Q4 2022 Scotts Miracle-Gro Co Earnings Call

Good morning, and welcome to the Q4 'twenty to 'twenty two.

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I'd now like to turn the conference I'll, Let you tell me Barry.

No I had.

Good morning, everyone wealth.

Welcome to the Scotts Miracle Gro Company Sports quarter earnings Conference call.

Today's comments from Jim and Dave had been prerecorded.

After their comments, we'll take your questions I want to remind everyone that our comments today will include forward looking statements and so our actual results could differ materially from what we discuss I'd refer you to our Form 10-K, which is filed with the securities and Exchange Commission. So that he may familiarize yourself with the full range of risk factors that could impact our risk.

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This call is being recorded and an archived version of the call will be stored on the Investor relations portion of our corporate website Scotts Miracle Gro Dot com, we have a lot of ground to cover so I'll turn the call over to Jim Hackett Orange to begin Jim.

Thanks, Kelly and good morning, everyone.

I don't think I have to revisit everything we face this past fiscal year or in the previous two run unusual times.

During the pandemic, we responded to the unprecedented challenges with winning strategies to manage all the craziness that came with it.

We did so by delivering record results.

Now we're in the aftermath of the peak COVID-19 years facing record inflation supply chain disruption, where in Ukraine, and a steep downturn in the cannabis industry, it's a messy situation.

But here's what I know we get it.

And the leadership team is on it.

We have our organization headed in the right direction my confidence stems from the work we did in the back half of fiscal 'twenty two to improve our cost structure.

It also is grounded in our plans for 'twenty three.

If there was doubt about our willingness to take bold and decisive steps to Orient our company to the realities of today I can assure you we're doing what's necessary to reduce debt and restore acceptable levels of profitability.

I'm optimistic we will remain within the bounds of our bank covenants.

I know youre looking for guidance, Dave Evans will explain how we see the year shaping up in the U S consumer and Hawthorne segments.

We're focused on hitting EBITDA and free cash flow targets in fact, our management incentive program for fiscal 'twenty. Three is based on leverage related metrics for fiscal 'twenty. Two we finished at six times debt to EBITDA, we're comfortable with our leverage trajectory to remain compliant for the first six months and have a clue.

Clear path into the fours by the end of the fiscal year.

The personal goal of mine and Mike look Meyer is to get to four and a half times.

This will position us to move leverage back to our normal levels in the threes by the close of 24.

As for cash flow, we continue to project $1 billion in free cash flow by the end of fiscal 'twenty four it's worth emphasizing that much of our leverage improvement is about timing is the calendar changes so will our leverage we will naturally and significantly delever in the intermediate term.

Our roadmap this year is based on three major themes.

First we're strengthening the balance sheet paying down debt, improving free cash flow and tightly managing operations.

We made significant progress with cost outs in fiscal 'twenty, two and we're making further reductions in fiscal 'twenty three to give us more room to responsibly manage leverage and move us toward our targets.

Second we're confident in the consumer business lawn and garden is a steady mature business that historically is a strong cash flow generator, we emerged from fiscal 'twenty to reaffirming the strength of our brands the power of our retail relationships and continued high consumer engagement these represent strengths and will capital.

Eyes on them.

Third we're remaking Hawthorne, it's not lost on me that this business has been a drag on earnings I want to emphasize that we believe in the future of the cannabis industry and its eventual turnaround there is a huge amount of value that will be unlocked in hawthorne. Once this rebound occurs.

But I also know that we need to overhaul Hawthorne to adjust the current realities and to protect core S. M. G from the cannabis downturn I will explain shortly how we are integrating hawthorne into Scotts Miracle Gro reconfiguring, its lighting portfolio and revamping its organizational structure.

Before I go much further I have a few comments about our fourth quarter.

We did what we said we'd do.

We revised our guidance multiple times last year more than I recall in a single year, but the fourth quarter prove we can be agile enough to make an impact quickly.

We made the quarter, we landed within our EPS guidance, we overachieve free cash flow expectations, and we stayed within our leverage threshold.

It was a good way to end the year and I'd like to think that just the start of a trend I want to express my heartfelt appreciation for our banks retailers and other partners for helping make it happen.

It's been an especially hard six months for our associates and I have a personal message for them as I know many of them are listening to this call.

I want to thank you for your commitment and loyalty. Your resilience is outstanding and will go a long way in contributing to our long term success words cannot express how much I appreciate your support and when we get these challenging times behind us I will not forget all your help and turning around the company.

Now, let's get back to the themes, starting with the balance sheet and leverage improvement.

Our SG&A for fiscal 'twenty, three is budgeted to be below fiscal 19.

We have minimized capital expenditures and put M&A activities on hold.

Our accomplishments thus far can be credited to the cross functional project springboard team, we announced last quarter.

The team quickly achieved over $100 million in annualized savings as a result of extensive actions that included reducing our footprints.

Tightening variable spending and eliminating hundreds of jobs starting at the highest levels.

Our management ranks have been reduced by 35%.

In addition, the springboard team executed asset sales and a large sale leaseback of our Hawthorne facility in Vancouver, Washington to generate incremental cash for debt reduction.

This year Springboards remit is to get our leverage into the fours at the end of fiscal 'twenty, three and into the threes by the close of 24.

Springboard 2.0, as I call. It will help us further streamline reduce working capital and conserve cash we.

We are taking a hard look at how we operate what we prioritize and where we invest we are driving operational efficiencies to the fullest extent.

Amongst springboard to point those focus areas, our inventory reduction, where we expect to realize at least $400 million in cash flow benefit this year by limiting production in selling through current inventory.

And another $85 million and cost outs to be realized in fiscal 'twenty, three and 'twenty four.

The team has so far identified 60 million of this $85 million target.

In addition, we believe we have at least $15 million of benefit from commodities as compared to earlier assumptions.

The majority of these savings will come from our supply chain, including reducing warehouse space company wide enhancing productivity through strategic material substitution that do not impact product quality improved labor efficiencies and resizing Hawthorne operations.

These cost reductions can potentially improve our leverage and give us runway to operate especially given the economic uncertainty.

While indications are that consumer remains resilient and our categories are central to their lives no one knows where the economy is headed.

The greatest economic minds have given wide ranging predictions on what to expect but even if the economy goes into recession history shows that consumers turned to our products.

During the recessionary period of 2008 to 2010, we realized year over year consumer sales increases of 2%, 15% and 6% respectively.

I'd sum things up this way, we are leaner less layered and higher performing we are more competitive and focused.

We will execute with precision and speed for those who know me I referred to a wall Street Journal article from the 19 nineties, where my family's miracle Gro took over Scotts.

The just was how the leadership of the Hagadorn family would bring Thriftiness and an entrepreneurial spirit to the new entity.

These are elements, we are embedding into our culture and the people who are a part of our company must buy into this approach and I'm convinced there will be a better company as a result.

Now, let's talk about my second theme the U S consumer business.

The fundamentals of our U S. Consumer business are strong our brands are everything they are iconic and loved by consumers. We have great partnerships with our retail partners. We have the best sales force and field execution in the industry and we had the leading market share.

Compared to the pre Covid year of 2019, our market share has increased or stayed flat in almost all categories. There are not many brands out there that can boast of brand awareness scores of 70% to 90% weekend.

Consumers are engaged and have a high intent to stay.

80% of the 20 million, new gardeners, who entered the category during Covid continue to be in it a recent federal reserve report on consumer behavior indicated people are emphasizing leisure time and for many this includes time at home.

Our plans to capitalize on these strengths I believe were being reasonable with this year's sales forecast by assuming will be flat in P. O S units in the U S consumer business with the exception of a 10% hike in units and fertilizer and seed which were down nearly 20% last year and represent one of our most weather dependent.

Mrs.

Poor weather was a factor in suppressing early season consumer sales last year in large part due to an unusual polar effect that hit the Midwest and northeast in March.

Current weather models are showing despite the ongoing dry conditions in the west more normal conditions in many of our key markets.

Now I don't want anyone to think we're cutting so deep that we're harming the core business.

We will respect and protect it.

We've heard from our largest investors that this business is as good as they come and we agree we will not take any actions that negatively impacted health or integrity.

In fact, we're investing in lawn and garden take innovation long with tenant of our success. We will continue to drive product development that meet evolving consumer needs such as drought tolerance solutions and cost effective sustainable ingredients with greater or equal efficacy.

We are also continuing to invest in sales and marketing, ensuring our salespeople and consumer facing teams have the tools and resources they need to deliver on our plan.

The key to regaining 10% in the more profitable sales mix of fertilizers in seeds is our strategy to engage consumers earlier at the very start of the season.

We will frontload, our marketing and promotional spend to drive early consumer traffic and augment it with execution at the field level and with the cooperation of our retailers.

Given the economy retailers are concerned about foot traffic, especially early in their fiscal year.

Lawn and garden plays a critical role in driving a high percentage of their overall transactions in the spring or.

Our brands are the catalysts for their early foot traffic and sales.

A third of our annual business occurs in March and April historically, confirming its a critical time to engage with consumers. We also know that consumers who make their first purchase before may spend twice as much in the category.

Our retailers are committed to joint promotions advertising and other activities.

The combination of our media retailer media and price promotion has a three to five time multiplier effect on P O S lift versus promotion or media alone.

Look no further than what we did this fall.

In a two week period, we executed joint efforts on our fall fertilizer business with a key retail partner.

The result was over 50% increase in P. O S units from prior year, a microcosm of what we expect this spring.

I want to emphasize it will be driving attachment with our brands and live goods soils plant food controls to.

It's important to remind you that live goods continues to be a key category for us and continues to grow at rates faster than many other lawn and garden categories.

When consumers buy plants and add products to their cards, they mostly by our brands.

We will undertake promotions and campaigns on the benefits of gardening to inflation.

Inflation is an opportunity for consumers to grow food at home and anticipated product shortage due to drought can further encourage more DIY planting.

I want to address gross margin.

Due to a variety of factors in fiscal 'twenty, two our margin rate declined for the second consecutive year and is now nearly six points below its historical norm.

We expect a further decline in fiscal 'twenty three this is not acceptable.

We have line of sight to meaningful margin rate improvement by the close of fiscal 'twenty, four and Dave will talk more about this in his comments.

We believe we can get gross margin back to historical levels through a softening of commodity costs supply chain efficiencies and productivity improvements with trade.

But if we still have a gap, we aren't ruling out pricing to get gross margin back where it needs to be.

Let's turn to Hawthorne My third theme.

We have a number of strategic levers, we could pursue with Hawthorne, but we've put them on hold until cannabis oversupply issues subside.

Our first order of business is to return Hawthorne to profitability knowing that its long term growth rates are still greater than those of our core business. That's the big reason, we got into this business in the first place.

But for now we've given Hawthorne and aggressive profit goal given we expect sales to be modestly down for the full year, we will get hawthorne's profitability back through cost reductions alone.

I told you last quarter that I believe we could achieve savings of $65 million in Hawthorne. We started work in fiscal 'twenty, two by closing multiple distribution centers selling assets and reducing the workforce.

More cost efficiency efforts are still underway Hawthorne will operate as a business unit much like our lawns gardens and control business units.

This will allow us to capitalize on the synergies of the parent company and significantly drive operating efficiencies.

We will absorb hawthorne into Scotts Miracle Gro in a manner that preserves its unique culture and core strengths because we believe in the business model and its long term potential.

Customer facing teams will continue to work directly with hydro retailers and growers.

No other company can do what Hawthorne does.

We are the partner to growers, we understand their challenges and we have the products and solutions to help them be more efficient productive and successful. We also know as does everyone else in this industry that things are beyond tough.

Many players are just trying to survive overs.

Oversupply, along with inconsistent state regulatory approaches and a lack of federal action on safe banking too witty E and other issues are contributing to the prolonged downturn.

This is what I have to say directly to our Hawthorne customers. We are not abandoning ship, we are tightening up but not giving up will ride this out with you and be ready for the market when it rebounds and it will.

The U S cannabis industry matters.

Economic impact on the American economy is nearly $100 billion. This year and is expected to rise to 158 billion by 'twenty twenty-six.

It supports just over half a million fulltime jobs.

And more people are consuming cannabis with expectations of around 71 million consumers by 2030 more states continue to legalize it in some form.

Thinking about the immediate opportunities ahead for Hawthorne, you can expect us to continue to innovate with Cavite and capitalize on the upside of the agro Lux Wigger L. E. D technology that we launched in early 'twenty two for the professional horticulture space.

In the short time since its launched the waiver has delivered over $60 million in new pro Horton sales and catapulted its market share any early D greenhouse growing space.

Tightening up Hawthorne includes rationalizing the lighting brand portfolio.

We will exit a high pressure sodium and high intensity discharge lighting to focus on Leds, where this industry is moving because of the energy and cost savings the.

The business community as well as consumers are increasingly focused on sustainability and this fits with where things are headed.

We will also exit the Lux brand as a continuation of the portfolio reduction that began this summer with the sunsetting of Sun systems.

When we acquired Luxe the cannabis market was in a much different place.

Our strategy was to expand upon our industry, leading davita brand. The Lux team improved our marketing savvy to growers with incredible Influencers and broadest technologies that can be integrated into arc of EDA offering, but we believe the wager can be the mid tier option as a replacement to Lux.

I'll now address a few elephants in the room My family is the largest shareholder in this company. This is more than a job for me. This company as my family legacy I've been part of this business most of my life and I will do what it takes to set this company up for ongoing success and long term shareholder value you have my commitment.

I will and have been making tough choices I will do what is required.

Regarding the dividend we have no plans to touch it based on what we see today the.

The truth is that cutting the dividend entirely or even by a percentage does not move leverage that much.

We've heard feedback from investors around this topic most of our largest shareholders have told us in clear terms that we should not cut the dividend unless absolutely necessary and here's what I think about issuing more equity based on our current view I do not believe it will be necessary as always we will evaluate our options and do what is.

It required rigor.

Regarding the concept of selling assets, we've looked at it and we'll continue to do so but given the circumstances and other considerations, it's not optimal for our company right now our board will explore these kinds of opportunities on an ongoing basis and determine if and when it's in the best interest of our company and shareholders.

Yeah.

One final item is an update on our search for a permanent CFO .

We are focused on external candidates, who are innovative thinkers have deep experience and are capable of working with our team we are close to making a decision.

I want to thank Dave for stepping in from the board I asked him to serve as interim CFO because he knows our company well and is a talented financial operator.

He has brought tremendous value and provided the financial leadership our company needed in this transition period.

I know, it's come with a great deal of work and stress.

Words cannot express my full appreciation for his partnership and support a.

I'll close with this week.

We continually talk to our largest shareholders and take what they say to heart.

We are making changes across the organization in creating stronger conditions for the success of our core business. In addition to re imagine and Hawthorne.

At the same time, we're highly confident in our brands and that of the consumer we have embraced a reality and evolved accordingly, Dave I'll now turn it over to you. Thank you.

Thanks, Jim.

I'll take a deeper dive into the P&L and balance sheet for fiscal 'twenty, two and provide direction for fiscal 'twenty three.

As you likely know this is my second time stepping into the CFO role Scott.

My previous experiences and relationships.

I mean, he hit the ground running.

It's clearly been a challenging time for the business, but over the past two months I've been here, it's been inspiring to see the commitment and dedication of our associates I understand the predictability and credibility in our financial projections are important drivers of our market performance are repeated changes to guidance in fiscal 'twenty, two and the late summer.

<unk> to free cash flow, primarily resulted from the unexpected and sudden volatility in the U S consumer market and the pace in which we reacted driving down costs and implementing operational changes.

We're bringing more rigor to our sales and cash flow forecasting and improving processes to better translate changes and operational assumptions to balance sheet forecasts.

This is imperative when running into constrained manner.

We can now better assess our position at an early stage and respond in a swift and coordinated manner.

Moving on to results.

U S consumer sales were down 18% for the quarter ending the year down 8%.

This was in line with our fiscal year guidance of down 8% to 9% I'll spend a few moments on this as it is particularly important context for fiscal 'twenty three.

The 8% decline in fiscal 'twenty, two sales was driven by a 15% decline in volume and mix.

Offset by a 7% benefit from year over year pricing.

The 15% decline related to volume and mix is a function of unit volume declines across most categories.

The most pronounced in our most weather sensitive categories lawn fertilizer and grass seed.

It also reflects a challenging year over year comp where in fiscal 'twenty. One the retail channel ended the year at a heavier retail inventory position than it started.

The 7% benefit from pricing reflects the cumulative benefit of actions taken in August of 'twenty. One in January April and August of 'twenty two.

We've been making every effort to manage the value equation with the consumers by minimizing price increases.

While at the same time attempting to keep pace with cost inflation.

Transitioning to Hawthorne.

Sales were down 49% for the quarter the.

The entire cannabis industry is under immense pressure due to oversupply limited enforcement and inadequate public policy.

As expected the overall run rate for Hawthorne improved slightly in the fourth quarter driven.

Driven by innovation and our horticulture lighting business.

Jim talked about wager, our new led product that drove the improvement in sales in the fourth quarter.

The rest of the Hawthorne portfolio experienced a decline in the fourth quarter similar to what we realized in our third quarter.

The fourth quarter results put Hawthorne full year sales down 50% compared to fiscal 'twenty one.

Moving on to gross margin rate the adjusted gross margin rate for the quarter was about 1400 basis points below last year, which brings the full year decline to about 400 basis points.

In line with our expectations.

Just like we mentioned in the third quarter, the largest driver of the fourth quarter gross margin decline was fixed cost deleverage stemming.

Stemming from the volume Miss in both segments.

Warehousing and manufacturing costs are largely fixed in the short term and these fixed costs are spread over fewer units in the quarter on.

On a full year basis fixed cost deleverage was also the largest driver of the decline in gross margin rate. This.

This was fairly punitive in fiscal 'twenty, two as both sides of the equation moved against us.

Our sales volume was clearly down but at the same time, our fixed costs grew as we expanded our supply chain footprint and inventories.

As we've reported all year rising commodity costs also impacted the gross margin rate.

The inflation, we've experienced has impacted us across the board on every commodity repurchase our top raw materials, all saw double digit increases for the year some in excess of 40%.

We've been consistent in our approach to managing this record high inflation.

Our pricing actions have been designed to offset the dollar impact of commodity inflation, but not necessarily rate.

Similar to our third quarter results SG&A was down 27% in the fourth quarter versus last year, leaving us down 18% for the full year. This.

This result was slightly better than our latest guidance drew.

Driven by continued momentum from springboard initiatives.

The three key themes driving the SG&A savings in Q4.

Are the same as what we shared last quarter.

Set of compensation.

Count restructuring and spending reductions adjusted.

Adjusted EBITDA for the year was $558 million down from $903 million in fiscal 'twenty, one the combination of lower EBITA.

And higher borrowing levels resulted in a leverage ratio of about six times debt to EBITDA at year end.

Though this amount of leverage was expected, we're clearly unsatisfied with the results.

I'll discuss our leverage outlook and my comments are in fiscal 'twenty three more.

Moving down the P&L in fiscal 'twenty, one we acquired a 50% equity interest in Bonnie plants.

Leading provider of live vegetables, herbs and fruit bond.

Bonnie's 2022 fiscal year finished in July .

The first month of our fourth quarter.

Bonnie sales saw a late surge in lands are down only 1%, however, Bonnie experienced high inflation across their entire cost structure, especially in their fuel costs that began to increase during their peak selling season.

They did not have visibility into the full extent of their cost increases and time to adequately adjust their pricing and SG&A costs.

These cost pressures translated to a $13 million loss in equity earnings on our P&L. The Bonnie team's working hard on our plan for fiscal 'twenty three to address their overall profitability no different from us.

Jim covered the operating changes that were making in the Hawthorne lighting category.

Sunsetting H B S unlocks to focus on Govinda L. A D resulted in an inventory and intangible asset restructuring charge of $110 million for the quarter.

We also recognized additional net charges of $19 million, which primarily consisted of employee termination benefits and other restructuring activities stemming from the continued efforts of project springboard.

Below the operating line interest expense was $13 million higher in the quarter and $39 million higher for the fiscal year. The change was driven by higher borrowing levels.

Our full year adjusted effective tax rate landed at approximately 22%.

The favorable rate is due to a benefit from discrete items related to the vesting of long term share based compensation on.

On the bottom line, we had a GAAP loss per share of $3.97 in the quarter.

Impaired to a loss of 86 cents last year.

The number includes the impairment and restructuring charges that I described earlier.

non-GAAP adjusted loss per share, which excludes impairment restructuring and other nonrecurring charges was $2.04 in the quarter compared with a loss of 82 cents a year ago.

This brought our full year non-GAAP earnings per share to $4.10 right in line with our latest guidance.

We ended fiscal 2022 with negative free cash flow of $243 million.

Better than our latest guidance of negative $275 million to $325 million.

There were two primary drivers of the negative cash flow.

First inventories were up $200 million or nearly $300 million when excluding the Hawthorne inventory write downs.

The increase was driven equally by additional physical inventory quantities and higher commodity costs.

Inventory was trending higher going into the third quarter.

But the operations team quickly adjusted their raw material purchases and production plans.

This quick pivot enabled us to limit the inventory increase for the year.

The second driver of negative cash flow was a decline in accounts payable of approximately $170 million. This decline was a result of the change in purchasing and production plans that we just covered.

Fewer purchases in the third and fourth quarters translated to lower accounts payable at year end I'll switch gears now to our outlook for fiscal 'twenty three.

As we look forward to fiscal 'twenty three.

Our primary objectives will be to generate strong EBITDA and cash flow and to strengthen the balance sheet.

While maintain quarterly compliance with our credit agreement covenants. Since these are our primary objectives my comments for fiscal 'twenty three.

Center around these metrics.

Jim has provided justification for optimism in our U S consumer business.

Starting with consumer purchases of our products at the store shelf.

Fact that our products perform well in the last recession.

Combined with discrete and incremental marketing promotional programs.

Both ours and retailers and an assumption of more normal weather in the spring supports cautious optimism.

But theres also significant uncertainty surrounding factors, we don't control.

To the positive household still appear to be in good shape and spending at a healthy clip, but inflation is at a 40 year high and taking an increasingly larger toll on household income and savings.

And within that broader context, we've taken significant price increases across all of our categories.

Transitioning from consumer purchase activity or P. O S. Two hour sales.

We are confident in our retailers commitment to the category.

We've made informed macro level assumptions relating to their inventory positions next year.

But can't anticipate with certainty external factors, which may influence their decisions 10 months out.

And as it relates to pricing we successfully executed the August 1st price increase as described on our third quarter call.

We now expect the net impact of year over year price increases to be high single digits.

Roughly offsetting the dollar impact of increased commodities.

More on commodities in a moment.

For Hawthorne sales.

We're making the assumption that we have reached the industry trough in the fourth quarter anticipate sales at the start of the year to mirror the run rate we ended with in fiscal 'twenty two.

We expect this to be followed by a seasonal increase in the spring.

Followed by year over year growth in the fourth quarter as the industry slowly recovers.

As you're all aware the lack of visibility into this market makes it challenging to declare the trough with certainty.

All of these factors and assumptions in aggregate.

Lead to an expectation of low single digit percentage growth in consolidated net sales in fiscal 'twenty three.

Moving down to gross margin rate, we see two primary headwinds in 'twenty three.

Increased year over year commodity costs and reduced fixed cost leverage we expect these to be partially offset by cost savings initiatives driven by springboard.

Approximately two thirds of the commodities that will run through our P&L in fiscal 'twenty three have either already been purchased.

Manufactured or hedged.

And with three years of rising costs.

A third of our cost of sales are now driven by assumptions subject to market forces.

While our assumptions for fiscal 'twenty three are supported by balanced market insights.

Some uncertainty remains.

That uncertainty risk or opportunity.

Will manifest itself in the later stages of fiscal 'twenty three.

Given inventories currently on hand and hedges.

Certain commodities examples being resins pallets in the international freight have slightly.

We moderated in recent weeks.

Those trends may not extend to our larger inputs related to fertilizers and energy derive products given the uncertain global environment the.

The second headwind relates to reduced fixed cost leverage which in fiscal 'twenty three is a function of lower production.

We ended fiscal 'twenty, two with consolidated inventory of $1.3 billion net of reserves.

We expect to exit fiscal 'twenty, three with a decline of at least $400 million.

To help drive this reduction will be producing less.

Which will result in fixed cost deleverage.

We expect these to gross margin rate headwinds to be partially mitigated by springboard supply chain initiatives.

These initiatives include right sizing our supply chain footprint.

Product rationalization efforts principally in Hawthorne.

And improved labor efficiencies.

Mix should also benefit us in 'twenty three.

All of these factors combined will result in net decline in our consolidated gross margin rate in fiscal 'twenty three.

Moving down to SG&A, we expect a year over year decline more than offsetting the impact of inflationary increases and the potential for reinstating incentive compensation the.

The decline will be driven by springboard initiatives spa.

Speaking of springboard as Jim discussed.

Springboard 1.0 yielded more than $100 million of improvements.

We're targeting an additional $85 million and our two point O initiative.

While we're still in the early days, we've already identified discrete initiatives to realize more than two thirds of this target.

The majority of the benefits identified to date relate to supply chain initiatives that Jim and I previously discussed.

Summing up the collective assumptions for revenue gross margin and SG&A.

We are committed to delivering low single digit percentage growth in adjusted non-GAAP operating income.

Adjustments from operating income to EBITDA are expected to be about $25 million higher in fiscal 'twenty, three and fiscal 'twenty two.

Primarily due to increased depreciation and a change to pay short term variable compensation. If targets are achieved mostly in shares rather than cash.

Below operating income, we expect interest expense to increase $35 million to $40 million.

The increase is being driven by higher interest rates, partially offset by lower average debt.

We expect our effective tax rate to be 25% to 26%.

And share count to modestly increase.

We remain committed to generating $1 billion in free cash flow over the next two years.

Leverage will remain elevated over the next two or three quarters.

However, given the normal seasonality of our business our credit agreement Amendment allows for a step up in maximum leverage from six to five to six five times debt to EBITDA for the second and third fiscal quarters.

With properly quarterly pacing of our initiatives and assumptions, we will remain below the maximum level stipulated by our credit agreements.

As Jim said in his comments, we are targeting to reduce our debt to EBITDA ratio into the fours by year end well.

Well this is not our traditional format for guidance.

This is also not a traditional year for both internal and external factors.

In summary, we've been diligently assessing each of these operating variables and implications to our fiscal 'twenty three plan.

We continue to take actions to mitigate risk and solidify our position going into next fiscal year and beyond.

And the direction, we provide for next year.

Is aligned with our priorities.

Strong focus on EBITDA and cash flow stream.

Strengthen the balance sheet, while maintain compliance with our credit agreement covenants.

Now I'll turn the call over to the operator for your questions. Thank you.

Excuse me, we will now global cross selling efforts.

To ask a question you May press Star then one on the telephone keypad.

You are using the platform.

I had said before pricing the key.

So we try your question please.

At this time, we will pause.

Okay.

Our vote.

And our first question.

Women.

Wait.

Okay.

Good morning.

My first question.

Is with regard to inventory levels at retail and pre season orders I know last year, we came into the year heavy can you give us a little more color on where they are right now and I think last time, you had last quarter, you've been optimistic that since P. O S is pretty decent that we'd have a.

A pretty decent pre season order did that shake out how you expected it to.

This is Mike look Maya.

Season order is pretty well fixed to about the same level of build as we did in the previous year. So it's really not pass base, it's really about.

Being ready for the season to break so we look at the same levels of shipments.

Basically as we saw last year, but.

But I'd say, we came out of the year Bill.

Down slightly so I would call it a tailwind on inventory.

And I think a.

Pretty significant commitment to next year and that build has already started so I think.

Sort of in line with what we wanted.

And not an inventory problem exiting the year if that answers the question.

It does.

And then one follow up with regard to your input costs. It seems like some some of them have come down some remain relatively elevated you just pushed through a relatively large price increase.

Historically I know you guys didn't do a lot of N season price increases do you feel like the environment is such that if your input cost did rise throughout the season that you would have the ability to go back to retailers with subsequent price increases.

I'll I'll I'll sort of take the beginning and then see who if anybody wants to add to it.

So hagadorn here.

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First the answer is yes.

And so that that's the big headline.

And it is true that we have not done you know I think maybe in my entire time here. It's of onetime other that we took in season pricing and I don't think we've ever taken more than two increases during our seasonal year.

You know I think that you.

You know I listen I'm not into the self criticism exactly except that.

I think we've been pretty decent at covering our sort of dollar cost. The problem is that's been pretty dilutive to our margin.

Over the called last year plus.

And so.

I think were still there was a good article last couple of days and at times, just about large branded companies and sort of trying to remedy sort of.

Similar issues, where they've gotten behind on margin with what's clear to me is that you know gross margin is our fuel we need it.

We are a consumer branded company.

And we need that for our own activation efforts plus we help the retailers fund their efforts and and so when we get behind on it like we've done I think it's pretty bad now the other side of that.

I've talked to most of our large retailers in the last week at the very senior level, so either at the CEO .

And or the.

Now the merchant teams.

<unk>.

I think there is.

A concern and I don't I don't mean this in a bad way. It just means that nobody really knows what to expect from the consumer and the level of sensitivity to pricing and I think this is the great question going into 'twenty three not just for us but for other branded good companies is what is that balance or you know what.

People would I guess call elasticity.

We don't really know.

And.

So we're going to have to sort of deal with this sort of sensitivities that people have on what can the consumer bear, but you know I would say that the work we're doing.

<unk>.

I aim and I've I've told folks here that this is not optional we need to get as quickly as possible.

Back to historic margin rates and they've actually if you go back Dave done quite a bit of work on this.

They are pretty stable with us and higher and so if we can't get back there through our efforts.

Then we're going to need to.

Deal with pricing I think it's very much fair for retailers to say you guys do with your stuff first before you expect a sand or the consumer to pay for margin issues, which a lot of which are driven by cost of goods, which we think will soften we hope.

This.

Our forecasting tells us that.

And then other things that Mike and his crew, we're doing within the supply chain to take cost out of the system.

But if we can't cover that gap, we will come back for pricing is just that important for us Dave not Kim I can keep just stated it perfectly right nothing.

Nothing more to add Mike anything you'd I would agree with that so.

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

Thank you Sir.

Yeah.

Our next question comes from Jay.

What J P Morgan.

Thanks very much.

Right.

Just three brief questions.

Your deferred taxes were negative 183 million. This year why is that and what might they be next year.

Second.

Do you have to drop your production roughly by 10% next year to hit your inventory target.

And then lastly can you analyze your increase in interest expense of 40 million that you forecast and if you do break your covenants.

What happens to incremental interest expense.

Alright, let me start here or reverse yeah.

Hum.

Well I mean, so deferred taxes grew.

A bit this year.

You'll see our effective tax rate was also kind of unusually low this year.

The biggest single factor driving the change in deferred taxes was the impairments we took this year.

So clearly as we begin a new year, we're not anticipating Warren impairments. So I wouldn't anticipate a similar type of change in the balance sheet next year on our deferred taxes.

The second question was on production.

Yeah, well, so we are targeting.

A minimum of $40 million reduction in inventory this year.

And that will be driving a reduction in our production forecast.

And the reduction in the order of magnitude.

Of 15%.

So if you really got to look by yesterday really super broad number ive to look at and understand for each major product category because the percentage of fixed costs is different whether you're looking at or lawn fertilizers or growing media, it's a whole different type of model.

But broadly to answer your question about 15% reduction.

The third question noninterest expense.

Yes, so interest expenses.

Is up.

Significantly from 'twenty, one to 'twenty two we see a further increase from 'twenty two to 'twenty three principally rate driven.

On a year over year basis, we would expect here.

Our average debt to be down.

In September 30 of 'twenty three relative to 'twenty two.

So it is principally rate driven.

As we said in our scripts we anticipate.

Given the broad array of assumptions.

We've made.

That our EBITA and debt levels will allow us to navigate the covenants throughout the year.

But I would also say that where we're not and we are prepared.

That it changes would occur during the year, we also won't be caught flat footed.

Does that answer your questions.

Sure.

So if the covenants were broken.

Would that do to your interest expense.

Well I've got to drive them down.

Yes.

We're going on the basis that we're not going to break a covenant because because we've got a plan that either we believe our plan won't result in that and should shut it will should we find ourselves down. The road then we're readily prepared to ensure we don't break any covenants or taking other actions.

You said that you would generate about $1 billion of free cash flow over the next two years.

Can you do a split.

What what's in 'twenty, three and what's in 'twenty four in rough terms.

Yeah, we're really not look I'm going to I'm going to be fairly and precise on this.

Because there's so many changing variables, but I would say what youll see is that 1 billion clearly will be front loaded to 'twenty three.

Because a good portion of that 1 billion relates to inventory reduction.

So provided we achieve our operating plan the sales and the production plans that we have today, we would see a large majority of that happened in this fiscal year.

Great. Thank you very much.

Welcome.

Our next question comes.

Carla Casella with JP Morgan.

Alright, Thank you and bill and get back at it.

Some of my questions already and specifically on that cash flow, but have you said how much of the billion cashflow. It's from the working capital release alone and is it mostly just inventory or do you see.

It increased from the payables as well.

Look when we look over a period of two years.

We think anywhere from 40 to up to 50% of the 1 billion could come from.

Inventory reduction.

We would really anticipate working capital.

To move fairly in line with with our volume.

Okay, great the second and third quarter, then weighted as well.

And for certain we would see our inventory book will start to see a decline in Q2.

But then we should really see the big decline in inventory in Q3 and then.

Q4.

You're not going to see.

Any meaningful change in inventory from September 30 to December 31, as we prepare for the season.

Okay great.

And then you did that sale leaseback at Hawthorne and you maintain it sounds like you're not looking to do asset sales right now, but you could consider in the future and I'm. Just wondering can you just give us a sense for what are your and the biggest chunk of assets that you could look through if you need to in the future.

Yes, Carla it's great question, and I would say that.

That we've done a fairly exhaustive review.

Of our assets to try to identify potential opportunities.

And.

You know the sale leaseback was actually executed in the late summer months.

That was actually a facility that we aim to get out of it in kind of the near to midterm anyways and so what we effectively are able to sale leaseback is accelerate the cash benefit to.

To move that to today.

In general we're not on a broad brush basis looking to kind of sell in.

And just refinance or assets that are core to our business. This was a kind of a different situation.

We are looking at other assets that are core to our business and we've taken some other modest actions to divest those but nothing that's individually significant.

We've talked in the past about other assets, we have and I'll just give you the assurance.

That management and the board are looking at all of those.

You know things are commonly come up her Hawthorne Bonnie plants, and I would just say that as a team we feel very committed to those assets at this point, we feel that there they're critical to our strategic vision for the future and we also feel that when we looked at the amount of value that we can get into.

<unk> market and the speed with which we can monetize them really didn't make them attractive opportunities for rapidly delevering your balance sheet.

So you know I think the message is twofold, one we did an exhaustive review.

To the conclusion of that is at this point today, we don't see any big items, we're looking at smaller items.

Okay, and then so do you own aside from the broader like brand assets to own most of your or any of your distribution warehousing manufacturing facilities that might be.

They are available.

For Sally back.

Differentiate distribution, primarily if not wholly leased leased manufacturing is.

Look with contract produced some of our some of our items at the vast majority we produce and what we produce its own right.

Okay great.

And then if I can just a follow up on you talked about fixed costs and lie about fixed cost leverage and deleverage.

Can you talk about what what what how you look at this now and what percentage of costs are fixed or I mean, given that so many of the other costs are moving around given commodity input.

Maybe is there a way to look at a dollar amount of costs that are fixed.

Central to compare versus the 85 million in savings you expect to generate here from project springboard, yes.

Yeah, just like in broad strokes.

I would say in the near term.

30% to 35% of our production asset of our manufacturing and distribution costs are fixed.

But that's a very near term look because through springboard. We're looking at effectively we're addressing everything as if it were variable and we're attacking these these items and in part that's why some of our springboard savings.

Wont even be realized entirely in 'twenty three because to the extent that we're addressing these near term fixed cost is longer term variable cost, we are resizing that supply chain footprint and reducing some of those costs.

Is that okay.

The rest of your question Paul.

Yeah that'll help wonky in the 35.

Production increases.

Integration effect, that's mostly than cost of goods sold.

Yes that would be embedded within our cost of goods sold.

So that is like our manufacturing facilities would be an example of that.

Okay, great. Thank you.

Our next question comes from Eric Wold.

<unk> with Cleveland Research.

Good morning.

Hi, Eric.

Alright.

Two things if I could first of all the 5% EBITDA.

Growth guidance for 'twenty three.

I'm, just trying to understand sort of what the key.

Key pressure points are the key drivers to support that gave you a pretty clear about the.

15% production cut and there's obviously also higher cost still embedded in inventory that you're working through.

I understand springboard on the other side provides benefit to this.

I guess as I look through it.

The consumer demand your guidance on sales and prices seem like.

Those are the key variables are achieving that 5% EBITDA growth.

Is that the right way to think about that or how do you think about the key.

<unk> and get into that 5% EBITDA growth guidance for 'twenty three.

Well I'll start and hand, it over to Dave I think that.

The sales assumptions.

And the springboard savings are probably the things that are what are being worked the assumptions on sales at least I think from.

From our point of view and.

Again, I talk this through with with retailers.

We just looked at last year, Eric as being.

Just a pretty tough year.

We had a approach on our advertising is I think.

Most people are aware.

That.

Not to do the sort of heavy early season like we're going to be doing this coming year.

And work more when the weather's good we spend the advertising we activate and we do this all based on sort of two weeks ahead kind of look at the world, which was a much more real time approach to sort of.

Promotion at the retail level.

I was having a conversation with the retailers last night.

And it was.

If were sniping kind of and how we marketed previously it felt like we came home with not having hitting any bad guys and what all of our ammo stone are sort of containers, we just didnt get clean shots.

Last year and that was California.

Texas again. This is so easily check that I don't think I'm, saying anything that most people don't know teck.

Texas was very cold kind of until it wasn't.

<unk>.

The Midwest and northeast.

A polar vortex sort of on forecast.

Hit us in sort of.

Late March and didn't really warm until.

Towards the end of April .

So when we look at the forecast and we say flat to last year and we get half of the decline back in launch, which we think was like their core season was really you know how important the Midwest northeast as to our long for and Texas for that matter to our lawn fertilizer.

And so we don't get that back we get half of what we missed and we think the forecast is good for that we think that retailer collaboration and I mean this in the at the deepest level and I am like.

Really thankful for the positive attitude of our retail partners. In this that is very motivated to make the seat I mean, I think everybody is.

Prehensile.

Just because of all the chatter.

On the economy, but I do think that they are highly committed in a very positive way and we all want this to to work. So the work between our marketing group our sales group.

Merchant teams at the retailers.

It couldn't be better.

And so we think that it's a fairly conservative forecast this gets back to the sales, but I think if.

If you know if Dave was.

Sort of doing magic on me he'd say.

Yeah, but it's it's still you know.

That was a lot count is counting on that there is.

And look Eric or where I'm a lot on this.

Before Dave.

Handcuffs me here.

Great.

Getting through the first half, which is really inventory load for us on the sales side.

Is kind of everything for US right now at least for me.

It gives us room, we naturally delever at that period of time.

And.

We don't really count on anything from the consumer at that point, it's just get the load in the retailers are motivated we're motivated it's kind of all I think at that point, it's going to be the second half of the year is going to be.

That half year that it's all about the consumer and so you know.

I'm, just trying to get there and we'll know.

At that point, where the consumers that whether it's Dave said it was <unk>.

Who knows but I wanted to just get back to springboard, then which is the other side of it you can go ahead, yeah. So look so I think I think tightly in and in the end here.

The team has built tremendous plans to give us confidence in the top line for next year, but as a CFO I'm, saying, yes, but I want I want to add some hedge against this.

So I go back to springboard is kind of our insurance policy.

And I'd say springboard, we're doing the right thing for the business to exit this cycle as a stronger better leaner company, but it's also getting us more insurance and I just want to emphasize that I've been extremely tough on the team here with springboard that Eric E springboard savings, they're real you.

You will see them on our P&L. If you look at the $100 million that we took in springboard 1.0, and you look at the 21 P&L twenty-three P&L you'll find those this isn't just some we're offsetting inflation.

Minimizing the rate of increase these are real reductions at the same time I'd say, what we're committing to in the next 85 million of which were well along but we still have work to do those are real savings.

That to me it takes a little bit of a herd edge off of.

If we're just slightly off on the top line.

Because of this uncertainty we've got some insurance against that and that's why specifically not providing detailed guidance on sales margin SG&A, because we're going to manage down to EBITDA.

And when you take out insurance wearing it.

It will offset some some some risks if they in fact do come.

Okay can you.

Can you just square for me you talk about a conservative forecast.

You talk about the consumer that's apprehensive.

And then the guidance assumes.

I think seven points of pricing U S consumer in 'twenty, two and another seven to $9 23.

It it seems like the pricing assumption for an apprehensive consumer.

Is optimistic.

Some of your perspective on that if you would.

Hi.

What do I think.

<unk>.

I didn't know this question would come from you, but like you know I I figured in the shower. This morning, it would come from someone.

<unk>.

And I can tell you last night.

Was it.

Really great night for me.

I got out of this place I went and visited with the very senior members of one of our most important retail partners.

The apprehension for sure is there and I think you can read it anywhere you want but nobody knows the answer to that you know we took pricing in last summer I think thats, our only tranche of pricing I think youre, saying when does it show up.

<unk> products will be more expensive, but I think products are more expensive.

Anywhere you go and that's really the issue which is not just us.

The problem with our pricing Eric as we've covered our dollars pretty well it has been pretty significantly dilutive. After all this time on our margin rate.

And.

For sure products are more expensive and they are with everything a cup of coffee a gallon of gasoline.

Kilowatt hour of electricity.

Natural gas I don't care, what it is.

That's the world we're living in.

We didn't take enough pricing to cover our margin percent.

So should everybody be nervous about it I guess, but that's really.

The world, we're in and we're not unique there.

Does it involve some you know I think moderate risk.

Yes, we're going to be.

Promoting significantly harder going into next season, we are going to be.

Promotional we levered with our retail partners and so people will get value.

Relative to sort of.

Sticker price.

Lots of things are happening that I think will sort of offset that and I think we look at this and say somebody buys a bag of fertilizer and it's a couple of bucks more expensive is that enough to not do it we did not see a shift to private label.

And.

Davis, writing me a note just to throw it out there.

Oh, eight to 10, which is.

<unk>.

During the last recessionary period people were driven toward.

Cheaper home improvement projects relative to cabinetry, and appliances and all the other expensive projects people could do so.

Look I think we have a reasonable history to look back of I think we look at our products and say.

You know when people buy something once or twice a year does it and it's more expensive is it enough not to buy it I don't think we have history on that.

But we're going to know.

Sort of seven to eight months from now.

Okay.

Fair enough and then.

That's fair enough I understand that last just housekeeping item for date, the EBITDA growth is that pretty consistent through the year.

In order to sustain the leverage ratio, where you are now or is it more back half.

Loaded do you mean do.

Do you mean, the delta between operating income and EBITDA or do.

Do you mean.

I assume that sustain the six X leverage youre at now through the year, especially through the first half were leveraged normally increase that's inherently it won't this year.

The math I think suggests that the EBITDA growth quarter to quarter has to be.

Consistent each quarter has to show some degree of EBITA growth am I thinking about that right or am I missing something.

Aircraft you are looking at it away.

I'm not sure I can answer that live on this call here.

I just haven't looked at it that way.

I can just tell you that EBIT growth that we have.

Built in our plan as is.

Today, I mean were not presenting a plan that says we're going to be in default.

We are presenting at plants as we will be in compliance, but I also don't think we're saying it stays at six either I think it stays within a six month quarter in six and a half limits that we have with our bank. Yes, that's exactly right. So so look it's kind of it's going to hang north of six around six.

Till we get to the third quarter of the season.

And I'll, just remind you that our leverage.

It goes up to six and a half starting starting next quarter. So we'll get a little bit more room here in Q2 goes to six five.

So that's the answer okay.

Thank you. Thank you.

Our next question comes from Chris Carey with Al firewall.

Hi, Hi, so just.

Just two quick ones for me.

Is the POS numbers that you put out there flat is that a volume number or is that a value number and then I can't quite tell or are you basically saying P. O S flat and you'll see how inventories shake out you can't really predict that from a shipment standpoint, you can.

Now what we're saying is this.

Yeah, Chris let me try to answer that.

If youre talking about 23, when Jim referred to in his script flat or plus 10 in first in seed he's referring to Pos.

And it's Pos units.

Okay. So then if you go back and kind of read my scripting and I was trying to kind of translate from <unk> units to.

Our sales by that incorporating in assumptions regarding retailer inventory and pricing the other elements of that.

Does that answer your question Chris.

Sure.

I assume it does.

Operator.

Excuse me, Chris Carey you May proceed.

Hey, Chris you Stiller.

Alright next question please.

Okay.

This concludes our question and answer session I would like to turn the conference back over to Pat Barry for any closing remark.

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

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

Okay.

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Yeah.

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