Q4 2021 Scotts Miracle-Gro Co Earnings Call

Good day and welcome to the Scotts Miracle Gro company's fourth 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.

Good morning to all of you and welcome to the Scotts Miracle Gro fourth quarter conference call by now you've likely seen our fourth quarter and year end press release in which we announced record full year results as well as our initial guidance for fiscal 2022.

We have a lot of ground to cover this morning with prepared comments from chairman and CEO Jim Hagedorn.

CFO Cory Miller.

As well as Hawthorne Division President Chris Hagadorn.

After their comments, we will take your questions and for the Q&A session, we'll be joined by President and COO, Mike look buyer in the interest of time, we request that you ask only one question and one follow up I will be available after the call and throughout the days ahead to answer any questions that we don't have time to address or need for the follow up.

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 discuss I'd.

I'd refer you to our Form 10-K, which was filed with the Securities and Exchange Commission. So that you might familiarize yourself with a 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This call is being recorded and an archived version of the call will be stored on the Investor relations portion of our corporate website, Scotts Miracle Gro Dot com.

Without further delay we will get started and I'll turn the call over to Jim Hagadorn to begin Jim. Thank you, Jim and good morning.

For the last month I've been thinking about the key themes I wanted to cover today.

I also spent a lot of time thinking about who exactly I wanted that target with my remarks.

I won't spend a lot of time, focusing on our quarter or the past year.

But it is worth pointing out that we just finished our third straight record year and remain extremely optimistic.

And it's worth pointing out that our 11% growth in U S consumer was against a 24% comp and a 39% growth in Hawthorne was against a comp of 64%.

I know there are obvious questions to address our stance on pricing the commodity outlook excess inventory in the cannabis market and our thoughts about capital allocation will cover all of these topics as well as share our thoughts about fiscal 'twenty two but.

But I've been a public company CEO for 20 years, now and too often I have seen the market's focus with short term issues overwhelmed the bigger picture.

So I want to spend most of my time focused on more than our current results.

Frankly, there are a lot of great things happening at the company right now some of them I can't share with you, but they are very exciting.

Our business is an important inflection point.

One that could transform what we look like five years from now.

We have the opportunity to make this company stronger to make the moat around our business wider and deeper and to empower a new generation of leaders to shape. It through their eyes, not just mine or my executive team.

We also see the current volatility in the market as an opportunity.

If you are willing to lean in during times like this.

There is potential to capture opportunities that others can't and an opportunity to further strengthen your competitive advantages and leveraging those advantages, it's what drives long term shareholder value.

So I want the real takeaway from today to be a better understanding of the journey, we're on and I'll be honest my target audience is pretty narrow.

To our sell side friends I appreciate the need to get your models refined and to share that information with your clients. We're committed to giving you what you need but my comments are not aimed at you.

My comments are also not aimed at short term investors.

Not going to get pulled into a rabbit hole about our quarterly splits the spot market price of commodities or a bridge to year over year SG&A.

I do however want to speak to those investors, who see the long term opportunity and SMG shares.

I want you to know where we're headed and why we're confident our efforts will create shareholder value.

We won't ignore the key questions about fiscal 'twenty, two but weave them into a broader context of how we're operating the business rather than the confines of how it impacts the P&L.

In order to look ahead I need to look backwards for just a moment.

For the five year period, we completed on September 30th our strategic plan assumed a relatively mature core business and enterprise growth of roughly 4% to 6% driven by the higher growth at Hawthorne, we sought to achieve a consistent shareholder return of 10% to 12% by leveraging the P&L repurchasing.

Shares maintaining a roughly 2% dividend yield we also set a five year target of cumulative free cash flow of $1 5 billion.

We exceeded each of those goals.

While we are proud of the achievement, we know that the strategy has run its course, because the opportunities are different now and where different too.

And so the next step in our evolution will reflect these realities, we have defined five distinct pillars of growth for the next five years.

Three of the fiber related to the U S consumer business. The other two are related to Hawthorne.

First.

We see a higher level of sustainable growth with our existing brands and our core business based largely on our ability to reach a new generation of consumers.

Second further growth of our direct to consumer efforts is there for the taking if we invest in people brands partnerships and infrastructure.

<unk> live goods remains a meaningful growth vehicle and a gateway for a more direct relationship with gardeners.

Our goal remains the same for consumers to see us as a gardening company not a gardening supply company.

Fourth the support Hawthorne's future growth, we must continue to put the commercial grower at the center of everything we do.

This means further strengthening our model driven by innovation and technical solutions.

And fifth there is no doubt the cannabis industry will continue to evolve and grow.

And there is little doubt that those companies creative and courageous enough to wait into that pool early have the potential for a first mover advantage.

We've shown our willingness to do this when we created Hawthorne and as I will describe later, we intend to do it again.

As we pursue these pillars, we are strengthening our team focusing on succession planning and ensuring our ESG efforts are embedded into our operations and also better understood by our key stakeholders. We debated this a team and with our board whether to pursue all these opportunities at once.

We all agreed we had to but.

But we recognize that succeeding against all of these pillars requires us to reorganize empower our new generation of leaders.

While there are no plans for me or any member of the current team to step away. Nearly every member of my team has made changes to their organizations.

The level of oversight needed to succeed against these efforts requires Mike will require to spend more of his time on the strategy and implementation of the fastest growing areas of the business.

He has reshaped this organization so that each of these pillars reports directly to him.

Therefore, he has given up most of his day to day responsibilities in the U S consumer segment to Josh peoples, and Dave Sweetheart, who will effectively serve as co leads of that business.

On the corporate side Corey has fortified his leadership team with an infusion of outside talent.

And Denise stump and Jim King have realigned their teams to better meet the needs of the business.

In addition, most of the M&A opportunities. We're pursuing include a management team that can further strengthen our own.

Every opportunity we see manifest itself, we could double the size of Scotts Miracle Gro within five years that's.

That's not the goal necessarily we want smart growth not growth simply for the sake of it but the magnitude of the opportunity could be game changing.

Let me briefly tell you how we expect to execute against these pillars or I can I'll talk about them in the context of our expectations for next year.

Between the first two pillars, we believe the U S. Consumer segment can achieve sustainable long term growth of 2% to 4% annually.

Our previous strategic plan assume growth of zero to 2%.

If we can sustain growth at this higher level those added two points carries significant P&L leverage and improve cash flow.

It's worth noting that the guidance we set for next year assumes flat to slightly declining growth in the U S consumer segment.

This is based on an assumed a reset of the business in a post COVID-19 world specifically, we're planning for a decline in unit volume offset by pricing.

Youll remember from our Q3 call that we took roughly five points of pricing effective in August.

In recent weeks, we have communicated to our retail partners a second price increase effective in January.

This more targeted increase will range from mid single to low double digits, depending on the product line.

In total we now expect pricing in 'twenty two to be in the high single digit side with the goal of covering commodity prices. While we believe our sales assumption for 'twenty. Two is a prudent way to plan the trends suggest a better outcome here's why.

Consumer Pos and units in fiscal 'twenty, one was six points higher than in 2020 more importantly, it was 21 points better than fiscal 19, and actually got stronger later in the year.

Consumer volume during the fourth quarter of fiscal 'twenty, one while down seven points from last year's record performance was 35 points higher than the same period in fiscal 2019.

Consumers are showing us that lawn and garden is an essential part of their lives.

Every cut of the data tells us they have stayed with the category and our brands throughout this past season.

Those trends have continued in October.

While it's a relatively small month, it's an important conclusion to the season, especially in the Midwest and northeast.

POS in units were up 4% in October compared to last year's record result, and up 42% compared to fiscal 2019.

As we enter the off season pass numbers won't tell us much until February.

And obviously, we won't know until next summer how much of the Covid bump we retained.

But I'm confident we will have a significantly higher base to grow from we continue to invest with that in mind.

Millennial homeowners clearly have become a demographic tailwind and are more than offsetting baby boomers, who are leaving the category.

This group of consumers care more about gardening than their parents and see the category is more rewarding and purpose driven as well.

A 30 year or couple of buying a home today and entering our category for the first time has the potential to stay with us for 20 years or longer.

We must operate with that timeframe in mind we.

We don't want our marketers to worry about hitting a target for wall Street their job is to drive consumer engagement brand loyalty and market share.

And we're going to give Josh peoples and his team the tools to get that done the.

The same holds true for our direct to consumer pillar.

This area is approaching 10% of our U S consumer sales and will only grow higher.

When we think about direct to consumer it goes well beyond selling items on our website.

It also means collaborating closely with our retail partners to support their online efforts.

It also means finding new partners, who can help us boost the appeal of gardening and have their own digital platforms that we can leverage.

Paddy Ziegler is one of our brightest and most creative leaders and direct our direct to consumer effort.

In addition to the efforts I've already mentioned she and her team have launched native online brands like Green digs knock knock and instead.

But one of their greatest successes is been with Aero grow.

Thanks to <unk> leadership, and with the infusion of our R&D and marketing capabilities, we took a declining business and tripled its sales since 2019 to nearly $100 million.

Pat He's been a champion for the potential of our direct to consumer platform since day, one and continues to re imagine the future of this business.

Succeeding in our direct to consumer effort also requires improving our it and supply chain infrastructure.

Dave Swinehart, whose role has recently been expanded to lead both supply chain and R&D is driving toward that goal.

We need to improve our ability to ship directly to consumers, especially in categories like live goods, which has significant online potential until recently, our direct to consumer efforts didn't warrant your attention, but thats changed.

While it remains too early to gauge the ultimate potential of this pillar it will be a significant contributor to growth as we go forward.

Equally convinced our third pillar live goods will be even more important.

<unk> goods or the gateway to lawn and garden category, but historically have been highly regional poorly marketed and highly commoditized.

We believe we can do better.

Had a great start with Bonnie and its leader, Mike cetera, and we're working with Bonnie's other owner, Alabama farmers coop, our AFC to pursue other growth opportunities that hold significant potential like.

Like us AFC has a vision to create a national branded business across several categories of live goods.

Together, we believe we can better meet the needs of gardeners and our retail partners through innovation marketing and supply chain, we've already made tremendous progress improving the Bonnie business and even there we've only scratched the surface.

The other two pillars are related to Hawthorne, Chris will spend more time discussing the current environment, but I want you to know I'm not obsessing about the sales in Q4 or what we think about Q1.

I believe Christmas team have a good handle on the current environment more importantly, I believe they're navigating the choppiness in the market, while keeping their eye on the long term opportunity if.

If the market is challenged for a couple of quarters expect them to take advantage of it we won't chase sales, but we will take an aggressive stance to further solidify hawthorne and strengthen its market position.

So expect US for example to further enhance our innovation efforts.

Finally visited our new R&D facility in British Columbia last week, it's amazing.

Recently visited fuel stations in Oregon, Florida and of course, Ohio, what's been the takeaway that the work we're doing on hemp and cannabis research is changing the industry.

From lighting to nutrients to growing media. Our research is not just focused on continuing to improve our product offerings, but more importantly to help growers get a better and more cost effective outcome.

Our unique understanding of plant science and the nuances of indoor cultivation is unmatched.

Not only is known in the industry doing what Hawthorne is doing or.

Our competitors can't even try to replicate that model I think you should keep that in mind.

We also are likely to use this period as an opportunity to step up our M&A efforts we.

We continue to be disciplined in our M&A efforts, but the economics of some of our deals have become more attractive recently the.

The final pillar of our strategy is embedded into the recent creation of a new subsidiary called the Hawthorne collective.

I've been alluding for months about the opportunities to invest in emerging areas of the cannabis industry.

But this is my first opportunity to discuss the effort in detail.

It starts with our recent investment in <unk> capital a Canadian based publicly traded company that owns or invest in a series of cannabis related businesses.

We share a common vision with the other major investors at risk.

To create a fully integrated business based on the acquisition of licenses for cultivation and distribution.

From their roof can partner with some of the most well managed brands in the cannabis industry.

There's a lot of speculation regarding the potential for new brands to prosper as the market expands into categories like beverages.

However, too few people are focused on existing brands in traditional categories.

This is already a multibillion dollar market with brands operating in the silos of individual states.

We're convinced there is tremendous potential for some of those brands to flourish more broadly as the market expands and our investment in <unk> reflects that belief.

We believe that our unique level of expertise in the cannabis industry gives us the right to win in areas beyond our existing portfolio <unk>.

However, today, we cannot make direct investments in those areas. In fact, we can't even have a direct ownership stake in a company that does.

But we can create an ownership option, which is what our convertible loan to risk capital reflects.

In the near term, we do not expect to see an impact from the investment in rib on our P&L.

And the amount of capital we have employed $150 million does not impact our ability to invest in other areas or return cash to shareholders in.

In the intermediate term it is possible risk may seek further capital infusions.

We could be interested depending on the opportunities im not going to speculate on how much we might invest.

The honest answer is it depends.

But just as we did when we purchased general Hydroponics Botanic care Kavita and canon filters, we're willing to make investments others might avoid until there is more clarity about the future.

If you were a short term investor you may not like it that's fine.

But the long term potential is real and it's significant.

Ultimately, if we convert our financial interest in river into equity, which is definitely the goal.

It may prompt us to reassess our current capital structure.

Many of you have asked if we'd break Hawthorne off as a separate company.

I've said, we'd only considered doing that for strategic reasons and not to chase valuation and Thats still true.

Over the past year, we've worked to understand what the potential separation would require and I believe we're capable of pulling the trigger on such a move if we decided it made sense let.

Let me be clear, we have no near term plans to do this.

But could it become a viable option I think the possibility is growing.

As I transition to Corey I want to emphasize that I'm, just as confident about our near term plans as I am about our long term strategy.

The U S consumer business is performing well and our consumers continue to demonstrate how important they see this category in their lives.

At Hawthorne, while we continue to expect top line pressure through Q1 <unk>.

I am confident in our team's ability to power through it and we still expect sales growth on a full year basis.

I appreciate your patience. This morning, as I know my prepared remarks are longer than normal.

Are there more challenges out there right now than a year ago, yes.

Am I thrilled with the equity price right now no.

But we're on a path to build a better and stronger business and we won't be distracted by the noise around us.

I mentioned earlier that we exceeded all of the financial targets, we set with our previous strategic plan and the goal is to remain on a path that allows shareholders to continue benefiting from the opportunities outlined in our new plan and the pillars that I discussed the.

The confidence we all have as part of our decision to increase our share repurchase efforts.

Old you last quarter, we had allocated $250 million for that purpose.

We now expect to add another $100 million to that total and we hope to acquire as many of those shares as possible in the next two quarters.

There's still a lot to cover this morning, So I wanted to step aside for now Corey why don't you pick it up from here.

Thanks, Jim I'm going to spend a few minutes on the big themes from our Q4 results, especially around sales and gross margin.

I'll share some thoughts about the guidance. We provided this morning for fiscal 'twenty, two and in between I'll turn things over to Chris to provide some color on Hawthorne.

Starting on the top line you saw this morning companywide sales growth for the full year was 19% which was in line with the updated guidance, we provided a few months ago.

U S consumer sales did better than we expected, finishing up 11% compared to the 7% to 9% growth we expected.

At $3 2 billion.

Sales grew by nearly $900 million in the last two years.

The supply chain team deserves a lot of credit for their ability to deliver this growth.

The targeted investments we have made and will continue making in this area will prove to be key.

Tumor engagement remained extremely strong through the fourth quarter and that kept our retailers equally engaged although U S. Consumer segment sales declined 28% in Q4, we were up against a plus 92% comp.

Also remember that Q4 had six fewer days this year than last year.

Adjusting for that sales in the quarter would have declined 23%.

At Hawthorne, the calendar shift cost of seven points for the quarter.

While year over year sales declined 2% the segment would have been up 5% on an apples to apples basis, when adjusting for the calendar in the U S. Hawthorne business grew by over 10% last year and Q4, given the same comparison.

Finally recall that Hawthorne was up against a plus 64% comp in the same period a year ago.

On a full year basis also grew 39% to $1 4 billion I'll remind you that number was $640 million in fiscal 2019, we have more than doubled the sales of that business in two years and all of that growth was organic on.

The segment profit line Hawthorne earned $164 million in fiscal 'twenty, one for an operating margin of 11, 5%.

Profit was up 46% from last year and more than 200% from 2019, we.

We've said repeatedly that we're trying to strike a balance between growth and improved profitability I think the results speak for themselves.

As many of you know I served as the finance leader at Hawthorne almost since the inception of that business before joining the corporate team as CFO.

As you look at the half of our results I encourage investors to look deeper than the numbers.

While the growth and profit improvements have been impressive.

The improvements we've made to how the business operates tell an even better story.

From the integration of seven separate businesses to the implementation of SAP.

The revamping of our sales force and the creation of the world's only cannabis focused R&D program. The efforts of this team has been outstanding.

All of you want to know more about the current state of the business. So let me take a pause here and turn the call over to Chris Hagadorn for a few minutes. Thanks, Cory I'll leave the details around the numbers to Corey, but I know you guys are wondering about the current state of the industry and how we're navigating it. So let me address that for a few minutes. We're obviously seeing some disruption in the market right now, but we expect it to be temporary.

Our field sales team began seeing the signs of a potential slowdown in late June we got smarter about the issues in July and that allowed us to share some of those insights on our third quarter conference call in August.

Let me caution that the growth will be significantly slower in Q4 than we'd seen for the rest of the year.

Since then many of you've been asking whether this will be a replay of 2018, we don't see it that way at all and we're not alone.

So you are in Las Vegas, a couple of weeks ago for the MJ Biz conference is the largest cannabis trade show in the World and if you were there you saw firsthand that this is not an industry that's spreading about the future.

Consumer demand for cannabis products continues to grow and the market continues to expand.

As it relates to the current environment, what was clear to me in Vegas was the industry is becoming increasingly adept at navigating the choppiness that's inevitable in a market like this what's happening right now is actually pretty straightforward and California. There was simply too much cannabis harvested in the past few months, especially from outdoor growers in the northern part of the state on top of a strong harvest from our first Turner.

<unk> earlier in the year, many growers harvested their second crop of canvas earlier. This season due to concerns about wildfires drought and in the case of the legacy market fear of increased enforcement efforts the.

The combination of too much product and relatively poor quality has put downward pressure on wholesale cannabis prices. However that issue should solve itself. Once the current supply makes its way through the marketplace.

Because the legacy market remains a big part of what's happening in California. The available data isn't great. So that makes it hard to give you a precise answer on how long it will take for the current oversupply to work itself through the market.

That's why we're currently forecasting Hawthorne sales to decline in the first quarter.

That said the single most important factor is the end market for cannabis continues to expand and we expect to start seeing growth again in the new calendar year and virtually no. One is expecting that factor change for the foreseeable future.

In fact, many high end growers have told US the current market issues are not impacting them at all and they continue to flourish.

Another important fact to remember is that unlike in 2018, there are no regulatory issues getting in the way right now.

Three years ago, California badly box the rollout of the recreational marketplace.

That overwhelmingly was the issue that impacted the market back then.

It was nearly impossible to get a license to operate legally regardless of whether you were cultivator or a dispensary.

The current marketplace in California remains more expensive and bureaucratic in other states. It is vastly improved from what we've seen in the past and the legal market there continues to grow.

Some of you are also wondering whether the current situation will result in some consolidation the answer is pretty simple, yes of course it will.

But those kinds of ebbs and flows are exactly what we expect to happen is what happened in Colorado back in 2015, it happened in Oregon, when and when legal.

And it's likely to happen in California to some degree.

In fact, that's also what we're seeing right now in Oklahoma.

Like many new markets, Oklahoma had explosive growth out of the gates and probably got a bit overbuilt. So we expect a pause there before growth resumes we.

We have told you repeatedly over the years that this industry is likely to be choppy from time to time. This is not the first time the industry has seen an oversupply of cannabis and just to be clear it will not be the last.

What's important for Hawthorne as we keep running our play.

The growth will be there in the long term I'm not worried about that.

Instead, I want to make sure that we're doing everything we need to to distance ourselves from the competition.

Jim has already told you that we won't slow down our innovation efforts, which by the way go much further than just new product development.

Which brings me full circle to the MJ Biz conference a couple weeks ago in Vegas.

Like most major Tradeshows MJ Biz was canceled last year due to COVID-19. So we haven't seen the industry all in one place for over two years.

What was clear to us and frankly nearly everyone. We interacted with is how far Hawthorne has come in those two years and how much we've distanced ourselves from the competition.

We have fundamentally changed our approach to selling and that transformation is continuing.

We brought new products to the market that have improved the results for growers by both increasing the yields and lowering their operating costs and we've used the innovation to help us more qualitative ways like the establishment of the Hawthorne Social Justice fund within our corporate Foundation.

While I understand the question do you all need to ask about the step down on our growth rate I would urge you not to lose sight of the bigger picture. There is no doubt that we're the clear leader in the industry. There is no doubt that our competitive advantages are unique and there is also no doubt that the cannabis industry still has miles of runway ahead of it.

So looking ahead at fiscal 'twenty two.

Not worried about a few speed bumps.

Other I'm excited to see how much further we can push this business and continue to lead the way in an industry that remains poised for years of growth.

With that Corey, let me turn it back to you.

Thanks, Chris.

Let's move down the P&L now to the gross margin line.

Like nearly all other CPG companies, we continue to see pressure from higher commodities and distribution costs. However.

However, the year over year change in the margin rate during Q4 require some additional context.

In Q4 of fiscal 'twenty, one the adjusted gross margin rate was.

Was 17, 4% compared with 24, 3% in 2020.

But company wide sales in Q4 of last year were up nearly 80%. So the fixed cost leverage and a relatively small quarter drove a massive improvement in the margin rate.

If you compare the Q4 gross margin rate in 'twenty, one versus 19 Youll see the difference is only a 100 basis points.

And that difference is a combination of segment mix and higher commodity costs.

On a full year basis, the gross margin rate declined 270 basis points to 33%.

The year over year increase in commodity costs of about $85 million nearly.

Nearly all of which was on planned was the primary reason for the decline.

Followed by higher distribution costs.

As you know we did not adjust our prices this year until August in the U S consumer business. So.

So we had limited ability to offset the commodity inflation during the first three quarters of the year.

That story will change significantly in fiscal 'twenty, two which I'll explain further when I cover our guidance for next year.

Higher volume was able to drive improved fixed cost leverage and conversion to help offset the commodity cost increases.

SG&A came in two percentage points lower in fiscal 'twenty, one at $743 million.

It declined 21% in the quarter to $161 million.

Lower variable compensation was the main driver.

Also in Q4 of 2020, we use some of our strong earnings upside to significantly increase our annual contribution to the Scotts Miracle Gro Foundation, which we did not repeat in fiscal 'twenty one.

Interest expense was $5 million higher in Q4, compared with a year ago.

But essentially flat on a full year basis remember, we issued $900 million of bonds in the second half of the year, which drove an increase in the quarter.

On the bottom line adjusted net income, which excludes restructuring impairment and onetime items was up 28% to $528 million or $9 23, a share. That's just a penny shy of a $2 per share increase in a single year.

And more than twice the $4 47, a share we earned in 2019. The EPS number is on the high end of the revised range. We set in early June and is a major accomplishment given the difficult comps and some other cost hurdles we've had to clear in the second half of the year.

We're obviously glad to answer any of your questions regarding our Q4 or full year results, but instead of spending more time on those details I want to switch gears and share our thoughts about fiscal 'twenty two.

As you saw in the press release. This morning, we see companywide sales next year of about flat to plus 3%.

This assumes the U S consumer segment is flat to minus 4% and at Hawthorne grows 8% to 12%.

None of those ranges assume the potential impact from acquisitions.

In U S. Consumer we are going into the year with the assumption that unit volume will decline high single digits.

Roughly half of that decline is expected from lower shipments in the first half of the year.

Remember that last year's Q1 was up nearly 150% as retailers worked hard to remedy depleted inventory levels.

<unk> current retail inventory levels remain higher than a year ago, we likely won't see a repeat of that kind of initial load in.

We're also for planning purposes, assuming modest declines in consumer takeaway in fiscal 'twenty, two mostly driven by the difficult comps we faced in the first half.

As Jim already indicated consumer Pos has been stronger than we expected in recent months and has actually been positive for the fall season.

It's easy for us to lean in to meet the higher consumer demand if it comes but the prudent play is to assume a slight decline.

Most and perhaps all of the planned unit volume decline should be offset by pricing.

You should see some benefit from pricing in Q1 from the August price increases and the balance will begin during our Q2.

As it relates to Hawthorne, we're planning for 8% to 12% growth on a full year basis as we expect to see continued pressure in Q1.

As Chris said, it's hard to be precise regarding the current inventory supply issues in the industry, but we're hoping to see a return to growth sometime in Q2.

Let's move on to gross margins.

We expect to see gross margin rate declined by 100 to 150 basis points on a full year basis.

We are cautiously optimistic that our pricing moves will offset expected commodity pressure.

That said, we expect about 65% to 70% of our cost to be locked in by the end of the calendar year. So we'll still have some exposure if costs move higher than the planned increases we are assuming.

The two biggest pressures on rate next year will come from lower fixed cost leverage and segment mix.

We would expect some leverage out of SG&A.

Meaning this line can range from a 6% decline year over year to a slight increase maybe 2%.

There are no major moving pieces in SG&A and we remained committed to investments we believe will drive the business not just in fiscal 'twenty two.

But the years to follow.

Below the operating line interest expense should be roughly $25 million higher based on the full year impact of our recent bond offerings are.

Our guidance also assumes no offsetting earnings impact from acquisitions, which is a pretty conservative starting point.

All of this rolls up to a guidance range for adjusted EPS of $8 50 to.

To $8 90.

I also want to talk about cash flow for a moment.

For the year, we just completed free cash flow, that's operating cash flow minus capex came in at $165 million.

All that is low from historical standards. There are three main reasons behind the year over year decline further.

First was variable compensation that was earned in fiscal 'twenty, but paid out in fiscal 'twenty, one that was about a $60 million impact.

We increased capex by about $45 million.

Third inventory levels were up 500 million from fiscal 'twenty, while most of this increase was paid during the year, we did lean on our vendor partners more than in the past to achieve extended payment terms.

As we look to fiscal 'twenty two.

Aiming for free cash flow of up to $300 million we.

We expect Capex to increase again, and we also expect inventory levels, while flat on a unit basis to be higher overall because of the increased costs.

These investments are necessary to continue meeting the required service levels to our customers.

Which is the higher priority, but as it relates to inventory we find ourselves in a very good place right now.

In both U S consumer and Hawthorne, we believe some competitors will have a hard time meeting demand.

And in the consumer business, we expect the market to see shortages of grass seed and Fagnant peat Moss the key ingredient Houston growing media.

We do not expect to be impacted by those issues and we do not expect to have any problems getting our customers at the appropriate inventory levels either.

Before we open the call for your questions I'll offer a final bit of commentary.

I agree with Jim's assessment.

We've got a lot of moving pieces right now and several active initiatives that could require us to update our outlook as we move through the year.

But even in the unlikely event that none of those efforts come to pass I believe the business is in a great spot. The challenges we're seeing on the cost of goods line are pretty consistent with what <unk> been hearing from other companies over the past two weeks and just as we said we would we've taken aggressive action to stay ahead of all of those challenges and protect the profitability of the business.

Ms.

When I think about how far this business has come in such a short period of time, it's hard not to feel good about where we sit right now.

And so with that let me turn things back to the operator, so we can take your questions.

If you would like to ask a question. Please signal of Perth. Please. Thank you My star one on your telephone keypad, if youre using a speakerphone. Please make sure. Your mute function is turned off to lay a signal three care equipment.

Again press Star one to ask a question.

We'll go ahead and take our first question from Jon Andersen with William Blair.

Good morning, everybody.

Hey, John.

A lot of different questions.

But let me start with Hawthorne.

Understand the situation in California, and thank you for the color on that.

Im wondering like you to comment on what Youre seeing in some of the newer states really over the last year.

A number of things that have legalized adult use.

Cannabis and yet in some of those states are quite large such that the total population.

Living in states with adult.

Legal legal has risen quite a bit my sense is that you haven't really seen demand from those newer states yet could you provide kind of an update on.

And when you expect that to kind of kick in thank you.

Hey, John Yes, Chris you're absolutely right. We saw a lot of states and when you talk about high population states that have seen adult use past I assume youre talking about states like New Jersey.

And we've always like to give you guys and ourselves frankly sort of a year, we think from passage of losses Thats. When we expect the market to kick in and while I think that's a reasonable estimate in most states.

You do have to couch that with the reality that this is depending on state legislature's getting the regulatory frameworks for these market setup and that's something that in the state like New Jersey has taken a lot longer than expected and as an example.

New Jersey had a big slate of.

Social equity licenses adult use grow licenses that were supposed to be granted back in 2019. Those licenses were just granted two weeks ago. Just an example of how slow that state has moved to actually approve what the voters have asked for.

And in that state those those adult use law.

Licenses will not actually be able to sell into the adult use market for a year. After they have been operational under medical so those guys have to build out their medical grows start operating for at least a year before they're eligible for adult use so.

Even when they passed adult use we've seen some regulatory hurdles that just really stretched that timeline out for us. So.

We expect new Jersey start kicking in and we're seeing some really early results, but it's still a very small state for us.

So again it's.

Our year has always been our kind of our number but it looks like that may be a little a little optimistic in some of these northeastern states that have kind of no existing framework and theyre kind of figure now.

Okay.

Great that's helpful.

I appreciate that but just as a follow up.

Maybe I'll stick with something bigger picture so.

Jim mentioned live goods several times as a gateway to lawn and garden.

One of the five pillars that you outlined of growth for the next several years. So can you just let us know what have you done and accomplished so far and live goods, a little bit more color around that and when you look forward. What is it that you haven't done that you want to do with live goods.

That would be accretive to your growth and earnings whether thats more with Bonnie whether it's broadening our relationship with AFG et cetera. Thanks.

Yeah.

Alright, I think I'll start and then hand, it to Mike, who I view as really sort of the.

The author of the strategy, which.

Totally behind.

I'll just hit what the what what have we done.

And we.

I think this year we've.

Stepped on a private is a little bit.

And learned.

A lot and I can let Mike talk about that because I think thats what are we going to do.

But let's start with what have we done.

I think we bought.

We're partnered with AFC on.

The finest brand really the only brand.

Thats national in live goods.

And Thats Bonnie.

And.

Worked with them to really begin to.

Professionalize and it's not that they were unprofessional, but I think.

We've learned a lot of how we want it to be.

Mike has really led that from our side.

And.

If you say, where we want to go is.

We want to participate in the other categories.

Under the same kind of idea of branded national the ability to use scale, but let's just remember what was our original interest in.

We're saying now it is true.

That we just don't want to be kind of a lawn and garden chemical company.

Debt.

People Garden.

And it starts with plants.

And the psychology of why people want a garden and there's a lot of.

Really good stuff for us.

Sort of sort of.

In that but.

We want to play in plants and we view.

Basically as a high growth area. So even if you look at what we're seeing now which is we believe based on.

Younger people.

Wanting to own home is very different than probably five or six years ago, when we were saying.

People are going to want to move to the city and have a condo and not have a yard I think we feel.

Very differently than that now.

And.

Young people want on homes, there's a gigantic bubble of kind of our kids who are at that phase now, where they are buying homes, and having kids and a dog or whatever.

And that data, we talked about a little bit they want to garden.

And so if you look at our core and you say, we think we can kind of double that which is not saying a lot I think Mike and I struggle with that zero to two to two to four.

But we're seeing a growth rate in live goods.

At least two ex that.

And so that was the attraction to the business.

Plus this idea of getting involved more in sort of the basics of gardening.

And.

The brand side of it which Bonnie brings to us. So the question is like.

What have we learned in kind of.

Mike What's what's your addition to the craft.

Well I think having a national network.

That's what Bonnie broad, but the sophistication there are really none other than Bonnie Theres no other national brand.

There's all kinds of really cool genetics and the activity that we can bring to the market and we look at it is Italian solution.

For the consumer.

With our other.

Products to actually.

Give the consumer a better opportunity to.

Have success enjoyed gardening so.

So we're working on.

It all together, we're looking at <unk>, we're looking at we're actually doing succulents, and we've expanded doing some color miracle gro flowers or in Loews.

And so we look at providing that national network and supply chain infrastructure, which is probably the weakness.

Every growers being able to.

Supply nationally.

Those products and then expand also with direct to consumer and get those products. There. So how much of your time is going into that Mike.

Or the supply chain of getting that where you want it.

<unk> 20, 25% right now so.

It really doses I mean, we've integrated companies, we got to integrate those systems. If you remember we're Scotts was for me 26 years ago. It really was an isolated supply chain. This Israeli nationalizing the supply chain good.

Good companies.

Really making it more effective.

So and the branding and the Martin and I would say <unk> is actually a huge opportunity that is really underdeveloped and so we want to simplify that for consumers.

Okay. Thanks.

Thanks, that's helpful I'll pass it on and get back in queue.

Thank you Jeff.

Alright, again that is star one to ask a question. If you find your question has been answered you may remove yourself from the queue by pressing star two.

We'll go ahead and take our next question from Peter Grom with UBS.

Hey, good morning, everyone. So just a few questions from.

For me.

Maybe just to start Jim you alluded to a greater willingness to separate.

<unk> from the legacy business and I know you said that you're expecting a near term, but could you maybe help us understand what is driving that growing confidence that there is something you may consider.

And then what could actually push you over the line and to actually making that happens I'll start there.

Thank you I could go on for an hour.

On that one.

Let me start with.

How welcome all foreigners within sort of the SMB world.

And that.

I think I.

Probably told you guys that before I think Chris.

I think was always kind of a reluctant partner.

And.

I think its I don't know how long Chris you've been in this job now how long seven to eight years.

Sure.

<unk> life.

The.

I think if you look at what we're doing with supply chain.

Innovation.

Really advancing sort of science.

The stuff that.

Weak.

Plus also being a buffer when they had issues like in 2018 were.

The the largest with Scott's really helped.

I think it's very much a virtuous place for Hawthorne to be in it.

I'd call it probably highly synergistic so when we get into this question of separation. The question is.

And im not saying you would suffer dis synergies, but I think it would have to be strategic and up.

But Chris is not in there would be but I think theres arrangements that could be made to sort of minimize that.

Why would I do it.

Because I think there is opportunities out there with like minded.

<unk> partners.

That.

Is big.

And.

I don't know.

Peter I don't I don't think we've met.

We have I apologize.

But let's just say maybe you don't know me that well I'm just not that good is.

Minor partner.

I think we've been doing deals gear where were.

What we call. It is respectful minority interest because thats kind of what people are willing to tolerate a lot of the people we're dealing with on a future basis. This is now.

Sort of confidentially talking down the road I think they don't want to sell their businesses would they participate in something that added a lot of value and became something important.

I think the answer is yes.

With a sort of join the allied.

<unk>.

Military whatever you want to call it.

The answers is yes, they would.

And if you look at the dollars involved.

I think it would be challenging to do this on the long term.

Where we are.

A relatively small partner.

What we have to offer.

Beyond sort of what.

What Hawthorne is.

As management structure capital.

Access to the public markets, both equity and financing.

A lot of things that we.

We have to offer.

And to sort of have a real estate at the table.

And my view is the big dog in the room in the industry is Hawthorne.

For the REIT structure.

<unk>.

I'll speak for myself.

Because I have a management team that are my partners.

I got a board of directors that I have to sort of work through.

<unk>.

My family.

<unk>.

I think I could see a contribution of Hawthorne in spite of sort of how welcome it is here.

To put together the right structure and I think that what that offers and I don't think we've suffered as a result of saying it's not super clean that you have this sort of.

Candidates business stuck into a consumer lawn and garden market our business.

And I think especially when the stock price was higher I thought it was.

Properly valued of.

<unk> value of Scott's value combined.

It's.

Total better than it does right now, but it is.

It felt right and I didn't think it was disadvantaged us at all.

I do think that there are people, who would make an argument and I am sympathetic to the argument that doesn't mean I completely agree with it.

Let's say, it's cleaner to have people who want to make.

Investments in sort of the canvas business, especially if something with this strategic is what.

I envision.

And not have that mixed into sort of lawn and garden business, which is a slower growing.

Probably more cash flow positive business.

So.

I could make an argument.

<unk>.

That that would be the right thing or could be.

We've also spent.

At least I'm going to say the last 18 months.

Making sure that we have separable financials.

That sort of our financial.

In a public way.

And we are I don't know I was talking to Ivan Smith.

Finally, two weeks ago.

And so we're there right where they're from a financial and legal point of view, where they are separable and I think what you said is within a month or two.

That's correct.

So again, there is no rush to it.

But I do think that.

Questing that came up about sort of the east coast in Jersey.

I think these are very valuable opportunities.

And I think the dollars and remember these are.

I'm not going to get critical of the United States government, except to say 280, <unk> is a piece of <expletive>.

Ridiculous that the United States government makes more in public marijuana than the owners of the businesses that are invested behind them and it has to be fixed.

And we're involved in DC solving that but on a before tax basis. These are significantly profitable business in their early years.

So I think if you look at the value of these businesses.

You can get to the point, where youre getting into real money.

And.

So sort of deal with balance of power issues, that's where I get to say.

Hawthorne really has to be a part of that so.

Hopefully that answers the question of but.

I don't think we're on the cusp of a deal but if you were one of my brothers sisters and they said when you think this could happen I would say.

A year or two years, something like that I wouldn't be surprised.

And one last thing.

I'm not sure I've actually done a call where my son had a speaking part.

I will stay as is.

A dad I'm pretty happy and proud to be sitting here.

With.

My eldest son at the table.

And.

If I was representing to you guys I would say.

He is ready to run things.

He is.

Maybe better than I am so I do think that.

The biggest thing we're working right now is just make sure we understand kind of the map that we're developing with some other people on how this thing progresses.

And then putting the management team together to actually support that business and Mike and I and the board spending a lot of time.

On that so that's.

That's a pretty open answer.

Truthful okay.

No that was really helpful.

Thank you for all that.

Yes.

Maybe for Chris I was hoping to get your view on the cadence of Hawthorne as you look out to fiscal 'twenty two can.

Can you maybe just help us understand the magnitude of the negative pressure you kind of expect in Q1.

What gives you confidence that it will snap back so aggressively.

This high single digit low double digit target for the year is there enough conservative conservatism in your guidance like Shouldnt.

The underlying trends take longer.

And then just I know, there's a lot here, but just the Oklahoma comment can you maybe help us understand how big Oklahoma is for Scott or the broader industry. Thanks.

Yeah, no problem, so Oklahoma is.

Has become a somewhat material state for us.

We saw kind of thousand plus percent growth over there in that state over the past couple of years.

And candidly it was a state that we've been talking internally about that.

We need to prepare ourselves for a little bit of fallout in Oklahoma.

Just because you can't see that kind of growth forever and we saw similar growth in states like like Oregon back in 2017, which led to kind of end product saturation in those states.

And the resulting kind of fallout that we dealt with a few years ago now again like I said in the prepared remarks.

I don't think anyone is anticipating this to be the same amplitude because like I said in the remarks. There is there were structural regulatory issues that were compounding. The oversupply then those don't exist here.

In terms of what gives us confidence that this can be sold through when I was out in Vegas, a couple of weeks ago I know if some of the analysts were as well.

And I heard from a bunch of people, who are pretty smart folks who've been in the industry for a long time I'm talking real cannabis people right now not sort of.

Corporate folks who've who've ones are we in like us, but I mean real cannabis guys, who said look this is not to scare anybody but this is the single biggest end product flood that the cannabis market has ever seen.

And I think it is probably true what gives me confidence here is this is a perishable crop.

It's only going to stick around for so long and.

As I also mentioned in prepared remarks.

This is something we're really seeing affecting the kind of middle and lower end to the markets much more substantially than the higher ends.

You talked to a lot of high end growers theyre growing more cannabis high and legal borrowers their own more candidates than they ever have they are selling it for higher retail prices than they ever have and they are selling everything they can grow and to be clear that is the core of our customer base. Our consumer base is folks growing high quality cannabis indoors. So we've got a pretty high degree of <unk>.

We're going to see this thing.

Shake out I would say over the first quarter of the next calendar year. So first quarter of Q1 or excuse me first quarter of 'twenty. Two we think the single shakeout.

Look we have been wrong before I think we've got better Intel on this than anybody frankly that includes our competitors and I think we've got more experience here to Corey.

Is really only member of my management team. That's that's moved on since 2018 and he has moved into the CFO role working with Jim.

Our team has seen this kind of action the marketplace before we knew what was happening when we saw it coming we knew how to prepare for it as best we could.

So I feel confident in the numbers for the full year, obviously, they are back loaded to the second to third to third and fourth quarters, but.

Again, our confidence is high.

The oversupply will shake out and when it does we are going to be better positioned than anybody to take advantage of the market.

Super helpful. Thank you I'll pass it on.

Okay.

Alright, well go ahead and take our next question from Bill Chappell with <unk> Securities.

Okay.

Thanks, Good morning.

I'll try to keep it short.

First on on.

Hawthorne on the M&A commentary.

Explain to me I guess, the rationale behind you have a pretty broad base of products most of the M&A, you've done or announced so in the past year has been really really small.

And.

And I understand that valuations are more attractive, but I mean, it's kind of a why bother.

End up buying.

$310 million of companies versus build it yourself. So help me understand why that what makes sense versus.

Kind of a part two to that first question of why did you actually repurchase shares in the quarter versus repurchasing them going forward.

So should I.

I'm sort of stunned by the repurchase part.

Let's just talk real quick about.

Sort of M&A pipe.

For Hawthorne it not.

The heartburn collectible what we'd call Apollo.

Early because they are quite different.

Bill you've been with US a long time I would say.

What do we like on the consumer side, what we have always called close in Adjacencies.

These are businesses and because of the sunlight connection.

There are opportunities.

In.

Distributed products for us that we understand.

That we already sell.

That we know if we bring into our supply chain.

Youre talking very significant IRR.

And I'll just throw in there that.

The.

The cultivation industry with all due respect to the many fantastic people out there doing that kind of work.

People when they have something works, they really stick with that.

And so there are branded businesses out there.

Sure.

Getting people to change is not as easy as it themes and where there are significant opportunities and synergies.

And we can buy at a fair price.

And then apply the synergies to the business.

Debt.

If I took you through them and I'm not going to do that right. Now you would basically say Oh Hell, Yes, you should do that now.

Not very exciting.

Look I want to go back just to led lighting for a second.

Led lighting was a business that really three years ago hardly existed.

At a big level.

That represents today.

Our single largest category.

And.

Well over 50% of our lighting dollars are now in Leds.

And I'm, telling you that this is.

<unk>.

This is all based on innovation.

We're.

I think together with Mike and his R&D team.

Chris and his folks defining the need Mike quarter from Harvard.

Building a strategic reason for the Davita business that is based on unique and important innovation and so this is a business we did build by ourselves and we built a category by ourselves.

And it's growing today.

We are pretty significantly back ordered on our led light and so this is an area, where if we had more components.

We'd be selling more products and not a little bit.

No.

I think that your question is we're doing both we're doing both innovation and building it ourselves, okay, and where something is a close adjacency and we can do.

Buy it up.

Mike and Chris and there are guys on the supply chain side could do their work plus we can then put our R&D effort against it I think.

The economics of it make a lot of sense and if I was telling you about it like deal by deal you say I agree with you.

So I don't think Chris you should pick.

Pick it up from Eric you want yes, I would like to.

When you talk with the small deals that we've done.

Recently.

As a floor and hydrologic.

Those are deals more in the case of.

Raj a floor is that close in Adjacencies, Jim is describing and I mean, we're talking close in both sort of from a <unk>.

Category perspective, the rightful Florida facility in Santa Rosa, California, literally shares offense with the legacy General Hydroponics facility that is still our main liquid nutrient production facility. They share a fence line. Their next door neighbor. So that was one we knew that team pretty well, we love the product we love the brand we love their ability to really.

Get traction in the marketplace and there could not have been an easier integration for us because we were next door neighbors already.

I mean literal physical next door neighbors in the case of hydrologic that deal goes back to when we first bought general Hydroponics I was talking to Ross Haley who at the time was the CEO of GH. When we did that deal and said Hey, Ross where should we go next to you gave US a long list of brands most of which we've acquired in the meantime, the top of that list with hydro <unk>.

<unk> took us a while to get that deal done.

But that is a brand that is really stands alone in the in the sort of the subcategory of reverse osmosis water filtration. There is hardly a commercial grow you walk into that does not have a hydrologic system in that facility there.

Their list of contacts and relationships in the industry is extremely deep and includes a number called theaters that we didn't have much of a relationship with.

So to us that was one strategically it was always on our list. It took us a few years to get there, but it just if we never forgot about that deal and I'm really really happy that we got it done and the team there is phenomenal and the past few months to get them integrated the businesses over performing our expectations. Even in this marketplace and then I just wanted to just last on.

Repurchase.

Our shareholder friendly approach that was really came out of.

Project focus or whatever I think thats, what we call it.

That was what we presented everybody that we don't really see a ton of opportunities out there.

To acquire.

That are attractive to us.

So we will just send the money back to the people who own this business I think part of what you're hearing on this call.

Is that that's not where we're at right now.

The change.

When I say I wouldn't say the strategy had a shelf life, but what's changed the opportunities around us whether it's in live goods, whether it's Ben.

Direct to consumer I mean, these pillars that I've been talking about are the opportunities and we're organizing around those so Mike has the ability to stay on top of them and they all report in but they all have growth rates that we think and we've got this fantastic business the core.

Slower growing high cash flow.

And remember that 165, plus $500 million of inventory.

Plus.

Capex plus youre talking like I don't know $700 million of cash flow.

This in 'twenty, one before you make those adjustments.

So it's a really great business.

<unk>.

The other businesses are we think are pretty obvious and higher growth rates and thats kind of why we're chasing it and that's why.

<unk>.

We basically have said we've got to integrate some acquisitions plus then if you look at the.

Half of our collective opportunity.

We want to invest there as well and that's really why we have decided.

That.

Returning cash to shareholders is still an important component of what we're doing but it's not the only thing we're doing and that's a lot of what Corey and I try to balances.

What's the right investment in the business, but there's a lot of opportunity right now and.

Im sort of really hopeful the United States is a step in the way I don't know I'm watching the FTC.

<unk>.

<unk>.

I was just going to add if you go back to last year share prices were a lot higher our return to share of return of valley.

<unk> to shareholders was going to be more around.

In the realm of the dividend versus a buyback.

If you go back.

Four to five months ago share price was a lot higher we did buy back about $40 million of shares in Q4. So it wasn't that we were out of the market now going into Q1.

We're feeling more comfortable with where our Q1 is the results we're seeing in the marketplace and we think that we can buy into the market on share repurchases at two to three expert level and feel comfortable with it.

Got it well I'll leave it there thanks so much.

Okay.

Sure.

All right. We can go ahead and take our next question from Andrew Carter with Stifel.

Hey, Thanks, Good morning, I, just I guess I wanted to ask given that the midpoint of your guidance next year suggests the gross margin will be down 430 basis points, where it peaked actually earlier this fiscal year trailing 12, so could you help us understand.

How the GM will face for the year's pricing absorbs inflation that comment around pricing above inflation was that a full year comment or was that expected to happen at some point and final comment just so we can get a sense of the ongoing degradation potential.

Potential for mix, where does hawthorne's margins stand today, and where do the owned brand stand what's your penetration. Thanks.

Look.

I wanted to start because thank you for asking that series of questions.

Sure.

I was in fitness this morning with with.

With Ivan and I said I'm going to disadvantage.

No.

The budget.

Or at least the expectations, we're setting I do want everybody to understand how and why we sort of.

Talk to you the way we have today and I think then.

Sure.

It probably is useful.

Setting the budget for this coming year was.

I think Cory would say we were looking at sort of <unk>.

Neutral operating 22 versus 21.

I would say we looked at.

And they are both true.

We looked at sort of.

What the street was thrown out there as a number for expectations for Scotts for next year or the year.

We are in.

And.

We built a number that I don't know call. It was a quarter above what we're seeing is sort of consensus.

Felt that was a pretty good place to start.

To be honest, it's a pretty negative number for us.

And.

Based on that we then started building a operating budget off of that debt.

Said.

If it's that bad and I don't expect it to be this is the point I'm trying to get across.

Is can we still can we build a budget that meet that number sort of your consensus plus call it a quarter.

And.

Still fund the things, we want to fund and be responsible about how we run our business and I think this is.

Coreys.

Input to his first budget cycle with us in this role.

I really look to Mike to say.

No.

Is this killing you because.

Budgeting is a pretty corrosive process actually I really don't like it that much I know, it's necessary, but it's pretty corrosive, particularly when you make inputs like that.

And Mike was okay with it because I think he sort of forced this issue of saying are we spending the money on the things. We think we can drive the business and can we lighten up on some of the other stuff and still make the numbers work. If the numbers are as bad as we're building.

The numbers from.

We came out with I think an agreement on that.

And this is what we're reflecting in how we talk to you guys.

<unk>.

My numbers and Mike numbers are quite a bit higher than that.

And.

Therefore, I just want everybody to kind of.

Every time I say stuff like this people freak out everybody gets the joke that.

This was a budgeting exercise we're setting expectations based on partly where you guys were partly based on this view of core ease of can we lease make the same operating numbers as we did last year.

And.

How then does it fit in with how Jim wants to manage the investment community.

<unk>.

As we get into the year not get ahead of ourselves but start to become.

More.

Transparency on the upside hopefully that's there.

And Thats, how we we kind of got to these numbers. So I do think when you ask the questions.

Try to understand that.

It's not like we're absolutely committed to these numbers, what we're committed to as a budgeting process that allows core you feel good that he's not overextended on the expense side.

Mike feels that you're spending the money on the things he wants to.

And we're not over promising to you guys and this is all part of the.

How we do it here this year.

We had a board meeting yesterday to go over this stuff.

And I wanted to kill myself during the meeting.

Based on what we're talent, which is kind of what we're telling you guys and.

It made me feel bad about the business, but the truth is I feel really good about the business.

And Mike and I are committed to a lot higher numbers and so.

I think when you asked the question is try to at least look at through at that sort of filter and Cory. So I'll hand, it to you to answer the real questions. Yes, I'd say the two things you brought up total company margin rate.

We guided to a decline of 100 to 150 basis points. If you look at the components that make that up segment mix as Hawthorne grows faster than.

The U S consumer business, we're going to naturally have an enterprise wide decline in our margin rate just because the margin rate of those two businesses.

So that's going to be about half and if the units come in where we plan, which is the decline we're going to see some deleverage.

That that will hurt our margin rate and like Jim said we're.

All expecting units to come in better than that but given the plan that we put in place.

Deleverage could happen should units come in lower and I would say your point on pricing versus cost.

Basically offset each other so if you look at the margin rate pricing and cost offset each other.

Do have.

Some buying left to be done in the rest of next year.

We're kind of a third exposed if you think of where we'll be locked at the end of the calendar year. So there is risk out there or opportunity depending on what happens in the marketplace.

For cost to change where they are at in our model today.

Last point on the Hawthorne EBITDA, you asked about where were the Hawthorne profitability as we're planning on about 500, I'm, sorry, 50 basis point improvement.

Year over year. So this is on the path that we've been on trying to get to a total earnings percent or 15%.

We continue down that path, we saw good improvement in 'twenty, one and expect about 50 basis points in 'twenty two.

Okay, great. Thank you and this might be a difficult question to answer, but you cited kind of a pull forward of the crop in the outdoor season in California, which I guess.

Potential upside of that is is that the crop <unk> really bad.

So could you kind of quantify for us than like maybe how the earlier pool like not selling to growers in August September may have hit numbers whatever product lines that might have affected nutrients. Just so we can kind of think of a back half headwind that hit this year and potentially comes back next year. Thanks.

Yes sure.

I mean look you're already set at the <unk>.

The slowdown has affected our consumables business significantly more than expected our hardware business.

So nutrients and growing media some other categories. We've seen we've seen much more downward pressure, which to me says that the.

The operational guys are kind of slowing things down waiting for product to sell through and not wasting time time pumping more product into a market. They know isn't isn't really moving right now.

Other hand.

The kind of high ticket hardware sales, we're seeing so this is lighting.

<unk> medication.

Water filtration et cetera, so kind of infrastructure stuff, we're still seeing really good uptake in the market on those products and again, it's in some cases outstripping our ability to meet the demand just with some supply chain disruptions, we're seeing particularly on lighting.

So we think that's all going to shake out we're still seeing again, new facilities get built as what that tells us.

And those facilities will come online and when they do it'll be buying our nutrients are growing media, which are all products. We were seeing exceptional growth in leading up to figure June July.

So the back half of the year, we're really is kind of stack with a lot of new train a lot of growing media sales, but when we brought the innovation on the on kind of the hardware infrastructure side, we have sold.

I sort of beat my chest last year about the new Davita led light that was at the time was our first generation led light that set a record within Scotts Miracle Gro for the single largest outlet from a.

Dollar perspective, the single largest product launch in company history.

We beat that record this year with our new led light.

We're selling more dehumidifiers from our partners at Questing, we ever had before including some really exciting very expensive high tech units that cover a broad array of HVAC stuff for the grower. So we're seeing those products continue to sell we're not seeing a lot of slowdown there. We're just waiting for the consumable side of the business to catch back up.

<unk>.

Great. Thanks ill pass it on.

Okay. We'll go ahead and take our next question from Joe <unk> with Raymond James.

Hey, Thanks, guys good morning.

Chris just wanted to follow up on that last comment regarding California, how quickly could eat into our growers wrap up the operations once the pricing to improve.

Pretty rapidly look it depends on what stages of build out there at obviously.

We've gotten pretty good until that there are there's a number of largely built out growth in California that are available right now too for potential acquisition.

So we know that there's some growth there sitting there kind of have built are mostly built that that grow with just arent, finishing until until the market recovers. So we expect to see a pretty rapid.

Recovery once once the market prices kind of encourage growers to get back into it. So again. These facilities. There are largely done it should be I would say.

Certainly less than six months from when demand recovers till those guys can be operational at full steam and I think frankly shorter than that I mean isn't it true also that.

In the legacy market or whatever you call it traditional market.

Okay.

This is kind of like a gypsy business, where people can get in and out very quickly.

Yes, yes, that's always been the case. So this is for for the <unk>.

To the extent that we have visibility to the legal status of people consuming our products, we sell are softer retail and where it goes from there.

Somewhat anyone's guess.

<unk> aware that there's a lot of black market growers out there.

We call legacy market growers.

Those folks will shut down for a quarter.

Just because it's for lights in a garage or six sites in the basement.

And its kind of its supplemental income for them, if they're not seeing the rewards for the activities that offset the risks theyre, taking they'll shut down and wait for that market to recover and all that youre sitting there waiting to get switched back on so that recovery or there is pretty much instantaneous and like I said, we think.

Our expectation as wholesale prices will start to recover within the first couple of months of the new calendar year and at that point, we expect to see market recovery follow.

Okay. That's helpful and just one more for Corey whats the anticipated incremental commodity and logistics headwinds in 'twenty, two and dollars and it sounds like correct me, if I'm wrong that the price increases the high single digit price increases call it not.

Not only offset that dollar for dollar, but you are maintaining your margins.

In both businesses as well.

Yes, if we look at the.

Rates that we're putting into the plan for each of the each of the segments segments are basically maintaining margin at the plan that we are building now.

If I think of headwind that we've experienced so far.

$85 million that that we saw in <unk>.

'twenty one.

That number will get annualized as we as we go into seeing those higher rates on those commodities for.

The entirety of 2002 or at least the entirety of our purchasing cycle.

Headwind there.

The pricing that we're taking though should negate that and we should be kind of.

Margin neutral as it comes to commodities.

Okay, great. Thanks, guys.

And we'll take our next question from Eric <unk> with Cleveland Research.

Thanks.

Trying to understand the importance of pricing.

Hawthorne business that I'm talking about and product pricing and Chris Your comment was interesting that you are.

Exposure is to the high end.

And then I'm trying to square that with your exposures at the high end, but your business is softer now and it seems like the business softer now is not the high end. So what I'm trying to make sense of is when candidates prices go down is that.

Bad for you does it matter for you is that changing.

Explain that.

Yes look our focus is on the high end, but we've got pretty broad exposure here.

And some of our really high volume products are used across kind of the quality spectrum I'm talking things like you know like our growing media products grow down in that sort of thing growers of every different kind.

On a quality level and station in the market use those products.

And wholesale prices, absolutely wholesale and product prices, absolutely matter to us and that was something we did a postmortem of what happened back in 2018.

To.

Just have a little bit more predictability, because we knew that it would that it would happen again in some form or fashion and here we are.

One of our one of the kind of leading indicators that we really zeroed in on was that wholesale cannabis price both in the illicit and legacy markets.

And we think we've got pretty good feelers out into both of those areas to get to zero in on what we think are.

Are pretty accurate prices.

Sure.

Look the high end guys are pretty insulated from the downward pressure, but theyre not insulated, 100% so when you've seen.

Price per pound of outdoor flower hit all time lows and I'm talking well below $500 a pound at wholesale for outdoor flower.

<unk>.

The high end indoor guys. They have seen some price depression as well, it's just not been nearly to the same extent so.

Someone in the indoor market could have sold a pound of flower for $4000 a year ago.

They may be down to $3200 $3000 now so they have still seen a significant.

Downward pressure on their price. It's just again, it's been really well insulated relative to the to the outdoor guys.

No again, so we do we do see some impact from those guys, but again, we sell we saw plenty of product the outdoor into the sort of light that greenhouse dues as well, it's just not the focus of the core of our product lines.

And then in terms of your assumption of where the business goes.

Does does the business work the way you want it to work with pricing, where it is now or do you need pricing to get.

Jack or halfway back to where it was.

I think look obviously wholesale prices recovering he is going to be beneficial to our business grows we'll have more cash in their pockets and they'll have more cash go out and spend with our retailers.

So we're looking forward to recovery that being said look ultimately we're talking long long long term and very speculative I think most people who look at the industry expect ultimately there will be sort of longer term and longer lasting.

Downward pressure on cannabis prices in part of this is the responsibility of the cannabis industry as a whole and something that we're more excited to hopefully have some influence over.

Once we really get the the Apollo the Hoffmann collective strategy off the ground is is preventing the commoditization of this product.

We.

Had 1 million questions from our board and from from investors and other people to say, what's going to stop us from being Tomatoes lettuce.

Number one I think you guys have been talking to you I would not I shouldn't say you guys, specifically, but people have been talking about how this injury can go outdoor and the <unk>.

Margins in the prices are going to get crushed and that just hasnt happened now and we don't expect it to happen we have long been advocates for it isn't to stay largely indoor and greenhouse. It's just it's much more control you can create a much better product for the consumer for the patient.

We expect that trend to continue and we've spoken to a lot of people who are I think as informed intelligent spaces anybody people who've been operating both in the illicit enlisted markets for decades, who believe that outdoor does not have a long standing placing this we've got products that are solving sustainability issues around indoor growing right now.

And again, you can be so much more precise with how you control that environment.

Getting back to your question.

We want to see prices recover we have a business that's built and can survive if prices do not recover all the way, but we don't expect that to be the case.

Okay.

And then.

The follow up for Jim you made a comment that I know you didn't commit to but.

Game changing opportunities that the company could double in size in the next five years is this.

Collective Apollo is this.

Have you or your.

You are speaking to that.

Accomplish those.

No.

Yes, yes and no.

It's the five pillars.

To do it I think you are.

Like I said, we believe that there is.

More growth in the <unk>.

Consumer business are.

Our legacy consumer business.

Obviously, we believe that there is faster growth on.

Direct to consumer.

Live goods, we think is actually.

A big piece of that.

Yeah.

Hawthorne, we continue to see in the hydro supply space.

Above average returns for us there.

And then you add on top of that.

The Apollo side, and I think you can pretty easily get to those numbers.

I mean, a lot of stuff has to happen correctly, but I think the answer is it's all of them.

Yes.

Okay. Thank you.

Okay.

Madison, if I could just interject here for a second.

The time will just take one more question here and then we'll wrap it up.

Okay. We'll go ahead and take our last question from Jeff Zekauskas with J P. Morgan.

Thanks, very much thanks for squeezing me in.

When you read some of the high when you read some of the press accounts in California.

It claims that the California market is about.

2 million pounds, and <unk> 6 million pounds of capacity that is it's two to three times oversupplied is that a fair characterization.

And then secondly to your raw materials raw material costs continue to rise that is do you expect them to be higher in the December quarter, and then higher in the first quarter of next year and how do you manage that conversation with your.

With your customers if that if that is the case that you've got rising raw materials into next year.

So I'll take the first half that this is Chris.

Yes, I don't think I.

I think saying the the California capacity is three.

<unk> three times, what they are selling domestically in that state that doesn't sound like a crazy claimed to me at all yet.

Yes, because California has long been you talk about sort of the bread basket of America. They have been the cannabis bread basket of America for the past 30 years. So all of the all the illicit market or the legacy market that continues to exist a huge portion of that is served by legacy growers in California.

So it's a little bit of the weird dynamics do you get in a market that has.

The legal market is bound by.

A prohibition on Interstate commerce theme.

Legacy market, obviously is not bound by those things.

So you end up with potentially we're looking dynamics unless you're just look really just one layer beneath the surface, which is California supplies.

Huge lion's share of the.

Black market cannabis for the country.

And so you got to factor that in now look it's something we expect to.

To change over the next few years as east coast markets get their own legal domestic supply now and we expect that the.

The market will balance a little bit more between east and west coasts, but thats that has not happened yet.

Okay.

And if I look at commodities I would say.

Most of our commodities are at multiyear highs oil and natural gas.

Multiyear highs.

Plastic, we're seeing slowing down a little bit.

It is starting to cause.

Okay.

Kind of a nine year high.

If it's going up we don't feel like it can go up a lot more before it flattens out or at least comes down a little bit and so we're looking at.

<unk>.

It cost to kind of flattened to come down a little bit in our plan.

Certainly there is there is risk to that.

If costs continue to go up.

We will have to look at other actions to try to offset that.

But if you look at what the customers would be saying I think we're seeing it across every category.

Different than what we've seen.

Historically, when when the cost goes up on a certain commodity.

The customers are seeing cost increases across all items in their store, which.

The consumer is going to have to bear that the entire market is going to have to figure that out, but we are not at a disadvantage to the market.

Okay.

I just want to throw out that.

The.

Cost of goods part relative to Hawthorne.

That was where it was focused on sort of pricing I think.

We are dealing with this is really business to business sales.

Two professionals, who I think understand.

Sort of what's happening.

<unk>.

And the global supply chain and that.

That a lot of our products, particularly sort of the.

Hard side.

Are more expensive, but there was a lot of benefit to having the eminent represents the ability to make more money for them.

These people to the extent that I do know them.

It's a very exciting place to meet.

These generally young people with good businesses that are making good money.

<unk>.

And I don't think they look at.

Our product is.

Sort of a back breaker I do think on the consumer side and we've talked about this a couple of times.

I don't think we know.

How the American consumers are going to respond to.

The cost pressures on pretty much everything.

That they buy.

Personally think its not healthy I've said that before and that.

<unk>.

I don't know I hope this will lessen than what occurred in Virginia and other states.

Is that.

I think getting inflation under control and getting the supply chain of America fixed is really.

Important because eventually it's going to lead to I think issues with consumers the ability to buy stuff now if.

If we want to talk positively about that.

This is our first rodeo, okay, and when the economy gets FUBAR.

People still want to buy and have a nice house and protect the value of the house and the garden when they can't do other things.

We are highly resistant to recession, and therefore, I don't feel scared about it I do think that on the consumer side nobody knows.

What's going to happen to consumer demand in an environment, where you are looking at basically double digit inflation and I don't think thats an exaggeration.

I was down in D. C. A couple of weeks ago and every Senator I spoke too numerous senators said do you think it's transitory and I.

I said, no and I think it is accelerating.

And so.

So I don't think we know I think on the Hawthorne side. They are professionals it doesn't represent that huge amount.

There their cost of goods on.

On the consumer side, it's a more worrying thing for America, and I think we're in a good position relative to it but again I don't think anybody knows I think everyone should be concerned.

Okay. Thanks very much.

Mr. King I would like to turn the conference back to you for any additional or closing remarks.

Thanks, Madison, Thanks, everybody for joining us. This morning, I know there were a couple of folks in the queue that we weren't able to get to just because of time constraints on our side. So feel free to give me a call anytime over the next handful days, including today.

$93 757 hundred 8622 and for everybody's planning purposes, we are currently.

Tentatively holding February 2nd.

For our Q1 earnings results and conference call. So we will talk to you that the whole loan before everybody jumps I do want to throw out there is something that I offered a king I'm sure I'll regret this.

I think for people, particularly who are interested in the Hawthorne business.

We are doing some really good work and I am encouraged Jim to find a way for the investment community to actually get a look at what we're up to.

Because I think you'd be impressed and.

I think it's important to your understanding of our business that we find some ways to showcase kind of what we're up to so that it's not just a few minutes on the call.

It's it's the real ability to say I think they are actually changing the game.

I would encourage you to ask for it and Jim.

Do it.

Alright, everybody with that I look forward to your request.

And we'll talk to you again in February 2nd Thanks, everybody have a great day.

This concludes today's call. Thank you all for your participation you may now disconnect.

Hum.

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Yeah.

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Okay.

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All right.

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Good day and welcome to the Scotts Miracle Gro company's fourth 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.

Good morning to all of you and welcome to the Scotts Miracle Gro fourth quarter conference call by now you've likely seen our fourth quarter and year end press release in which we announced record full year results as well as our initial guidance for fiscal 2022, we have a lot of ground to cover this.

Morning, with prepared comments from chairman and CEO, Jim Hagadorn.

CFO Cory Miller.

As well as hardware Division President Chris Hagadorn.

After their comments, we will take your questions and for the Q&A session, we'll be joined by President and COO, Mike look buyer in the interest of time, we request that you ask only one question and one follow up.

I will be available after the call and throughout the days ahead to answer any questions that we don't have time to address or need further follow up.

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 discuss.

I'd refer you to our Form 10-K, which is filed with the Securities and Exchange Commission. So that you might 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.

Got some miracle Gro Dot com.

Without further delay we will get started and I'll turn the call over to Jim Hagadorn to begin Jim. Thank you, Jim and good morning.

For the last month I've been thinking about the key themes I wanted to cover today.

And I also spent a lot of time thinking about who exactly I wanted the target with my remarks.

I won't spend a lot of time, focusing on a quarter over the past year.

But it is worth pointing out that we just finished our third straight record year and remain extremely optimistic.

And it's worth pointing out that our 11% growth in U S consumer was against a 24% comp and a 39% growth in Hawthorne was against a comp of 64%.

I know there are obvious questions to address our stance on pricing the commodity outlook excess inventory in the cannabis market and our thoughts about capital allocation.

We will cover all of these topics as well as share our thoughts about fiscal 'twenty two.

But I've been a public company CEO for 20 years, now and too often I have seen the market's focus with short term issues overwhelmed the bigger picture.

So I want to spend most of my time focused on more than our current results.

Frankly, there are a lot of great things happening at the company right now some of them I can't share with you, but they are very exciting.

Our business is an important inflection 0.1 that could transform won't look like five years from now.

We have the opportunity to make this company stronger to make the moat around our business wider and deeper and to empower a new generation of leaders to shape. It through their eyes, not just mine or my executive team.

We also see the current volatility in the market as an opportunity.

If youre willing to lean in during times like this.

There is potential to capture opportunities that others can't and an opportunity to further strengthening your competitive advantages and leveraging those advantages, it's what drives long term shareholder value.

So I want the real takeaway from today to be a better understanding of the journey, we're on and I'll be honest my target audience is pretty narrow.

To our sell side friends I appreciate the need to get your models refined and to share that information with your clients. We're committed to giving you what you need but my comments are not aimed at you.

My comments are also not aimed at short term investors.

<unk> not going to get pulled into a rabbit hole about our quarterly splits the spot market price of commodities or a bridge to year over year SG&A.

I do however want to speak to those investors, who see the long term opportunity and SMG shares I want you to know where we're headed and why we're confident our efforts will create shareholder value.

We won't ignore the key questions about fiscal 'twenty, two but weave them into a broader context of how we're operating the business rather than the confines of how it impacts the P&L.

In order to look ahead I need to look backwards for just a moment.

For the five year period, we completed on September 30th our strategic plan assumed a relatively mature core business and enterprise growth of roughly 4% to 6% driven by the higher growth at Hawthorne, we sought to achieve a consistent shareholder return of 10% to 12% by leveraging the P&L repurchasing.

Chairs, maintaining a roughly 2% dividend yield we also set a five year target of cumulative free cash flow of $1 5 billion.

We exceeded each of those goals.

While we are proud of the achievement, we know that the strategy has run its course, because the opportunities are different now and where different too.

And so the next step in our evolution will reflect these realities, we have defined five distinct pillars of growth for the next five years.

Three of the fiber related to the U S consumer business. The other two are related to Hawthorne.

First we see a higher level of sustainable growth with our existing brands and our core business based largely on our ability to reach a new generation of consumers.

Second further growth of our direct to consumer efforts is there for the taking if we invest in people brands partnerships and infrastructure.

Third live goods remains a meaningful growth vehicle and a gateway for a more direct relationship with gardeners.

Our goal remains the same for consumers to see us as a gardening company not a gardening supply company fourth the support Hawthorne's future growth, we must continue to put the commercial grower at the center of everything we do.

This means further strengthening our model driven by innovation and technical solutions.

And fifth there is no doubt the cannabis industry will continue to evolve and grow.

And there is little doubt that those companies creative and courageous enough to wait into that pool early has the potential for a first mover advantage.

We've shown our willingness to do this when we created Hawthorne and as I will describe later, we intend to do it again.

As we pursue these pillars, we are strengthening our team focusing on succession planning and ensuring our ESG efforts are embedded into our operations and also better understood by our key stakeholders. We debated this a team and with our board whether to pursue all of these opportunities at once.

We all agreed we had to but.

But we recognize that succeeding against all of these pillars requires us to reorganize and power a new generation of leaders.

While there are no plans for me or any member of the current team to step away. Nearly every member of my team has made changes to their organizations.

The level of oversight needed to succeed against these efforts requires Mike will require to spend more of his time on the strategy and implementation of the fastest growing areas of the business.

He has reshaped this organization so that each of these pillars reports directly to him.

Therefore, he has given up most of his day to day responsibilities in the U S consumer segment to Josh peoples, and Dave Sweetheart, who will effectively serve as co leads of that business.

On the corporate side Corey has fortified his leadership team with an infusion of outside talent.

Denise Stump and Jim King have realigned their teams to better meet the needs of the business.

In addition, most of the M&A opportunities. We're pursuing include a management team that can further strengthen our own.

Every opportunity we see manifest itself, we could double the size of Scotts Miracle Gro within five years that's.

That's not the goal necessarily we want smart growth not growth simply for the sake of it but the magnitude of the opportunity could be game changing.

Let me briefly tell you how we expect to execute against these pillars, where I can I'll talk about them in the context of our expectations for next year.

Between the first two pillars, we believe the U S. Consumer segment can achieve sustainable long term growth of 2% to 4% annually.

Our previous strategic plan assume growth of zero to 2%.

If we can sustain growth at this higher level those added two points carries significant P&L leverage and improve cash flow.

It's worth noting that the guidance we set for next year assumes flat to slightly declining growth in the U S consumer segment.

This is based on an assumed a reset of the business in a post COVID-19 world specifically, we're planning for a decline in unit volume offset by pricing.

You will remember from our Q3 call that we took roughly five points of pricing effective in August.

In recent weeks, we have communicated to our retail partners a second price increase effective in January.

This more targeted increase will range from mid single to low double digits, depending on the product line.

In total we now expect pricing in 'twenty two to be in the high single digit side with the goal of covering commodity prices. While we believe our sales assumption for 'twenty. Two is a prudent way to plan the trends suggest a better outcome here's why.

Consumer Pos in units in fiscal 'twenty, one was six points higher than in 2020 more importantly, it was 21 points better than fiscal 19, and actually got stronger later in the year.

Consumer volume during the fourth quarter of fiscal 'twenty, one while down seven points from last year's record performance with 35 points higher than the same period in fiscal 2019.

Consumers are showing us that lawn and garden is an essential part of their lives.

Every cut of the data tells us they have stayed with the category and our brands throughout this past season.

Those trends have continued in October.

While it's a relatively small month, it's an important conclusion to the season, especially in the Midwest and northeast.

POS in units were up 4% in October compared to last year's record result, and up 42% compared to fiscal 2019.

As we enter the off season to Pos numbers won't tell us much until February.

And obviously, we won't know until next summer how much of the Covid bump we retained but I am confident we will have a significantly higher base to grow from we continue to invest with that in mind.

Millennial homeowners clearly have become a demographic tailwind and are more than offsetting baby boomers, who are leaving the category.

This group of consumers care more about gardening than their parents and see the category is more rewarding and purpose driven as well.

30 year old couple of buying a home today and entering our category for the first time has the potential to stay with us for 20 years or longer.

We must operate with that timeframe in mind.

We don't want our marketers to worry about hitting a target for wall Street their job is to drive consumer engagement brand loyalty and market share.

And we're going to give Josh peoples and his team the tools to get that done the.

The same holds true for our direct to consumer pillar.

This area is approaching 10% of our U S consumer sales and will only grow higher.

When we think about direct to consumer it goes well beyond selling items on our website.

It also means collaborating closely with our retail partners to support their online efforts.

It also means finding new partners, who can help us boost the appeal of gardening and have their own digital platforms that we can leverage.

Paddy Ziegler is one of our brightest and most creative leaders and direct our direct to consumer effort.

In addition to the efforts I've already mentioned she and her team have launched native online brands like Green digs knock knock and instead.

But one of their greatest successes is been with Aero grow.

<unk> leadership and with the infusion of our R&D and marketing capabilities, we took a declining business and tripled its sales since 2019 to nearly $100 million.

Pat He's been a champion for the potential of our direct to consumer platform since day, one and continues to re imagine the future of this business.

Succeeding in our direct to consumer effort also requires improving our it and supply chain infrastructure.

Dave Swinehart, whose role has recently been expanded to lead both supply chain and R&D is driving toward that goal.

We need to improve our ability to ship directly to consumers, especially in categories like live goods, which has significant online potential until recently, our direct to consumer efforts didn't warrant your attention, but thats changed.

While it remains too early to gauge the ultimate potential of this pillar it will be a significant contributor to growth as we go forward.

Equally convinced our third pillar live goods will be even more important.

<unk> goods or the gateway to lawn and garden category, but historically have been highly regional poorly marketed and highly commoditized.

We believe we can do better.

Had a great start with Bonnie and its leader, Mike cetera, and we're working with Bonnie as other owner, Alabama farmers coop, our AFC to pursue other growth opportunities that hold significant potential like.

Like US AFC has addition to create a national branded business across several categories of live goods.

Together, we believe we can better meet the needs of gardeners and our retail partners through innovation marketing and supply chain, we've already made tremendous progress improving the Bonnie business and even there we've only scratched the surface.

The other two pillars are related to Hawthorne, Chris will spend more time discussing the current environment, but I want you to know I'm not obsessing about the sales in Q4 or what we think about Q1.

I believe Christmas team have a good handle on the current environment more importantly, I believe theyre navigating the choppiness in the market, while keeping their eye on the long term opportunity.

If the market is challenged for a couple of quarters expect them to take advantage of it we won't chase sales, but we will take an aggressive stance to further solidify hawthorne and strengthen its market position.

So expect US for example to further enhance our innovation efforts.

I finally visited our new R&D facility in British Columbia last week, it's amazing.

I recently visited field stations in Oregon, Florida and of course, Ohio, what's been the takeaway that the work we're doing on hemp and cannabis research is changing the industry.

From lighting to nutrients to growing media. Our research is not just focused on continuing to improve our product offerings, but more importantly to help growers get a better and more cost effective outcome.

Our unique understanding of plant science and the nuances of indoor cultivation is unmatched.

Not only is known in the industry doing what Hawthorne is doing or.

Our competitors can't even try to replicate that model I think you should keep that in mind.

We also are likely to use this period as an opportunity to step up our M&A efforts, we continue to be disciplined in our M&A efforts, but the economics of some of our deals have become more attractive recently the.

The final pillar of our strategy is embedded into the recent creation of a new subsidiary called the Hawthorne collective.

I've been alluding for months about the opportunities to invest in emerging areas of the cannabis industry.

But this is my first opportunity to discuss the effort in detail.

It starts with our recent investment in <unk> capital a Canadian based publicly traded company that owns or invest in the series of cannabis related businesses.

We share a common vision with the other major investors at risk.

To create a fully integrated business based on the acquisition of licenses for cultivation and distribution.

From their roof can partner with some of the most well managed brands in the cannabis industry.

A lot of speculation regarding the potential for new brands to prosper as the market expands into categories like beverages. However, too few people are focused on existing brands in traditional categories.

This is already a multibillion dollar market with brands operating in the silos of individual states.

We're convinced there is tremendous potential for some of those brands to flourish more broadly as the market expands and our investment in <unk> reflects that belief we.

We believe that our unique level of expertise in the cannabis industry gives us the right to win in areas beyond our existing portfolio.

However, today, we cannot make direct investments in those areas. In fact, we can't even have a direct ownership stake in a company that does.

But we can create an ownership option, which is what our convertible loan to risk capital reflects.

In the near term, we do not expect to see an impact from the investment in rib on our P&L.

And the amount of capital we have employed $150 million does not impact our ability to invest in other areas or return cash to shareholders.

In the intermediate term it is possible really may seek further capital infusions.

We could be interested depending on the opportunities im not going to speculate on how much we might invest.

The honest answer is it depends.

But just as we did when we purchased general Hydroponics Botanic care Kavita and canon filters, we're willing to make investments others might avoid until there is more clarity about the future if.

If you were a short term investor you may not like it that's fine.

But the long term potential is real and it's significant.

Ultimately, if we convert our financial interest in river into equity, which is definitely the goal.

It may prompt us to reassess our current capital structure.

Many of you have asked if we'd break Hawthorne off as a separate company.

I've said, we'd only considered doing that for strategic reasons and not to chase valuation and Thats still true.

Over the past year, we've worked to understand what the potential separation would require and I believe we're capable of pulling the trigger on such a move if we decided it made sense let.

Let me be clear, we have no near term plans to do this.

But could it become a viable option I think the possibility is growing.

As I transition to Corey I want to emphasize that I'm, just as confident about our near term plans as I am about our long term strategy.

The U S consumer business is performing well and our consumers continue to demonstrate how important they see this category in their lives.

At Hawthorne, while we continue to expect top line pressure through Q1 <unk>.

I am confident in our team's ability to power through it and we still expect sales growth on a full year basis.

I appreciate your patience. This morning, as I know my prepared remarks are longer than normal.

Are there more challenges out there right now than a year ago, yes.

Am I thrilled with the equity price right now no.

But we're on a path to build a better and stronger business and we won't be distracted by the noise around us.

I mentioned earlier that we exceeded all of the financial targets, we set with our previous strategic plan and the goal is to remain on a path that allows shareholders to continue benefiting from the opportunities outlined in our new plan and the pillars that I discussed.

The confidence we all have as part of our decision to increase our share repurchase efforts.

Told you last quarter, we had allocated $250 million for that purpose.

We now expect to add another $100 million, so that total and we hope to acquire as many of those shares as possible in the next two quarters.

There's still a lot to cover this morning, So I wanted to step aside for now Corey why don't you pick it up from here.

Thanks, Jim I'm going to spend a few minutes on the big themes from our Q4 results, especially around sales and gross margin.

I'll share some thoughts about the guidance we provided this morning for fiscal 'twenty two.

And in between I'll turn things over to Chris to provide some color on Hawthorne.

Starting on the top line you saw this morning companywide sales growth for the full year was 19% which was in line with the updated guidance, we provided a few months ago.

U S consumer sales did better than we expected, finishing up 11% compared to the 7% to 9% growth we expected.

At $3 2 billion.

Sales grew by nearly $900 million in the last two years.

The supply chain team deserves a lot of credit for their ability to deliver this growth.

Targeted investments, we have made and will continue making in this area will prove to be key consumer engagement remained extremely strong through the fourth quarter and that kept our retailers equally engaged although U S. Consumer segment sales declined 28% in Q4, we were up against a plus 92% comp.

Also remember that Q4 had six fewer days this year than last year.

Adjusting for that sales in the quarter would have declined 23%.

At Hawthorne, the calendar shift cost of seven points for the quarter.

While year over year sales declined 2% the segment would have been up 5% on an apples to apples basis, when adjusting for the calendar in the U S. Hawthorne business grew by over 10% last year and Q4, given the same comparison.

Finally recall that Hawthorne was up against a plus 64% comp in the same period a year ago.

On a full year basis also grew 39% to $1 4 billion I'll remind you that number was $640 million in fiscal 2019, we have more than doubled the sales of that business in two years and all of that growth was organic.

On the segment profit line Hawthorne earned $164 million in fiscal 'twenty, one for an operating margin of 11, 5%.

The profit was up 46% from last year and more than 200% from 2019 we've.

We've said repeatedly that we're trying to strike a balance between growth and improved profitability I think the results speak for themselves.

As many of you know I served as the finance leader to Hawthorne almost since the inception of that business before joining the corporate team as CFO.

As you look at the <unk> results I encourage investors to look deeper than the numbers.

While the growth and profit improvements have been impressive.

The improvements we've made to how the business operates tell an even better story.

From the integration of seven separate businesses to the implementation of SAP.

The revamping of our sales force and the creation of the world's only cannabis focused R&D program. The efforts of this team has been outstanding.

All of you want to know more about the current state of the business. So let me take a pause here and turn the call over to Chris Hagadorn for a few minutes. Thanks, Cory I'll leave the details around the numbers to Corey, but I know you guys are wondering about the current state of the industry and how we're navigating it. So let me address that for a few minutes. We're obviously seeing some disruption in the market right now, but we expect it to be temporary.

Our field sales team began seeing the signs of a potential slowdown in late June we got smarter about the issues in July and that allowed us to share some of those insights on our third quarter conference call in August.

Let me caution that the growth will be significantly slower in Q4 than we'd seen for the rest of the year.

Since then many of you've been asking whether this will be a replay of 2018, we don't see it that way at all and we're not alone.

So you were in Las Vegas, a couple of weeks ago for the MJ Biz conference is the largest cannabis trade show in the World and if you were there you saw firsthand that this is not an industry that is fretting about the future.

Consumer demand for cannabis products continues to grow and the market continues to expand.

As it relates to the current environment, what was clear to me in Vegas was the industry is becoming increasingly adept at navigating the choppiness that's inevitable in a market like this what's happening right now is actually pretty straightforward and California. There was simply too much cannabis harvested in the past few months, especially from outdoor growers in the northern part of the state on top of a strong harvest in the first turn of <unk>.

<unk> earlier in the year, many growers harvested their second crop of canvas earlier. This season due to concerns about wildfires drought and in the case of the legacy market fear of increased enforcement efforts the.

The combination of too much product and relatively poor quality has put downward pressure on wholesale cannabis prices. However that issue should solve itself. Once the current supply makes its way through the marketplace.

Because the legacy market remains a big part of what's happening in California. The available data isn't great. So that makes it hard to give you a precise answer on how long it will take for the current oversupply to work itself through the market.

It's why we're currently forecasting Hawthorne sales to decline in the first quarter.

The single most important factors at the end market for cannabis continues to expand and we expect to start seeing growth again in the new calendar year and virtually no. One is expecting that factor change for the foreseeable future.

In fact, many high end growers have told US the current market issues are not impacting them at all and they continue to flourish.

Another important fact to remember is that unlike in 2018, there are no regulatory issues getting in the way right now.

Three years ago, California badly box the rollout of the recreational marketplace.

That overwhelmingly was the issue that impacted the market back then.

It was nearly impossible to get a license to operate legally regardless of whether you were cultivator or a dispensary.

While the current marketplace in California remains more expensive and bureaucratic no. Other states. It is vastly improved from what we've seen in the past and the legal market there continues to grow.

Some of you are also wondering whether the current situation will result in some consolidation.

Answer is pretty simple, yes of course it will.

But those kinds of ebbs and flows are exactly what we expect to happen. It's what happened in Colorado back in 2015, it happened in Oregon, when I when legal and.

And it's likely to happen in California to some degree and.

In fact, that's also what we're seeing right now in Oklahoma.

Like many new markets, Oklahoma had explosive growth out of the gates and probably got a bit overbuilt. So we expect a pause there before growth resumes.

We have told you repeatedly over the years that this industry is likely to be choppy from time to time. This is not the first time the industry has seen an oversupply of cannabis and just to be clear it will not be the last.

What's important for Hawthorne as we keep running our play.

The growth will be there in the long term I'm not worried about that.

Instead, I want to make sure that we're doing everything we need to to distance ourselves from the competition.

Jim has already told you that we won't slow down our innovation efforts, which by the way go much further than just new product development.

Which brings me full circle to the MJ Biz conference a couple weeks ago in Vegas.

Most major Tradeshows MJ Biz was canceled last year due to COVID-19. So we haven't seen the industry all in one place for over two years.

It's clear to us and frankly nearly everyone. We interacted with is how far Hawthorne has come in those two years and how much we distance ourselves from the competition.

We have fundamentally changed our approach to selling and that transformation is continuing.

We brought new products to the market that have improved the results for growers by both increasing the yields and lowering their operating costs and we've used the innovation to help us more qualitative ways like the establishment of the Hawthorne Social Justice fund within our corporate Foundation.

While I understand the question do you all need to ask about the step down on our growth rate I would urge you not to lose sight of the bigger picture.

There is no doubt that we're the clear leader in the industry. There is no doubt that our competitive advantages are unique and there is also no doubt that the cannabis industry still has miles of runway ahead of it.

So looking ahead at fiscal 'twenty, two I'm not worried about a few speed bumps.

Rather I'm excited to see how much further we can push this business and continue to lead the way in an industry that remains poised for years of growth.

With that Corey let me turn it back to you. Thanks, Chris.

Let's move down the P&L now to the gross margin line.

Like nearly all other CPG companies, we continue to see pressure from higher commodities and distribution costs How's.

However, the year over year change in the margin rate during Q4 require some additional context.

In Q4 of fiscal 'twenty, one the adjusted gross margin rate was.

It was 17, 4% compared with 24, 3% in 2020.

But company wide sales in Q4 of last year were up nearly 80%. So the fixed cost leverage and a relatively small quarter drove a massive improvement in the margin rate.

If you compare the Q4 gross margin rate in 'twenty, one versus 19 Youll see the difference is only a 100 basis points.

And that difference is a combination of segment mix and higher commodity costs.

On a full year basis, the gross margin rate declined 270 basis points to 33%.

The year over year increase in commodity costs of about $85 million.

Nearly all of which was on plan was the primary reason for the decline.

Followed by higher distribution costs.

As you know we did not adjust our prices this year until August in the U S consumer business. So.

So we had limited ability to offset the commodity inflation during the first three quarters of the year.

That story will change significantly in fiscal 'twenty, two which I'll explain further when I cover our guidance for next year.

Higher volume was able to drive improved fixed cost leverage and conversion to help offset the commodity cost increases.

SG&A came in two percentage points lower in fiscal 'twenty, one at $743 million.

It declined 21% in the quarter to $161 million.

Lower variable compensation was the main driver.

Also in Q4 of 2020, we use some of our strong earnings upside to significantly increase our annual contribution to the Scotts Miracle Gro Foundation, which we did not repeat in fiscal 'twenty one.

Interest expense was $5 million higher in Q4, compared with a year ago.

But essentially flat on a full year basis remember, we issued $900 million of bonds in the second half of the year, which drove an increase in the quarter.

On the bottom line adjusted net income, which excludes restructuring impairment and one time items was up 28% to $528 million or $9 23, a share. That's just a penny shy of a $2 per share increase in a single year.

And more than twice the $4.47 a share we earned in 2019. The EPS number is on the high end of the revised range. We set in early June and is a major accomplishment given the difficult comps and some of the cost hurdles we've had to clear in the second half of the year.

We're obviously glad to answer any of your questions regarding our Q4 or full year results, but instead of spending more time on those details I wanted to switch gears and share our thoughts about fiscal 'twenty two.

As you saw in the press release. This morning, we see companywide sales next year of about flat to plus 3%.

This assumes the U S consumer segment is flat to minus 4% and that Hawthorne grows 8% to 12%.

None of those ranges assume that potential impact from acquisitions.

In U S. Consumer we are going into the year with the assumption that unit volume will decline high single digits.

Roughly half of that decline is expected from lower shipments in the first half of the year.

Remember that last year's Q1 was up nearly 150% as retailers worked hard to remedy depleted inventory levels.

<unk> current retail inventory levels remain higher than a year ago, we likely won't see a repeat of that kind of initial load in.

We're also for planning purposes, assuming modest declines in consumer takeaway in fiscal 'twenty, two mostly driven by the difficult comps we faced in the first half.

As Jim already indicated consumer Pos has been stronger than we expected in recent months and has actually been positive for the fall season.

It's easy for us to lean in to meet the higher consumer demand if it comes but the prudent play is to assume a slight decline.

Most and perhaps all of the planned unit volume decline should be offset by pricing.

You should see some benefit from pricing in Q1 from the August price increases and the balance will begin during our Q2.

As it relates to Hawthorne, we're planning for 8% to 12% growth on a full year basis as we expect to see continued pressure in Q1.

As Chris said, it's hard to be precise regarding the current inventory supply issues in the industry, but we're hoping to see a return to growth sometime in Q2.

Let's move on to gross margins.

We expect to see gross margin rate declined by 100 to 150 basis points on a full year basis.

We are cautiously optimistic that our pricing moves will offset expected commodity pressure.

That said, we expect about 65% to 70% of our cost to be locked in by the end of the calendar year. So we'll still have some exposure if costs move higher than the planned increases we are assuming.

The two biggest pressures on rate next year will come from lower fixed cost leverage and segment mix.

We would expect some leverage out of SG&A.

This line can range from a 6% decline year over year to a slight increase maybe 2%.

There are no major moving pieces in SG&A and we remained committed to investments we believe will drive the business not just in fiscal 'twenty two but.

But the years to follow below the operating line interest expense should be roughly $25 million higher based on the full year impact of our recent bond offerings.

Our guidance also assumes no offsetting earnings impact from acquisitions, which is a pretty conservative starting point.

All of this rolls up to a guidance range for adjusted EPS of $8 50 to.

To $8 90.

I also want to talk about cash flow for a moment.

For the year, we just completed free cash flow, that's operating cash flow minus capex came in at $165 million.

That is low from historical standards. There are three main reasons behind the year over year decline further.

<unk> was variable compensation that was earned in fiscal 'twenty, but paid out in fiscal 'twenty, one that was about a $60 million impact.

We increased capex by about $45 million.

Third inventory levels were up 500 million from fiscal 'twenty, while most of this increase was paid during the year, we did lean on our vendor partners more than in the past to achieve extended payment terms.

As we look to fiscal 'twenty two.

Aiming for free cash flow of up to $300 million.

We expect Capex to increase again, and we also expect inventory levels, while flat on a unit basis to be higher overall because of the increased costs.

These investments are necessary to continue meeting the required service level to our customers.

Which is the higher priority, but as it relates to inventory we find ourselves in a very good place right now.

In both U S consumer and Hawthorne, we believe some competitors will have a hard time meeting demand.

And then the consumer business, we expect the market to see shortages of grass seed is fagnant peat Moss the key ingredient Houston growing media.

We do not expect to be impacted by those issues and we do not expect to have any problems getting our customers at the appropriate inventory levels either.

Before we open the call for your questions I'll offer a final bit of commentary.

I agree with Jim's assessment.

We've got a lot of moving pieces right now and several active initiatives that could require us to update our outlook as we move through the year.

But even in the unlikely event that none of those efforts come to pass I believe the business is in a great spot. The challenges we're seeing on the cost of goods line are pretty consistent with what <unk> been hearing from other companies over the past two weeks and just as we said we would we've taken aggressive action to stay ahead of all of those challenges and protect the profitability of the business.

Ms.

When I think about how far this business has come in such a short period of time, it's hard not to feel good about where we sit right now.

And so with that let me turn things back to the operator, so we can take your questions.

If you would like to ask a question please signal path.

Please. Thank you my star one on your telephone keypad. If you are using a speaker phone. Please make sure. Your mute function is turned off to lifecycle tree care equipment.

Again press Star one to ask a question. We'll go ahead and take our first question from Jon Andersen with William Blair.

Good morning, everybody.

Hey, John.

A lot of different questions.

But let me start with Hawthorne.

Understand the situation in California, and thank you for the color on that.

I am wondering like you to comment on what Youre seeing in some of the newer states really over the last year.

A number of things that have legalized adult use.

Cannabis and yet in some of those states are quite large such that the total population.

Living in states with adult.

Legal legal has risen quite a bit my sense is that you haven't really seen demand from those newer states yet could you provide kind of an update on.

And when you expect that to kind of kick in thank you.

Hey, John Yes, Chris you're absolutely right. We saw a lot of states and when you talk about high population states. We've seen adult use past I assume youre talking about states like New Jersey.

And we've always like to give you guys and ourselves frankly sort of a year, we think from passage of losses Thats. When we expect the market to kick in and while I think that's a reasonable estimate in most states.

You do have to couch that with the reality that this is depending on state legislature is getting the regulatory frameworks for these market setup and thats something that in the state like New Jersey has taken a lot longer than expected and as an example.

New Jersey had a big slate of.

Social equity licenses adult use grow licenses that were supposed to be granted back in 2019. Those licenses were just granted two weeks ago. Just an example of how slow that state has moved to actually approve what the voters have asked for.

And in that state those those adult use law.

Licenses will not actually be able to sell into the adult use market for a year. After they have been operational under medical so those guys have to build out their medical grows start operating for at least a year before they're eligible for adult use so.

Even when they passed adult use we've seen some regulatory hurdles that just really stretched that timeline out for us. So.

We expect new Jersey start kicking in and we're seeing some really early results, but it's still a very small state for us.

So again it's.

A year and has always been our kind of our number but it looks like that may be a little a little optimistic in some of these northeastern states that have kind of no existing framework and theyre kind of figure now.

Okay.

Great that's helpful.

I appreciate that but just as a follow up.

Maybe I'll stick with something bigger picture so.

Jim mentioned live goods several times as the gateway to lawn and garden.

One of the five pillars that you outline of growth for the next several years. So what can you just let us know what have you done and accomplished so far and live goods, a little bit more color around that and when you look forward. What is it that you haven't done that you want to do with live goods.

That would be accretive to your growth in earnings whether thats more with Bonnie whether it's broadening the relationship with AFG et cetera. Thanks.

Alright, I think I'll start and then hand, it to Mike, who I view as really sort of the.

The author of the strategy, which.

Totally behind.

I'll just hit what the what what have we done.

And we.

I think this year we've.

Stepped on a private is a little bit.

And learned.

A lot and I can let Mike talk about that because I think thats what are we going to do.

But let's start with what have we done.

I think we bought.

We're partnered with ASC on.

The finest brand really the only brand.

Thats national in live goods.

And that's Barney.

And.

Worked with them to really begin to.

Professionalize and it's not that they were unprofessional, but I think.

We've learned a lot of how we want it to be.

Mike has really led that from our side.

And.

If you say, where we want to go is.

We want to participate in the other categories.

Under the same kind of idea of branded national the ability to use scale, but let's just remember what was our original interest in.

We're saying now and it's true.

That we just don't want to be kind of a lawn and garden chemical company.

Debt.

People garden really and it starts with plants.

And the psychology of why people want to garden, and there's a lot of it.

Really good stuff for us.

Sort of sort of.

In that but.

We want to play in plants and we view.

Basically as a high growth area. So even if you look at what we're seeing now which is we believe based on.

Younger people.

Wanting to own homes very different than probably five or six years ago, when we were saying.

People are going to want to move.

The move to the city and have a condo and not have a yard I think we feel.

Very differently than that now.

And.

Young people want on homes is a gigantic bubble of kind of our kids, who are if that phase now where they are buying homes, and having kids and a dog or whatever and.

No.

And that data, we talked about a little but they want to garden.

And so if you look at our core and you say, we think we can kind of double that which is not saying a lot I think Mike and I struggle with that zero to two to two to four.

But we're seeing a growth rate in live goods.

At least two ex that.

So that was the attraction to the business.

Plus this idea of getting involved more in sort of the basics of gardening.

And.

The brand side of it which Bonnie brings to us. So the question of is like.

What have we learned in kind of.

Mike What's what's your addition to the craft.

Well I think having a national network.

That's what Bonnie broad, but the sophistication there are really none other than Bonnie Theres no other national brand.

There's all kinds of really cool genetics and the activity that we can bring to the market and we look at it as tie in that solution.

For the consumer.

With our other.

Products to actually.

Give the consumer a better opportunity to.

Have success and enjoy gardening so.

So.

We're tying it all together we're looking at <unk>, we're looking at we're actually doing succulents, we've expanded doing some color miracle gro flowers or in Loews.

And so we look at providing that national network and supply chain infrastructure, which is probably the weakness.

Every girl or is it being able to.

Supply nationally.

Those products and then expand also whether it's direct to consumer and get those products. There. So how much of your time is going into that Mike.

Sort of the supply chain of getting that where you want it.

Probably 20, 25% right now so.

It really does I mean, we've integrated companies, we got to integrate those systems are if you remember we're Scotts was for me 26 years ago. It really was an isolated supply chain. This Israeli nationalizing the supply chain of the life, good companies and really making it more effective and so in the <unk>.

R&D and the marketing and I would say indoor is actually a huge opportunity that is really underdeveloped and so we wanted to simplify that for consumers.

Okay. Thanks.

Thanks, that's helpful I'll pass it on and get back in queue.

Thank you John.

Alright, again that is star one to ask a question. If you find your question has been answered you may remove yourself from the queue by pressing star two.

I'll go ahead and take our next question from Peter Grom with UBS.

Hey, good morning, everyone. So just a few questions.

For me.

Maybe just to start Jim you alluded to a greater willingness to separate popcorn from the legacy business and I know you said that it's not something you're expecting a near term, but could you maybe help us understand what is driving that growing confidence that this is something we may consider.

And then what could actually push you over the line to actually making that happens I'll start there.

Thank you I could go on for an hour.

On that one.

Let me start with.

How welcome Hawthorne is within sort of the SMB world.

And that.

I think I, probably told you guys. This before I think Chris.

I think was always kind of reluctant partner.

And.

I think its I don't know how long Chris you've been in this job now how long seven to eight years.

Sure.

<unk> life.

The.

I think if you look at what we're doing with supply chain.

Innovation.

Advancing sort of science.

The stuff that.

Weak.

That's also being a buffer when they had issues like in 2018 were.

The the largest Scott's really helped.

I think it's very much a virtuous place for Hawthorne to be in it.

I'd call it probably highly synergistic so when we get into this question of separation. The question is.

I'm, not saying you would suffer dis synergies, but I think it would have to be strategic enough.

But Chris is not there would be but I think theres arrangements that could be made to sort of minimize that.

Why would I do it.

Because I think there is opportunities out there with like minded.

Partners.

That.

Is big.

And.

I don't know.

Peter I don't I don't think we've met.

We have I apologize.

But let's just say maybe you don't know me that well I'm just not that good.

Minor partner.

I think we've been doing deals gear where were.

What we call. It is respectful minority interest because thats kind of what people are willing to tolerate a lot of the people we're dealing with on a future basis. This is now.

Confidentially talking down the road I think they don't want to sell their businesses would they participate in something that added a lot of value and became something important.

I think the answer is yes.

With a sort of join the allied.

<unk>.

Military whatever you want to call it.

The answer is yes, they would.

And if you look at the dollars involved.

Think it would be challenging to do this on the long term.

Where we are.

A relatively small partner.

What we have to offer.

Beyond sort of what.

What Hawthorne is.

As management structure capital.

Access to the public markets, both equity and financing.

Yes.

A lot of things that we have to offer.

And to sort of have a real estate at the table.

And my view is the big dog in the room in the industry is Hawthorne.

For the REIT structure.

I'll speak for myself.

Because I have a management team that are my partners.

I got a board of directors that I have to sort of work through.

<unk>.

My family.

I think I could see a contribution of popcorn and spa.

<unk>.

Sort of how welcome it is here.

To put together the right structure and I think that what that offers and I don't think we've suffered is.

As a result of thing it's not Super clean that you have this sort of.

Cannabis business stuck into consumer lawn and garden market our business.

And I think especially when the stock price was higher I thought it was.

Properly valued.

Authors value of Scott's value combined.

It's.

Got a little better than it does right now but it is.

It felt right and I didn't think it was disadvantaged us at all.

I do think that there are people, who would make an argument and I am sympathetic to the argument that doesn't mean I completely agree with it.

Let's say, it's cleaner to have people who want to make.

Investments in sort of the cannabis business, especially if something with this strategic is what.

I envision.

And not have that mixed into the sort of lawn and garden business, which is a slower growing.

Probably more cash flow positive business.

So.

I could make an argument.

That.

That that would be the right thing or could be.

We've also spent it.

At least I'm going to say the last 18 months.

Making sure that we have separable financials.

That's sort of our financial.

In a public way.

And we are I don't know I was talking to Ivan Smith.

Finally, two weeks ago.

And so we're there right where they're from a financial and legal point of view, where there are separable and I think what you said is within a month or two.

That's correct.

So again, there is no rush to it.

But I do think that.

Questing that came up about sort of the east coast in Jersey.

I think these are very valuable opportunities.

And I think the dollars and remember these are.

I'm not going to get critical of the United States government, except to say 280, <unk> is a piece of ship it.

It's ridiculous that the United States government or it makes more in public marijuana than the owners of the businesses that are invested behind it but it has to be fixed.

And we're involved in DC solving that but on a before tax basis. These are significantly profitable business in their early years.

And so I think if you look at the value of these businesses.

You can get to the point, where youre getting into real money.

And.

So sort of deal with balance of power issues, that's where I get to say.

Hawthorne really has to be a part of that and so.

Hopefully that answers the question of but.

I don't think we're on the cusp of a deal.

If you were one of my brothers Sisters, and they said when do you think this could happen I would say.

A year or two years, something like that I wouldn't be surprised.

And one last thing.

I'm not sure I've actually done a call where my son Hana speaking part.

I will say is.

That I'm pretty happy and proud to be sitting here.

With.

My oldest son at the table.

And.

If I was representing to you guys I would say.

He is ready to run things.

He is may.

It may be better than I am so I do think that.

The biggest thing we're working right now is just make sure we understand kind of the map that we're developing with some other people on how this thing progresses.

And then putting the management team together to actually support that business and Mike and I and the board are spending a lot of time.

On that so.

Right.

That's a pretty open to answer <unk>.

And truthful okay.

No that was really helpful.

Thank you for all that I guess.

Maybe for Chris I was hoping to get your view on the cadence of Hawthorne as you look out to fiscal 'twenty two can.

Can you maybe just help us understand the magnitude of the negative pressure you kind of expect in Q1, what gives you confidence that it will snap back so aggressively.

High single digit low double digit target for the year is there enough conservative conservatism in your guidance like Shouldnt.

The underlying trends take longer.

And then just I know, there's a lot here, but just the Oklahoma comment can you maybe help us understand how big Oklahoma is for Scott or the broader industry.

Yeah, no problem so oklahoma's.

It has become a somewhat material state for us.

We saw kind of thousand plus percent growth over there in that state over the past couple of years.

And candidly it was a state that we've been talking internally about that we need to prepare ourselves for a little bit of fallout.

Oklahoma.

Just because you can't see that kind of growth forever and we saw similar growth in states like Oregon back in 2017, which led to kind of end product saturation in those states.

And the resulting kind of fallout that we dealt with a few years ago now again like I said in the prepared remarks.

Don't think anyone is anticipating this to be the same amplitude because like I said in the remarks. There is there were structural regulatory issues that were compounding. The oversupply then those those don't exist here.

In terms of what gives us confidence that this can be sold through them I was out in Vegas, a couple of weeks ago I know some of the analysts were as well.

And I heard from a bunch of people, who are pretty smart folks who've been in industry for a long time I'm talking real camps people right now not sort of.

Corporate folks who've who've ones are weighing like us, but I mean real cannabis guys, who said look this is not to scare anybody but this is the single biggest end product flood that the cannabis markets ever seen.

And I think it's probably true what gives me confidence here is this is a perishable crop.

It's only going to stick around for so long and.

As I also mentioned in the prepared remarks.

This is something we're really seeing affecting the kind of middle and low range the markets much more substantially than the higher ends.

You talked to a lot of high end growers theyre growing more cannabis high and legal borrowers their own more candidates than they ever have they are selling it for higher retail prices than they ever have and they're selling everything they can grow and to be clear that is the core of our customer base. Our consumer base is folks growing high quality cannabis indoors. So we've got a pretty high degree of <unk>.

We're going to see this thing.

Shake out I would say over the first quarter of the next calendar year. So first quarter of Q1 or excuse me first quarter of 'twenty. Two we think this thing will shake out.

Look we we have been wrong before I think we've got better Intel on this than than anybody frankly that includes our competitors and I think we've got more experience here to Corey.

He is really only member of my management team. That's that's moved on since 2018 and he has moved into the CFO role working with Jim.

Our team has seen this kind of action in the marketplace before we knew what was happening when we saw it coming we knew how to prepare for it as best we could.

So I feel confident in the numbers for the full year, obviously, they are back loaded to the second to third to <unk>.

Third and fourth quarters, but.

Again, our confidence is high.

The oversupply will shake out and when it does we are going to be better positioned than anybody to take advantage of the market.

Super helpful. Thank you I'll pass it on.

Okay.

Alright, well go ahead and take our next question from Bill <unk> with <unk> Securities.

Okay.

Thanks, Good morning.

I'll try to keep it short.

First on on.

Hawthorne M&A commentary.

Explain to me I guess.

The rationale behind you have a pretty broad base of products most of the M&A, you've done or announced so in the past year has been really really small.

And.

And I understand that valuations are more attractive, but I mean, it's kind of a two or why bother if you could end up buying.

$310 million companies versus build it yourself. So help me understand why that what makes sense versus.

Or part two to that first question of why Didnt, you actually repurchase shares in the quarter versus repurchasing them going forward.

So should I.

I'm, just sort of stunned by the repurchase part.

Aye.

Let's just talk real quick about.

Sort of M&A pipe.

For Hawthorne it not.

The hopper collectible, what we'd call Apollo.

<unk> because they are quite different.

Bill you've been with US a long time I.

I would say.

What do we like on the consumer side, what we have always call close in Adjacencies.

These are businesses and because of the sunlight connection.

There are opportunities.

In.

Distributed products for us that we understand.

That we already sell.

That we know if we bring into our supply chain.

Youre talking very significant IRR.

And I'll just throw in there that.

The.

The cultivation industry with all due respect to the many.

Fantastic people out there doing that kind of work.

People when they have something works, they really stick with that.

And so there are branded businesses out there.

Sure.

Getting people to change is not as easy as it seems.

And where there are significant opportunities and synergies.

And we can buy at a fair price.

And then apply the synergies to the business.

Ed.

If I took you through them and I'm not going to do that right. Now you would basically say Oh Hell, Yes, you should do that.

Not very exciting.

Look I wanted to go back just to led lighting for a second.

Led lighting was a business that really three years ago hardly existed.

At a big level.

That represents today.

Our single largest category.

And.

Well over 50% of our lighting dollars are now in Leds.

And I'm telling you. This this is.

<unk>.

This is all based on innovation.

We're.

I think together with Mike and his R&D team.

Chris and his folks.

Finding the need Mike Porter from Harvard.

Building a strategic reason for the <unk> business that is based on unique and important innovation and so this is a business we did build by ourselves and we built a category by ourselves.

And it's growing today.

We are pretty significantly back order on our led light and so this is an area, where if we had more components.

We'd be selling more products and not a little bit.

No.

I think that your question is we're doing both we're doing both innovation and building it ourselves, okay, and where is something as a close adjacency and we can do.

Buy it up.

Mike and Chris and there are guys on the supply chain side could do their work plus we can then put our R&D effort against it I think.

The economics of that make a lot of sense and if I was telling you about it deal by deal you'd say I agree with you.

So I don't think Chris you should pick.

Pick it up from there if you want yes, no I would like to.

When you talk about the small deals that we've done.

Recently.

So floor and hydrologic.

Those are deals more in the case of.

Raj a floor is that close in adjacency Jim's describing and I mean, we're talking close in both sort of from a <unk>.

Category perspective, the rifle, Florida facility in Santa Rosa, California, literally shares offense with the legacy General Hydroponics facility that is still our main liquid nutrient production facility. They share a fence line. Their next door neighbor. So that was one we knew that team pretty well, we love the product we love the brand we love their ability to really.

Get traction in the marketplace and there could not have been an easier integration for us because we were next door neighbors already.

I mean literal physical next door neighbors in the case of hydrologic that deal goes back to when we first bought general Hydroponics I was talking to Ross Haley who at the time was the CEO of GH. When we did that deal and said Hey, Ross where should we go next to you gave US a long list of brands most of which we've acquired in the meantime, the top of that list with hydro <unk>.

It took us a while to get that deal done.

But that is a brand that is really stands alone in the in the sort of the subcategory of reverse osmosis water filtration. There is hardly a commercial grow you walk into that does not have a hydrologic system in that facility there.

Their list of contacts and relationships in the industry is extremely deep and includes a number of call features that we didn't have much of a relationship with.

So to us that was one strategically it was always on our list. It took us a few years to get there, but it just if we never forgot about that deal and I'm really really happy that we got it done and the team there is phenomenal and the past few months again, the integrated the businesses over performing our expectations. Even in this marketplace and then I just wanted to just last on.

Repurchase.

Our shareholder friendly approach that was really came out of.

Project focus or whatever I think thats, what we call it.

That was what we presented everybody that we don't really see a ton of opportunities out there.

To acquire.

That are attractive to us.

So we'll just send the money back to the people who own this business I think part of what you're hearing on this call.

Is that that's not where we're at right now.

The change.

When I say I wouldn't say the strategy had a shelf life, but whats changed the opportunities around us whether it's in live goods, whether it's Ben.

Direct to consumer I mean, these pillars that I've been talking about are the opportunities.

And we're organizing around those so Mike has the ability to stay on top of them and they all report in but they all have growth rates that we think and we've got this fantastic business the core slower growing high cash flow.

And remember that 165, plus $500 million of inventory.

Plus.

Capex plus youre talking like I don't know $700 million of cash flow.

This in 'twenty, one before you make those adjustments.

So it's a really great business.

On the other businesses are we think are pretty obvious and higher growth rates and thats kind of why we're chasing it and thats why.

<unk>.

We basically have said we've got to integrate some acquisitions plus then if you look at the.

Half of our collective opportunity.

We want to invest there as well and that's really why we have decided.

That.

Returning cash to shareholders is still an important component of what we're doing but it's not the only thing we're doing and that's a lot of what Corey and I try to balances.

What's the right investment in the business, but there's a lot of opportunity right now and.

Im sort of really hopeful the United States is a step in the way I don't know im watching the FTC.

Dammit, but.

I was just going to add if you go back to last year share prices were a lot higher our return to share of return of valley.

Value to shareholders was going to be more around.

In the realm of a dividend versus a buyback if you go back.

Four to five months ago share price was a lot higher we did buy back about $40 million of shares in Q4. So it wasn't that we were out of the market now going into Q1.

We're feeling more comfortable with where our Q1 is the results we're seeing in the marketplace and we think that we can buy into the market.

Share repurchases at two to three expert level and feel comfortable with it.

Got it well I'll leave it there thanks so much.

Okay.

All right. We can go ahead and take our next question from Andrew Carter with Stifel.

Hey, Thanks, Good morning, I, just I guess I wanted to ask.

That the midpoint of your guidance next year suggests the gross margin will be down 430 basis points, where it peaked actually earlier this fiscal year trailing 12. So could you help us understand how the GM will face for the year's pricing absorbed inflation that comment around pricing above inflation was that a full year comment or was that expected to have.

But at some point and final comment just so we can get a sense of the ongoing degradation potential.

Potential for mix, we're just hawthorne's margins stand today, and where do the owned brand stand what's your penetration. Thanks.

So.

I want to start because thank you for asking that series of questions.

<unk>.

Within fitness this morning with with.

With Ivan and I said I'm going to <unk>.

The budget.

Or at least the expectations, we're setting I do want everybody to understand how and why we sort of.

Talk to you the way we have today and I think then.

Sure.

It probably is useful.

Setting the budget for this coming year was.

I think Cory would say, we're looking at sort of.

Neutral operating 22 versus 21.

I would say we looked at.

And they are both true.

We looked at sort of.

What the street was thrown out there as a number for expectations for Scotts for next year or the year.

We are in.

And.

We built a number that I don't know call. It was a quarter above what we're seeing is sort of consensus.

Felt that was a pretty good place to start.

To be honest, it's a pretty negative number for us.

And.

Based on that we then started building a operating budget off of that that.

Said.

If it's that bad and I don't expect it to be this is the point I'm trying to get across is can we still can we build a budget that meet that number sort of your consensus plus call it a quarter.

And.

Still fund the things, we want to fund and be responsible about how we run our business and I think this is.

Quarries.

Input to his first budget cycle with us in this role.

I really look to Mike to say.

Is this killing you because I view budgeting is a pretty corrosive process actually I really don't like it that much I know, it's necessary, but it's pretty corrosive, particularly when you make inputs like that.

And Mike was okay with it because I think it sort of forced this issue of saying are we spending the money and the things. We think we can drive the business and can we lighten up on some of the other stuff and still make the numbers work. If the numbers are as bad as we're building.

The numbers from and we came out with I think an agreement on that.

And this is what we're reflecting in how we talk to you guys, but my.

My numbers and Michael number quite a bit higher than that.

And.

Therefore.

Just want everybody to kind of.

Every time I say stuff like this people freak out everybody gets the joke that we.

This was a budgeting exercise we're setting expectations based on partly where you guys were partly based on this view of core use of can we lease make the same operating numbers as we did last year.

And.

How then does it fit in with how Jim wants to manage the investment community.

<unk>.

As we get into the year not get ahead of ourselves but start to become.

More.

Transparency on the upside hopefully that's there and thats, how we we kind of got to these numbers. So I do think when you ask the questions.

Try to understand that.

It's not like we're absolutely committed to these numbers, what we're committed to as a budgeting process that allows corrugate feel good that he's not overextended on the expense side.

And then Mike feels to be spending the money on the things he wants to.

And we're not over promising to you guys and this is all part of the.

How how we do it here.

This year we.

We had a board meeting yesterday to go over this stuff.

And I wanted to kill myself during the meeting.

Based on what we're talent, which is kind of what we're telling you guys and.

It made me feel bad about the business, but the truth is I feel really good about the business.

Mike and I are.

Committed there are a lot higher numbers and so.

When you ask the question is try to lease look it through with that sort of filter and Corey So I hand, it to you to answer the real questions.

Two things you brought up total company margin rate.

We guided to a decline of 100 to 150 basis points. If you look at the components that make that up segment mix as Hawthorne grows faster than.

The U S consumer business, we're going to naturally have an enterprise wide decline in our margin rate just because of the margin rate of those two businesses.

So thats going to be about half and if the units come in where we planned which is the decline we're going to see some deleverage.

That that will hurt our margin rate and like Jim said we're.

All expecting units to come in better than that but given the plan that we put in place.

The deleverage could happen should units come in lower and I would say your point on pricing versus cost.

They basically offset each other so if you look at the margin rate pricing and cost offset each other we.

We do have.

Some buying left to be done in the rest of next year.

We're kind of a third exposed if you think of where we'll be locked at the end of the calendar year. So there is risk out there or opportunity depending on what happens in the marketplace.

For cost to change where they are at in our model today.

Last point on.

On the Hawthorne EBITDA, you asked about where the Hawthorne profitability as we're planning on about 500, I'm, sorry, 50 basis point improvement.

Year over year. So this is on the path that we've been on trying to get to a total earnings percent of 15%.

And we continue down that path, we saw good improvement in 'twenty, one and expect about 50 basis points in 'twenty two.

Okay, great. Thank you and this might be a difficult question to answer, but you cited kind of a pull forward of the crop in the outdoor season in California, which I guess the potential upside of that is is that the crop tober is really bad.

Could you kind of quantify for us than like maybe how the earlier pool like not selling to growers in August September may have hit numbers whatever product lines that might have affected nutrients. Just so we can kind of think of a back half headwind that hit this year and potentially comes back next year. Thanks.

Yes sure.

I mean look you already said it the disc.

The slowdown has affected our consumables business significantly more than selected our hardware business.

So nutrients and growing media some other categories. We've seen we've seen much more downward pressure, which to me says that the.

The operational guys are kind of slowing things down waiting for product to sell through and not wasting. It some time pumping more product into a market. They know isn't isn't really moving right now.

Other hand.

The kind of high ticket hardware sales we are seeing so this is lighting.

Modification.

Water filtration et cetera, so kind of infrastructure stuff, we're still seeing really good uptake in the market on those products and again, it's in some cases outstripping our ability to meet the demand just with some supply chain disruptions, we're seeing particularly on lighting.

So we think that's all going to shake out we're still seeing again, new facilities get built as what that tells us.

And those facilities will come online and when they do they'll be buying our nutrients are growing media, which are all products. We we're seeing exceptional growth in leading up to figure June July.

So the back half of the year, we're really is kind of stacked with a lot of new train a lot of growing media sales, but when we brought the innovation on the on kind of the hardware infrastructure side, it's sold.

I sort of beat my chest last year about the new <unk> led light that was at the time was our first generation led light that set a record within Scotts Miracle Gro for the single largest outlet for one.

Dollar perspective, the single largest product launch in company history.

We beat that record this year with our new led light.

We're selling more dehumidifiers from our partners at Questing, we ever had before including some really exciting very expensive kind of high tech units that cover a broad array of HVAC stuff for the grower. So we're seeing those products continue to sell we're not seeing a lot of slowdown there. We're just waiting for the consumable side of the business to catch back up.

<unk>.

Great. Thanks, I'll pass it on.

Okay. We'll go ahead and take our next question from Joe <unk> with Raymond James.

Hey, Thanks, guys good morning.

Chris just wanted to follow up on that last comment regarding California, how quickly can can ease into our growers wrap up their operations once the pricing starts to improve.

Pretty rapidly look it depends on what stages of build out there at obviously.

We've gotten pretty good Intel that there are there's a number of largely built out growth in California that are available right now too for potential acquisition.

So we know that there is some growth there sitting there kind of have built are mostly built that grow just arent, finishing until until the market recovers. So we expect to see a pretty rapid.

Recovery once once the market prices kind of encourage growers to get back into it. So again. These facilities. There are largely done it should be I would say.

Certainly less than six months from when demand recovers till those guys can be operational at full steam and I think frankly shorter than that isn't it true also that.

In the legacy market or whatever you call it traditional market.

But.

This is kind of like a gypsy business, where people can get in and out very quickly.

Yes, yes, that's always been the case. So this is for for the and welcome.

To the extent, we have visibility to the legal status of the people consuming our products, we sell ourself to retail and where it goes from there is somewhat anyone's guess.

But we are aware that there's a lot of black market growers out there.

We call legacy market growers.

Those folks will shut down for a quarter.

Just because it's for lights in their garage or six sites in the basement.

And it's kind of a state supplemental income for them, if they're not seeing the rewards for the activities that offset the risks theyre, taking they'll shut down and wait for that market to recover and all that youre sitting there waiting to get switched back on so that recovery right. There is pretty much instantaneous and like I said, we think.

Our expectation as wholesale prices will start to recover within the first couple months of the new calendar year and at that point, we expect to see market recovery follow.

Okay helpful. And then one more for Corey whats, the anticipated incremental commodity and logistics headwinds in 'twenty, two and dollars and it sounds like correct me, if I'm wrong that the price increases the high single digit price increases call it not.

Not only offset that dollar for dollar, but youre maintaining your margin.

Businesses as well.

Yes, if we look at the <unk>.

They were putting into the plan for each of the each of the segments segments are basically maintaining margin at the plan that we are building now.

So I think of headwind that we've experienced so far kind of $85 million that that we saw in 'twenty one.

That number will get annualized as we as we go into seeing those higher rates on those commodities for.

The entirety of 22 or at least the entirety of our purchasing cycle.

No.

Headwind there.

The pricing that we're taking though should negate that and we should be kind of.

Margin neutral as it comes to commodities.

Okay, great. Thanks, guys.

And we'll take our next question from Eric <unk> with Cleveland Research.

Thanks.

To understand the importance of pricing.

The Hawthorne business, and I'm talking about and product pricing and Chris Your comment was interesting that you are.

Exposures to the high end.

And then I'm trying to square that with your exposures at the high end, but your business is softer now and it seems like the business softer now is nothing.