Good day and welcome to The Scotts Miracle-Gro Company's First Quarter Earnings Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Jim King. Please go ahead, sir. Good morning, everyone, and welcome to The Scotts Miracle-Gro first quarter conference call. Joining me this morning is our Chairman and CEO, Jim Hagedorn; Chief Financial Officer, Cory Miller; as well as President and Chief Operating Officer, Mike Lukemire; and Chris Hagedorn, Group President of Hawthorne. In a moment, Jim, Chris and Cory will share some prepared remarks, and then we'll open the call to your questions. In the interest of time, we request that you ask only one question and one follow-up. I've already scheduled time with many of you after the call to fill in the gaps. Anyone else who wants to set up some Q&A time can call me directly at (937) 578-5622, and we'll work to set up some time as quickly as we can. A quick bit of housekeeping before we start. Cory and I will be participating in two investor conferences during the week of March 7. The first is the Raymond James Annual Institutional Investors Conference at the Grand Lakes Resort in Orlando. We'll travel to Boston to present the next day at the UBS Annual Global Consumer and Retail Conference. We would expect both presentations to be available via webcast, and we'll publish more details related to the date and times as we get closer to the events. With that, let's move on to today's call. As always, we expect to make forward-looking statements this morning, so I want to caution that our actual results could differ materially from what we say. Investors should familiarize themselves with the full range of risk factors that could impact our results. Those are filed in our Form 10-K, which is filed with the Securities and Exchange Commission. I want to remind everyone that today's call is being recorded, and an archived version of the call will be available on our website. With that, let's get started this morning, and so I'll turn things over to Jim Hagedorn. Jim?

Thanks, Jim, and good morning, everyone. The first quarter may comprise a small percentage of the year, but it doesn't mean things are slow around here. Quite the contrary, in fact, there are several important storylines coming out of Q1 that are worth exploring in more detail. Among them: a continued high level of consumer engagement that led to a second straight year of Q1 profitability in the U.S. Consumer segment, with strong momentum as we ended the calendar year. The announcement of a third pricing action in the consumer business that will take effect in the second half of the year; an increase in our full year sales guidance for the segment; some moderation, finally, in commodity prices; continued re-strengthening of our supply chain and has us well positioned to meet the demands for the upcoming season; restructuring efforts in Hawthorne that will make the business even stronger; and plenty of activity, including two more Hawthorne acquisitions in what is the most robust M&A pipeline we've had in 25 years. Yes, there's a lot to cover. Before I jump into the details, I want to share a story that helps us put context around the strategy I outlined on our last call and its potential to drive value for our shareholders. As most of you know, my brothers and sisters and I own roughly 25% of the Company. As part of our recent meeting with our advisers, we discussed the financial return on the family's investment since the merger of Scotts and Miracle-Gro in 1994. Just like other long-term shareholders, we've done well. The most important part of the discussion; however, was centered around the simple question, why? Why have we done so well? And that's the part of the story that matters to all shareholders. One of the benefits, I believe, from strong family ownership in a public company is that we take a long-term view, and we're not afraid to think like an activist and recognize the need to re-imagine the Company from time to time. This is one of those times. On our last call, I said we're pursuing five pillars of growth that could double the size of Scotts Miracle-Gro through both organic and acquired growth over the next five years. I also said we would explore the possibility of dividing the Company into two pieces. Obviously, those things won't happen overnight. But the progress we've made already this fiscal year demonstrates just how seriously we're focused on this journey and how bold we're willing to be. So let's jump in. I want to start with the U.S. Consumer business. I usually leave the numbers to Cory, but I want to start by touching on the P&L. If you're only looking at the year-over-year comparisons, I'd say you're looking at things the wrong way. Look at it with a historical context. While it remains the smallest quarter of the year, Q1 has become increasingly important on a full year basis. We've moved more shipments into the quarter to better serve our retailers, a change that has improved the performance of the business significantly. You'll miss that fact if you just compare the year-over-year results. For example, Q1 volume is down from last year but up 107% over fiscal '20 and significantly higher when compared to the average in the four years before COVID. This feels like a base we can grow from. The year-over-year gross margin rate is down 2%, but the segment's margin is up more than 1,300 basis points compared to the average of the four years prior to COVID. And that's true in the face of sharply higher commodities. The same story holds with segment income, which was a positive number for only the second time in our history. On average, the bottom line result was $50 million better than in each of the four years prior to COVID. And as we look ahead, there's good reason to believe that the first quarter of U.S. Consumer segment on an EBITDA basis could remain profitable going forward. If we look at consumer activity, it's another good story. In Q1, POS, as measured by consumer purchases at our largest retailers, was up 3% in units. It was up 9% in dollars. Both numbers were against a plus-40% comp a year ago. Normally, I caution against reading too much into our Q1 POS, and that caution still applies. What's different this time, however, is the December quarter marks a continuation of a trend dating back to spring of last year that shows a level of consumer engagement that consistently has outpaced our expectations. The COVID impact on POS continues to complicate the pure year-over-year comparison. But if you look at POS units over the past four quarters, we're up 22% compared to two years ago. More importantly, that two-year comparison has grown stronger with time, suggesting that the COVID benefit may be more permanent than we first expected, which would result in a much higher base from which to grow. I'm not going to predict whether POS for the March quarter will be positive because we continue to have difficult comps. But our most recent consumer sentiment data, which we received just last week, tells us consumers continue to see gardening as important to their lifestyles. It also tells us they plan for their spending levels to be consistent with last year, an important fact given the overall amount of inflation in the economy. And while we continue to expect a modest decline in overall participation levels, more than two-thirds of consumers who do plan to participate in gardening this year said they expect to buy more plants and have bigger gardens. Everything we're seeing and everything our retail partners are sharing with us is cementing our optimism as we move closer to the peak of the season. We've increased our sales guidance for the U.S. Consumer business to a range of minus 2% to plus 2% on a full year basis, an increase of 200 basis points from our previous range. This increase does not require us to change our view of the balance of the year. We're able to increase the range for two reasons. First, the Q1 result was better than expected and should be a permanent benefit for the year. Also, we have communicated to our retail partners another price increase for the second half that will impact our full year results by 1%. The difficult decision to take a third price increase in a single year, while unprecedented for Scotts Miracle-Gro, was necessary in the face of continued cost increases that created a bigger headwind than we expected. The additional point of pricing, which takes effect in Q3, will get us back in line with our goal to offset commodity increases that have been a challenge for the past year. Fortunately, we've been seeing a few key commodity inputs peak over the past month, and it's beginning to feel like the worst may be behind us. Like others, we're still seeing higher distribution costs, but I'll leave it to Cory to discuss that in more detail. The additional round of pricing is not merely rooted in protecting our margins. It's about supporting our retailers and protecting our competitive advantages. Over the years, we've built a market-leading position and driven strong returns for our retail partners by investing strongly behind innovation as well as sales and marketing support. These competitive advantages drove both consumer engagement before and during the COVID crisis. We didn't outperform our competitors during COVID due to dumb luck. We won because consumers trusted our brands to deliver the results they are seeking. We won because our marketing team created relevant messages that resonated with those consumers and drove them to the stores. And we won because retailers knew they could count on our sales force to help manage their lawn and garden departments during the height of the crisis. Given the current challenges in the labor market, our in-store sales force is more important than ever in supporting our retailers, and we need to protect that investment. That's also true of our supply chain, which has been able to meet retailer demand when others could not. I said in the last call, we don't like this level of pricing, and I don't. But the actions we've taken allow us to protect those competitive advantages and strengthen our relationship with consumers and retailers even further. Speaking of relationships, I want to provide an update on the performance of Bonnie Plants and our strategy for live goods. There is good news on both fronts. First, Bonnie POS is in line with our core legacy brands, and we're expecting another strong season in the edible gardening space. Over the past few months, there have been significant improvements to the Bonnie supply chain both in the way of process improvement and a new influx of talent. We're also seeing continued integration of our sales and marketing efforts. This should result in a better in-store experience for consumers and more cross-selling opportunities for our core brands, especially Miracle-Gro. As you know, we see live goods as an important gateway to the relationship with consumers. Our relationship with Bonnie has already improved the category, and we believe there's more we can do to enhance the range of choices available to consumers. Together with the Bonnie team as well as our partner, Alabama Farmers Coop, we have been actively exploring additional M&A opportunities that could significantly strengthen our live goods portfolio and bring a higher level of consumer-driven innovation and retailer support to the industry. While it's too early to share any details, we're excited by the prospects, and we'll be sharing more with you as these discussions play out. From nearly every angle, I'm extremely bullish about the potential in the core lawn and garden business right now. And I'm equally optimistic about the steps we're taking to further strengthen our franchise and transform what it means to be an industry leader. We knew before COVID hit, demographic trends were starting to work in our favor. We saw that millennials were becoming interested in this space and in our brands. But once their lives became centered around their homes, they turned to gardening in numbers we never expected. A decade ago, this group was barely evident in our results. Today, they're driving our results. Our job is to keep them engaged to have them see gardening as relevant to their lives and to see our brands as critical to their success. Throughout the entire business, we're taking the right steps and making the right investments to ensure this happens. So yes, I'm optimistic as we prepare for the season. That's true not just for fiscal '22 but in the years to come. And I know Mike Lukemire and his entire team see it the same way. Okay. Let's shift to Hawthorne. I'll start with the obvious. It's clear this year is going to be a challenge, and we'll see a decline in sales. I'll let Cory cover the numbers, but we already laid out much of what needs to be said in our announcement on January 4. While the current market reality is frustrating, we're not discouraged. We continue to believe in this space and its long-term potential. And over the past several months, there's been a lot of activity occurring that is designed to make the business even stronger when the market returns to growth. As many of you know, Hawthorne experienced a tough downturn in 2018. And it was on one of these calls that I publicly criticized the team for being paralyzed by the stress of the moment and said they needed to step up. You're not going to hear that this time. The learnings from 2018 have helped us tremendously, and the way the team is managing this situation couldn't be more different. First, the team saw the market decline coming as far back as June, and that allowed us to prepare. Second, they knew they couldn't change the reality of the situation, so there was not a panicked effort to chase sales that weren't there. Third and most importantly, they put on their activist hat and said, how can we use this downturn to make our business better? I have no doubt their answers to that question will, in fact, make Hawthorne better. So, I'm going to pause for a few moments and ask Chris to give you an update.

Thanks, Jim. Hey, everyone. Let me start by taking a quick moment to update you on current industry trends. It's beginning to feel like we've seen the bottom of the market. We haven't bounced off the bottom yet, but daily sales trends have been consistent for about a month, and that makes it a bit easier to navigate. Also, we're beginning to see some slightly better results in consumable categories, like nutrients and growing media, which is also an encouraging sign. You guys know the nature of the industry's challenge right now, so I don't need to elaborate. As I said in our January 4 announcement, we expect to see growth again in the second half of the year, but I'm not going to speculate on exactly when that will happen or to what extent. What I can tell you is that our business will be significantly stronger once the downturn ends. We've made key acquisitions, have taken steps to restructure our manufacturing footprint and realigned the management team based on the future needs of the business. You probably saw our announcement last month about the acquisition of Luxx Lighting and True Liberty Bags, but let me give you some more context. There is no doubt that Gavita is the premier lighting brand in the indoor cultivation space. It has been a home run for Hawthorne and is critical to our long-term success. And Sun System, the private label brand we acquired from Sunlight Supply, is a solid opening price point fixture. Lighting is the most important category in our industry. It's a category where we made a commitment to innovation and to being a leader. For growers, lighting is where they spend the most money, and it's the category that has the biggest impact on their crop. The right lighting strategy creates a relationship with those growers, that opens the door for us to sell a full portfolio of solutions. Over the last two years, our R&D and supply chain teams have helped drive our success in the critical area of LED lighting. We created the best products in the market, which has helped accelerate the industry's move to LEDs and strengthened our market share. Even though that's true, we still knew that we needed more than we had. We looked at all the available options in the market and decided that Luxx was the brand with the greatest potential. Luxx is unique because it was designed by cannabis growers and is widely used by commercial cultivators who know its history and trust its performance. The current market conditions made the economics of the Luxx acquisition extremely attractive, especially when you consider the synergies it allows us to capture. The Luxx deal makes this the perfect time to begin to consolidate our lighting manufacturing to a single location. We announced last week that we will move our current lighting production, mostly HPS lights, from Vancouver, Washington to Southern California. We'll move other LED assembly we've been doing it there too. This move will significantly reduce our inbound and outbound distribution costs, better leverage our labor force and take advantage of one of the best manufacturing plants in the SMG network. Those savings will allow us to take substantial costs out of each fixture and significantly improve our already market-leading position, especially in the critical LED market. As part of this restructuring effort, we're also closing the manufacturing facility for HydroLogic, which we acquired last year. We are moving that work to our Santa Rosa facility, which is the original home of General Hydroponics. And we're consolidating distribution on the East Coast to a facility we recently built in New Jersey to meet the expected demand from new markets in the years to come. Back to M&A, the other acquisition we announced, True Liberty Bags, is a much smaller deal but speaks to our strategy of putting the grower at the center of everything we do. True Liberty's products are used in the post-harvest process to freeze, store and transport large harvest quantities. The products are designed to prevent cross-contamination and preserve the quality of the plant. It is a niche category but a critical one. True Liberty is the clear leader in the space and a brand that commercial cultivators trust. The acquisitions in the last six months of Luxx, True Liberty, HydroLogic and Rhizoflora don't just add to the P&L. These brands make Hawthorne more critical to cultivators who continue to see us as far more than just a distributor. They see us as a trusted provider that understands the nuances of their business and one that continues to invest to bring them better product solutions and generate higher returns. The other changes that we've made, is a realignment of the team to focus on the needs of the business once the market returns. The restructuring has resulted in the elimination of roughly 200 positions. While the business decision was easy, it's never a good day when you have to part with valued members of the team. We did everything we could to provide them a soft landing, and I sincerely wish them well moving forward. We also made some changes in Hawthorne management. Tom Crabtree joined the team a few months ago to lead our sales effort. You heard from him most recently during our virtual Analyst Day as a member of the U.S. Consumer team. Tom has a great background. He started off in the SMG supply chain and then moved to sales, including a stint in which he transformed the Home Depot sales team. From there, he went on to lead all of sales in the U.S. Consumer business. And more than anything else, Tom is a great leader. He knows how to build teams, how to motivate them and how to design programs that drive results. As we look to the future, it was clear to me that Tom was the right person to be the chief operator of Hawthorne, and he was recently promoted into that role. As you can see, while sales have slowed for the time being, we haven't. Every one of these changes makes our business stronger and will help further distance Hawthorne from our competitors. I'll be around for Q&A. But for now, let me turn things back over to Jim.

Thanks, Chris. You'll remember that the fifth pillar of our growth strategy is to explore opportunities in the emerging areas of the cannabis industry that are more consumer-facing. While SMG can invest directly in that space right now, we can build optionality that we can capitalize on later. The creation of the Hawthorne Collective and the convertible loan we made to RIV Capital are part of that strategy. Because RIV is a public company, I can't provide many details this morning about its activity. But recall that we do have three feet on their board, which is very active in setting the strategy and vision for what comes next. It is through that lens that I can tell you to expect some important developments over the next quarter. As a result, we may choose to infuse more cash into RIV over the balance of the year that would increase our ownership stake if we converted the loan to equity But we would still maintain a non-controlling and non-ownership interest, and the magnitude of any additional cash would not approach the initial investment we made last year. On the topic of Hawthorne and the Hawthorne Collective, I want to make one more comment. I know the discussion we had in the call last year regarding a possible split of the Company got a lot of attention. Jim King has told me he had literally dozens of conversations about this issue with current or potential shareholders. I want to reiterate that we've made no firm decision about whether to proceed down this path, and it will take a while before we do. Since our last call, however, we've established an internal team to study this issue and help explore the right courses of action. There are arguments to be made for splitting and equally compelling arguments to be made to continue operating as one company. We don't feel any pressure to lean one direction or the other, but we'll rely on the facts and analysis to guide our decision-making. Before I wrap up and turn things over to Cory, I want to close with this thought, and it brings me back to the meeting with my family. Our business is sitting in a pretty good place right now, and it would be easy to sit back and just harvest the fruits of our labor over the next few years. But the opportunities in front of us are simply too obvious and consequential to ignore. If we're successful in executing our strategy, this will be a much bigger and more profitable business that will drive meaningful value for our shareholders. I'm not going to tell you we won't have challenges along the way. The degree of difficulty associated with some of our efforts is high, but any path worth pursuing can be slippery at times. I'm confident those who choose to travel with us in the years ahead will be glad they did. We have a lot of exciting pieces coming together in the months and quarters ahead, and I look forward to tracking our progress with you along the way. For now, I'm going to turn things over to Cory to cover the first quarter financials. Cory?

Thanks, Jim, and hello, everyone. My comments will be brief this morning. A lot has already been covered through either our pre-announcement last month or by Jim and Chris this morning. But there are a few key themes I want to cover, specifically about the adjustments we've made to our guidance, the current trends with cost of goods, and how we're thinking about capital allocation as we look ahead. On the P&L, there were no real surprises on the top line. Total company sales were down 24% against a 105% comp a year ago. U.S. Consumer sales were down 16% on a 147% comparison. And Hawthorne was down 38% against 71% growth a year ago. In U.S. Consumer, we saw good POS, as Jim already mentioned. And retailers finished the quarter with inventory in line with where they were a year ago. That was the best-case scenario for us. They remain committed to the category through the fall season and kept appropriate levels of inventory in their stores as we approach the slowest weeks of the year. That leaves them well positioned as we pivot into our key selling season, and the shipments we saw through January leave us optimistic. The midpoint of our increase in our sales guidance for the segment assumes an eight-point decline in volume for the full year, offset entirely by pricing. The trends through four months suggest this might be a conservative estimate. But as Jim said, we're less than 10% of the way through the year, and it's way too early to predict what will happen in the spring. Shifting to Hawthorne, the sales decline was due primarily to the slowness of the broader cannabis market. The supply chain challenges we've mentioned previously are difficult to precisely quantify, but we believe they caused around 5% of the downward pressure in the quarter. Those challenges, primarily in the LED lighting space, have been remedied and we are back in stock with the components we need to once again be manufacturing and shipping LED lights, which remain in strong demand. Let's move on to gross margins because this is an area that's important to understand. As you know, Q1 results often fall prey to the law of small numbers, and that's exactly what happened with gross margin. The adjusted rate was down 570 basis points in the quarter driven by the year-over-year decline in volume and its impact on manufacturing, distribution, and other fixed costs. Commodity prices were also a headwind in the quarter but offset by a 400 basis point improvement from pricing actions. Jim mentioned the importance of looking at the gross margin rate in historical context, and I totally agree. The result in the quarter was more than 600 basis points better than in fiscal '20 and more than 850 basis points better than fiscal '19. Over the past several years, we have effectively moved business into Q1 to ensure retailers are properly set for the season, which should keep us at a level of profitability that is higher going forward. As I look at the balance of the year, we are maintaining our gross margin rate guidance for a decline of 100 to 150 basis points. Right now, I'd expect us to be at the lower or worse end of that range. Margins for the balance of the year should be relatively flat but could vary a bit each quarter, positively or negatively, based primarily on timing and mix. You probably saw my quote in the press release this morning about commodity costs, and Jim touched on it slightly too. Let me elaborate. In total, we are 70% locked on commodities for the year, which is slightly behind normal. We would normally have all of our costs locked right now on pallets, but we're only at 30% because vendors are not currently entering into long-term contracts due to the volatility of lumber prices. On everything else, we're actually in good shape, including urea, where we're nearly 80% locked for the year. The better news is that we're starting to see some relief. Resin has been retreating for a couple of months now. Urea has begun to do the same. No one has been accurately predicting input costs for the last year, so I want to be cautious. Still, I'm increasingly optimistic that the pricing moves we've taken should offset these commodity headwinds on a full year basis. SG&A was down 2% after a sharp increase last year. Recall that our guidance calls for SG&A to decline up to 6% for the year, and it's an area we're keeping an eye on as we move closer to the season. The only other issue on the P&L that merits your attention is the $7 million loss on the equity income line, which is related to our 50% ownership in Bonnie. Remember, we did not have that ownership stake a year ago, and Q1 is a seasonal loss quarter for Bonnie. As Jim said, the business has had a solid start for the year, and we're optimistic about the upcoming season. On the bottom line, our seasonal loss on a GAAP basis was $0.90 a share compared with income of $0.43 last year. Adjusted earnings, which excludes restructuring, impairment, and nonrecurring charges, was a loss of $0.88 compared with earnings a year ago of $0.39. You might recall that fiscal '21 marked the first time in company history that we reported a first-quarter profit. Chris mentioned in his remarks the realignment we've made at Hawthorne. We expect those actions to result in a restructuring charge of up to $5 million in the second quarter. That charge will be excluded from our full year guidance. Let me briefly touch on the balance sheet, specifically focusing on inventories, which are up about $590 million from last year. First, recall that inventory levels were lower than we had wanted a year ago as we were shipping product nearly as fast as we could build it in both major segments. Second, recall that we consciously built an inventory cushion last year to ensure we are able to keep our retailers at the appropriate levels throughout the season. And finally, about 25% of this increase is due to the higher input costs we've been experiencing over the past year. We remain comfortable with inventory at this level and continue to see it as a competitive advantage. We expect to see some competitors continue to struggle to meet demand this year, which we believe will work to our advantage. Finally, I want to focus on capital allocation. We are still planning for CapEx to be approximately $200 million for the year as we continue to improve our supply chain and invest in our e-commerce infrastructure. Remember, we had been investing based on the assumption that our U.S. Consumer segment would grow at a point or two per year. Since fiscal 2019, it's up around 40%, and we've pushed our capacity to its limit. So these investments are necessary. Jim commented several times about the M&A opportunities in front of us. So let me provide some context. We are currently budgeting slightly more than $200 million for future transactions over the balance of the year. The opportunities that remain on the table, if executed, should be immediately accretive to earnings and go a long way in advancing our strategy. In terms of returning cash to shareholders, we repurchased $125 million of our shares in Q1 and have a 10b5-1 in place for another $50 million in our Q2. We currently do not have a 10b5-1 in place for the second half of the year and would expect that any share repurchase activity during that period would occur in the open market. Additionally, we have no current plans for a special dividend this year. Given our current outlook for the business and our expected outlay of capital, we could slightly exceed our leverage target of 3.5x by the end of the fiscal year. We were at 3.3x at the end of Q1. If we exceed our 3.5x target, we expect to get back below that level within a quarter or two, and we will still be well within our current debt covenants. Before I open the call for your questions, let me say that I'm really pleased with where we're sitting right now. We know we have some near-term challenges in Hawthorne, but we are focusing on the demand that we can't control. What we're focusing on is what we can control, and that is what we look like when the growth does return. I'm convinced we'll be better positioned than ever with a better margin profile and competitive advantages that have been strengthened over the past several months. In U.S. Consumer, I share Jim's optimism. There's no need to make further adjustments in our guidance right now, but the trends are certainly tilting in our favor for the upcoming season and beyond. And finally, on a personal note, I've recently completed my first full year in this role. My engagement with all of you was a new experience for me, and it's given me a better appreciation of the issues on the minds of our shareholders. Through this new lens, I'm working closely with my colleagues to ensure we're acting as proper stewards of our capital and focusing on driving value for all of you. And while I've also grown to appreciate the importance of this quarterly discussion with all of you, it's also reinforced my view that we can't run the business on a quarter-to-quarter basis. Value is driven over the long term, and I'm convinced that the steps we're taking to strengthen the business will do exactly that. Now, let me turn the call over to the operator for your questions.

And our first question will come from Jon Andersen with William Blair. Please go ahead.

Congrats, Cory, on your first year under your belt. I wanted to start with a question on the U.S. Consumer business, really related to demand or consumer engagement as the pandemic wanes or presumably wanes. You've taken your numbers up for the year for that segment, which suggests a certain degree of confidence. I'm guessing that's coming from some of the real-time data that you're seeing through point of sale. You also referenced some survey work. But I'm just wondering if you could talk a little bit more about what gives you the confidence in that business, again, as consumers kind of return to travel, return to their workplace and the general inflation that the consumer is faced with at present across all consumer categories because that's a big topic for investors that we talk to?

Jon, Jim Hagedorn here. There's a lot to unpack in that question. The point of sale data is definitely encouraging. For the past couple of years, especially since COVID began, we’ve hoped to maintain strong sales data. So, it's still a challenge for Mike and me to say we expect sales will increase between minus two to plus two. However, the POS data, though limited, indicates that consumers are still engaged. The survey results suggest that there’s a growing interest in gardening, particularly among younger individuals who are even more enthusiastic about it than previous generations and are willing to spend more money on it. Lastly, the enthusiasm from retailers for this category, both online and in physical stores, is very positive and shows a strong commitment. We’re experiencing a more successful and timely product rollout into retail this year compared to the past. Retailers are engaged, and so far, consumers are purchasing, not just in our category but also in live goods. The information we have, along with our marketing plans and innovations, leads us to project that sales will be flat, which may not sound impressive. What do you think, Mike?

No. But I'm an optimist. We are noticing an upgrade in live goods, with a demand for higher quality. We are seeing larger pots, and consumers seem to be interested in that. This gives us confidence that they want to engage further and achieve greater success. The demand for premium plants and products has increased, and we have not seen consumers retreat from pricing increases. This contributes to our optimism, and we are observing this trend in the South right now.

Do you think pricing will discourage people from gardening? To be honest, we don't know, and neither do the retailers. If we look back to 2020, there was virtually no promotion at all, and last year, there was probably half as much promotion as in 2020. Despite that, prices rose significantly for consumers without any promotions or Black Friday events to lower them, resulting in an incredible business year. It was during COVID when people were at home, and we were clear about our expectations; we managed to maintain our position and saw unit growth of about 10% last year. However, we are currently experiencing pressures that I've never seen before, and our retailers are acutely aware. We're seeing double-digit increases across the board, which are impacting our margin rate. This is a significant concern for us, and while I'm not overly worried, we will monitor the situation closely. The pricing is substantial and necessary, and while I'm not too concerned, I wonder how you feel about it, Mike?

No. I mean all indications there is consumers are not walking from that activity. And we're seeing them trading up. The live goods are early indicators.

But not just live goods, Mike. Our Roundup sales in the Southwest, which is a leading indicator of the market, are significant. Yes. So I mean, I'd say so far, so good, Jon.

That's helpful. One follow-up, different topic completely. Jim, you mentioned you have an internal team that's actively evaluating the prospect of dividing the Company. Anything else you can say about kind of the criteria you're using to determine or make a decision on that, what you need to see to make a decision and the time frame associated with it?

Yes, it's a good question with a complex answer that I know some might prefer I skip, but I'll approach it. First, let's consider Hawthorne as a legal business. Unlike plant-touching businesses, we don't face many of the reputational risks associated with taxation and banking. There are significant synergies in seamlessly integrating Hawthorne into our supply chain and R&D initiatives. So, on many levels, it seems logical to keep it there. The question arises as to why we would consider separation, and I see two clear reasons. One is that within the investment community, there are investors who recognize our strong lawn and garden business as having high cash flow and predictability. Those interested in the cannabis market typically have different investment profiles. That may hold some truth, but I'm not sure it surpasses the benefits I’ve mentioned of retaining the integration. Personally, keeping it together allows Chris to stay with us, which is important to me as his CEO, mentor, and father. It would be disheartening to see him choose a different path. Another aspect is what we plan to do with the Hawthorne Collective, which will become clearer in the coming months as we develop our work through RIV. Control is important to us, and as we clarify our strategy on Apollo or the Hawthorne Collective, I’m not referring to acquisition funds but rather to the value of the enterprises we intend to merge into an alliance that I believe could result in the premier cannabis opportunity. This will be more apparent when these elements can be consolidated onto a U.S. exchange, potentially leading to the most valuable pure cannabis venture globally, and we're making significant progress towards that goal. If we wish to maintain some level of control, we may need Hawthorne to secure an ownership stake that reflects our dedication to the industry while ensuring we have a substantial say in its management. This dimension is crucial. I can't definitively say which option is better, but I believe everything will unify. Looking at the potential dis-synergies of separating, I think the value generated from the proposed entity could outweigh the relatively minor challenges that might arise from detachment. I hope that clarifies things.

Yes. That's terrific, very interesting. Thanks for the color and I appreciate it.

Up next, we'll take a question from Joe Altobello with Raymond James. Please go ahead.

First question for Chris. The oversupply of cannabis in the market has been discussed, particularly in California and Oklahoma. Are there other markets experiencing the same issue? Is there a concern that this oversupply situation might continue to spread later this year instead of improving?

Certainly. There is definitely not just one state affected by this issue. California is significantly impacted and remains our most important state market, accounting for nearly half of our business. However, we're also seeing substantial effects in Michigan, our second-largest market. That said, several states, particularly in the Northeast and the Eastern corridor, are performing quite well, albeit from a small base. This is reminiscent of the growth we observed in Oklahoma a few years ago. Some states are experiencing growth rates of 100,000% or 200,000% from their smaller base. While we have markets thriving, the oversupply issue stems largely from the legacy illicit market, which operates without regard to state boundaries. Consequently, we see this issue across larger, more developed markets. States with stronger or developing legal markets are generally faring better. Regarding the duration of this situation, historically, such issues do not last long. As legal markets mature and cannabis sales transition from the illicit to the legal sector, these disruptions should diminish in severity and frequency. Current reports suggest that we might see the oversupply resolved by April, perhaps a bit later into the early summer. Overall, we remain optimistic that by mid-summer, we will witness a significant recovery in our business, reflected in our projections for the year. My main focus is on the trend we end the year with, and I am confident it will be upward as the oversupply gets sold through or disposed of, since cannabis is perishable. We expect that within the next couple of quarters, the inventory will be cleared, and we will regain a growth position based on the information we have.

Chris, I want to share my perspective that this market feels quite immature. There's a prevailing mindset of quick riches, but we often face market downturns, leading to cycles of instability. Hawthorne's role should be to guide people in understanding production and pricing dynamics. We are enhancing our capabilities in both R&D and the economic aspects of our business by hiring reputable professionals who are eager to explore this new industry and help our customers gain a clearer view of the future. Currently, the visibility in this industry is quite limited, making navigation challenging. We aim to support the professionalization of this industry and serve as a constructive influence as it matures. I believe our competitors are unlikely to make similar investments that would benefit the industry.

That's very helpful. I guess just to kind of follow up on that, are there any liquidity issues that you're seeing amongst your hydroponics customers at this point?

Joe, we've noticed that the situation varies at the retail level. Some of our vendors face risks, and I don't intend to offend anyone, especially our customers and vendors. Businesses show different levels of sophistication; some are well-prepared, maintaining ample cash reserves and managing conservatively, while others operate more on a month-to-month basis. Those month-to-month operators are certainly struggling. Recently, we met with retailers in Michigan who were feeling quite down. Their outlook is short-term, lacking the visibility we have. After enduring six months of tough market conditions, they're understandably discouraged, and some are running low on cash. We are taking steps to assist our reliable customers who provide us with financial information, helping us understand their businesses better. We're extending similar efforts to some of our vendors. However, it’s clear that this market disruption will lead to a shakeout, where some businesses may not survive. For us, rather than focusing on the retail or customer side, we see this as an opportunity to encourage further consolidation on the equipment and vendor side. Some businesses will exit, which could provide us with additional deal flow at attractive valuations. While this situation is not beneficial for the industry as a whole, we believe we can leverage these circumstances to our advantage.

Yes, I would like to echo what Chris mentioned. I don't believe we are facing any significant issues with our aging receivables, which may directly address the question. However, I recall that Forbes mentioned over the summer that it would be a difficult time for many businesses. From an evolutionary perspective, such challenges often lead to stronger companies. I believe Hawthorne has become more resilient due to the events of 2018. We are fully committed to this sector in a way that is far from uninspired. The Luxx acquisition was significantly less expensive than initially forecasted due to current market conditions. There will certainly be opportunities ahead; while Hawthorne doesn't have an extensive list of targets, we anticipate that stronger retailers and cultivators will emerge, and Hawthorne will become more robust as a result of these developments.

And up next, we'll take a question from Peter Grom with UBS. Please go ahead.

I have a broad question regarding the guidance for the year. I understand there are many factors at play, but could you explain why you still feel confident about the earnings range at this time? From my quick calculations, using the midpoint of sales, gross margin at the lower end, and SG&A decreasing in mid-single digits, it seems the numbers are leaning more towards the low end of the range rather than the high end. The high end appears a bit more challenging to reach. Is that a fair assessment? Additionally, does it incorporate any caution in case some of the main pressure points, like consumer demand or weather, worsen from here? It seems like there isn’t much concern in the U.S. Consumer business, but I’m really trying to get clarity on how we should view the potential upside or downside to the earnings outlook.

Yes. Peter, this is Cory. If you look at the guidance that we have out there a month ago, we did pull down the volume in Hawthorne. The quarter came in kind of where we expected. Our outlook for the year hasn't changed a lot there. But we did pull down the sales level on Hawthorne. That's obviously going to put some pressure on the earnings line. At that same point, we feel more confident than we did when we set the guidance on our U.S. Consumer business. Things continue to go in the right direction. Our retail partners are engaged. Our POS is in a spot that makes us feel comfortable. You kind of net those two out from a revenue perspective, and you get down to a bottom line that is consistent with the range we put out. We put out a $0.40 range at that point. Day by day, I kind of pick a number that varies from the low end to the middle of that range. I'd say that's probably where we're at today. Looking at margins and what we expect on the cost side of the inputs, I feel more comfortable now than I did a couple of months ago. So you kind of nail that down, you get to a range that's still in that 850 to 890. And if I was pegging a number today, I'd say we're probably in the bottom half of that range. But a lot of things could turn around, and we have some conservative estimates in there that can take it up a little bit.

Jim Hagedorn here. I want to share my thoughts. This business can be quite volatile, and a lot depends on the timing of when we can operate outdoors across America. April through June is particularly busy for us. For instance, in Vermont, we expect some significant sales this Thursday and Friday. I believe Cory provided some insights on that. While I don’t fully agree with your perspective, I remain confident that maintaining flat performance in our consumer business is achievable. If we surpass that, it can bring numerous benefits our way. We will have clearer insights in a couple of months, which is the ideal time for assessment. We have substantial control over our operations and are not in a crisis mode trying to safeguard our profits. Instead, we are focused on running our spring operations with our partners. We haven't reached a point of urgency to protect our financials, and we are prepared to do so if necessary, but that’s not currently the case. Mike, do you have anything to add?

No. I'm cautiously optimistic, and we'll do the right thing as the season unfolds.

Got it. That's really helpful. I have a few quick follow-up questions about Hawthorne. You've mentioned that the category seems to be stabilizing with daily sales. Can you provide some insight into what that looks like in percentage terms for January? Regarding the guidance of flat to a 10% decline, can you clarify the uncertainty tied to this? Are you anticipating a return to growth by July, and would an earlier return be considered a positive outcome? Additionally, there was a note in the January release about preorders increasing for nutrients and grow media. I may have missed it in the earlier comments, but is that still accurate?

Yes. I'd say if you look at the activity we've had since we talked last or put numbers out last, I'd say we're kind of right along that path to the full year guidance. The timing that we see on a turnaround, like Chris said, is kind of spring to summer. We're figuring out what that means from a daily sales standpoint. But nothing we're seeing right now is causing us to come off of the guidance we put out there for the full year range. We still feel pretty comfortable in it.

Yes. To build on what Cory mentioned, regarding the growing media sales and some nutrient sales we referenced in last month's release, I can confirm that our preorder sales have already surpassed our total pre-orders from last year. We expect these orders to be fulfilled between this month and June. This suggests to us that retailers, despite some challenges, remain confident in a recovery. They wouldn't be placing such large orders if they didn't expect customer demand. Additionally, we've observed a notable increase in propagation supply sales recently, with many people starting seeds and clones. These trends are encouraging indicators of market confidence for us and lead us to believe that we will see a rebound in business come spring and early summer. While I’m cautious not to get ahead of myself, the current indicators within our business are quite promising.

Yes, I want to mention that part of what you're seeing is influenced by current prices and people's willingness to invest in new growth. This willingness is somewhat constrained by the pricing at this level. For example, Hydrofarms has a consumer business in Canada that might be artificially boosting their numbers, and they lack the lighting business that we have. We are heavily invested in lighting, and if you look at what Hawthorne has accomplished over the past three years with LEDs, the numbers for traditional HPS lighting have decreased significantly. There is a faster transition to LED lighting than anticipated in this industry, and Hawthorne's work and the acquisition of Luxx have created a strong lighting business in a growing market. This benefit will manifest over the coming years. It's important to consider that Hawthorne is significantly influenced by our main offerings, which include lighting, HVAC, and humidification work, as we are more engaged in build-out projects. Therefore, when evaluating Hawthorne, it's clear that it represents a more diverse and strategic business within this industry compared to a standard distributor.

I want to be specific about Hawthorne. Did lighting contribute to the decline in profitability this quarter? How do you see profitability for the business evolving from here? Many of the details you mentioned about inventories suggest that you're back to having more components, demand is strong, and you're shipping lights. That's my first question. Additionally, this restructuring seems like it will enable you to reduce lighting prices. Can you elaborate on that? Are you facing any resistance regarding lighting prices? Are you preparing for the industry's shift to the East Coast as more states begin to open up, thereby enhancing your competitive position? Underlying this, there are numerous questions about lighting, but the main focus is on profitability and the strategic choices you're making to potentially enhance your value proposition moving forward.

Chris, Jim Hagedorn here. Everyone wanted to respond to this, so there’s some competition, but I’ll take the lead. We are definitely not lowering prices on lighting. We are focused on producing our best light sources as quickly as possible. This relates back to my comments on LEDs, which is also true for a lot of other products. Business is strong. I believe it's the traditional HPS and CMH lights that are facing pressure. I noticed finance was eager to jump in when you asked the question, so I won't interfere. Mark, why don't you come over? Mark Sheiwer is our CFO for Hawthorne, and you may remember him from when he was Scott’s controller before moving to Hawthorne. Would you like to share what’s influencing your numbers?

On our sales decline this quarter, I would say half of it is related to lighting, while about two-thirds is from our durables product line. So that's the main driver behind the sales decline. Additionally, the overall decrease in our profitability is affected by fixed cost leverage, which impacts our earnings for the quarter. However, as we recover in the latter half of the year, I believe we will be well-positioned for profitability. These are the key points I wanted to mention.

Well, Chris, I think the important part of this is the significant transition to LEDs from traditional lighting.

HPS is the word.

But I think if you look and say, where is Hawthorne relative to the market, we are in a really, really good position on LEDs. And LEDs is clearly where the entire market is moving.

Yes, to build on that, Chris, the current wave of LED adoption is not exclusive to the cannabis sector. This aspect is crucial to our strategy as we view our product offering as far more expansive than solely catering to cannabis growers. While that remains our primary focus, we are also undertaking significant lighting projects through our ProHort business in Canada and Europe, all utilizing LED technology. The adoption of LEDs, as Jim indicated, is occurring broadly across controlled agricultural environments, whether for cannabis or other crops. However, we are noticing that some product categories, which constitute about half of our business, have hit a plateau. This is due to a hesitance among clients to invest in new facilities, which will significantly affect our profitability. When the market rebounds and cultivation resumes, especially as the wholesale price of cannabis increases, we stand to gain more than any competitor because of our strong market position. We expect this rebound in the latter half of the year. Regarding our supply chain strategy, as Jim mentioned, we are not aiming to participate in a price war. Our lights offer real value and innovative features that justify their market prices, and we believe customers are willing to pay these prices. Our focus has been on maintaining our supply of these products efficiently. In-sourcing some manufacturing is not only about cutting costs or increasing our margins but also about gaining better control over our supply chain to reduce dependency on external partners, which can leave us in challenging situations. We want to avoid experiencing issues where we cannot fulfill product orders. Therefore, a significant part of our strategy is ensuring we can control our own destiny.

And last on that, Chris, is the Luke went out to Temecula, we have a gigantic plastics plant out there, great workforce, great management team. And Mike and Dave Swihart came back and basically said, we’re moving everything down to Temecula. And the benefit we’re talking about is triple digit in dollars.

On a per-fixture basis.

This is a significant capability to manage costs, and it's not about conceding anything. We can remain competitive and offer market-leading products at both entry-level and premium price points, backed by technology that justifies our pricing. Our supply chain for LEDs is quite dispersed globally. Mike, do you have anything to add?

I think you’ll optimize your cost, you optimize your inventory and availability, and you’re also controlling how your innovation is getting rolled out. So this is the optimization opportunity that comes with LED.

And puts it much closer to the market.

That’s great perspective. And I guess, and I’ll keep this quick if I could almost put a bow on that from here. Profitability in that business because of the inventory, because of some of the head count, because of supply chain, whatever it is, profitability should see sequential improvement from here. And perhaps on a total fleet basis, you’re slightly profitable in Hawthorne in Q2, and you ramp more in the back half because of the improvement in lighting. If you could just frame that to kind of help set expectations for the segment, I think it would be constructive.

Yes. Chris, I think you’re looking at that right. Lost a little bit in Q1, looking for volume to increase and get back in the positive side in Q2. And if you look at Q3 and Q4, that’s where the majority of our profit by far is going to happen for this year. So it gets us back to a full year number that certainly isn’t at the earnings rate that we saw last year, but it’s a rate on a go-forward basis shows a trend that we’re in the right direction and getting back to that point.

Yes, I agree with what Mark mentioned. Our long-term goal is to achieve a 15% operating margin, and we are confident we will make progress toward that target, similar to the path we were on in recent years. Regarding the first part of your question, we anticipate that the second quarter will be relatively flat in terms of sales. For the third and fourth quarters, we expect a significant rebound, which is what I emphasized at the beginning of the call. This quarter has been challenging for us. We project that Q2 will level out as spring arrives. Traditionally, Q1 has been our weakest quarter, even in favorable years, and we foresee a return to substantial sales growth in Q3 and Q4.

And our next question will come from Gaurav Jain with Barclays.

One quick one. So based on what you have said on Hawthorne margins, it would imply that your U.S. Consumer margins are actually not down a lot for full year ‘22. So when commodity costs start trending down, let’s suppose they start trending down at some point of time. Then does it imply that you will retain the pricing on the consumer side and your consumer margins will actually improve quite significantly from the numbers you have this year?

I will start and then pass it to Cory. It's somewhat similar to the advantage of relocating lighting manufacturing to Temecula. We don't see that as a way to lower our selling prices. The only factor affecting consumers is a potential decrease in the cost of goods, which we are optimistic about. We don't plan to lower our prices; rather, that's a conversation we have with our retailers, and it largely depends on how consumers are responding. Our intention would be to maintain those prices, while observing consumer behavior for any signs of weakness. Again, that would be a discussion with our retail partners about what we are all observing in the market. Cory, do you have anything to add?

Yes. I’d just add to the point that when you look at our margins, there’s going to be 2 main components to make sure that we can get back to a margin rate that is kind of flat to last year. One is going to be the sales volume. As we continue to see sales volume increases above our original plan, that’s going to be a positive fixed cost leverage for us that will help our margin rate. The second one is going to be around commodity costs. As we’ve locked in kind of 2/3 to ¾ of our costs for the year, we feel like we’re in a good spot. For that remaining portion that’s still out there to buy, we’re seeing some favorable trends. Costs are starting to come down a little bit. That could allow us to get some benefit over the remainder of the year and the remainder of the amount that we purchased to get our margin rate down to a spot that’s about flat as well. So depending on how those 2 things come in for the rest of the year, we could be down around flattish for U.S. Consumer margins.

Okay, everyone. Thanks for joining us this morning. Again, as a reminder, we've got a couple of IR events coming up in the week of March 7. So we'll be making some announcements beforehand in terms of the date and time. And if there are any other follow-up questions that we didn't get to today, feel free to give me a ring directly. I'm at (937) 578-5622. Thanks for joining us, everybody. Have a great day.

And everyone, this concludes today's call. We thank you again for your participation. You may now disconnect.