Good day and welcome to the Q4, 2022 Scotts Miracle-Gro Company Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask a question. Please note, this event is being recorded. I would now like to turn the conference over to Kelly Berry. Please go ahead.

Good morning, everyone. Welcome to The Scotts Miracle-Gro fourth quarter earnings conference call. Today's comments from Jim and Dave have been prerecorded. After their comments, we'll take your questions. I want to remind everyone that our comments today will include forward-looking statements. And so our actual results could differ materially from what we discussed. I'd refer you to our Form 10-K, which is filed with the Securities and Exchange Commission so that you may familiarize yourself with the full range of risk factors that could impact our results. This call is being recorded, and an archived version of the call will be stored on the Investor Relations portion of our corporate website scottsmiraclegro.com We have a lot of ground to cover, so I'll turn the call over to Jim Hagedorn to begin. Jim?

Thanks, Kelly. And good morning, everyone. I don't think I have to revisit everything we've faced this past fiscal year or in the previous two; we're in unusual times. During the pandemic, we responded to the unprecedented challenges with winning strategies to manage all the craziness that came with it. We did so by delivering record results. Now we're in the aftermath of the peak COVID years facing record inflation, supply chain disruption, war in Ukraine, and a steep downturn in the cannabis industry. It's a messy situation. But here's what I know. We get it and the leadership team is on it. We have our organization headed in the right direction. My confidence stems from the work we did in the back half of fiscal '22 to improve our cost structure. It also is grounded in our plans for '23. If there is doubt about our willingness to take bold and decisive steps to orient our company to the realities of today, I can assure you we're doing what's necessary to reduce debt and restore acceptable levels of profitability. I'm optimistic we will remain within the bounds of our bank covenants. I know you're looking for guidance, Dave Evans will explain how we see the year shaping up in the U.S. consumer and Hawthorne segments. We're focused on hitting EBITDA and free cash flow targets. In fact, our management incentive program for fiscal '23 is based on leverage related metrics. For fiscal '22, we finished at six times debt to EBITDA, and we're comfortable with our leverage trajectory to remain compliant for the first six months and have a clear path into the fours by the end of the fiscal year. The personal goal of mine and Michael Lukemire is to get to 4.5%. This will position us to move leverage back to our normal levels in the threes by the close of '24. As for cash flow, we continue to project $1 billion in free cash flow by the end of fiscal '24. It's worth emphasizing that much of our leverage improvement is about timing. As the calendar changes, so will our leverage; we will naturally and significantly deliver in the intermediate term. Our roadmap this year is based on three major themes. First, we're strengthening the balance sheet, paying down debt, improving free cash flow, and tightly managing operations. We made significant progress with cost outs in fiscal '22, and we're making further reductions in fiscal '23 to give us more room to responsibly manage leverage and move us toward our targets. Second, we're confident in the consumer business; lawn and garden is a steady mature business that historically has been a strong cash flow generator. We emerged from fiscal '22 reaffirming the strength of our brands, the power of our retail relationships, and continued high consumer engagement. These represent strengths, and we'll capitalize on them. Third, we're remaking Hawthorne. It's not lost on me that this business has been a drag on earnings. I want to emphasize that we believe in the future of the cannabis industry and its eventual turnaround. There is a huge amount of value that will be unlocked in Hawthorne once this rebound occurs. But I also know that we need to overhaul Hawthorne to adjust to current realities and to protect core Scotts Miracle-Gro from the cannabis downturn. I'll explain shortly how we are integrating Hawthorne into Scotts Miracle-Gro, reconfiguring its lighting portfolio, and revamping its organizational structure. Before I go much further, I have a few comments about our fourth quarter. We did what we said we would do. We revised our guidance multiple times last year, more than I recall in a single year. But the fourth quarter proved we can be agile enough to make an impact quickly. We made the quarter; we landed within our EPS guidance, we overachieved free cash flow expectations, and we stayed within our leverage threshold. It was a good way to end the year, and I'd like to think that it's just the start of a trend. I want to express my heartfelt appreciation for our banks, retailers, and other partners for helping make it happen. It's been an especially hard six months for our associates, and I have a personal message for them, as I know many of them are listening to this call. I want to thank you for your commitment and loyalty. Your resilience is outstanding and will go a long way in contributing to our long-term success. Words can't express how much I appreciate your support. And when we get these challenging times behind us, I will not forget all your help in turning around the company. Now let's get back to the themes, starting with the balance sheet and leverage improvement. Our SG&A for fiscal '23 is budgeted to be below fiscal '19. We have minimized capital expenditures and put M&A activities on hold. Our accomplishments thus far can be credited to the cross-functional project Springboard team we announced last quarter. The team quickly achieved over $100 million in annualized savings as a result of extensive actions that included reducing our footprints, tightening variable spending, and eliminating hundreds of jobs starting at the highest levels. Our management ranks have been reduced by 35%. In addition, the Springboard team executed asset sales and a large sale leaseback of our Hawthorne facility in Vancouver, Washington to generate incremental cash for debt reduction. This year Springboard's remit is to get our leverage into the fours at the end of fiscal '23 and into the threes by the close of '24. Springboard 2.0 as I call it, will help us further streamline, reduce working capital, and conserve cash. We are taking a hard look at how we operate, what we prioritize and where we invest. We are driving operational efficiencies to the fullest extent. Amongst Springboard 2.0 is a focus area on our inventory reduction, where we expect to realize at least $400 million in cash flow benefit this year by limiting production and selling through current inventory, and another $85 million in cost outs to be realized in fiscal '23 and '24. The team has thus far identified $60 million of this $85 million target. In addition, we believe we have at least $15 million of benefit from commodities, compared to earlier assumptions. The majority of the savings will come from our supply chain, including reducing warehouse space company-wide, enhancing productivity through strategic materials substitutions that do not impact product quality, improving labor efficiencies, and resizing Hawthorne operations. These cost reductions can potentially improve our leverage and give us runway to operate, especially given the economic uncertainty. While indications show the consumer remains resilient and that our categories are essential to their lives, no one knows where the economy is headed. The greatest economic minds have given wide-ranging predictions on what to expect. But even if the economy goes into recession, history shows that consumers turn to our products. During the recessionary period of 2008 to 2010, we realized year-over-year consumer sales increases of 2%, 15%, and 6%, respectively. I'd sum things up this way: we are leaner, less layered, and higher performing. We are more competitive and focused. We will execute with precision and speed. For those who know me, I refer to a Wall Street Journal article from the 1990s where my family's Miracle-Gro took over Scott's. The gist was how the leadership of the Hagedorn family would bring thriftiness and an entrepreneurial spirit to the new entity. These are elements we are embedding into our culture, and the people who are a part of our company must buy into this approach. And I'm convinced we will be a better company as a result. Now let's talk about my second theme, the U.S. consumer business. The fundamentals of our U.S. consumer business are strong. Our brands are everything. They are iconic and loved by consumers. We have great partnerships with our retail partners. We have the best sales force and execution in the industry. And we have the leading market share. Compared to the pre-COVID year of 2019, our market share has increased or stayed flat in almost all categories. There are not many brands out there that can boast brand awareness scores of 70% to 90%; we can! Consumers are engaged and have a high intent to stay. 80% of the 20 million new gardeners who entered the category during COVID continue to be active. A recent Federal Reserve report on consumer behavior indicated people are emphasizing leisure time, and for many, this includes time at home. Our plans to capitalize on the strengths are reasonable with this year's sales forecast by assuming we will be flat in POS units in the U.S. consumer business with the exception of a 10% hike in units for fertilizer and seed, which were down nearly 20% last year and represent one of our most weather-dependent businesses. Poor weather was a factor in suppressing early season consumer sales last year, in large part due to an unusual polar effect that hit the Midwest and Northeast in March. Current weather models indicate that despite the ongoing dry conditions in the West, we are likely to see more normal conditions in many of our key markets. Now, I don't want anyone to think we're cutting so deep that we're harming the core business. We will respect and protect it. We've heard from our largest investors that this business is as good as they come, and we agree. We will not take any actions that negatively impact its health or integrity. In fact, we're investing in lawn and garden innovation long a tenant of our success; we will continue to drive product development that meets evolving consumer needs, such as drought tolerance solutions, and cost-effective sustainable ingredients with greater or equal efficacy. We are also continuing to invest in sales and marketing, ensuring our salespeople and consumer-facing teams have the tools and resources they need to deliver on our plan. The key to regaining that 10% in the more profitable sales mix of fertilizers and seeds is our strategy to engage consumers earlier at the very start of the season. We will front-load our marketing and promotional spend to drive early consumer traffic and augment it with execution at the field level and with the cooperation of our retailers. Given the economy, retailers are concerned about foot traffic, especially early in their fiscal year. Lawn and garden plays a critical role in driving a high percentage of their overall transactions in the spring. Our brands are the catalyst for their early foot traffic and sales. A third of our annual business occurs in March and April historically, confirming it's a critical time to engage with consumers. We also know that consumers who make their first purchase before May will spend twice as much in the category. Our retailers are committed to joint promotions, advertising, and other activities. The combination of our media, retailer media, and price promotion has a three to five times multiplier effect on POS lift versus promotion or media alone. Look no further than what we did this fall. In a two-week period, we executed joint efforts on our fall fertilizer business with a key retail partner. The result was over a 50% increase in POS units from the prior year—a microcosm of what we expect this spring. I want to emphasize that we'll be driving attachment with our brands and live goods, soils, plant food, and controls too. It's important to remind you that live goods continues to be a key category for us and continues to grow and breed faster than many other lawn and garden categories. When consumers buy plants and add products to their carts, they predominantly buy our brands. We will undertake promotions and campaigns on the benefits of gardening too. Inflation presents an opportunity for consumers to grow food at home. Anticipated product shortages due to drought can further encourage more DIY planting. I want to address gross margin. Due to various factors in fiscal '22, our margin rate declined for the second consecutive year and is now nearly six points below its historical norm. We expect a further decline in fiscal '23. This is not acceptable. We have line of sight to meaningful margin rate improvement by the close of fiscal '24, and Dave will talk more about this in his comments. We believe we can get gross margin back to historical levels through a softening of commodity costs, supply chain efficiencies, and productivity improvements with trade. But if we still have a gap, we aren't ruling out pricing to get gross margin back where it needs to be. Let's turn to Hawthorne, my third theme. We have several strategic levers we could pursue with Hawthorne, but we have put them on hold until the cannabis oversupply issues subside. Our first order of business is to return Hawthorne to profitability, knowing that its long-term growth rates are still greater than those of our core business—that's the big reason we got into this business in the first place. But for now, we've given Hawthorne an aggressive profit goal. Given that we expect sales to be modestly down for the full year, we will achieve Hawthorne's profitability back through cost reductions alone. I told you last quarter that I believe we could achieve savings of $65 million in Hawthorne. We started work in fiscal '22 by closing multiple distribution centers, selling assets, and reducing the workforce. More cost efficiency efforts are still underway. Hawthorne will operate as a business unit much like our lawns, gardens, and control business units. This will allow us to capitalize on the synergies of the parent company and significantly drive operating efficiencies. We will absorb Hawthorne into Scotts Miracle-Gro in a manner that preserves its unique culture and core strength because we believe in the business model and its long-term potential. Customer-facing teams will continue to work directly with hydro retailers and growers. No other company can do what Hawthorne does. We are a partner to growers. We understand their challenges, and we have the products and solutions to help them be more efficient, productive and successful. We also know, as does everyone else in this industry, that things are beyond tough. Many players are just trying to survive. Oversupply, along with inconsistent state regulatory approaches, and a lack of federal action on safe banking, 280E, and other issues are contributing to the prolonged downturn. This is what I have to say directly to our Hawthorne customers: we are not abandoning ship. We are tightening up but not giving up. We'll ride this out with you and be ready for the market when it rebounds—and it will. The U.S. cannabis industry matters. Its economic impact on the American economy is nearly $100 billion this year, and is expected to rise to $158 billion by 2026. It supports just over 0.5 million full-time jobs, and more people are consuming, with expectations of around 71 million consumers by 2030, as more states continue to legalize it in some form. Thinking about the immediate opportunities ahead for Hawthorne, you can expect us to continue to innovate with Gavita and capitalize on the upside of the Agrolux WEGA LED technology that we launched in early '22 for the professional horticulture space. In the short time since its launch, the WEGA has delivered over $60 million in new ProHort sales and catapulted its market share in the LED greenhouse growing space. Tightening up Hawthorne includes rationalizing the lighting brand portfolio; we will exit high pressure sodium and high intensity discharge lighting to focus on LEDs, where this industry is moving because of energy and cost savings. The business community, as well as consumers, are increasingly focused on sustainability, and this fits with where things are headed. We will also exit the Luxx brand as a continuation of the portfolio reduction that began this summer with the sunsetting of SunSystems. When we acquired Luxx, the cannabis market was in a much different place. Our strategy was to expand upon our industry-leading Gavita brand, and the Luxx team improved on marketing savvy to growers with credible influencers and brought us technologies that can be integrated into our Gavita offering. But we believe the WEGA can serve as a mid-tier option as a replacement to Luxx. I'll now address a few elephants in the room. My family is the largest shareholder in this company. This is more than a job for me; this company is my family legacy. I've been part of this business most of my life, and I'll do whatever it takes to set this company up for ongoing success and long-term shareholder value. You have my commitment; I will and have been making tough choices, and I will do what is required. Regarding the dividend, we have no plans to touch it based on what we see today. The truth is that cutting the dividend entirely or even by a percentage does not significantly improve leverage. We've heard feedback from investors around this topic. Most of our largest shareholders have told us in clear terms that we should not cut the dividend unless absolutely necessary. And here's what I think about issuing more equity: based on our current view, I do not believe it will be necessary. As always, we will evaluate our options and do what is required. Regarding the concept of selling assets, we've looked at it and we'll continue to do so. But given the circumstances and other considerations, it's not optimal for our company right now. Our board will explore these kinds of opportunities on an ongoing basis and determine if and when it's in the best interest of our company and shareholders. One final item is an update on our search for a permanent CFO. We have focused on external candidates who are innovative thinkers, have deep experience, and are capable of working with our team. We are close to making a decision. I want to thank Dave for stepping in from the board. I asked him to serve as interim CFO because he knows our company well and is a talented financial operator. He's brought tremendous value and provided the financial leadership our company needed in this transition period. I know it's come with a great deal of work and stress. Words cannot express my full appreciation for his partnership and support. I'll close with this: we continually talk to our largest shareholders and take what they say to heart. We are making changes across the organization and creating stronger conditions for the success of our core business, in addition to reimagining Hawthorne. At the same time, we're highly confident in our brands and those of the consumer. We have embraced our reality and evolved accordingly. Dave, I'll now turn it over to you. Thank you.

Thanks, Jim. I'll take a deeper dive into the P&L and balance sheet for fiscal '22 and provide direction for fiscal '23. As you likely know, this is my second time stepping into the CFO role at Scotts. My previous experiences and relationships have allowed me to hit the ground running. It's clearly been a challenging time for the business. But over the past two months I've been here, it's been inspiring to see the commitment and dedication of our associates. I understand that predictability and credibility in our financial projections are important drivers for market performance. Our repeated changes to guidance in fiscal '22 and the late summer correction to free cash flow primarily resulted from the unexpected and sudden volatility in the U.S. consumer market and the pace in which we reacted, driving down costs and implementing operational changes. We're bringing more rigor to our sales and cash flow forecasting and improving processes to better translate changes in operational assumptions and balance sheet forecasts. This is imperative when running in a strained manner. We can now better assess our position at an early stage and respond in a swift and coordinated manner. Moving on to results, U.S. consumer sales were down 18% for the quarter, ending the year down 8%. This was in-line with our fiscal year guidance of down 8% to 9%. I'll spend a few moments on this; it's particularly important context for fiscal '23. The 8% decline in fiscal '22 sales was driven by a 15% decline in volume and mix, offset by a 7% benefit from year-over-year pricing. The 15% decline related to volume and mix is a function of unifying declines across most categories, the most pronounced in our most weather-sensitive categories, lawn fertilizers, and grass seed. It also reflects a challenging year-over-year comparison where in fiscal '21, the retail channel ended the year with a heavier retail inventory position than it started. The 7% benefit from pricing reflects the cumulative benefit of actions taken in August of '21 and January, April, and August of '22. We've been making every effort to manage the value equation with the consumers by minimizing price increases while at the same time attempting to keep pace with cost inflation. Transitioning to Hawthorne, sales were down 49% for the quarter. The entire cannabis industry is under immense pressure due to oversupply, limited enforcement, and inadequate public policy. As expected, the overall run-rate for Hawthorne improved slightly in the fourth quarter, driven by innovation in our horticultural lighting business. Jim talked about WEGA, our new LED product that drove the improvement in sales in the fourth quarter. The rest of the Hawthorne portfolio experienced a decline in the fourth quarter, similar to what we realized in our third quarter. The fourth-quarter results put Hawthorne's full-year sales down 50% compared to fiscal '21. Moving on to gross margin rate. The adjusted gross margin rate for the quarter was about 1,400 basis points below last year, which brings the full-year decline to about 400 basis points—in line with our expectations. Just like we mentioned in the third quarter, the largest driver of the fourth quarter gross margin decline was fixed cost deleverage stemming from the volumes in both segments. Warehousing and manufacturing costs are largely fixed in the short term. And these fixed costs are spread over fewer units in the quarter. On a full-year basis, fixed cost deleverage was also the largest driver in the declining gross margin rate. This has been fairly punitive in fiscal '22 as both sides of the equation moved against us. Our sales volume was clearly down, but at the same time, our fixed costs grew as we expanded our supply chain footprint and inventories. As we've reported all year, rising commodity costs also impacted the gross margin rate. The inflation we've experienced has impacted us across the board on every commodity we purchase. Our top raw materials all saw double-digit increases for the year, some in excess of 40%. We've been consistent in our approach to managing this record high inflation. Our pricing actions have been designed to offset the dollar impact of commodity inflation, but not necessarily the rate. Similar to our third-quarter results, SG&A was down 27% in the fourth quarter versus last year, leaving us down 18% for the full year. This result was slightly better than our latest guidance, driven by continued momentum from Springboard initiatives. The three key themes driving SG&A savings in Q4 are the same as what we shared last quarter: incentive compensation, headcount restructuring, and spending reductions. Adjusted EBITDA for the year was $558 million, down from $903 million in fiscal '21. The combination of lower EBITDA and higher borrowing levels resulted in a leverage ratio of about six times debt to EBITDA at year-end. Though this amount of leverage was expected, we're clearly unsatisfied with the results. I'll discuss our leverage outlook in my comments around fiscal '23. Moving down the P&L. In fiscal '21 we acquired a 50% equity interest in Bonnie Plants, a leading provider of live vegetables, herbs, and fruit. Bonnie's 2022 fiscal year finished in July, the first month of our fourth quarter. Bonnie sales saw a late surge and landed down only 1%. However, Bonnie experienced high inflation across their entire cost structure, especially in their fuel costs that began to increase during their peak selling season. They did not have visibility into the full extent of their cost increases and time to adequately adjust their pricing and SG&A costs. These cost pressures translated to a $13 million loss in equity earnings on our P&L. The Bonnie team is working hard on a plan for fiscal '23 to address the overall profitability, no different from us. Jim covered the operating changes that we're making in the Hawthorne lighting category. Sunsetting HPS and Luxx to focus on Gavita LED resulted in an inventory and intangible asset restructuring charge of $110 million for the quarter. We also recognized additional net charges of $90 million, which primarily consisted of employee termination benefits and other restructuring activities stemming from the continued efforts of project Springboard. Below the operating line, interest expense was $13 million higher in the quarter and $39 million higher for the fiscal year. The change was driven by higher borrowing levels. Our full-year adjusted effective tax rate landed at approximately 22%. The favorable rate is due to benefits from discrete items related to the vesting of long-term share-based compensation. On the bottom line, we had a GAAP loss per share of $3.97 in the quarter, compared to a loss of $0.86 last year. The number includes the impairment and restructuring charges that I described earlier. The non-GAAP adjusted loss per share, which excludes impairment, restructuring, and other non-recurring charges, was $2.04 in the quarter compared with a loss of $0.82 a year ago. This brought our full-year non-GAAP earnings per share to $4.10, right in line with our latest guidance. We ended fiscal 2022 with negative free cash flow of $243 million, better than our latest guidance of negative $275 million to $325 million. There were two primary drivers of the negative cash flow. First, inventories were up $200 million, or nearly $300 million when excluding the Hawthorne inventory write downs. The increase was driven equally by additional physical inventory quantities and higher commodity costs. Inventory was trending higher going into the third quarter, but the operations team quickly adjusted their raw material purchases and production plans. This quick pivot enabled us to limit the inventory increase for the year. The second driver of negative cash flow was a decline in accounts payable of approximately $170 million. This decline was a result of the change in purchasing and production plans that we just covered. Fewer purchases in the third and fourth quarters translated to lower accounts payable at year-end. I'll switch gears now to our outlook for fiscal '23. As we look forward to fiscal '23, our primary objectives will be to generate strong EBITDA and cash flow and to strengthen the balance sheet while maintaining quarterly compliance with our credit agreement covenants. Since these are our primary objectives, my comments for fiscal '23 will center around these metrics. Jim has provided justification for optimism and our U.S. consumer business. Starting with consumer purchases of our products at the store shelf, the fact that our products performed well in the last recession, combined with discrete and incremental marketing and promotional programs, both ours and the retailers', and an assumption of more normal weather in the spring supports cautious optimism. But there's also significant uncertainty surrounding factors we don't control. To the positive, households still appear to be in good shape and spending at a healthy clip. But inflation is at a 40-year high and taking an increasingly larger toll on household income and savings. And within that broader context, we've taken significant price increases across all of our categories. Transitioning from consumer purchase activity or POS to our sales, we're confident in our retailers' commitment to the category. We've made informed macro-level assumptions relating to their inventory positions next year, but can't anticipate with certainty external factors which may influence their decisions ten months out. And as it relates to pricing, we successfully executed the August 1 price increase as described on a third-quarter call. We now expect the net impact of year-over-year price increases to be high single digits, roughly offsetting the dollar impact of increased commodities. More on commodities in a moment. For Hawthorne sales, we're making the assumption we have reached the industry trough in the fourth quarter and anticipate sales at the start of the year to merely run-rate we ended with in fiscal '22. We expect this to be followed by a seasonal increase in the spring, followed by year-over-year growth in the fourth quarter as the industry slowly recovers. As you're all aware, the lack of visibility into this market makes it challenging to declare the trough with certainty. All these factors and assumptions in aggregate lead to an expectation of low single-digit percentage growth in consolidated net sales in fiscal '23. Moving down to gross margin rate, we see two primary headwinds in '23: increased year-over-year commodity costs and reduced fixed cost leverage. We expect these to be partially offset by cost-saving initiatives driven by Springboard. Approximately two-thirds of the commodities that run through our P&L in fiscal '23 have either already been purchased, manufactured, or hedged. And with three years of rising costs, about a third of our cost of sales are now driven by assumptions subject to market forces. While our assumptions for fiscal '23 are supported by balanced market insights, some uncertainty remains. That uncertainty, risk or opportunity will manifest itself in the later stages of fiscal '23 given inventories currently on hand and hedges. Certain commodities, examples being resins, pallets, and international freight have slightly moderated in recent weeks. Those trends may not extend to our larger inputs related to fertilizers and energy-derived products, given the uncertain global environment. The second headwind relates to reduced fixed cost leverage, which in fiscal '23 is a function of lower production. We ended fiscal '22 with consolidated inventory of $1.3 billion net of reserves. We expect to exit fiscal '23 with a decline of at least $400 million. To help drive this reduction, we'll be producing less, which will result in fixed cost deleverage. We expect these two gross margin rate headwinds to be partially mitigated by Springboard supply chain issues. These initiatives include right-sizing our supply chain footprint, product rationalization efforts principally in Hawthorne, and improved labor efficiencies. Mix should also benefit us in '23. All these factors combined will result in a net decline in consolidated gross margin rate in fiscal '23. Moving down to SG&A. We expect the year-over-year decline to more than offset the impact of inflationary increases and the potential for reinstating incentive compensation. The decline will be driven by Springboard initiatives. Speaking of Springboard, as Jim discussed, Springboard 1.0 yielded more than $100 million of improvements. We're targeting an additional $85 million in our 2.0 initiative. While we're still in the early days, we've already identified discrete initiatives to realize more than two thirds of this target. The majority of the benefits identified to date relate to supply chain initiatives that Jim and I previously discussed. Summing up the collective assumptions for revenue, gross margin, and SG&A, we're committed to delivering low single-digit percentage growth in adjusted non-GAAP operating income. Adjustments from operating income to EBITDA are expected to be about $25 million higher in fiscal '23 than in fiscal '22, primarily due to increased depreciation and a change in how we pay short-term variable compensation if targets are achieved, mostly in shares rather than cash. Below operating income, we expect interest expenses to increase by $35 million to $40 million. The increase is being driven by higher interest rates, partially offset by lower average debt. We expect our effective tax rate to be 25% to 26% and share count to modestly increase. We remain committed to generating $1 billion in free cash flow over the next two years. Leverage will remain elevated over the next two or three quarters. However, given the normal seasonality of our business, our credit agreement amendment allows for a step-up in maximum leverage from 6.25 to 6.5 times debt-to-EBITDA for the second and third fiscal quarters. With the properly corralled pacing of our initiatives, and assumptions, we will remain below the maximum level stipulated by our credit agreements. As Jim said in his comments, we are targeting to reduce our debt-to-EBITDA ratio into the 4s by year-end. While this is not our traditional format for guidance, this is also not a traditional year for both internal and external factors. In summary, we've been diligently assessing each of these operating variables and their implications on our fiscal '23 plan. We continue to take actions to mitigate risk and solidify our position going into the next fiscal year and beyond. The direction we provide for next year is in line with our priorities: a strong focus on EBITDA and cash flow to strengthen the balance sheet while maintaining compliance with our credit agreement covenants. Now I'll turn the call over to the operator for your questions. Thank you.

Certainly. We will now begin the question-and-answer session. And our first question comes from William Reuter with Bank of America.

Good morning. My first question is about inventory levels at retail and preseason orders. I know last year we started the year with high inventory. Can you provide an update on their current status? Also, last quarter you seemed optimistic about preseason orders due to decent point of sale performance. Did that turn out as you expected?

This is Mike Lukemire. The preseason order is pretty well fixed at about the same level of build as we did in the previous year. So it's really not POS-based; it's really about being ready for the season to break. So we look at the same levels of shipments basically as we saw last year.

But I'd say we came out of the year, Bill, down slightly. So I would call it a tailwind on inventory. And I think a pretty significant commitment to next year, and that build has already started. So I think sort of in line with what we wanted and not an inventory problem exiting the year, if that answers the question.

It does. And then one follow-up. With regard to your input costs, it seems like some of them have come down, while some remain relatively elevated. You've just pushed through a relatively large price increase. Historically, I know you guys didn't do a lot of price increases. Do you feel like the environment is such that if your input costs did rise throughout the season, you would have the ability to go back to retailers with subsequent price increases?

I'll start with the initial points and see if anyone else wants to add. The short answer is yes. That's the key takeaway. We haven't really implemented mid-season pricing adjustments much; in fact, I can recall just once during my time here that we did so, and we've never taken more than two price increases in a single season. I believe we've managed to cover our costs reasonably well, but that success hasn't translated into stronger margins over the last year. There was a recent article discussing how large branded companies are facing similar margin pressures, which resonates with our situation. Gross margin is essential for us as a consumer-focused brand; it fuels our activation efforts and supports our retail partners. Falling behind on margin is concerning. Recently, I've spoken with senior leaders at many of our major retailers, including CEOs and merchant teams. There seems to be some uncertainty about consumer behavior and how sensitive people are to pricing, which poses a critical question for 2023—not just for us but for many brands: how will consumer elasticity respond? We need to navigate these sensitivities around what consumers can accept, and I’ve made it clear that getting back to our historical margin rates is imperative and non-negotiable. Our historical margins, as evidenced by Dave's research, have been stable and even higher in the past. If we can't achieve that through our current strategies, we'll have to consider raising prices again. It's reasonable for retailers to expect us to resolve our margin issues first, especially since many are linked to cost of goods, which we anticipate will decrease. We're optimistic based on our forecasting, and Mike and his team are working hard to streamline our supply chain costs. However, if we cannot bridge that gap, we will need to revisit pricing, as it's crucial for our business.

No, Jim, I think you just stated that perfectly. Nothing more than that.

I would agree with that.

Perfect. Very helpful. Thanks for taking the questions as always.

Our next question comes from Jeff Zekauskas with JP Morgan.

Thanks very much. Just three brief questions. Your deferred taxes were, I don't know, negative $183 million this year. Why is that? And what might they be next year? Second, do you have to drop your production roughly by 10% next year to hit your inventory targets? And then lastly, can you analyze your increase in interest expense of $40 million that you forecast? And if you do break your covenants, what happens to incrementally interest expense?

Let me start by saying that deferred taxes increased slightly this year, and our effective tax rate was unusually low. The primary reason for the change in deferred taxes was the impairments we recorded this year. As we move into a new year, we do not expect to see more impairments, so I would not foresee a similar change in our deferred taxes on the balance sheet next year. Regarding production, we are aiming for a reduction of at least $40 million in inventory this year, which will lead to a reduction in our production forecasts by about 15%. It is important to consider each major product category since the percentage of fixed costs varies between our fertilizers and growing media, which follow different models. Overall, to answer your question, we are looking at a 15% reduction. A third question on interest expense. Yes, so interest expense is up significantly from '21 to '22. We see a further increase from '22 to '23, principally rate-driven. On a year-over-year basis, we would expect our average debt to be down in September 30 '23 relative to '22. So it is principally rate-driven. As we said in our scripts, we anticipate, given the broad array of assumptions that we've made, that our EBITDA and debt levels will allow us to navigate the covenants throughout the year. But I would also say that we're not— and we are prepared that if changes would occur during the year, we also won't be caught flat-footed. Does that answer your questions?

So if the covenants were broken, what would that do to your interest expense?

Well, that we're driving down.

Yeah, and we're going on the basis that we're not going to break the covenant. Because we've got a plan that either we believe our plan will result in that. And should we find ourselves down the road, then we're readily prepared to ensure we don't break the covenants by taking other actions.

You said that you generate about $1 billion in free cash flow over the next two years? Can we do a split? What's in '23 and what's in '24 any rough talks?

Yeah, we're really not. Look, I'm going to be fairly precise on this. Because there's so many changes in variables. But I'd say what you'll see is that $1 billion clearly will be front-loaded to '23 because a good portion of $1 billion relates to inventory reduction. So provided we achieve our operating plan with the sales and production plans that we have today, we would see a large majority of that happen this fiscal year.

Thank you very much.

Our next question comes from Carla Casella with JPMorgan.

Thank you, Bill and Jeff asked a couple of my questions already, specifically on that cash flow. But have you said how much of the $1 billion cash flow is from the working capital release alone? And is it mostly just inventory or do you see a significant increase from the payables as well?

We look over a period of two years; we think anywhere from 40% to 50% of the $1 billion could come from inventory reduction. We'd anticipate working capital to move fairly in line with our volume.

Okay, great. So the second third quarter then waited as well?

Certainly we would see our inventory. Look, we'll start to see a decline in Q2, but then we should really see a big decline in inventory in Q3, and then Q4. You're going to see any meaningful change in inventory from September 30 to December 31 as we prepare for the season.

Okay, great. And then you did that sale leaseback at Hawthorne. And you mentioned it sounds like you're not looking to do asset sales right now, but you could consider in the future. So just wondering, can you give us a sense for what are your kind of the biggest chunks of assets that you could look to if you need to in the future?

Yeah, Carla great question. I would say that we've done a fairly exhaustive review of our assets to try to identify potential opportunities. And here the sale leaseback was actually executed in the late summer months. So that was actually a facility that we aimed to get out of in the kind of near to midterm anyways. So what we effectively were able to do through the sale leaseback is accelerate the cash benefit to move that to today. In general, we're not on a broad brush basis looking to kind of sell and just refinance our assets that are core to our business. This was kind of a different situation. We are looking at other assets that are core to our business, and we've taken some other modest actions to divest those, but nothing that's individually significant. We've talked in the past about other assets that we have, and I just give you the assurance that management and the board are looking at all those things that commonly come up: our Hawthorne, Bonnie Plants. And I would just say that as a team, we feel very committed to those assets at this point. We feel that they're critical to our strategic vision for the future. And we also feel that when we look at the amount of value that we could get in today's market, and the speed with which we can monetize them, really didn't make them attractive opportunities for rapidly delivering our balance sheet. So, I think the message is twofold. One, we did an exhaustive review. And two, the conclusion is that at this point today, we don't see any big items; we're looking at smaller items.

Okay, and then so do you own aside from those broader brand assets, do you own most of your distribution warehousing manufacturing facilities that might be available for sale leaseback?

To differentiate: distribution is primarily wholly leased. Manufacturing is, look, we contract produce some of our items that the vast majority we produce it's owned right.

Okay, great. And then if I can just to follow up on you talked about fixed costs and low about fixed costs, leveraging and deleverage. Can you talk about how you look at this now, what percentage of costs are fixed? Or I mean, given this so many of the other costs of moving around giving commodity inputs? Maybe is there a way to look at a dollar amount of costs that are fixed? To get a sense of comparing versus $85 million in savings expects to generate this year from Project Springboard?

Yeah, just like in broad strokes, I would say in the near term, 30% to 35% of our production asset of our manufacturing and distribution costs are fixed. But that's a very near-term look, because through Springboard, we're looking at effectively, we're testing everything as if it were variable. And we're attacking these items. And in part, that's why some of our Springboard savings won't even be realized entirely in '23, because to the extent that we're addressing these near-term fixed costs as longer-term variable costs. We are resizing that supply chain footprint and reducing some of those costs.

Does that answer your question, Carla?

Yeah, that's helped. Thank you. And then just to confirm, the 35% production, manufacturing, distribution, fixed—that’s mostly then cost of goods sold?

Yes, it would be embedded within our cost of goods sold. So that is like our manufacturing facilities would be an example of that.

Okay. Great. Thank you.

Our next question comes from Eric Bosshard with Cleveland Research.

Good morning.

Hi, Eric.

Hi. Two things that I could. First of all, the 5% EBITDA growth guidance for '23. I'm just trying to understand sort of what the key pressure points are the key drivers to support that. Dave, you're pretty clear about the 15% production cut. And there's obviously also higher costs still embedded in inventory that you're working through. I understand Springboard on the other side provides benefit to this. I guess as I look through it to the consumer demand, your guidance on sales and price seem like those are the key variables of achieving that 5% EBITDA growth. Is that the right way to think about that, or how do you think about the key achievements in getting into that 5% EBITDA growth guidance for '23?

I'll start and hand it over to Dave. I think that the sales assumptions and the Springboard savings are probably the things that are what are being worked. The assumptions in sales, at least, I think from our point of view—and again, I've talked this through with retailers—we just looked at last year, Eric, as being just a pretty tough year. We had a approach to our advertising, as I think most people are aware, that not to do the sort of heavy early season like we're going to be doing this coming year. And work more when the weather is good. We spent on advertising we activate, and we do this all based on sort of two weeks ahead kind of look at the world, which was a much more real-time approach to sort of promotion at the retail level. I was having a conversation with a retailer last night, and it was if we're sniping, kind of, and how we marketed previously, it felt like we came home with not having hit any bad guys, with all of our ammo still in our sort of containers. We just didn't get clean shots last year. And that was California, Texas; again, this is so easily checked that I don't think I'm saying anything that most people don't know. Texas was very cold until it wasn't; the Midwest and Northeast had a Polar Vortex that sort of unforecasted hit us in late March and didn't really warm until toward the end of April. So when we look at the forecast and we say flat to last year, and we get half of the decline back in lawns, which we think was like their core season was really how important the Midwest Northeast is to our lawn fertilizer season. So we don't get that back. We get half of what we missed, and we think the forecast is good for that. We think, again, the retailer collaboration—and I mean this at the deepest level—truly thankful for the positive attitude of our retail partners in this. They are very motivated to make this work. I think everybody is apprehensive, just because of all the chatter about the economy. But I do think that they're highly committed in a very positive way. And we all want this to work. So the work between our marketing group, our sales group, the merchant teams, the retailers just couldn't be better. And so we think that it's a fairly conservative forecast that gets back to the sales. But I think if Dave was sort of doing magic on me, he'd say, yeah. But it's still a lot cap is counting on that. Look, Eric, or I'm a lot on this, me just before Dave handcuffs me here. Getting through the first half, which is really inventory load for us, on the sales side is kind of everything for us right now, at least for me. It gives us room, we naturally lower at that period and we don't really count on anything from the consumer at that point. It's just getting the load in—the retailers are motivated, we're motivated. It's—it’s kind of all, I think at that point, it's going to be—the second half of the year is going to be that happier. It's all about the consumer. And so, I'm just trying to get there, and we'll know from at that point where the consumer is at, whether it's Dave said, it was—it who knows? But I want to just get back to Springboard, then which is the other side of you.

Look, I think in the end here, I mean, I think the team has built tremendous plans to give us confidence in the top line for next year. But as a CFO, I'm saying, yeah, but I want to have some hedge against this. And so I go back to Springboard as kind of our insurance policy. And I'd say Springboard is we're doing the right thing for the business to exit this cycle as a stronger, better, leaner company. But it's also getting us more insurance. And I just want to emphasize, I've been extremely tough on the team here, with Springboard, that Eric, Springboard savings, they're real; you will see them on our P&L. If you look at the $100 million that we took and Springboard 1.0, and you look at the '21 P&L to '23 P&L, you'll find those—this isn't just some offsetting inflation kind of minimizing the rate of increase. These are real reductions. At the same time, I'd say what we're committing to the next $85 million of which we're well along, but we still have work to do. Those are real savings. And so that to me takes a little bit of a hedge off of if we're just slightly off on the top line, because of this uncertainty, we've got some insurance against that. And that's why specifically not providing detailed guidance on sales margin SG&A because we're going to manage down to EBITDA. And we're going to take out insurance where we're going to be able to offset some risks if they do in fact come.

Okay, can you just square for me? You talked about a conservative forecast. Can you talk about the consumer that's apprehensive? And then the guidance assumes, I think, seven points of pricing U.S. consumer in '22 and another seven to nine in '23. It seems like the pricing assumption for an apprehensive consumer is optimistic. Tell me your perspective on math if you want?

What do I think? I didn't know this question would come from you, but like I feared in the shower this morning it would come from someone. And I can tell you last night was a really great night for me. I got out of this place; I went and visited with the very senior members of one of our most important retail partners. The apprehension for sure is there, and I think you can read it anywhere you want. But nobody knows the answer to that. We took pricing in last summer. I think that's our only tranche of pricing. I think you're saying when this shows, products will be more expensive, but I think products are more expensive—anywhere you go. And that's really the issue, which is not just us. The problem with our pricing, Eric, is we've covered our dollars pretty well. It has been pretty significantly elusive after all this time on our margin rate. And for sure, products are more expensive. And they are with everything: a cup of coffee, a gallon of gasoline, a kilowatt-hour of electricity, natural gas, I don't care what it is. That's the world we're living in. We didn't take enough pricing to cover our margin percent. And so should everybody be nervous about it, I guess, but that's really the world we're in. And we're not unique there. It does involve some, I think, moderate risk. Yes, we're going to be promoting significantly harder; we're going into next season, we are going to be from emotionally levered with our retail partners. And so people will get value relative to sort of sticker price. Lots of things are happening that I think will sort of offset that. And I think we look at this and say, somebody buys a bag of fertilizer, and it's a couple of bucks more expensive. Is that enough to not do it? We did not see a shift to private label. And, Dave, is writing me a note, just throw it out there: eight to ten, which is during the last recessionary period, people were driven toward cheaper home improvement projects relative to cabinetry and appliances and all the other expensive projects people could do. So look, I think we have a reasonable history to look back up. I think we look at our products and say when people buy something once or twice a year, does it—it's more expensive. Is it enough not to buy it? I don't think we have history on that. But we're going to know sort of seven-eight months from now.

Okay, fair enough. That's fair enough; I understand that. Last, just a housekeeping item for Dave. The EBITDA growth, is that pretty consistent through the year in order to sustain the leverage ratio where you are now? Or is it more back half loaded?

Eric, you're looking at it a way? I'm not sure I can answer that live on this call here. I'm just, I just kind of looked at it that way. I can just tell you that EBITDA growth that we've built in our plan is—we're not presenting a plan that says we're going to be in default. I mean, we're not presenting a plan that says we will be in compliance.

But I also don't think we're saying it stays at 6x either. I think it stays within 6.25 and 6.5 limits that we have with our bank.

Yeah, that's exactly right. So look, it's going to hang north of six around six until we get to the third quarter of the season. And I'll just remind you that our leverage covenant goes up to 6.5 starting next quarter. So we'll get a little bit more room here in Q2 goes to 6.5. So that's the answer.

Okay. Thank you.

Our next question comes from Chris Carey with Wells Fargo.

Hi. Just quick ones for me. Is the POS number that you put out there flat? Is that a volume number? Or is that a value number? And then I can't quite tell, are you basically saying POS flat and you'll see how inventory shakes out? You can't really predict that from a shipment standpoint. Thanks.

Yeah, Chris, let me try to answer that. If you're talking about '23, when Jim refers to in the script flat or plus 10 for, he's referring to POS, and it's POS units. So then if you go back and kind of read my script again, I was trying to kind of translate from POS units to our sales by incorporating in assumptions regarding retail inventory and pricing, the other elements of that. Does that answer your question, Chris?

Operator?

Excuse me, Chris Carey, you may proceed.

Chris, are you still there?

All right. Next question, please.

This concludes our question-and-answer session. I would like to turn the conference back over to Kelly Berry for any closing remarks.

Thanks, Priscilla. And thanks, everyone, for joining us today. I know we didn't get to some of your questions, so please feel free to call me directly or email me in the coming days and we'll get to you. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.