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 I want to remind everyone that today's call is being recorded, and an archived version of the call will be available on our website.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…

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…

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 feets 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…

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, were 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…

[Operator Instructions] 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 in that question. The POS data for sure is good. We've been for a couple of years now sort of after COVID started saying if we could just hang on to the sales data. So for us to be saying, you know what, we think sales will be up minus two to plus two is -- it's still hard for Mike and I to do that. But I think that the POS data, while it's small, basically says that the consumer is still engaged. The survey data, again, just says that people want a garden -- that the young people who want a garden are more interested in gardening even than their parents were, and they are willing to spend more money. And for me last, and I'll hand it over to Mike, is the retailer enthusiasm for the category is just -- and I'm talking both online and brick-and-mortar is just really positive and committed to the space. And I think you're seeing that in our movement of product into the stores, and I'm going to say a much earlier and successful kind of load into retail than we've seen in the past. And so the retailers are engaged, the consumers seem to be buying so far. It's not just us, live goods as well. And then the data we're getting plus our plans and -- to market and our innovation and new products. So, I think that's what sort of drives us to say, sales will be flat, which it doesn't sound that great. Does that sound great to you, Mike?

No. But -- I'm an optimist. But we're also seeing out there that -- there's an upgrade in live goods and the demand for live goods at a higher quality level. And so, we're seeing larger pots, and consumers are leaning in with that. So that gives us a degree of confidence that they want to do more and they want to have greater success. And so in the premiums of -- having a premium plant, premium products has actually -- we've seen signs that that has actually risen. So the pricing action so far, we've not seen consumers walk away from that. So that adds to our optimism. And we're seeing that in the South right now.

The sort of negative that you threw out there, which is, do you think pricing is going to deter people from gardening? And that if I was going to be honest, I'd say, we don't know. The retailers don't know. I think if you go back to sort of '20 where there was effectively no promotion at all and last year, I would say there was probably half as much promotion as there was in '20, but there was zero promotion. And the result of that was that retails probably went up double digits to the consumer without any ability to sort of have promotions, Black Friday events that push prices down. And the business was insane. Now that -- again, I think you mentioned that it was during COVID and people were at home, et cetera. But I think people thought we pretty much were out front about saying, if we can just hang on to what we got and we grew -- I think units were up like 10% last year. So, I know that I've never seen sort of pressures like this, and I'm sure our retailers are listening. This is not covering, so we're definitely in double-digit range on these three price increases pretty much across the board, and it's still eating into our margin rate. So I think it is the big concern of what are we going to see? I'm not too worried about it. But it's something we're going to watch carefully. And I just -- I got to be honest with you, right, which is that it's a lot of pricing. It's necessary, as I said in sort of my script, but I'm not too worried about it. I don't know, Mike, are you?

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 kind of a leading indicator of the market are -- I don't know what the numbers are, but they're -- it's big.

About 45%.

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. So it's a good question, probably a complicated answer, which everybody would probably be happy if I didn't answer, but I'm going to sort of lead into it. Look, first, start with Hawthorne as a legal business. So, we don't have a lot of the sort of issues on reputational risk, et cetera, that plant-touching businesses have both on taxation and banking. We have a ton of synergies by integrating Hawthorne into our supply chain and R&D efforts. So in a lot of ways, you'd say it makes sense to leave it there. And so, the question would be then why would you separate it, and there's probably two reasons that I think are probably the clearest. One is that I think in the investment community, there are probably people or entities that would say, "You got a fantastic lawn and garden business, high cash flow, very predictable." And the cannabis market people who want to invest in that are a different type of investor. And I think there's probably some truth to that. I'm not sure it outweighs what I've talked about before, the advantages of keeping it included. And I'll just talk personally. Keeping it included keeps Chris sort of with us. And I'm going to say, just as a -- the CEO, a mentor and his dad, I think having him involved in the core, which is our family enterprise, makes me happy. And it would be sad to see him make a choice that went in a different direction. I think the other issue is what we're doing with the Hawthorne Collective, and it's going to become more clear over the next couple of months, the work we're doing through RIV. I think we'll start to make things clear. And one of the things that's…

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.

I guess -- first question for Chris, I suppose. The oversupply of cannabis that's going on in the market, you guys have talked about a couple of markets in particular, California and Oklahoma. Are there other markets that are in the same situation? And is there a concern that we sort of see this rolling oversupply situation sort of spreading later this year rather than getting better?

Hey, Joe, yes. So it is definitely not an issue that is contained to any one sort of discrete state market. California is significantly affected. And California, obviously, is our single most significant state market, still close to half of our business. But we're seeing significant impact in a state like Michigan, which is our second-largest market. Now that being said, we've got plenty of states, primarily Northeast or I should say just sort of the Eastern kind of corridor in general, that are doing really well. Now it's off a small base. This is similar to what we saw kind of -- and I hesitate to even use Oklahoma as a comp here, but the growth that we saw off a small base in Oklahoma a few years ago. So, we're seeing 100,000%, 200,000% growth in some states off a small base. So, there still are markets that are doing really well for us. But the oversupply, the intelligence we have, it's really driven by the sort of the legacy illicit market, and that is a market that doesn't really abide by state boundaries. So we're seeing this across the board in sort of the larger, more developed markets. The states with stronger or more developing legal markets are typically doing a little bit better. Now in terms of how long we think it will stick around, I don't think it's historically going to stick around for a long time. As legal markets get better and sort of we're trading kind of cannabis sales from the illicit market to the legal market, these sorts of disruption should get sort of smaller in amplitude and less frequent. We think this one will probably be through -- we're getting kind of varying reports. We try to track wholesale prices of cannabis…

And Chris, I want to just throw out, again, my own view, whether -- I think this is -- I would be generous, I think, in calling it an immature market where there's just -- I'm going to get rich. I'm going to grow all the stuff, market crashes, and we team to go through these cycles. And I think part of what Hawthorne needs to do is help be an influence to -- for people to understand production, to understand pricing. And we're -- and this is true both in the R&D side, but also the economics of this business is something that we're hiring. I just don't want to talk names, but well-known professionals who are interested in looking at this new industry and helping understand the economics of it and do this as a service to our customers that help them basically look farther forward. Because it does seem like the high beams in this industry go forward like two feet, and there's just a lot of black out there. And the ability to run in this stuff is pretty high. So again, more to follow on this, but we are looking to help this industry professionalize and to be a maturing sort of influence in the space. And I don't think our competition in any way can make these kind of investments to 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 have seen -- some of these guys, it depends at the retail level. Even some of our vendors, there's I would say, at the risk. And I don't mean to be offensive to anybody here, certainly not our customers and our vendors. But there's varying levels of sophistication in these businesses. Some guys are really prepared and reserve plenty of cash and kind of operate their business in relatively conservative ways. Other people are much more kind of month-to-month. Some of those more month-to-month operators are in a difficult position for sure. So we had some guys up in Michigan pretty recently and the retailers up there just feeling really down. Because to Jim's point, their horizon is pretty close in, they just -- they don't have, I think, some of the visibility that we have. And when they kind of fought through for six months of just really tough, tough market conditions, those guys get down. And in some cases, yes, they're running pretty low on cash. So, there's some things that we're doing to try to make life a little bit easier for some of our good, reliable customers who are able to provide us with financials and help us understand their businesses. We're trying to do the same thing with some of our vendors. But there's no doubt that there is going to be some kind of shakeout as a result of this market disruption, some businesses will not survive. And for us, we look at it not so much on our -- on the retail or our customer side, but on the equipment and sort of vendor side, we look at this as an opportunity to kind of, again, further drive consolidation. Some folks are going to fall out. It will create opportunity for additional deal flow for us at really appealing valuation. So it's not like it's a good thing for the industry overall, but I do think we can take advantage of some of these circumstances.

Yes. I mean I'd just barely touch on what Chris said. I don't think we have any significant issues on our aging on receivables. So that maybe directly answers the question. But I do think that -- I think it was Forbes kind of over the summer, I think the headline was it's going to be a bloodbath. From a Darwinian point of view, the bloodbath is going to create stronger people. I think Hawthorne is stronger as a result of what happened in '18. And we're absolutely committed to this space and I don't think in a way that anybody would say is lame. We -- the Luxx deal was significantly cheaper than the original price based on market conditions. There are definitely going to be opportunities that -- now Hawthorne doesn't have a huge list of things they're after, but there are definitely going to be stronger retailers, stronger cultivators, and Hawthorne is going to be stronger as a result of what's happening here just from a Darwinian point of view.

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

So, I guess my question is more of a broad-based question just around the guidance for the year. I know there are a lot of moving pieces, but can you maybe walk us through why you still feel comfortable with the earnings range at this point in time? It's just -- from working through the numbers quickly, like using the midpoint of sales, gross margin at the low end, SG&A down mid-single digits, it really puts numbers at more at the low end of the range rather than the high end. The high end is a little bit more difficult to get to. So maybe first, is that fair? And then second, does it embed any conservatism? Should some of the key pressure points get worse from here, like consumer demand or weather? It doesn't sound like it does in the U.S. Consumer business, but just really trying to understand how we should think about framing kind of the 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.

Look, Jim Hagedorn here. I'll throw in sort of my two cents. I think you know how violent this business is, and so much of it depends on when you can get out in a T-shirt and garden around America. And so let's just say, April through June is kind of where things are going bananas. So for us to call a year when -- I think up in Vermont, we're supposed to get like 15-ish Thursday and Friday. I think Cory gave you the -- so I'll start by saying. I don't think your thinking is all through bard, but I think that we continue to be pretty confident that flat for the consumer business is an achievable number. And if we can exceed that, there's just a lot of benefits that kind of come together for us. And so, we'll know a lot more sort of two or three months from now. And that would be the best time to do it. We've got a lot of control over this business. And we're not in our emergency checklist at this point trying to do anything. We're just running our business, looking to run our spring business with our partners. And so we haven't pulled our ripcord to say, "Oh, my God, we have to protect the P&L." We have a ton of ability to do that if things get tough out there, but we're just not there. Mike, anything to add?

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

Got it. Super helpful. I guess just some follow-ups quickly on just Hawthorne, just the commentary that the category appears to be bottoming with kind of daily sales. I think it was on holding stable. Can you maybe help us frame what that actually looks like on a percentage basis in January? And then the guidance of kind of flat to minus 10%, just the uncertainty, right, because the category were trying to grow it in April or July? I mean I guess what's embedded in that guidance? Like if it is based on a return to growth in July and an earlier return would be upside? And then just -- I know there's a lot here, but just, Cory, like in the release in January, there was a comment that preorders were up for nutrients and grow media? I may have missed this in the premier remarks, but is that still the case?

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. And just to add to what Cory said. So, you mentioned what we referenced in the release last month about growing media sales and some nutrient sales. So yes, we're still seeing preorder sales that have already exceeded our full order -- or full year pre-orders from last year. So those are going to go out sort of this month through June. What that really indicates to us, though, is that the retailers -- despite that depression I mentioned during the last answer, that those retailers are feeling confident there is going to be a bounce back. They wouldn't be ordering in these quantities if they didn't think they'd have customers coming in to buy. Also, in just the past few weeks, we're seeing a pretty significant uptick in propagation supply sales. So again, just people starting seeds, people doing clones and that kind of thing. Again, this is all kind of forward-looking kind of market confidence indicators to us that give us a pretty good feeling that, again, come spring, early summer, we'll see this bounce back. I don't want to count my chickens before they hatch, but again, all the indicators that we got within our business are pretty positive right now.

Yes. I want to throw in just to sort of comment is that maybe a plug for Hawthorne. I mean part of what you're seeing is based on these prices, people's willingness to build out new grows and invest. And I think that, to some extent, is retarded as a result of the pricing that's out there and people's willingness to build out with prices at this level. And I think if you look at like Hydrofarms, I hate to say, I don't believe it. But I think they have a consumer business in Canada, they probably is artificially pushing up their number. And in addition, they don't have the lighting business that we do. And so we're highly invested in lighting. And I think that -- this is the plug part. If you look at what Hawthorne has done in the last, call it, 3 years with LEDs, if you look at HPS lighting, the old traditional lighting, those numbers are down pretty far. What you're seeing is a much more rapid changeover to LED lighting than I think anybody in this industry, and we're the biggest would have anticipated. The work that Hawthorne's done and the acquisition of Luxx have just built a very, very powerful lighting business in the part of the market that's growing really well. And I think that, that benefit is going to play out over the next years. And so I think you have to look at Hawthorne in that Hawthorne is more impacted as a result of the biggest part of our business, which is lighting and sort of HVAC, humidification, it's been air conditioning and stuff. And so we're much more involved in sort of build-out work. And so I think if you can logically look at what's going on there -- but I think if you look at the franchise of Hawthorne, I think it's just a much more diverse and strategic business for this industry than somebody who is effectively a distributor.

Our next question will come from Chris Carey with Wells Fargo Securities.

So I guess I want to be a little specific on Hawthorne. Did lighting drive the decline in profitability in the quarter? How do you kind of see profitability for the business trending from here? And I kind of ask that in the context, a lot of these tidbits that you threw out around inventories are back in, you have more components, demand is there, you’re shipping lights. So that’s kind of question one. And then tied to it is, this restructuring seems like it’s going to allow you to lower pricing on lighting. And can you just expand on that, right? Is -- are you getting pushback on lighting prices? Is this -- are you gearing for this East Coast move of the industry as more states start to open up and expanding your competitive positioning? So underlying that, there’s a lot of questions around lighting, but the key idea is just profitability and some of the strategic decisions that you’re making to potentially improve your value proposition from here.

Chris, Jim Hagedorn here. Everybody wanted to answer this one, so everybody’s competing sort of -- but I pull rank on this one. We are definitely not in a race to the bottom on pricing on lights, absolutely not. Our best light source on as fast as we can make them. And that really gets back to my comments on LEDs. And that’s also true with lots. Business is good. I think it’s the HPS and CMH lights, the more traditional lights, that are under pressure. And I know Christmas finance guys were running over when you were asking the question to sort of feed them. So I won’t get in the way there. Mark, do you want to -- just come over. Mark Sheiwer is our -- he’s the CFO for Hawthorne. I think you guys may have known him. He was the -- Scott’s controller before he went over to Hawthorne. You want to talk a little bit about what’s kind of driving your numbers?

Sure. So on our sales decline, I would say, for this quarter, it’s -- half of it is around lighting. And I would say about 2/3 of it is our durables product line and stuff. So I would say on the sales decline, that’s what you’re seeing in a big piece of it. And then obviously, with the overall decline in our profitability, fixed cost leverage impacts our numbers and our earnings for the quarter. But I think as we kind of lever up in the rebound for the back half of the year, we’ll be primed for profitability. So I would say those are the kind of key --

Well, Chris, I think the important part of this is this big shift over to LEDs from the sort of old sort of -- I’m not going to call a metal highlight because then people will yell at me. But the sort of old school --

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.

Well -- and yes, just to build on that, Chris, it’s really -- it’s not -- this is the LED sort of adoption wave that we’re seeing is not limited to cannabis. And this is an important part of our strategy is really looking at this -- at our product line, our offering as a much broader offering than just kind of serving the cannabis growers. Clearly, there are bread and butter and that’s who we are focused on primarily. But we are selling massive lighting jobs through our ProHort business in Canada and Europe, all LEDs. So -- the adoption of LEDs, as Jim mentioned, is taking place really across the board and kind of controlled environment in agriculture, whether that’s cannabis or otherwise. Now clearly seeing a sort of product categories is about half of our business kind of hit a wall here. And this is a result of people does not want to build out new facilities. Clearly, that’s going to impact our profitability in a significant way. When the market comes back and people start growing again when it’s worth it for them to do so in the wholesale price of cannabis rebounds, we are going to benefit from that much more than anybody else because of our positioning. And like I said, we expect that to be back half of the year. In terms of the moves that we’ve made on supply chain, like Jim said, we are not interested in the race at the bottom here. We’ve got some really value-added lights, some really interesting innovations use that deserve the price that they demand to the market. And we don’t think customers are squeamish about paying it. The question for us has been keeping ourselves and supplying those products and make them as efficiently as we can. And moving -- in-sourcing some of that manufacturing is not just about cost reduction for us, increasing our margin or offering a lower price to consumers. It’s also about just controlling our supply chain a little bit more and not being so dependent on folks and leaving us in the lurch. Because that’s -- it’s a hard thing when you’re going through a market like this, and you’ve got people that want to order product and you just don’t have the process to fill those orders. So we’re just not going to leave ourselves in that position again. And that’s a lot of what’s driving this is just controlling 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.

So this is one of the things -- I don’t think we want to be more specific than that, but this is a very major ability to kind of right cost, and it is not about giving that back. And we can be competitive very much. We can have market-leading products, both on the opening price point and on the premium side with technology that justifies the pricing. But we’re just taking all -- I mean we’re doing -- if you looked at the supply chain for LEDs between us and Luxx, it's sort of spread out all over the world. And that -- anything to add on that, Mike?

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.

Exactly.

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.

Well -- and I don’t want to toot our own horns here under the circumstances report the numbers that we are right now. But getting back to profitability under the current circumstances for this year, when you look at the market conditions and you layer on top, the fact that we’ve doubled our distribution center footprint, that we’ve increased head count pretty significantly just to match the scale and the growth of the category over the past few years. Getting back to reasonable profitability this year, I just want to sort of commend the team because that’s -- it’s an accomplishment under the circumstances and something we’re proud that we intend to accomplish.

And up next, we'll hear from William Reuter with Bank of America.

I just have one. In some of Jim's opening comments, you mentioned that the M&A pipeline is potentially the biggest it's been in 25 years. And then later on, when kind of discussing the year, we kind of penciled out $200 million. So on the surface, you seem a little bit incongruent, I guess I was wondering if you could kind of take these 2 statements and help me put them together and then thinking about where and why that you would be willing to take leverage for the right acquisition.

Let me just kind of start on the M&A pipe. So I think that Bonnie is the recipient of the growth opportunity here. And sort of the beauty of that is that there's leverage capability at Bonnie, and we are willing to contribute and so is Alabama Farmers Coop. And that was pretty careful to say our partners because they're really great partners. But we have an interesting flow into Bonnie without us having to pony up all the money. And so leverage capacity at Bonnie plus a contribution from us and AFC is -- kind of offers us the ability to sort of lever up the opportunities without Scotts having to pay for the whole thing. In addition, the moves we're making on the RIV side effectively already paid for. That money has already been contributed. And we talked about an additional contribution to have more opportunity within RIV, and that's probably $50 million to $100 million additionally. But again, we're using RIV to get to where we want to get to without Scott's having to contribute all the money to do that. Remember, they started with $200 million, and we contributed that -- I think, call it, $150 million. So I think that within that lens, what it means is there's pretty significant opportunity that does not have the dollar for dollar show up on Scott's balance sheet. I don't know if that -- Cory, if that makes any sense.

Yes. I think that's right. And if you think of the activity that we've had over the last 6 months, we just completed 4 deals within Hawthorne. We're integrating those in. We're trying to see how much we can bite off and integrate into our business when you look over the next 9 months to get to the end of the year. And if you think of leverage, we kind of ended the quarter at 3.3. And I think in my script it says we'll likely get over 3.5. We can get to 3.5, 3.7. Still feel like we're really safe within the covenants that are out there today and the opportunities that Jim laid out there. I'd say we have a couple of other small opportunities on the smaller side. There would be opportunities as well for the rest of the fiscal year and just making sure we're continuing to move forward with all these acquisitions to operate the 5 pillars we've laid out and focus on our long-term strategy.

We've also used a little bit of SMG equity and anticipate doing that in live goods as well, a small amount. On the sort of inventory side -- if you're basically looking at cash, if you look at the inventory side, it's a pretty significant increase. I don't know, $600 million, $700 million, I think, is roughly the number. But I think you probably could take $200 million or $300 million and say, if we had that last year, we would have been a lot happier. So I'm going to say 1/3 of it or so is just getting back where we should have been last year, and the rest of it is investing to make sure we can actually supply for the spring. And we'll look at that over time. But I think if we look at our inventory and retail inventories, we're pretty happy with where they are right now. We feel well prepared. We do not feel overextended ourselves, and we don't feel that way about retailers. Retailers are ordering heavy right now. So there's no indication there's any sort of inventory at retail or with us that's an issue. On the capital side, I think what we said is figure like -- or at least what we're talking internally is like $200 million a year for some years, I don't know, 3 to 5, I'd say, something like that. We're going to look at that over time and see if we think that those numbers are appropriate. Part of the issue, and I think everyone is well aware of this, is that we had a very well-balanced system for, call it, 0% to 2% growth. Where you look now and you say it's, I don't know, Corey, I think, said plus 40, plus 35, whatever the number is. It's basically resized our requirements for manufacturing. And some of the investments we're making, like this year right now and next year, are part of just getting our production capacity and our ability to distribute both on the core and at Hawthorne where it needs to be based on the growth we saw. And remember, the growth in consumer has not gone anywhere. It's actually been maintained. So -- but I think beyond this year and next year, we'll take a look at how the business is performing. And there's no commitment out past -- as far as I'm concerned, out past that if we don't see the growth that we're looking for. Anything you'd add, Cory, on that?

No. I think that's good.

Our next question will come from Bill Chappell with Truist Securities.

Mike, can we talk a little bit more about just the pricing, both what’s going in place and what’s going in, in 3Q? And when I ask that -- this time last year, you were really leaning in on a promotional level, trying to capture or maintain a big chunk of those consumers that had come into the category. I think the thought was you were going to scale back on some of that. So I guess, one, trying to understand how much of this is list price versus how much of it is it kind of a pullback on promotion. And two, putting in a price increase in 3Q really depends on when you put it in since there’s so much of the sales happening April 1 versus June 1. So just trying to understand when that goes through and how that looks as well.

Okay. That’s a lot.

You should have written it down, Mike.

I know. No, I think the pricing that’s going in, in April was primarily around our growing media business. And so -- and that will be tied, and we’re working with the retailers on timing of promotion and activity. And so -- and Cory has the number of what it actually turns out. It’s a significant number as a percent, but it nets out to --

Yes. It nets out to about 1% of sales, but it’s really focused on our soil business. And Bill, to answer your question, it’s 4 1 is what we’re looking to implement that pricing on.

We expect retailers to -- they didn’t go all the way back to pre-COVID or -- pre-COVID promotional. So I’d say that came out about 50% to 60%. That’s probably going to be similar on the promotional side. And so I think we’re more specific on what promotions we’re going to run that drive a bigger basket, and that has worked. We are leaning in more with the advertising again and what we call the -- what do we call those, Jim, if buy in markets or whatever.

Air rates.

Air rates that specific markets and hitting those markets with advertising and timely promotion more so than a national promotion, and that’s been successful with all retailers.

Yes. Bill, I would -- Bill, what I would say is just visiting with retailers, it does have a pretty competitive feel this year. They all seem fairly hostile and wanting to get everything they can. So we understand our programs. I just think the retailers are going to be pretty active this year looking to cement their businesses. And it’s just how they talk sounds aggressive to me. So I think, yes, I might actually see higher level of promotion this year than last year. I want to throw out there just while we’re kind of on retail is, there was this young guy when I first got out of the military down in the Southwest named Craig Menear. And so we kind of grew up together. When I was back in the private Miracle-Gro days and I first met Craig, and I want to say that -- I thought Frank was -- Frank Blake was a terrific CEO, one of the best. Meniere was awesome. It basically says I’m getting old, if people I grew up with are leaving the industry. I know Ted has gotten people in these press releases saying is the sort of managing sort of the art and science of merchandising. I think Meniere very much was that. Anybody who spent some time with Meniere when he brings out his notebooks with all his stats in it always tense up a little bit. But I want to sort of thank Craig for his time as CEO at Depot. And this is not that I don’t love all retailers, we do. And I want to congratulate Ted Decker on -- and he’s been a fantastic merchant partner for us, and it will be interesting seeing him having everything reporting to him. So I want to congratulate both those guys and say, well, Craig, we’ll miss you, dude.

Can I jump in? I don’t really know how to follow that. But so I just want to follow up on the pricing. So just to be clear, you don’t feel like there’s going to be a big dropoff on volume, even though promotions being pulled back 30%, 40% versus kind of last year levels? You’re comfortable that you’ve retained these customers?

Yes. So there’s kind of 3 waves of pricing that when you think about…

The answer is yes. We’re comfortable.

We’re comfortable, but I want to clarify because I had I pointed out the April 1 pricing that we’re kind of finishing up with the retailers now on that’s going to take us back to April 1. That is Wave 3 of 3 waves of pricing that we’ve taken. We took pricing last August. That obviously flows into this year. We took pricing again that was effective January 1. We didn’t see a slowdown in ordering then. And then again, we have the April 1 pricing that we’re going to look to put in place. And it varies by item across the different areas of our U.S. Consumer portfolio, but kind of nets down to a number that is in that 8%, 9% range that we talked about earlier.

Yes. I want to be careful about -- promotional level is not going back because of -- I mean the same level. It increased last year from 2 years ago. It’s going to be about the same level. It’s not going back 30 to 40 because of pricing, but we’re not seeing an increase either, at least that’s what we’re seeing, they’re saying, and so from our interactions. So to Jim’s point, getting more competitive, somebody can do something, but that’s what that -- all indications, that’s where we’re going to be.

Got it. And then, Chris, just a short-answer question. Is the assumption this year kind of your outlook mainly for California, Oklahoma, others getting back to normal? Or are you expecting kind of meaningful pickup out of new markets like New York, New Jersey, Virginia, Connecticut?

Yes. We’re really looking at both a rebound in the traditionally strong markets you described, those West Coast markets, Michigan as well. But as I said, we’re also seeing significant growth in those new markets. So if you look at -- let me just pull these numbers up here. I mean you look at Florida, we’re up 20%. You look at a sort of smaller basis state like Alabama, we’re up over 1,000%. New York, we’re up over 100%. So we’re seeing growth there. It’s going to take some time for the revenue, just the scale of the markets in those states, to account for sort of the shift away from California. So it’s going to take time for the -- sort of the balancing of the country to really reach a balance. So it’s going to be some combination, but the primary bounce back is going to be from the more traditional states just because the other states are still too small.

Our next question comes from Andrew Carter with Stifel.

I'll keep this one quick. I wanted to make sure I understood what the cadence for Hawthorne is for the year. I think your guidance implies negative 9 to plus 4 for the remainder of the year. 2Q come in a similar magnitude as this one or will it be just kind of a hockey stick? Second question is your kind of trailing 12 operating margin on Hawthorne is 9%. You finished at 12.5% last year, and last guidance was up 50 basis points. Could you give us kind of any indication where you expect the business to end and kind of a long-term expectation now that you have the supply chain initiatives?

We're going to have -- answer this one.

Sure. So on the second part, you'll have to repeat the first one again for me. But on the second part, just on our EBITDA or our earnings rate, we would expect in the back half of the year probably to be in that higher single digit as we ramp up our sales volume again with the market rebound. And then longer term, as we begin to flex on that, we should be able to get back to where we were at in the prior year and beyond. So -- and continue to make our push again to become closer to 15% as our overall target. So I would say it's a slight pause this year, obviously, and then we'll start that upward trajectory again in the next year.

Yes. So again, echoing what Mark said, the long-term objective is to be a 15% operating margin business. We have every confidence we're going to get back to that -- or I should say, get back to sort of marching towards that goal, the path that we were on in the past few years. As far as the first part of the question, we expect to see the second quarter to be sort of closer, I think, to flat from a sales perspective. And then for quarters 3 and 4 to really see that significant bounce back is what I said at the beginning of the call, one of the first questions was I'm more focused on kind of how we end the year from a trend perspective. So like -- yes, like I said, it's this quarter is kind of a punch in the gut. We expect to see Q2 kind of flatten out as the spring comes. This is -- traditionally, Q1 is our weakest quarter even in good years, and then we expect this to see more significant sales -- or return to sort of significant sales growth in quarter 3 and 4.

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?

Okay. I’ll take the beginning and pass it to Cory, which is basically -- it’s a little bit like the benefit of moving lighting manufacturing down to Temecula. We don’t view that as a tool to reduce our selling price. I think that the only factor on the consumer side is moderation in cost of goods, which we’re very hopeful for. I don’t think we’d look to sort of reduce our pricing. I think that’s a discussion we have with our retailers, and a lot of it would be based on what we’re seeing with sort of the elasticity with the consumer. So I think the idea would be to hold those -- hold that pricing. And -- but just look and see what’s happening with the consumer and if we felt it was weakness. And again, that’s a discussion we would have with our retail partners on kind of what we’re all seeing in the marketplace. But Cory, I don’t know what you would add on that.

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.

Operator, let me jump in real quick. We’ll take one more question just in the interest of time, and then we’ll wrap things up.

And our final question will come from Eric Bosshard with Cleveland Research.

On the consumer business, clearly, you are -- have a lot of confidence in how the season is going to play out to raise your numbers here in February. What I'm trying to figure out is the source of that confidence as we go into a year where you've got these 3 price increases that have gone in your inventory levels. I understand you're comfortable with them, but they're higher than they've been historically by a pretty wide margin. I guess the core is -- of the question, 2 things. One, why the level of conviction? And two, if the consumer shows up in April, looks at 3 price increases and decides to behave differently, how do you manage through that? Or is that the retailers' issue to solve?

Dude, it's all of our issue to solve if we see sort of elasticity issues. So I think that I'm just trying to like carefully -- be careful with my words here because I think we kind of answered that question already. I don't think they're the expectations on POS that we have called flat are particularly aggressive, to be honest. The retailers -- and dude, you probably have the best intel in the analyst community on what's happening sort of at retail. But I would be shocked and amazed if you haven't sensed the level of conviction for lawn and garden and the level of aggression that they see this as a sort of core category that they want to press on. The homeownership, the demographics of lawn and gardening are just really good for us at the moment. I was dealing with a personal tax issue yesterday talking to our accountant from PwC. And she has a kid, and she's like we're going to move to New Jersey. But she said, we can't find a house. Like if we don't make an offer like instantly above ask, we keep losing these houses. And it just makes it very stressful trying to get out of the city. So I think that, that trend is something we've talked about a lot that just, I think, benefits us long term because this is a huge group of people who are interested. And I think just like her, and this goes back to Maner telling me this sort of a year before I believed it, which is that when young people have kids, they want a home. And our data says that they want to have a nice yard and garden. And so I think if you look and say the retailers…

'08 or ‘09, yes.

I think we sold somewhat less bags, but we made way more money doing it. And I think the business is very, very healthy. So I don't know. Does that answer your question? And Mike, he may have directed at you.

No, I would say we've taken our pricing in phases more specific to certain categories. We're not -- actually, we're seeing volume stronger. So we haven't seen any decline. Now that's early. And so that's one good indication. The other is we've got more people leaning into the category than ever. And so you're seeing Tractor Supply and ACE to even doing more and TrueValue and Costco. So it's not -- it's -- there are a lot of people that are putting more into lawn and garden than ever before. And so the interest in the category is much greater than it has been. So the consumer back, we're not seeing it. And so our degree of confidence grows with that.

But I'd also add that our partnership in the retail environment, there is no doubt that you go into I don't care who it is. What you're going to see is much skinnier labor force just as they are not able to fill all their positions. And the importance then of the Scott's team in there. And as you look at our sort of live goods approach in addition to our kind of legacy lawn and garden business, the objective will be to put more people in the stores. And that's a big advantage for us to be sort of be there when even the store labor can't cover what's happening. So it gives us a lot -- I wouldn't call it control but a lot of ability to take advantage of opportunities that other people just don't have the labor to execute against.

Yes, I was just going to add 3 points, Eric, as well. Retailer engagement is really strong. Our positioning with our additional inventory this year, we missed sales last year because we couldn't ship out quick enough. So our additional inventory this year makes me more comfortable than we were a year ago. And I'll say that the final point on why I feel more comfortable in looking at the sales this year, our key weekends last year were kind of lousy. You think of every weekend that we went into, we had rotten weather in every one of them. I think it was Memorial Day. There's snow on the ground, and it was like one of the coldest ones ever. So you go into those key weekends with good results, it doesn't have to even be great results, but good results will get us to a spot where flat unit -- or I'm sorry, flat dollars, feels like about that we're willing to make at this point.

Yes. And I'd probably -- on the online marketplace. And some of that is our legacy retailers, their online business, but also pure online players plus our own, that business is starting to get pretty big. I mean I think that business -- all online sales for us, it goes in Pattie's category, which is our direct-to-consumer, I think you're getting up to like $300 million or maybe more. What was the number she drew a couple of days ago? But call it roughly $300 million. It's getting to be meaningful numbers. And that business has an above-average growth rate as well.

Okay, everybody. 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.