The Scotts Miracle-Gro Company (SMG) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the UBS Global Consumer and Retail Conference here in New York City. My name is Peter Grom. I'm the UBS U.S. Beverages and Household product analyst. And we are very excited to have joining us this morning from The Scotts Miracle-Gro, Chief Financial Officer and Executive Vice President, Matt Garth. The past few years for Scotts Miracle-Gro has been volatile to say the least, with the company seeing outsized top and bottom line growth during the pandemic with performance recently a bit more challenged as a result of demand normalization across a number of different categories, outsized cost inflation, inventory dynamics, a whole slew of things. And I know the path forward remains a bit uncertain here, but there does seem to be a higher degree of confidence that Scotts can emerge on this. So there seems to be there's just a view ties kind of light at the end of the tunnel. So we have a lot of ground to cover today. I have a series of questions that I plan to run through for roughly 35 minutes of the 45 minutes we have here today. And then the last 10 to 15 minutes, we'll kind of open it up to audience Q&A. I think you all receive questions on how to submit questions more on they will kind of show up here on this iPad. [Operator Instructions]. Before we start, I'm required to read a legal disclaimer. As a research analyst, I'm required to provide certain disclosures relating to the nature of my own relationship and that of UBS with any company on which I express a view on this call today. These disclosures are available at www.ubs.com/disclosures. Alternatively, please reach out to me, and I can provide them to you after the call. Scotts would also like me to remind everyone that they may make forward-looking statements based on their current plans and assumptions. Forward-looking statements are not guarantees of future performance and actual results may differ materially. As such, please familiarize yourself with Scotts' full range of risk factors, which can be found in the quarterly and annual filing reports with the SEC. So that's a lot.

So with that, why don't we start? I mean, so I guess you've kind of been in the CFO role for a few months and I know investors are becoming more familiar with you. You've been on the road. You've done a few of these conferences. But I think it will be helpful to just kind of get a sense of kind of what attracted you to Scotts especially kind of just given the point of uncertainty that the company was at a few months back.

Yes. And I really appreciate. First of all, thank you, everyone. Love being at the conference. Love this format that we give to it informally. So thank you for that. I also appreciated how you entered the conversation for the company because we have been through a period of challenge, what I'll call, which was explosive growth and investing to maximize the value creation during that explosive growth period. Turning very quickly to post pandemic, where the tables turn to getting the balance sheet strength and taking out costs and making very determined actions to get there quickly. I've come in -- I want to say, after the team put in very firm foundations to creating the necessary steps to capture those cost savings to capture those interim value creation opportunities while repairing the balance sheet. And so I am very blessed to have had a lot of that work already done or in the process of being completed. So as I was looking at the opportunity, I said the market, I don't think really understands the story, and there's probably more negativity than in the story and what investors perceive than there actually is with what the company is doing on the ground. All these great activities, everything that underlies SpringBoard and the connectivity of springboard to the shop floor to the boardroom, it is just unbelievably linked. And so the power of that was evident to me in the interview process, but you probably know this by now, I'm a lifelong Scotts customer. I am a avid lawn and gardener. And I use the products. And so when the opportunity came up to match sort of a personal passion with professional capability skill set, I don't want to say this is my first rodeo, but I've been through a number of company situations that are similar to this previously and navigating with the banks, with investors to show the future value capability of the company, I felt very comfortable with. So personal passion, professional passion, all meeting and the upside to it is my daughter is a freshman at Ohio State University. And so I get to see her more frequently much to her so grin.

There are a few football games in there. I'm sure it's a -- so I guess starting with the U.S. consumer, I would love to just get some long-term perspective. So Matt, a little less than 2 years ago, the company held a virtual Investor Day that was kind of outlining the growth objectives. And I think 1 of the things that was really emphasized a couple of years ago was just kind of how the view of the growth trajectory of the U.S. consumer business has really changed, right? I think at the time there was just new interest, millennials having greater interest in the category, household formation. And I think the view was that it was the U.S. consumer could grow 2% to 4% per year, which I think was about 200 basis points kind of ahead of your prior expectations. And I know the world's evolved quite a bit over the last 2 years. So I guess how are you thinking about the growth potential for U.S. consumer looking ahead? And is that kind of 2% to 4% still a reasonable target?

Yes. Let's start with the underlying reasons, why? I think the growth strategies, the 3 pillars that relate to big consumer business are very much in place. So around the core product, doing extensions, leveraging that brand and those brands that we have to develop more capabilities, capture that larger consumer market. Remember, versus 2019, we have about 20 million more consumers in the lawn and garden category. And so that base, we think, is pretty sticky. [ Aimee ] likes to say it's about 70% to 80% sticky, and we're seeing that in our volume trends, '22 into '23. So the market size has grown. Pricing, we've also taken some significant moves in pricing. So you'll see that in top line numbers but units as well, feeling pretty good about. The second component, direct-to-consumer, how we engage with the customer which is the retailers, how we engage with the consumers in educating them, giving them paths to buy our products, giving them markers and time to remind them when to use our products, that direct-to-consumer path really robust, really strengthened and then live plants. Live plants is a very exciting category for us, right? And Bonnie is our real entrant and foray into that. And so all of you in the room and listening on the webcast, when you go to your favorite large retailer and you go to the garden center, in the spring, you will see a number of plants on the outside of that garden center on carts, those are Bonnie. And we are obviously supplying those. You go inside the garden center, all the soils, all the grow media, all the mulches, we supply that. We go to the controls category, that's all us. And then ferts and seeds, that's all us as well. So a very strong position and live plants is the first thing that the consumer sees. And then getting miracle-Gro in there to sustain and grow those plants, that's the full solution. So live plants also a great, important growing component for us. So underlying pillars intact that 2% to 3% growth, I call it GDP plus. And the reason I say GDP plus is because, yes, we're going to grow as sort of the economy grows and as consumer grows and how households grow. Embedded in that is your ongoing low single-digit volume growth rate. Pricing remains very strong in that GDP plus capability, but what we do as a company, one of the big areas where Scotts Miracle-Gro excels is on the innovation side, growing the category in itself, bringing new products to bear to the marketplace at higher price points, of course, but also new capabilities for the consumer that makes it important and capable for them to pay, that's ongoing. And so that creates the rest of that kind of 2% to 4% kind of 1 from innovation and the rest is GDP. So GDP plus.

Okay. That's helpful. And I guess, I kind of wanted to -- you alluded to it earlier, you kind of just touched on it now in terms of household formation. And we've seen this kind of play out a little bit in other CPG categories where you had this explosive growth and then you had a kind of a retrenchment, if you will, right? And I guess I want to talk about we've seen household formation kind of come in our household penetration and the data we look at coming a little bit off the peak, but it's still well above kind of pre-COVID levels, right? And I guess, can you just talk about your comfort that where you can sustain that level, and we're not going to just kind of return to where the category was in 2019?

Yes. And that goes to those 20 million consumers who did come in through the pandemic. And the fact that kind of 70%, 80%, we're seeing return purchases. So absolutely, the consumer is sticking in the lawn and garden category and we feel good about that now. Everything that we're doing from a marketing perspective here in 2023 is to excite the consumer is to activate the consumer and to remind them when and how to use our products. Like right now, and I think anybody who's turned on a TV, a radio opened up your laptop and going to the Internet lately, you've probably seen our daylong savings campaign. Now daylong saving is extremely important, right? It is a measurable benefit to the consumer off of a 12,000 square foot bag of triple action, they're getting $20 off. So that's very powerful. But for us, it's opening up the early part of the season. It's bringing them into the store, creating foot traffic for the retailer in an early part of the season where they normally wouldn't. And so we're seeing a very good response from that daylong savings program. That being said, that lays the groundwork for a strong full season because we know that consumers who come in and purchase by the end of April, a product end up spending 2x more across the rest of the season. So incentivizing them to come in, yes, activating them, reminding them to come in and use our product are very important. And it goes to those consumers who came in during the pandemic season, a lot of them are millennials, first-time homeowners. They need to be reminded and educated how to use our products. And so you'll see our marketing activity through the rest of the season go towards reminding, activating the consumer and helping them stay in the market.

Okay. And maybe sticking with that, right? I mean, I know 1Q is a seasonably small quarter, but off to a really, really strong start. And so maybe can you just talk about what you're seeing in terms of retail engagement. You talked about some of the activation that you're doing and maybe just in markets where spring is a bit earlier, like Texas or Florida? What are you seeing there? And I guess kind of just getting on that point, right, how do you kind of know for sure that it's really a result of kind of this early season activation versus kind of [indiscernible] well, for a lot of this country, January was pretty warm, right? So I mean, how do you kind of disaggregate that to make sure that it's really just related to the activation that you're doing versus saying, well, it's a little bit warmer out. I need to kind of get the long going.

Okay. A lot built into that question. Okay. I'll take it a lot of back-to-school references today. One question with 27 subparts. So remember, the first half of the year for us is a load out and load in to the retailers. And what we talked about in the first quarter is that the activity of our supply chain, our operating team, our sales team was very interconnected with the retailers to ensure that we had a load out that actually outperformed what we had thought -- the load-out plan, the load-in plan, I apologize, with our retailers is pretty much bought in, right? So we knew that coming into the season. So having strong performance against that the retailers being fully engaged in that plan and the delivery schedules being able to accept all fully tied in together, it's not easy. That supply chain capability on both sides of the house worked really well. That laid the groundwork for us to say, "Hey, Q1 better than we thought, Q2 also likely from a load out perspective to stay right on plan, which means that, although we got a little bit ahead in Q1, pulled some orders in from Q2, we still expected the first half to meet the load-in plan. That's great. And the reason why is because we were seeing good POS in the early part of the season, which is in your Florida and Texas market. To your point, all the activities that we do to activate the consumer and our marketing people talk about it this way, which I think is extremely powerful and we were in Orlando last week and resonated with people down there. You could take two regions outside of Orlando, one in which we do media marketing, reminding consumers now is the time to buy, the benefits of buying early in the season to your lawn and the beautification of your property and a market where we don't do that. And the foot traffic, the buy-in and the results are about 200% higher in those markets where we actually do the media. So very powerful performance based on reminding the consumer engaging with them to get into the store. Weather does help, we're not expecting an outsized crazy good weather season, we're expecting normal and from a broader perspective on the consumer side, we're looking at the season as kind of we were down 20% in ferts and seeds, '22 versus '21 volume. We're taking about 10% of that back this year in our view. So not getting back to the '22 levels, just getting back a bit higher, calling back half of what we lost, and then every other category essentially is staying flat. So Jim would say, Jim is the Chairman, would say maybe that's a little conservative. We would say it's reasonable, conservative as to how we're approaching the year. So weather normal outlook for the year, reasonable. And as we've seen the consumer come in, in those Florida and Texas markets, they've been coming in a bit higher than what we had expected. So the benefits of some early warmer season markets warming up, the benefits of media is impacting the consumer and having them come in. And by the way, Florida, Texas, California would be kind of coming all online right now, too, but the weather events there have probably delayed that a bit. They represent those 3 markets kind of 25% of our overall volume. So significant to see.

No, that's really helpful. And I guess, it's still really early here in the spring, but every incremental week starts to kind of matter more, right?

And I guess, I get this notion in my head, and I have it from merchandisers, whether you go to your favorite retailer, you can talk to your merchandiser there. You hit 50 degrees, that garden center lights up. It's like a switch. And so sunny or not, 50-degree weather people are coming in.

Yes. So I guess, I mean, it's been colder. I mean I'm in New Jersey it's known more times this month than all winter. So just...

Normal, by the way. Just saying like we expect March to be cold and snowy. I mean anyway.

No, that's very fair. So I guess it's just any -- I guess to your point, things are progressing in March the way you kind of would have thought from a weather perspective, the colder weather we've seen is necessarily kind of a risk given really seeing any changes that.

This is the limit, right? So getting product into -- and this is why the power of being able to perform in that first quarter, the power of our supply chain and I'll also talk about some of the risk, right, is getting that load in completed to plan with our customers, the retailers. Where the risk is, is to your point, if you have kind of 3, 4 days, 2 days, 3 days of foul weather that stopped shipments. Well, we're shipping kind of $30 million, $40 million a day that could have a meaningful impact to your point, right? Where is the risk? That's the risk. But now we're talking 3, 4 days where we're pretty much committed to the load-in. We're seeing good POS. So this is kind of an end of quarter thing versus the broader picture is still pretty much -- is very much intact.

Yes. No, that makes a lot of sense. It seems like the POS has been great, which is good to see. But maybe building on the point on it being conservative or prudent, whatever the reasonable -- reasonable, sorry. Help us -- I guess I want to maybe go to just help us on why it would be conservative, I guess, in some ways? And I guess, walk through kind of -- like a scenario analysis, right? If we get like an actually a good spring, like what could the upside look like? And I guess, how do you think or prepare for spring like last year, again, like just kind of given where you are from a financial position perspective. Like how do you think about that? And how do you kind of prepare for that? Because you can't really control it unfortunately.

No. You can't control it, but a lot of the things that we're doing, so go back to the early part of the conversation, the consumer response is very high, right? So when we activate the consumer, it is a very algorithmic type output. So positive around that, and we didn't really have to do that during the pandemic, by the way. And last year, we're actually spending 25-plus percent more in media -- activation media this year than we did last year. So what we know works that media spend, working to activate the consumer. To your point, as you look out and you say, okay, we get past the second quarter and POS comes in lower, remember, we already are in a position where we're working through inventory positions. We pulled back on operating volumes by about 15% and so we're running out inventory. Retailers are also looking to get to a lower inventory position. So we're already in the process of kind of moving that out. The risk here is more to the upside. There will be additional levers. If the consumer doesn't come in, we can go deeper with SpringBoard. Jim has talked about that. We can try and drive savings out through additional efficiencies in SG&A, additional efficiencies in costs. And so we will get on that very quickly if things go lower or if the consumer doesn't come in the way we expect it. On the upside, because we are not producing as much, because we are working through inventories. If you have a very good spring, the consumer is activated, everybody wants to spend more time in their backyards this season versus last year, and we have data that supports that, by the way. There's a thing called the turn. So you get your first orders out. The load-in is done. People start to pull off the shelves and then you need replenishment, that's the turn. That will require pull in more inventory and guess what, we could be somewhat top out in certain product categories or certain products themselves. That would require additional production. That would be a potential benefit because then we get additional production, we get additional leverage coverage and therefore, higher profitability.

Okay. That's helpful. And then I guess just rounding out the top line questions. Hawthorne has been a bit of a challenge. Maybe speak to what you're seeing there? And kind of when you think about the long term, right, I mean, obviously, the category has seen a lot of retrenchment growth expectations have come in. So I guess how would you frame kind of a realistic long-term growth expectation for Hawthorne once you kind of get past this -- once you can maybe return to normal, as you will.

Okay. So let me split that into 2 pieces. The first is, what is the market? The second is what is Hawthorne, okay? My viewpoint, the cannabis market, $100 billion plus a year, basically mature. Here in New York City, other types of elements, right? So there's 1,300 liquid licenses. There's 1,500 dispensaries, only one of them legal, right, in New York City. So it's -- there are multiple dynamics playing out. For us, the addressable market we've said is kind of $5 billion because it's the infrastructure, it's going after some of the components, which I'll talk about in a second. The trajectory change in cannabis, where you saw kind of 25-plus percent growth came from the development of the legalization of the market. which would have led to all types of capital efficiencies, all types of improvements and the ability to extend capital and create value off of it. Without legalization, that's much harder to do, right? You're not raising capital efficiently. The prices you're paying for capital are extremely high. Therefore, the quality that you can put into your capability to create product is actually lower. And so that's sort of what you've seen in this development curve. And currently, you're working through a situation where there was a lot of oversupply of product based on the fact that there was kind of unconstrained license growth to grow, which created an oversupply of product, which now some of those growers are coming out of the market, demand for our products is down because of that and that creates a change intermediately for what the market looks like. But on a more normal basis, legalization provides a path to kind of 7% to 8% growth CAGR. Right now, the market has kind of separated 25% legal, 75% illicit. Again, a mature market operating, but capital inefficient. Over time, that will change as legalization happens and it will happen, you're going to move to a market that's 75-plus percent legal and very, very little illicit. And there's a lot of factors that go into that. So that's the market. And that's how it will evolve over time. Legalization matters to us because of those capital efficiencies because the market is going to move to a lot of similarities to beer and alcohol, mass and premium brands. And so that plays well into Hawthorne. What is Hawthorne. Hawthorne is a full suite solution to the cannabis industry, whereby -- we have capabilities that are unmatched in the marketplace. We start with the genetics of a plan, understanding what grows the best plant, what varieties work together to create the densest, highest quality grow that is disease insect free. Match that with growing media that's tailored for that grow, nutrients that are specific to that plant providing the controls and the infrastructure to maintain that growth and oh, by the way, match it with lighting that is directed at that cannabis to produce the best quality at the lowest cost. That's what Hawthorne does. That's the value proposition and working with customers to create the lowest cost grow opportunities is where Hawthorne fits in. So right now, when you've seen wholesale prices for cannabis dropped by 2/3 from kind of pre-pandemic levels, right? That's extremely important. Partnering with people on creative ways to reduce costs going forward, creating high premium product capability, maybe at a higher cost but at a much higher price point, whether it's wholesale or retail for those products, for those growers and partnering with them through the whole chain to be able to do that. And so as we move forward with Hawthorne, in the intermediate term, really, the path to profitability is on us. It's a cost out, right? Because I can't tell you the market trajectory of revenues for our addressable market or for the entire cannabis industry right now. What I can tell you is we have, again, an extremely unique position and value proposition and strengthening around that here at kind of zero value because we're in a position of strength because we have a unique offering, I think it enables us to exit this period of time, much, much stronger on the Hawthorne side.

That's great and very helpful. I want to shift to gross margin. You've kind of outlined an expectation for down low single digits. And I think last week, you kind of put around some parameters of that some puts and takes, maybe go over that again. And then I guess as we think about the phasing of the year, is there anything we need to be kind of aware of as you think about kind of the gross margin progression as you go to Q2, Q3, Q4?

Yes. So for 2023, a few big components on the margin line. One, that -- and I talked about it earlier, the leveraging of our fixed cost, we are down 15% in production this year versus last year. So that's a big piece of that call down. The other piece is that we are having a return of some of our compensation spend that we didn't have last year. And so those are really 2 big pieces this year versus last year. However, to your greater point, which is where are we on the trend line of what the margins in and I'm going to talk to U.S. consumer right now, what should U.S. consumer be versus where it is and the delta there is kind of 800, 900 basis points. And what we've seen is 1/3 of that is raw materials. And just to put this in perspective, about 30% of our COGS are inflationary raw materials. And that used to be 25%, but because of inflation that's grown. And you've seen some of the categories have a deflationary price so far this year, that could change. But it's loaded into our inventory. It's going to take us some time to work it through. So not an immediate benefit, but that 1/3, that's related to those inflationary raw materials. And that's going to come out over time and reestablish itself. The next 1/3 is this deleveraging of our fixed cost base that we control but it's, as we talked about earlier, somewhat market driven. And so as we get back to a normal operating capability and fully utilizing our operations, that will come back. The other component to get back there is the things that we normally do, which are innovation, efficiency gains, strict cost management. Those will contribute to the other 1/3 of climb back to the levels that we've seen historically.

That's helpful. I mean maybe talking about the first 1/3, right? So commodities, you've gotten from now 1/3 of your cost basket. I mean what are you seeing from a cost perspective at this point? And I think -- because I mean, I think we can clearly see a lot of the spot prices are moving lower for some of your key commodities. And I guess how should we think about kind of the timing of when we should start to see those benefits flow through the P&L?

Sure. So let's use urea as a descriptor for what's going on right now. Again, 30% of your COGS in 2023, we're by and large locked, urea and a lot of the other inflationary factors. So when you came into 2023 and through 2022, [indiscernible] was in the $600 per tonne range. Now it's trending in the $400 per tonne range. So a pretty significant decrease from where we were historically. However, by and large, locked for 2023, as you move into 2024, yes, that provides us some lower levels, and we begin locking in kind of now for 2024. However, as you look at the inventory cost position, you're still carrying through. And remember, I said we're all working inventory out of the system, us and retailers. So we'll take a big chunk out of that high-cost inventory this year. And then as we move into 2024, the inventories that we have created this year will be at a higher cost in 2024. So it's going to take us a little bit of time to recover those costs that are coming through. But yes, you're right. You are seeing benefits on a lower inflationary raw material perspective.

Okay. And then, I guess, you kind of alluded to kind of the gap from a U.S. consumer perspective. But I want to just think about it from a consolidated standpoint, right? And if you kind of look at -- take your guidance for this year, you're kind of looking at gross margin, call it, 25% to 26%, right? Nice -- and you were to compare that to fiscal '19 or whatnot, which is, I think, in the low 30s. It just still implies quite a bit of recovery, right? I guess just maybe more of an open-ended question. Like how would you characterize the gross margin recapture opportunity. Is that low 30s still achievable? Do you need commodities to kind of fully go back to where they used to be? Just like help us frame that and kind of maybe more of like a time line that we should kind of expect to kind of get back to that, if it is a reasonable target.

I absolutely think it's a reasonable target. It's the time line that you're talking about. Look, we took pricing actions to cover the dollars of inflationary activity. What that does is it actually is margin dilutive, right? And so that's not something you're going to overcome quickly. So you do need to see, and we just talked about sort of the time line of how those inflationary costs are going to work through our cost structure -- inflationary costs, and I said that's about 1/3 of that delta between the 25, 26 and the low 30s. As you move into the fixed cost leverage, that's kind of another 1/3. And to me, that's in our control, right? So manage through this inventory position, keep the efficiencies in place, keep the supply chain and operating teams very much engaged on focusing on every additional unit they can get out, every single hour, and that will manage itself. That last piece, right? Pricing, we're very cognizant about in terms of creating value for the consumer, for our retailer and for us, innovation, new products. You've seen us introduce a number of new products. I think Roundup dual action is something that we're all very excited about. You'll start to see marketing campaign around that as we move through the year. Other Miracle-Gro extensions also coming all very important to continuing to contribute to margin additive type activities. And so those will take place over time, but that's the normal process of margin growth for us and reestablishing some of that we're doing now, and that will continue.

Okay. We have about 10 minutes left. I want to make sure are there any questions? There's nothing on the iPad. But if anyone has a question. Go ahead.

All right. We noted that the market [indiscernible].

It's a great question. And normal weather is what we had called for. And remember, what we are looking for is -- and I'm going to go units in U.S. consumer. Again, POS up 10% in ferts and seeds, everything else flat. Pricing is actually coming higher. So U.S. consumer would be a little bit better on a year-over-year basis dollars-wise. That being said, really, the turn here and what you need to start monitoring is POS and takeaways that are beginning at the major retailers post our second quarter. So by April, early May, when the weather starts to creep above 50, you'll either hear us or hear others talking about great foot traffic in retail centers, in lawn and garden in particular. The first half going pretty much like we thought it would. But there's a lot of us and retailers controlling that. The unknown is the consumer and how they're going to show up. But everything that we're doing actioning the consumer, everything that we're reading about, consumers wanting to spend more time at home, more time in their backyards and even in economically challenged environments, which I'm not calling that we're in right now, right, or that we're approaching. We tend to do better in those periods as well because people stay at home, improve in place and want to beautify their properties.

And [indiscernible].

It's predicated on the takeaway in the second half. Yes. I mean -- so that's actually -- so the volumes around the load in, that's the first half, second half is really the POS piece where the consumers are engaged.

Any other questions? Right I thought a lot of talk about Project SpringBoard, and I know it's already underway. And it was kind of underway when you joined, right? But $185 million of savings is a pretty substantial amount when you just kind of look at the overall profitability of the company. So can you just talk about Project SpringBoard, where the company saw the greatest opportunities? And is there kind of room for further opportunities ahead?

So remember, there's 2 components to the SpringBoard. The first was $100 million and the second $85 million. That was an easy math. Overall, about 50% of that is coming through Hawthorne. So remember, Hawthorne at the time was kind of 20% of the portfolio, if you look at 2022. So a lot of those savings aimed at adjusting Hawthorne to the level of the market activity. Overall, about probably half of the savings in SpringBoard are coming through personnel reductions as well. I'll say it this way. I think -- and you started it and I started it. The company built a platform for significant growth. And that growth was there. It was achievable. I mean the trend lines in Hawthorne ahead of legalization we're proving out. And should legalization have happened, likely would have sustained, maybe at a lower level, but the capability that the company had built to support growing markets to support in U.S. consumer, a growing consumer because of the uplift from the pandemic, all rational. The change and the rapidity of the change was something that people didn't see. So the $185 million, a lot of that is coming out of SG&A. And when you look at what we've been talking about, kind of that 19% SG&A level that we had, getting more to the 15%, 16% level, and we're at the low end of that right now. A lot of that is just sort of positioning the company for growth that we may not need going forward, right? That being said, in Hawthorne, and I think I'm going to repeat myself here, the intermediate term, what the real delta change is going to be the cost outs. And those cost-outs are being delivered by the SpringBoard team and realigning that business delivered through the spring board effort. So are there additional opportunities there? I think and I said this, if the consumer doesn't come in, we'll take another hard pass with SpringBoard and use the same practices, same initiatives to get to the next level, right? Because if you think about savings commensurate with the trajectory of revenues, that's what we're going to have to do. And so there's been a lot of activity within the organization to sustain capability, to sustain talent management, to sustain the future of the company. If you need to go a little bit deeper, you take a harder look at some of those things.

That makes a lot of sense. And I guess, thinking about that SG&A number that you kind of outlined kind of that mid-teens, right? How do you think about that evolving in the world where some of the headwinds you've been facing become tailwinds, right? In other words, if commodities moderate and you're getting your fixed cost leverage back into the P&L. Do you just kind of keep that SG&A, call it, 15%? Or do you kind of look to reinvest some of those savings and kind of rebuild it back up to kind of maybe not all the way back to 19%...

I'm using 15% to 16% deliberately because right now, I think we're low. I think there's a pathway towards maybe the middle to high end of that range. But it's -- frankly, in my eyes, the reason we're talking about a percentage is it is revenue dependent. We know that when we work media and when we work on consumer initiatives, it drives revenue. And so I think as revenue comes back, you'll see some additional spend dollar-wise, but we're going to try and maintain the percentage within that realm, and we know where to spend that has the highest payoff. By the way, all through this, what hasn't changed is our R&D and innovation capability. We've kept that intact. We've not really touched those budgets. And that just shows you the commitment and the importance that the company has in driving value through those processes.

That makes a lot of sense. We have a few minutes left here. I do want to ask about cash flow and cash flow and leverage have been key topics of discussion over the past few months. And the company has outlined a plan for $1 billion of free cash flow over the next 2 years. Can you just walk through the building blocks of that? Is that split 50-50 this year, next year? And clearly, deleverage is a priority kind of here in the near term. But how would you think about capital allocation once you kind of achieve your target leverage ratio?

Sure. It was -- it's $1 billion over 2 years. And it splits out as we're looking at it right now, fairly evenly, about $500 million this year, $500 million next year. The underlying cash flow capability of the company is about $300 million right now. We're going to improve that over time. I want to -- the additional inventory, working capital improvements that we talked about earlier in this conversation, they're going to deliver about $200 million a year. So each year is $300 million of ongoing free capital. And then excess working capital reductions are the additional $200 million. That's $500 million this year, $500 million next year. By the way, let me just finish. I'm sorry. I know you're very excited here. Let me go through the capital allocation approach because this is -- Jim and I spent a lot of time talking about, okay, in the immediate term, and I'm going to call that kind of like the next 18 months, the use of capital, and you said debt pay down, it's pretty transparent to everyone, right? We're going to manage this quarter, the second quarter, this is the tight quarter for us, right? Maximum working capital build, loading in and trailing 12 months EBITDA, not really where we wanted it to be. So this will be the tightest against our net leverage covenant. That being said, the 65, 651, 652, we'll manage through that. I'm less concerned about that. I know there's noise to equity investors. But I don't think that, that's a significant consideration because once we get to the second part of the season, cash flow starts to come in strong and we'll navigate ourselves down. So the use in the discussion around capital approach, capital priorities, quickly becomes outside of this 18 months, this debt pay down period, what do you do? Well, this has been a company that we've had consistent strong levels of shareholder return activities, direct shareholder return activities whether through dividends or through share repurchases, we'll continue that, right? So get yourself now a nice balanced approach between balance sheet strength, shareholder return initiatives and then there are other opportunities, adjacencies that this company has a natural right in that could be some M&A capability. That's the fun stuff, where you can start to say the strategic moat around Scotts is the strength of its brands, the innovation capability, the supply chain. What else is there that fits into that mode. But again, that's kind of down the road. I think everything that we're doing with our CapEx is short payback, high return, I would expect that as we look to deploy inorganic capital as well moving forward.

Okay. Well, we're basically out of time here. So why don't we leave it here. So Matt, on behalf of UBS, those in the audience and those listening, thank you so much for joining us today. We wish you nothing but the best of luck, and let's just hope for a pretty good spring here from weather perspective.

There we go, daylong savings, go get your products now. Thank you.