’t run out of stock. It is not a super fine way of running a business, but it’s what we did. I think the answer is, I think it gets better over time. I think it starts with something as simple as the entire global supply chain shut down for a month at the beginning of COVID.

You lost 1/12 of the capacity of the world because everybody was shut down. Then when it came out of it, everybody had all this money and the government was stimulating and everybody wanted to buy XXXX. I fundamentally think that solves itself over time, but I am not a major fan of the policy of the United States at the moment, which is that I think stimulating the economy more with build back better, whatever the hell it’s called.

When people can’t get materials and labor right now, I don’t quite understand it other than politically, maybe it makes sense to Democrats. I think this probably continues for a year or two until it’s settles out.

Jonathan: I just want to shift gears just a bit to Hawthorne, which is your hydroponics business and it’s under the leadership, I believe, of your son, Chris. You built this into an almost $1.5 billion business in less than a decade. First, I just want to hear, how did you decided to get into this category in the first place and did he get a lot of pushback?

Jim: It’s a cool story, but the answer is, yes, on the pushback side. It started out where I was in a pizzeria  with two young women reporters for the Wall Street Journal. I think people can always trick me into saying stupid XXXX that gets me in trouble later. I didn’t have any babysitters with me. I got these two young women from the journal who were actually good reporters.

They said, “What do you think about marijuana?” I said, “What do you mean?” They said, “Do you think it’s a business you guys should be in?” I said, “Do I think it’s part of lawn and garden? Yes, it’s growing plants [00:34:00] and we sell XXX to help people grow plants. Why wouldn’t it be included?”

That was probably like a decade ago at this point. I showed up at the next board meeting and my chairman of the audit committee and my lead independent director pulled me aside and said, “Hell, Jim, have we ever said no to you before?” Actually, I have a very supportive board. I love working with them.

I said, “I don’t think so.” They said, “This is the time. The answer is, no. You’re not doing pot.” That lasted for a couple of years until I was making West Coast trips. I’m talking California, Colorado, Washington State, all the West states that are big and marijuana today, but it was all essentially illegal back then.

You’d start to see lawn and garden apartments that were being taken over by these niche brands. You talk to people and they’d say, “Dude, it’s giant. These people are coming in once a month. They’re paying cash. They don’t negotiate. They buy huge quantities and it’s getting to the point or for some of the independence, it was as big as lawn and garden to them. I kept coming back to Ohio and saying, “Yo, this business is happening.”

The crazy thing today, is it still a Schedule I narcotic, which is insane how anyone can defend that. You’d ask people, “What are people growing with this XXXX?” They’d look it right in the eyes and say, “Tomatoes.” That was not that long ago but it was clear that tomato business was getting to be real and Chris said, “Come out of an advertising agency in New York after college.”

We set him up running basically an indoor urban gardening business that was selling stuff where people live in New York city and urban young people, how they garden and it got to the point where we said,” You know what? You should include this hydroponic.” [00:36:00] That’s what people called it, hydroponic but it’s really cannabis supply for cultivators.

Eventually, that business got shed a couple of years ago. The urban, indoor organic gardening business went back into consumer and Hawthorne just kept the cannabis supply business. It’s been tremendous fun and it’s a real vision. It’s a lot of what I wanted to do in consumer lawn and garden, which is consolidate and be the vendor that I told you about like Depot person would say,” No, Scotts is like the best vendor I have.”

I’ve heard this from a lot of people when they’re being edgy with me on the consumer side, it’s like, “Why would they let you get this big, Jim?” They let us get this big because we’ve got the big brands, we advertising bring consumers in this store, we service the product, we do it pretty flawlessly.

We’re kind of the perfect vendor. The question is on the hydroponics side, what businesses would you have to be in? How would you show yourself to be this great partner to marijuana cultivators, where they say, “No, I love doing this with these guys. They bring technical support. They have all the brands I need. They combine it all in one delivery. They give me good pricing,” and we’re probably 70%, 80% of the way where I’ve wanted to do it.

The gratifying part is a compliment to Chris and Mike Lukemire, as a compliment to both of them, I have said to myself over the years, “I’m a crazy XXXXer at work.” I’ve surrounded myself with good technical operators but it gets tiring where you’re the only source of strategy thought in the business because everybody else is very much a technical implementer.

Where Mike has gotten to and Chris is they’re really good strategic partners to me today. That not only makes me [00:38:00] happy as a father to Christopher but very comfortable with Mike Lukemire. Our biggest issue, honestly, is that we’re both in our 60s. We are doing so much cool stuff right now that I just wish I was 20 years younger.

I mean, seriously, it’s one of those things where I don’t have a plan to leave but I also don’t want to be assassinated in my bed by the next generation who wants to take over. It’s not that important to me but I think I’m adding value right now but it’s just– I got a really good team to lead right now.

They’re really up in their game to include strategic game work that they’re definitely on the right track. I’ve always wanted that to be where my leadership team would come to me with ideas that would take my stuff as the beginning and then say, “Yo, not only do we think that’s a cool idea, here’s how we’re thinking we’re going to implement it.”

You say, “Well, that’s even better.” I think we’re getting to that point. I think we’re really seeing it in Hawthorne and this other project we’re calling Apollo, which is a super interesting part. I’m hoping that the investment community tries to understand what we’re up to there.

My end-of-year call, which I think has been good for the equity. I’ve been trying to be much more strategic about trying to help people understand what it is we’re up to because a Q3 call only people want to talk about margin and what’s going on in Q1 in Hawthorne. Seriously, I don’t think it was any questions other than, “What’s going on with your margin rate? Why didn’t you take more pricing? What’s happening in Hawthorne in Q1?”

We never really had a chance to say, “You have any idea how much cool stuff we’re up to?” Apollo was a part of that.

Jonathan: The one, I guess, big headwind I see and it’s obviously outside of your control is the regulatory environment. How is that impacting the growth strategy at Hawthorne?

Jim: [00:40:00] I have a point of view, I’ll tell it to you, but the answer is, I don’t know. If you could deal with safe banking 280E, which is taxation, according to the IRS code, if you’re engaging in a federally illegal business, you cannot deduct your business expenses, which means your taxable income is your revenue and which makes your federal rate nearly 80%. Effectively, anybody who’s gone legal can’t make money.

This issue of what do we consider legalization or major progress, and we’ve defined it because a bunch of deals we’re doing some of which are known, and some of which aren’t, basically said restructuring these as effectively loans that upon certain things happening, convert to equity.

Our lawyers were happy with this. JP Morgan is happy with this. Wells, Deloitte is happy with this, that we’re not stepping on a third rail issue, which has been really important for us as we pioneer a business that, five years ago, people weren’t that cool with it.

Today, I think people are cool with it, but the banks are super sensitive I think both on reputational and compliance issues on pot. We’re saying the right to make these conversions occurs when two things happen. One, you can bank with national banks and I don’t think that’s going to take that long.

Two, is the major stock exchanges in the United States, NASDAQ, and Nyse, except they’ll list companies that are directly touching pot. When those two things occur, we have the right to convert. I’m not really talking about legalization right now.

I have to say, other than a very few states like Oklahoma, most times when politicians touch this, they screw it up for years. I’m not [00:42:00] sure I need the feds to do anything other than don’t enforce, which they’re not enforcing anyway. Then you have banking and taxation, and those would be big steps forward. I don’t know what my expectations are.

Jonathan: If tomorrow you wake up and the taxation and the banking issue were gone, besides switching debt to equity, how does a strategy of Hawthorne change?

Jim: I’ve said from Mike and me, how do we want the business to be managed? We’ve decided there’s these five pillars, but call them business lines, that we want to play in. They’re really all cousins and nephews have two lines. One, is consumer. One, is marijuana, but all plant-based called.

You got our existing consumer legacy franchise. You have live goods, which we think is really important. You have direct to consumer, which we think needs to be a standalone, free-standing business, selling directly to consumers. Within that, managing the retail direct to consumer to where, whether it’s Amazon or homedepot.com does that. That’s three.

Then Hawthorne on the pot side plus Apollo. It’s two businesses, but five different business lines that we want to play in. We think in the world of, if you believe that prohibition on marijuana ends, I think our view is that is nearly certain. Now, this was the conversation. Why is it senators can easily change this when both Republicans, Independents, and Democrats all support this?

How hard is that from a risk point of view as a politician? It shouldn’t be that challenging, but they make it challenging. I think that’s all the dysfunction that occurs in there. Our view is if prohibition ends, where’s the big money going to be earned? [00:44:00] Well, what we know in consumer, consumer brands. Ready to consume consumer brands.

If we knew alcohol prohibition was going to end, houses that own a bunch of distilled liquor brands or beer brands would be where we’d invest. That’s what we see on the consumer side is that if you put a pie chart as the money up there, that ultimately, consumer brands are we think where the biggest money is going to be in a post-prohibition world and that’s where we want to put money.

The part that’s confusing about that is today, these are mostly, particularly in the East Coast, state-by-state limited monopolies permit holders. If you own the permits, especially the early legacy permits in a state like New Jersey or New York, these early medical permits were completely vertical, cultivation all the way to retail. You could argue implicit within that is brands. We’re right now trying to build a portfolio of brands and licenses that allow us particularly east of the Mississippi. My view is, there’s an old-world, a new world of marijuana, the old world is called west of the Mississippi. The new world is east of Mississippi, create a map that we can exploit with brands, cultivation, retail.

I think we’re very far down the road I’m just trying to understand. Now, we’re trying to implement it. It’s not for the faint heart, I’ll tell you that.

Jonathan: To use an analogy, cannabis legalization is like the gold rush. You’re the pick and shovel guy with Hawthorne. The real money, the gold rush was made with the pick and shovels. Mining for the most part for gold really wasn’t that profitable except for some people. Is growing cannabis where you want to be?

Jim: No, I think that the answer is what Hawthorne offers us virtually every [00:46:00] cultivator in the United States is our customer. We know the really great growers out there. I would say, I don’t think it’s an exaggeration to say that’s probably 10% or less of the population of cultivators are highly skillful at what they do. They’re all expendable. They want to participate.

We’ve talked to a lot of these people who own these great businesses but remember, the way at least the United States is organized today, it’s state by state. People who are powerful from California, aren’t powerful from Colorado, but they’re all state by state. When we talk to them and say, “We want to create long-term and equity,” the best equity in history in the space.

If you look at the MSOs, to some extent or the competition here, I got to say, it’s not that they don’t get it, but I think brands, they feel are less important. If you look at the quality of their product, I think we would argue some of these highly specialized people that already buy our stuff that we go in their growth facilities. We know who they are and they want to play with us.

I think cultivation is not crazy important except to say, the quality of the product is pretty important. I think in today’s world, if you’re not cultivating it, it’s pretty hard to get to the quality you want by outsourcing the production. I’m not sure long-term that owning retail and cultivation is important.

I think in the short-term if you look at the map, that’s what I call it, you’re forced into saying, if you want to play in New York, you need a permit. You need a license. You want to play in Jersey, you need a license.

I’ll tell you one of the big losses in election day, Steve Sweeney. Steve Sweeney is the senate leader in Jersey, was probably the most advanced politician I’ve ever talked to about marijuana strategy on a go-forward basis and its importance to the state of New Jersey. [00:48:00] It’s pretty screwed up that he lost to a truck driver who only spent less than $20,000 on his campaign.

Jonathan: That was an insane story, that loss. Going in terms of the regulation, you are the biggest player out there. You’re a publicly-traded company. You have a big target on your back. Does Hawthorne in some ways have a competitive disadvantage because you’re now under a regulatory microscope?

Jim: No, I think it’s an advantage. I’m a big fan of the industry. I’m not sure what I expected 10 years ago. You’d meet people, you’d go to these shows like MJBizCon, and early days like eight years ago, and the people in the industry, they were young, mostly male, mostly white, and still that’s pretty much the case.

I would say they reminded me, I’d come back to Marysville and people say, “What was it like?” I’d say, “It’s like somewhere between a motorcycle gang, and elite special operations. That’s what it feels like.” The people who are really good at it, remember, they suffered through the industry when it was highly outlawed, and suffered from arrests and all kinds of XXXX and harassment.

I’ve told a lot of CEOs, “If you ever want to have faith in young people,” and this is not true of all cultivators, but a lot of these cultivators, they run really good businesses. They didn’t go to business school. They’re self-taught, they’re young, and you know what they do with their money? They buy home next to mom and dad. They invest in your communities.

All of a sudden you say this is a great entrepreneurial business, who the government has been such a pain in the ass. Remember, just think about that. You want to invest in a state like Florida and build-out? It’s going to be at least $50 million to build out your cultivation facility. You can’t borrow from a bank.

You’ve got to borrow from weirdos and listen, it’s a business model. [00:50:00] You can borrow money in New York and Los Angeles. You know what they’re paying? Over 20% per year, with a covenant package that’s really scary when you read it, “You pay, or I get your entire business.”

It’s a real challenge where you don’t have access to normal capital. Then your tax rate basically means you can’t make money. I think that the young people who are running this business in spite of everything being stacked against them are some very, very cool business people. It’s been a lot of fun to partner up with them.

Jonathan: One of the things you mentioned on the last earnings call, someone asked, “Do you ever separate Hawthorne from Scotts?” You said, “You can go on for an hour on why that would make sense.” That was, and I just love to hear why you think that makes sense.

Jim: I’ll give you the reasons why it doesn’t make sense. If you look at the balance, you’ll figure it out. Why it does make sense to be part of SMG is R&D, supply chain, IT, general management, access to capital, and it’s a legal business.

Unlike a lot of the difficult we talked about on the plant-touching side, Hawthorne is completely legal. The banks are comfortable with it. The government’s not trying to enforce against us. We have all the synergies of being involved with the core, where the core has all these things that they can use and Hawthorne gets access to that.

There was a lot of struggle early on where Hawthorne wanted to do everything themselves, but the more we said, “Guys, some of that stuff you’ll never be big enough to be better than Scotts. We can give you that stuff nearly for free,” that’s why it makes sense.

The synergies of being part of it, actually, I know the numbers, and they’re pretty significant. Separating the de-synergies of separating Hawthorne are our material. Lots of reasons to stay part of it. If you believe the bullXXXX I told you about Apollo, [00:52:00] which is where we think the majority of the money is going to be, which again, is consumer brands.

This is not inconsistent with where we are on the SMG side. There are some of these guys from the West Coast that if they sold their business today, they could sell it for $1 billion. We’ve put $150 million at the RIV, we’ve had $200 million. Plus, to say, we got $350 million to play with RIV.

If one of those people said, “We’ll join. We become the minority shareholder, serious minority shareholder,” some of these people are really good, but they’re not going to run a multi-billion dollar business. They don’t think they could. They want to be partners. They want to ride with it. All of a sudden, you say to yourself, “I need poker chips to throw in, or we end up a minority partner.” That’s where Hawthorne.

Hawthorne is the most valuable business in the pot industry in the world. If we aren’t willing to use Hawthorne as a currency, we’re going to be overwhelmed and not be able to maintain control of it. I do think that there probably are investors who say, “Why are you making it so hard for me?” I know that we’ve had interest in some of these sovereign funds from the Mid-East who have basically said, “I’m not investing in a pot business.” I love the Scotts business, but I’m not investing in the pot business.”

I think there’s arguably some, if you separate the business that makes it easier from an investor point of view to say, “I know what I’m buying here. I’m interested in the pot business, or I’m interested in the consumer branded business.” If you listen to our call, it’s not that I’m chasing growth right now, but there are a lot of opportunities that we have visibility to right now.

I wouldn’t be surprised in five years of business, it’s twice the size of this right now. Therefore, even if there are some of de-synergies, if strategically we need Hawthorne to be part of it so that we don’t lose control of it, that’s the argument that I would make.

Jonathan: I think doing something because Wall Street tells you to do something is generally a bad [00:54:00] idea, but why not spin out 20% of it get a value?

Jim: This is not because Wall Street says. This is I love the people we’re talking about partnering with on the Apollo side. Do I want those guys to be the foster and they’re telling us what to do? I just don’t think it would work. I think there’s a lot of disciplines you’d get within Scotts, access to capital markets, the discipline, accounting, all the things that just go with every day being here.

I would be afraid, honestly, if we said we’re going to take a bunch of young guys who are 35 years old, and they’re going to be the majority shareholders. I just think that that’s a business that I’m not sure I’d want to be a part of. This is not because the Street is telling me anything.

This is because I’m a much better manager, I think Chris, as well, where we understand our authority. I think we need authority in Apollo. I think the upside is big enough that I’m making the number up right now but if you said there are $50 million of de-synergies, actually, I don’t think it matters in the big scheme of things. If you could actually create what you’re talking about, which is the finest pot equity, remember, a lot of stuff has to happen so we’re map building right now. If you could do that, does $50 million of de-synergies really matter? I don’t think so.

Jonathan: Not at all. As I said, doing things because Wall Street says to do so is generally a bad idea, but one of the things that they really have a tough time is SMGs top to value for a couple of reasons. One, it’s a two-quarter business, and then you have the weather issue. Is this a business that really needs to be public at this point? Why deal with annoying Wall Street analysts?

Jim: Henry Kravis came to visit with me. This is ’07, I think it was and the stock was probably less than $50 at the time. We can [00:56:00] privatize the business. You’ll make so much goddamn money. I think Doug Braunstein was the CFO over JP Morgan and a great banker.

I said, “You’re going to go borrow a bunch of money from Doug for free because interest rates are jack XXXX and we’ll buy the company. Now, I’m going to have a shareholder with a large appetite for making money, and I’m going to have to report to you guys. Then I’m going to have to go public again to get rid of you.”

Why can’t I just go and do a big dividend to our shareholders and I’ll borrow the money from Doug for nothing and distribute it to shareholders? Which we did and in today’s market, I’m not completely satisfied, but I think at this price, I don’t think the family would want the risk.

I think you’d say to yourself, “Do I like that world where I would have to have financial partners help me out, I think? Do I want to let them in?” I don’t know. If it was your family, would you do it?

Jonathan: I think you got a great business and I’m confident in the long-term aspect of Hawthorne.

Jim: In regard to challenging it and having a calendar that’s subject to not only weather but is effectively a six-month business, I think we’re a pretty consistent earner. I think we have a much more consistent business than it sounds. I think difference between good weather and bad weather is probably a percent or two.

That’s not that huge. I don’t think it’s that hard to value. I think if you look at our debt, we tend to issue debt at investment grade cost when we’re a non-investment grade issuer. What do I think? I think we get a lot of credit for being pretty reasonably run company with pretty consistent earnings.

I would add, we tell the Street what we’re going to do, and we do it, which I view as usually a good thing for the investment community is I think if we tell the Street clearly what we’re up to and we do it, even if the results involve degradation of some of the quality of business metrics in the short-term, [00:58:00] I think the Street buys into that chip and says, “I think this team can solve that problem.”

Hawthorne is a little bit different because the problem with Apollo right now is with 280E called an 80% tax rate on the federal side and then throw state taxes and local taxes and all the burdens that go along with that, you effectively can’t make money legally in the pot industry at the moment. It’s the weirdest thing.

Who makes the most money in pot right now? The federal government. That’s XXXX up. The problem is there’s not visibility to financial returns on that money in the short-term. You have to do it based on what you think the value of the franchises and I think the Street can handle that. I think my family can handle that, but time will tell on that one.

I think that’s a more challenging valuation metric is to say, “Well, wait a minute, how much money are you bringing in? What’s the cash flow?” That’s a harder one because then you got to talk to Chuck Schumer and say, “Solve this problem dude. America is in favor. 75% of America lives in states where this XXXX’s legal. The feds need to get on top of this.”

Jonathan: Jim, I want to thank you for being on The World According to Boyar. I really enjoy learning more about your fascinating story. How the pandemic has provided a significant tailwind for the consumer business and the tremendous opportunities at Hawthorne. I look forward as a shareholder to watching your progress. Thanks for coming on.

Jim: Thanks, guys.

Jonathan: I hope you enjoyed the show. To be sure you never miss another episode of The World According to Boyar, please follow us on Twitter at @BoyarValue. Also, if you would like to receive the Boyar Value group’s latest report on Scotts Miracle-Gro, please email info@boyarvaluegroup.com or click the link in the show notes. Until next time.

[music]

[01:00:00] [silence]

[01:00:02] [END OF AUDIO]