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

Good afternoon, everyone, and welcome to the UBS Global Consumer Retail Conference here in New York City. My name is Peter Grom, the U.S. beverages and household products analyst here at UBS. We are very excited to have joining us this afternoon from Scotts Miracle-Gro, Chief Financial Officer; and Executive Vice President, Matt Garth. The past few years at Scotts Miracle-Gro have been volatile, to say the least, And we saw outsized top bottom line growth during the pandemic. With performance more recently a bit more challenged as a result of the demand normalization across a number of categories, cost inflation, inventory dynamics among others. The path forward certainly seems a bit uncertain, but there does seem to be a higher degree of confidence from the Scotts team that there could be light or nearing light at the end of the tunnel. We have a lot of ground to cover in terms of the stuff today, but I have a series of questions that I plan to run through with Matt for the best 30 to 35 minutes. And then we have 45 in total. So the last 10 to 15, if you guys have any questions, please feel free to submit them. Though, come through on this iPad that I'm going to get up and grabbing a second here. But before we start, I am 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 this. So with that, all we get started. Matt. Thank you.

Thank you. Appreciate you having us.

So I'm probably going to surprise you with this, but I want to start with the U.S. consumer. And Look, you've done a tremendous job of outlining the building blocks of the high single-digit sales target, low double-digit volume target for the consumer business to earnings, you did it last week as well. But when you unpack the shelf space gains, the volume loss from price and increases from promotions, can you maybe just help us understand how big each of those are within the guidance, the 30 shelf space, a bigger driver? I'm just trying to understand how important all these things are to the total company guidance or the whole segment guidance.

Yes. So remember, so for U.S. consumer, like you said, high single-digit sales growth. That's coming through a few different ways. That is coming through -- like you said, starting with a price down actually, of about 2%. Now historically, when we give price, there is a one-for-one exchange on price elasticity. So we would expect volumes to go up 1%. We've actually been a little conservative in how we're looking at price, elasticity given the performance of the consumer and the unknowns there. So price down to volume up a little bit, less than 2 to start with. And then the rest to get to 10%, total volume is split between listings, new innovations and promotional activity that we didn't have last year. And those buckets of promotional activity and listings and new innovations are relatively split 50-50. And what does that mean? It means in promotional activity, where we had a whole host of suppliers that were providing early season soil activation promotions and mulch promotions. And all kinds of tie promotions with other things that people could pull off the shelf, those this year will be Scotts Miracle-Gro products. And frankly, most of those are coming from more regional players, not big national players, it's other people who can ship locally those products. Now remember, we have a natural -- a national network that is built around growing media where we can create and ship those products direct to our retail partners at an advantaged cost. So doing it on a national scale is a benefit. And that is a big piece of that promotional uplift. On the listing gains and the new product introductions, there are some shelf gains that we are making. You wouldn't typically see them against some of our better-known competitors. But even there, we're going to work hard with them, and it's good to have competition and then we'll fight it out. But in some of the other brands, the private label brands, you'll see Scotts Miracle-Gro replacing those products. And what you'll also see is a number of new product introductions this year that come in with expanded shelf space, longer duration shelf space and that's happening at our home centers, garden centers and also at clubs like [ Costco ], where you'll see a new [ Scotts Max line ] that will be there through the entire season as opposed to just the beginning of the season, which is what you've seen in prior years. So we feel, to your point, good about the volume builds coming into the season. And as you know, and I know you have 16 questions, so I'll make this short answer -- shorter answer. These blocks are built around the first half and loading in. And from there -- and maybe this is a question we'll get to later -- go ahead, you go ahead...

No. I mean, that was my question. It's like the shelf resets and the games like you have a high degree of visibility in that. But there's also a component that is also requires the consumer show up or they need to respond in the way you expect from the past reduction.

Absolutely. And that goes -- that piece just goes right into the price elasticity, which even going back to the fall. Now remember, we outperformed in our first quarter, so which is the fourth quarter of the calendar year, our first year -- our first quarter fiscal. And that was based on the fact that we dropped pricing on things like seeds where we were way out of the market, right? So we took pricing and then our retail partners took pricing. And so we -- in some instances, we're greater than 150% of competitors and a private label. So we took pricing and we saw price elasticity improve by 2-plus percentage points, and that was part of the big driver of our performance in the first quarter. So we know that price downs work. Now to the greater point though, that you're making around where the consumer is -- previously, I asked, Peter, you listened to a number of other companies. And as we've been out on the road, we've heard from a lot of other companies, the consumer is still an unknown. But coming into this year, we said we're not expecting anything to happen in the lawn and garden space. So the entire market space 0 versus '23. The consumer, what they did in '23, we expect them to repeat whether it's on our products or products that we've gained share of and replace. So we're not expecting the significant change in how they performed. But to your earlier point, the first half load in, the trades we made with our retail partners on price downs to get these additional listings and then promotional activity, all very real, and we're loading into that right now.

Okay. Maybe kind of shifting to the consumer. What's the latest on POS trends, I guess. I know it's still really early, but you have seen pockets of good weather, pockets of bad weather, pretty nice here in New York in the past couple of days. So just curious to get your perspective on where POS trends versus where you kind of thought they would be? And then within that, do you have any early reads kind of on -- within the important market for spring is actually starting break versus kind of having a one-off nice day here in New York?

Absolutely. And the way to set it up is by the end of March, we've done about 20-ish percent of our full year POS. So important, but it's not the full story, right? And what do we expect for POS this year? Well, if you go through the math and what we've said is retail inventories, we expect to come down because they were still kind of 1 percentage point of POS high. So we expect that to release this year. You're looking at a POS for us that is our volume gains, plus that inventory channel takeout, which means POS needs to be slightly higher than 10%, and that was the plan. Now again, the market grows 0. The consumer does nothing different, but just because of our gain because the inventory drawdown, POS ends up being a higher number than our volume gains. And through the first part of the year, you've seen us on plan, if not positive performance in POS. And that comes on the back of whether it's good weather or bad weather, people are seemingly responding to the positions that we've taken, some of the promotional activity that just picked up last week, frankly, and the numbers there -- on the back of very good early season numbers last year, we're seeing very strong POS gains this year. So it all looks to be moving in the right direction, certainly on plan, and we're going to continue to motivate around that. Maybe later in this conversation, we're going to get into some of the marketing spend, how we're connecting with consumers. The different things that we're doing, the different intelligence that we have this year, the time our spends more appropriately with when people are going to be shopping in the lawn and garden market. And we feel really confident about that and good about the changes we made on a year-over-year basis.

That makes sense. I mean, I guess kind of bringing it back to the guidance. And that was really helpful just in outlining what you said from a POS perspective. But the guidance also -- I want to go back to the category, right, and kind of flat POS outlook. A lot of wood to chop here, to your point, the only 20% by the end of this month for you. But how should we think about the flow-through or upside or downside to your guidance depending on how the category performs? And I guess, is it kind of like one-to-one, right? If POS for the category is up 1%, you see 1 point increase? Or does it kind of drive further outperformance because you're building share on top of that?

Yes and yes. It's very specific. So where you would really want to see good outperformance this year. And I think it's for everybody, not just us in the space. You would like to see [indiscernible] business outperform, which means POS is higher on ferts and seeds. And that is a really good development for people being in their yard and taking time to work for a greater, more beautiful backyard. That would, I think, lift all boats because if people engage early in the season, they spend 2x more across the rest of the season. So getting that first piece here is really developmental to the value of the basket as you move forward. And the value of the basket is Scott. Yes, I mean it -- the reason I'm going down this path is the mix gets more favorable on that second purchase because it's generally another -- or seed purchase, right, versus more mulch. Because you're going to get your all promotional activity of mulch is going to happen around now-ish, right? And then as the warmer weather hits the northern markets, you'll see more promotional around them. But that's one load-in and then you do [ multi gain ] maybe in the fall. But a nice mid-season second round of ferts and seeds would be -- that would accrue to Scott, I think, more favorably than just 1% [ people ].

Okay. That's really helpful perspective. And then I know we're kind of about 1.5 months away from early May when you're going to give 2Q results. So maybe just a few questions on the near-term path. One, just given the POS data that we have is a little bit less reliable, what really should be -- should we be watching for to kind of inform how you're tracking versus kind of the guidance or expectations. And then building -- and this is actually a question I've gotten quite a bit more recently. And I think I have a decent idea, but I think it would be helpful to hear from you. What is actually ideal from a weather perspective for your business. I think a lot of -- it just warm sunny day, there is more nuance on that.

It is more nuance on that. But to your earlier question, what should you be watching? I think at this point, the POS numbers that you have access to that we will talk about are going to be really important. Now why? And is it important to our year? Is it important to impacting our 3 goals for this year of $575 million in EBITDA, $560 million of free cash flow and finding a strategic solution for [ Althorne ]. It is, but there's a lot of insight just to understand the state of the consumer and where they are acting in the lawn and garden space, that's going to lay out investments that we're going to make later this year, but also for the next few years. So coming out of the pandemic, getting some stability in the consumer, which is why we're planning for 0, right, and understanding where they're going to come out. If they come out better, great, if they come out worse. Why? Even if they come up better, why, what are the trends that we can now see in the consumer where we can lay the path work for going forward? Weather. We've made a lot of changes, like I said, year-over-year on how we use data and how we embed data into decision-making that impacts marketing, that impacts promotional activity. And that doesn't mean that we're not sensitive to data. And the ideal weather for us is a cool and it can be violent but end to enter that yields some early spring range but opens up to kind of 55, 60-degree weekends throughout the country where people feel they need to be outside and connecting with their yard. And that's normal, right? You don't need to have great weather for that to happen. What you can have is what we experienced the last 2 years, which was rainy through June, cold through mid-June and a short summer period where everything stayed relatively green in the Northeast and Midwest because summer didn't really start until late. And then by the time people got around to it, if they even went to their backyards because they spent the majority of the outside of the home during the summer. They came back to a yard that was greening up again because all came in kind of wet and cool. So a return to normal would be beneficial. But reading even beyond the weather, we have tools now where we can be more agile in how we are allocating our spend and our promotional activity. So we can grab people on the weekends. If Amy was set up here, who's our Head of everything, she would say, yes, during the pandemic, the day didn't matter. Now the day matters, again, the weekends matter to us again and having good weather on the weekends is important, but not more important than just good seasonal transitions that allow people to get into lawn and garden across multiple weekends.

Okay. So that makes sense. I guess just as it relates to upcoming earnings, I mean last year, the company more or less decided to [indiscernible] kind of giving you an update on U.S. consumer until early June, is that a practice that we should expect to be the normal moving more? Or was it just more of a function of like because of the bad weather last year, you want to see how it played out, like I'm just kind of curious...

Well, we did 2 things. One I think the U.S. consumer, we're happy to talk about any time. And the direction for U.S. consumer is very clear to us. And hopefully, through this conversation, we can make it much more clear. But what we're expecting this year, no change. And that's not going to change until probably June when we see what happens in April and May, right? And again, we're not expecting a lot. We're really not expecting a lot for the market. For Hawthorne, we discontinued guidance just because we're making significant changes to that business. And the baseline revenue is there, and it's kind of trucking along. But given these changes, we just said, hey, give us a quarter, and then we'll come back to you with what run rate you should be using. So we just pause there.

So just on the U.S. consumer point. So even if things are coming in better, you would still kind of hold off on providing more [ sustain ] until June?

Yes, I'm not going to -- Yes. I mean things are -- yes, no, no, I'm not going to come out and bang my chest. Like this is -- we are not in that point -- if your...

We thought about idea.

Come on. It's a really good approach. And the approach is -- there's so much we did knock up the last 2 years. And by the way, I take great personal pride because I'm going to have lawn and garden enthusiast, and I get into the season. And so I take great pride, and it was even before I came to Scott in these things. But now obviously, it's even more into my blood. And what didn't we know that said last year, the market would rebound, that people naturally would go back to doing lawn and garden work. That seemed rational, right? After a 20% down year in ferts and seeds, that you'd recover some of that. You didn't. As a matter of fact, it went down another 10%. This is why you won't see me beating my chest. While Jim won't beat his chest right now, it is yes point, but then deliver demonstrate, hold each other accountable. And if it's not coming each other accountable to deliver on the 3 things we have to do this year, $575 million, $560 million and something for Hawthorne. And that is very powerful for the organization to have clear direction like that. So I'm not skirting it. And I think if we see good things happening in the early part of the season here, we'll tell you, I think we do a competitor's conference in June, we'll get back. I think Amy is forcing me to talk about what the outlook is going to be at that time. So you'll get an update then.

So I know a lot of this discussion in very near term, but I would be curious to kind of get an updated perspective on the long term of the U.S.. [indiscernible]. Obviously, there was a period of outsized growth [indiscernible] penetration, again, does it matter? We were all reporting from home. It seems like we've fully normalized a bit here over the last couple of years. So as we look ahead, how should we think about the building blocks of growth for this business?

I get so excited about charting the future of Scotts Miracle-Gro, okay? And we'll get the Hawthorne in a second. But on the U.S. consumer business, is really North America, right, because it includes Canada. There is just so much innovation that's coming through the pipeline that changes the way consumers can easily access a beautiful yard, and whether that's in the garden or on the lawn, all of those new innovations that were going to come out over the next couple of years are formulated to attack all of your great headlines, which are heat, drought, all that great resistance pesticides, herbicides, rodenticides, everything that's tailored for the consumer to get a better result. So what does all that do? That embeds in it an underlying natural growth rate. and you put some natural pricing that brand leaders should have and that we've typically done over the past few decades and that we will return to. You get a nice 3% to 4% top line growth in the U.S. consumer business. Our margins are going to return to the mid-30s. We've laid out the components of what that is going to be. We haven't said what time line it's going to happen and then maybe you'll push me to do that, I don't know. But that gets you a 3% grower with 35% margins. We're going to hold our SG&A around 15% to 16%, which allows for more than enough for investments in marketing and innovation and our sales force, supporting the brand strength. And then we should be able to deliver EBITDAs in the high teens near 0 and free cash flow yield around 8% to 10%. This is just the U.S. consumer business. This is going to be a phenomenal free cash flow generator like it always has been. And finding a way to have that EBITDA generate deleverage and get us back to a flexible capital allocation policy that includes direct shareholder returns through share repurchases. The sooner we can do that, the better. And that's where we're going. And so the pressure that Jim puts on us to get these margins back to where they need to be, sooner than what we thought we could is what we're working every day.

Okay. We spent a lot of time in U.S. consumer, I suppose probably should talk about Hawthorne here for a second. But taking a step back, and I realize that [ hindsight ] is 2020. But would you think the company would have approached moving to hydroponics differently if they knew what was going to happen today. Because like I guess it's more rethinking on that. But in many ways, it's like yes, the industry has been under a lot of pressure. But it does feel like there is still an attractive end market for hydroponics longer term that is still not realized its full potential, and that make...

Okay. Good. Because I mean, usually, when people ask me that question, they stop before they say that last piece and then my blood pressure shoots up and I get really defensive. So thank you for managing it well, which is exactly where we are, which is we built a highly meaningful portfolio that has great brands but also great technical capability that drives value through the industry. And so that's what we want to do. We want to help people improve their grow, improve the capability of their products, help them grow more good. And that applies to the cannabis industry. And so the development of what we purchased was rapid in a market environment where investors were pushing us for more and faster and bigger. Remember, the value of Hawthorne was around $8 billion at the peak. That was kind of 50% more than Scott's America growth was valued at that time. So there was a lot of appreciation for what we were doing. No one could have foreseen to your point, the drop out of both cylinders, both pandemic. So SMG Core and Hawthorne, both kind of coming off the rails at the same time, and we're left with a high debt load. But we're navigating through that. And I think there's a lot of lessons that the company has learned, but developing positions of strength is one that we built around for generation. And so that's what we walked away with. We still think Hawthorne is uniquely positioned. We still think that there are assets within Hawthorne and outside of Hawthorne that provide opportunity to strengthen right now in the bottom of the industry to create massive value going forward. Now what does that massive value look like? The industry itself, and I was just with a grower earlier this week, there's going to be a capital refresh that is going to happen. And that capital refresh is going to take place inside the Gro for all types of products from lights down to hydroponics pumps to dehumidifiers that are designed for 3- to 5-year commercial lifetime, those clocks are ticking and they're almost up. Now there's a lot of hurdles to getting capital in the marketplace to be able to facilitate that capital refresh inside the gross, but that's on the come. And so that's nearest term value. And that's good. But there is significant long-term value to your point, upon normalization of the entire industry, which is it's still in an oversupply situation, and we'll move through that. And at the same time -- I know this is being webcast, but the people who are managing this from a federal and state level just don't understand core basic economics whatsoever. And it's been very destructive to the entire development of the market. And so there needs to be at some point, normalcy there or the market will just move to all of methods like it's been for generations. The $100 billion market that is the same size as the $100 billion beer industry in North America. So smarter heads need to prevail. And if not, the market will normalize. You're seeing capital formation take place in the industry in spite of everything that's going on. And so the near term should be good long term. If all this merits out to a positive in terms of being able to orchestrate a business and capital efficient way, that will be very supportive to offer -- and other hydroponics businesses as we move forward. And it is the impetus for what we're trying to do now, which is to strengthen Hawthorn, build around these positions, deepen our moat and then position it for a future where there's significant value being applied to these businesses.

That's helpful. And one thing you said last week was that kind of called my [ear ]. I think you said that 4 months ago, you would have thought it was more likely than not Hawthorn more than Scotts [indiscernible], But today, that's changed. What's changed your perspective, the last 4 months?

Yes. And I think this stems from what Jim said on the first quarter call, and where the dialogue is going now, which is all those things we just talked about in terms of immediate-term value drivers, those all hold true. The market environment itself we thought would be in a more supportive position. What does that mean? Valuations have not returned at all to the supply side of Canada. There are publicly traded companies out there that are trading at a fraction of what their value should be. There are lease touching businesses that are trading at a far fraction of what they should be. I mean, these are businesses that are generating hundreds of millions of dollars of EBITDA, growing at 8% with ongoing continuing margins probably greater than 50% at the gross margin level, that are trading for a [ $1.25 ] turn of sales. So valuations are dumped. They are not, in my words, being respected as proper businesses. And it makes sense, given what the federal and state governments have been doing to screw this all up. But it does mean that the opportunities that we have are good, but the time lines to get them done are more protracted. And that was the enthusiasm. We were -- yes, we are good. We have multiple irons in the fire that are moving forward. And the realization is they're still moving forward. There's still great opportunity in Hawthorne and with other partners, it's just -- it's taking longer than what we thought. And that's okay because the market just isn't there. I also get the question from time to time, why don't you just spin out offline? Well, okay, today, spinning out Hawthorne would be a little more difficult for all the reasons we just went through. There's no marketplace for it. And we want it to be a properly enriched company as it moves forward and beneficial to SMG shareholders. And so that time will come. That is still very much the strategy for Hawthorne. But doing it in a race to put an asset into place in the market that isn't being respected. You wouldn't even follow it, I'm sure. They'll come and I can't even force you. But the point is those are -- that's a likely outcome that we want to steer away from and ensure that Scott's shareholders get the most value from that asset and the investments we've made. Okay. That's really helpful.

So why don't we shift gears to talk a little bit about margins. You kind of alluded to it before. It seems to be the area of focus of a lot of investors. And particularly as you look at the rebuild earnings power over the next several years. So maybe just to start on this year, the 250 basis points of expansion, certainly a nice step, right direction. Can you maybe just unpack the drivers embedded in the outlook? And I guess, is there anything nuance that we need to think about in terms of phasing, just kind of given the sales facing kind of discuss on the last call.

Well, the sales phasing we discussed on the last call was, in particular to this year, which is relative to last year, which last year was the abnormality, right? So last year, we loaded in kind of 60% of the year in the first half and usually it's 50-50. And so this year, back to the normal 50-50. So that's phasing and that does impact EBITDA levels. In the first quarter, it was down year-over-year. second quarter year-over-year, but second half will be up, right, because the way that we phased the year. So that plays into it a little bit. But the gross margin recovery this year is going to be about 250 basis points. The vast majority of that is coming to -- coming through the annualization of cost takeouts and changes to the organization that we've made. Those are all structural in nature and by and large, mostly done at this point. So feel really good about recovering margin activity this year. As you move forward, what we've said is, we're coming off of '23 when gross margins for the company were 23.7%. We said we're about 1,000 basis points behind where we want to be and where the company should be. And the recovery of that begins in earnest in '24 with the 250 basis points. As you move into '24 and '25, pardon me, and beyond, what we've pointed to is really 2 elements. And the 2 elements are the fact that we are running about 15% to 20% below optimal to allow for inventory reductions across the system, ours and retailers. So that damages our gross margin because we're not getting the fixed cost leverage that we should from running optimally. That's about half of the remainder. The other half is the play on pricing versus deflationary factors that are taking place in our cost structure. Remember, through the pandemic, we were able to price inflationary cost dollar for dollar, but we took the margin impact on our shoulders. The margin benefit accrued to retailers. All good. But at this point, we won our margin back. That's why on the last call, Jim said, look, there's no more price to come from Scotts Miracle-Gro. And as deflationary factors come into our cost structure, they are going to rebuild our gross margins to where they should be. in perspective though, the deflation that's happened so far is not of the magnitude of the total rise. Case in point, urea, which we had locked in last year around $650 a ton. This year would be $350 a ton, but in 2019 was $150 per ton. So we're going to need to maintain and grow pricing to get back to the margin accretion that we should have above the cost structure that it is today. So all of this is hard work. To your point on phasing and where I thought you were going well, give me a breakdown of 1,000 basis points. So when are you going to get it?

That was the next question.

Yes. Exactly. Totally. So we're working through it. And I do think fixed cost leverage can come back. We've already pointed to the fact that some of that raw material deflationary benefit will occur in 2 that fixed cost leveraging will occur in '25 when we get back to full production, not all of it because you do have some offsets, and there are components of the cost structure even on the fixed cost side that have gone up. And so we need to gain efficiencies over time to offset those. But the pathway back to '35 is pretty clear to us. It's the time line to get there. And I'll tell you what it all nets down to is back to significant EBITDA generation in this company that leads to deleveraging faster. And so we are incentivized to delever as fast as possible in this company. It's built into our comp program for this year. That is important because the sooner we can delever, the sooner we get back to those shareholder-friendly activities of maintaining that dividend in a strong way, maybe growing it over time. direct returns to shareholders through share repurchases, which we haven't been doing that is normal for us to do. So getting back to that financial flexibility will be important.

So I guess -- it sounds like -- I guess I'd just be curious, like let's just say that the sales projections plan as expected this year. Would you expect fixed cost deleverage to kind of go away next year? Look, just because it seems like...

Not fully, right? That's what I was kind of -- not cautioning, but saying it's going to take us more than next year to get all of it back. So again, if we say 250 of that 1,000 points of coming this year. There's 750 left. It's about split relatively evenly between the 2 fixed cost leverage, you know is going to happens. It's going to happen, but there are some gains that we need to make above just getting back to 100%. And that's just going to take a bit longer. On the raw material side, you'll get that immediate chunk down, but it got to manage, yes, got to manage. So yes, I think it's going to take more than the next year to get back to 34%.

Okay. Yes, I was just trying to think through it. If it's like, okay, let's just say you get half of that raw material back. That's, I don't know, let's just call it, 200 basis points off of the 26%, which would get you to 28% for next year. So I was just trying to think through, okay, like maybe there is a path to 30 and then 35. But...

I don't think that, that's an incongruent way of thinking about it, but we haven't gone out and given guidance around it. I -- look, there is extreme pressure to get out of net leverage held as soon as possible. But not because we're constrained. As a matter of fact, this year, we're operating very naturally. We've said that go back and look at transcripts. We are operating naturally. We don't feel constrained. But the financial power to be able to use our free cash flow towards balanced opportunities, that's really where we want it.

Okay. That's really helpful. And I guess maybe shifting to the cost savings that you're discussing for projects spend more. I mean I know some of this was underway before you've really joined. But where has the company seen the greatest opportunity to kind of rightsize the cost structure? And are there more opportunities as you look ahead? Are we kind of now finished?

I don't think you're ever finished. The bulk of the cost, actually, you can't even say both because it's kind of 50-50 between Hawthorn and U.S. consumer. It's 50-50 and corporate, pardon me. And then it's 50-50 headcount versus restructuring activities to the overall network. Most of those costs have been taken out prior to '24. You'll get -- for Phase III, you're getting $65 million this year. Out of the $100 million, you might get another kind of $10 million to $15 million next year on those restructuring and savings opportunities that we put forth through SpringBoard. There is more to go. Now the more to go is really going to be reinvested over time in the power drivers of our company, which is the sales force innovation and our supply chain network, all those things that, frankly, strengthened the brand and the value that we contribute, right? And so those costs are going to come out of corporate. We're going to get more efficient. We're going to continue to drive and we can do more with less. And we have a great team in place today that can take on more. And it's not about reducing headcount, it's about making the team more efficient moving forward. Through the network, our organization tends to try and outperform inflation in terms of overall productivity gains, got to stay on that and continue to drive it. And so in those areas where the last couple of years, that's been hard staying on that rhythm and driving for more the team is on, and it's going to accrue to beneficial gross margin activity. over time. So that's what we're working on. Those are all proper and regular things that you do in blocking and tackling every day. But the benefit of that gets repositioned into the areas where we want to make investment.

Okay. And then as part of that, a question that comes up a lot is just how sustainable is this mid-teens SG&A as a percentage of sales. It sounds like you -- it is sustainable.

So if we build out that long-term model that I just gave, and use it for rough math for the company because U.S. consumer, by and large, is the future of the company and when there's a strategic opportunity for Hawthorne, take it. 35% margins, 15% to 16% SG&A on a business that's growing kind of 3% to 4% top line. That means that, that percentage allows for more dollars. And what I just said previously about driving more efficiency through resource units means you don't need to apply more costs there. So you don't need to grow that dollar over time, you're just going to get more and more efficient. And that leaves more money for marketing and R&D and our sales force, right? These are our power drivers. And around 15% to 16% over a long-term duration, we can afford all that by maintaining the efficiencies that we have today.

That's really helpful. We have a few minutes left here, but I want to make sure that I get a leverage and free cash flow question in here. You've been very clear on the leverage, 2Q being the tightest quarter as it relates to the covenants. And maybe this is the wrong interpretation, but you also sound quite confident during the earnings call as well as last week, I felt like that not going to be an issue. So is that a fair characterization?

I said it on the earnings call, I will continue to say that, and I am comfortable with our position against the financial covenant in the second quarter and beyond. What we did and shame on me and Amy scolded me for it that ends up in a written transcript by the way. Yes, seriously. I was trying to convey to the market that the past couple of quarters, we've had about a turn of excess space. This quarter, it's going to be more acute because this is our highest working capital build period. So don't be surprised. And I think a lot of people took that as there's risk. Well, I said I'm comfortable with where we are, and we are going to maintain compliance. And we will move forward very quickly in deleveraging from that point. And this is a lot of hard work. I get to represent these words, but this is an entire organization that is focused on recovering our financial flexibility. So it's meaningful.

Yes. And like building on that, just free cash flow, I mean, can you just talk about the confidence and the path forward from here?

Yes. Free cash flow, again, remember, there are a lot of levers that $560 million, $260-ish million of it is coming out of working capital. And by and large, a lot of that has already been worked through. And so the remainder is that normal underlying $300 million of free cash flow that we do year-on-year out. So we feel good that the target was $1 billion over 2 years, and we feel confident that we're going to achieve that. And by the way, that's going to allow us to pay down about $350 million of additional debt this year and maintain that deleveraging opportunity that we have.

Okay. And I guess last one for me.

Number 16 -- 17.

I switch him around, I want to you -- I'll give you -- king questions. We work through it. I just kind of sticking with the earnings recovery narrative, but also kind of thinking through like the balance sheet and deleverage that you just kind of touched on, right? And it's just something that as I was going through the model, and you kind of just announced, I mean, I don't want to end on kind of a boring topic up below the line, but I'm just trying to think about interest expense today versus where it could be. I'm trying to think about the tax rate of kind of 29% to 30% versus historically being 25%. Like how should we think about those things like longer term. So those are going to be big drivers...

Let's build that model. I'm with you. I am totally with you. Look, someone said it earlier, this is a company that should churn out $5 in EPS. Yes. We have $170 million of interest expense right now. Now, that is brutal, right? That's what is at $2.50 a share, I mean, that is a massive contribution to EPS. Our tax rate at 29% to 30%, this is unnatural, right? It historically has been kind of 26% to 27%, okay, not a huge needle mover, but it's still fairly significant. And the team is working hard to recover the tax rate to get it to where it is. Now it's hard because we're a U.S. business. what we do. So getting offsets from other jurisdictions, not as easy. But we'll find ways to do that and optimize the tax rate. The interest expense -- yes, we'll take down $350 million of debt this year, continue to pile free cash flow into debt paydown while we can. And even when we get back to our net leverage target, which is around 3% to 3.5%, as we approach that, we can start to push, some of that cash flow to share repurchases, absolutely. But you're going to maintain that debt paydown pace of $150 million to $300 million for a period of time because you want to accrue that to EPS. The other component here in that model that I built for you, that long-term Scotts Miracle-Gro model, right? So 3% top line growth, 35% margins, 15% to 16%. SG&A, 18% to 20% EBITDA margins and 8% to 10% free cash flow growth, that should yield 8% to 10% kind of EPS growth -- sorry, 8% to 10% free cash flow yield, which you use to buy back shares. That is the model. That is the power of this company. And so getting the baseline back, getting the capital structure appropriate and returning to the financial flexibility that our branded power deserves that, again, like I said, that is a level of urgency that we have. It is the priority. It's how were comp, and that's why we're making aggressive moves in driving positions now and into the future because you get back to doing that this for me, and I know we're not allowed to talk about stock price, but it's an easy double, right? I delever. I get back on the share recipes and my margins are kind of 35% on a 3% to 4% grower. This is a phenomenal business to be invested in and to managed by the way.

Great. Well, why don't we leave it there, Matt? Thank you so much for joining us, and we wish you nothing, but the [indiscernible] moving forward.

Yes. Absolutely. Thank you.