All right. 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. Companies saw outsized top and bottom line growth during the pandemic, with performance more recently a bit more challenged as a result of 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 30-35 minutes. And then we have 45 in total, so the last 10-15, if you guys have any questions, please feel free to submit them. They'll come through on this iPad that I'm going to get up and grab in 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.
With that, why don't we get started? Matt, thank you.
Absolutely. 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.
Oh, good.
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. You did turn earnings. You did it last week as well. But when you unpack the shelf space gains, the volume lifts from price, and increases from promotions, can you maybe just help us understand how big each of those are within the guidance? The third beachhead is shelf space, a bigger driver. I'm just trying to understand how important all these things are to this total company guidance or the whole segment guidance.
Yeah. 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 1-for-1 exchange on price elasticity. So we would expect volume 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 pieces 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 application promotions and mulch promotions and all kinds of tied 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 national network that is built around growing media where we can create and ship those products direct to our retail partners at an advantage 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 expect to have competition, and we'll fight it out. In some of the other brands, the private label brands, you'll see Scotts Miracle-Gro replacing those products. 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 entire years. We feel, to your point, good about the volume builds coming into the season.
As you know, I know you have 16 questions, so I'll make this a shorter answer. These blocks are built around the first half and loading in. From there, and maybe this is a question we'll get to later, go ahead. You go ahead now.
No, I mean, that was my question. It's like the shelf resets and the gains, you have a high degree of visibility into it. I mean, there's also a component that also requires the consumer to show up or need to respond in the way you expect from the consumption.
Absolutely. Absolutely. And that piece just goes right into the price elasticity, which even going back to the fall now, remember, we outperformed in our first quarter, which is the fourth quarter of the calendar 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 in some instances, we're greater than 150% of competitors and of private label pricing, and we saw price elasticity improve by 2+ percentage points. And that was part of the big driver of outperformance in the first quarter. So we know that price downs work. Now, for the greater point, though, that you're making around where the consumer is, previously, I asked Peter, he'd 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 stays 0 versus 2023. The consumer, what they did in 2023, we expect them to repeat, whether it's on our products or products that we've gained share of and replaced. So we're not expecting a significant change in how they perform. But to your earlier point, first half load in, the trades we made with our retail partners on price downs to get these additional listings and new 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 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 within the important markets where spring is actually starting to break versus kind of having a one-off night stay here in New York?
Absolutely. And the way to set it up is by the end of March, we've done about 20-ish% of our full-year POS. So important, but it's not the full story, right? And what did we expect for POS this year? Well, if you go through the math, and what we said is retailer inventories we expect to come down because they were still kind of one 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 gains, because of the inventory drawdown, POS ends up being a higher number than our volume gains.
Through the first part of the year, you've seen an on-plan, if not positive, performance in POS. That comes on the back of whether it's good weather, bad weather. People are seemingly responding to positions that we take in, some of the promotional activity that just picked up last week, frankly. The numbers there, on the back of very good early season numbers last year, we're seeing very strong POS gains this year. 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 to time our spends more appropriately with when people are going to be shopping in the lawn and garden markets. We feel really confident about that and good about the changes we made on a yearly 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 apply from a POS perspective. But guidance also, I want to go back to the category, right, and kind of flat POS outlook. A lot of wood to chop, to your point, almost 20% by the end of this month. 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 need one point increase, or is it kind of try further outperformance because you're building share on top of that?
Yes and yes. It's very geo-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 the lawn business outperform, which means POS is higher on fertilizers 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 two times 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.
The value of the basket for Scotts, yeah, I mean, the reason I'm going down this path is the mix gets more favorable on that second purchase because it's generally another fert or seed purchase, right, versus more mulch. Because you're going to get your annual promotional activity, and mulch is going to happen around now-ish, right? And then as the warmer weather hits the northern markets, you'll see more promotional activity around then. But that's one load in, and then you do mulch again maybe in the fall. But a nice mid-season, second round of ferts and seeds would be yeah, that would accrue to Scotts, I think, more favorably than just 1%.
Okay. That's really helpful perspective. And then I know we're kind of about a month and a half away from early May when you're going to get key results. So maybe just a few questions on the near-term path. One, just given the POS data that you have is a little bit less reliable, what really should we be watching for to kind of inform how you're tracking versus kind of the guidance or expectations? And then building on, 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 mean, I think a lot of people, is it just warm, sunny days, or is it more nuanced than that?
No, it is more nuanced than 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 three goals for this year of $575 million in EBITDA, $560 million of free cash flow, and finding a strategic solution for Hawthorne? It is. There's a lot of insight just to understand the state of 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 zero, 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 out better, why? What are the trends that we can now see in the consumer where we can lay the groundwork 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.
The ideal weather for us is, yeah, a cool and contingently violent, but tend to winter that yields some early spring rains but opens up to kind of 55, 60-degree weekends throughout the country where people feel the need to be outside and connecting with their yard. That's normal, right? You don't need to have great weather for that to happen. What you can't have is what we experienced the last two years, which was rainy through June, cold through mid-June, and then 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 their money and time 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. A return to normal would be beneficial. 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 Aimee was sat up here and 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. That makes sense. I guess just as it relates to upcoming earnings, I mean, last year, the company more or less decided to post, so I'm kind of giving an update on U.S. Consumer until early June. Is that a practice that we should expect to be the norm moving forward, or was it just more of a function of because of the bad weather last year you wanted to see how it played out? I'm just kind of curious because.
Well, we did two things. One, I think the U.S. Consumer, we're happy to talk about anytime. The direction for U.S. Consumer is very clear to us. Hopefully, through this conversation, we can make it much more clear. But what we're expecting this year, no change. That's not going to change until probably June when we see what happens in April and May, right? 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. 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 rates you should be using." So we just paused there.
Just on the U.S. Consumer point, so even if things are coming in better, you would still kind of hold off from providing more sustained until June?
Yeah. I'm not going to. I mean, things are. No, no. I'm not going to come out and bang my chest. We are not in that point. Here, Peter, this is really.
I mean, it's not a bad idea.
No, come on. It's a really good approach. The approach is there's so much we did not know the last two years. By the way, I take great personal pride because I'm an avid lawn and garden enthusiast, and I get into the season. So I take great pride, and it was even before I came to Scotts, in these things. But now, obviously, it's even more into my blood. 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 turf and seeds, you'd recover some of that. Didn't. As a matter of fact, it went down another 10%. This is why you won't see me beating my chest, why Jim won't beat his chest right now.
It is, yes. Point, but then deliver, demonstrate, hold each other accountable. If it's not coming, hold each other accountable to delivering the three things we have to do this year, the 575, 560, 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, I will tell you, I think we do a competitor conference in June. We'll get back. I think Aimee's forcing me to talk about what the outlook's going to be at that time. So you'll get an update then.
Aimee?
Yeah.
So I know a lot of this discussion is in very near term, but I would be curious to kind of get an updated perspective on the long term of the U.S. Obviously, there was a period of outside growth, new household penetration. Again, it didn't matter. We were all working 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 starting the future of Scotts Miracle-Gro, okay? We'll get to Hawthorne in a second. On the U.S. Consumer business, it's really North America, right, because it includes Canada. There's just so much innovation that's coming through the pipeline that changes the way consumers easily access a beautiful yard. Whether that's in the garden or on the lawn, all of those new innovations that we're 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. What does all of that do? That embeds in it an underlying natural growth rate.
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%-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 timeline it's going to happen in. And maybe you'll push me to do that here. I don't know. But that gets you a 2% grower with 35% margins. We're going to hold our SG&A around 15%-16%, which allows for more than enough for investments in marketing and innovation and our sales force supporting the brand strength.
Then we should be able to deliver EBITDA in the high teens near 20% and free cash flow yield around 8%-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. Finding a way to have that EBITDA generate the leverage 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. That's where we're going. 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've spent a lot of time in U.S. Consumer. I suppose we probably should talk about Hawthorne here for a second. But taking a step back, and I realize that hindsight 20/20, would you think the company would have approached moving to hydroponics differently if they knew what was going to happen today? Because I guess it's more me thinking out loud, 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 it still not realized its full potential in other ways.
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 that 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 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. And the value of Hawthorne was around $8 billion at the peak.
That was kind of 50% more than Scotts Miracle-Gro 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 dropout 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've built around for generations. 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 grow for all types of products, from lights down to hydroponic pumps to dehumidifiers that are designed for 3-5-year commercial lifetimes. 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 grows. But that's all in 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 still in an oversupply situation. And we'll move through that.
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. It's been very destructive to the entire development of the market. So there needs to be, at some point, normalcy there, or the market will just move to all illicit in for generations. It's a $100 billion market that is the same size as the $100 billion beer industry in North America. So smart heads need to prevail. If not, the market will normalize. You're seeing capital formation take place in the industry in spite of everything that's going on. Near-term should be good.
Long-term, if all this merits out to a positive in terms of being able to orchestrate a business in a capital-efficient way, that'll be very supportive to Hawthorne and other hydroponics businesses as we move forward. And it is the impetus for what we're trying to do now, which is strengthen Hawthorne, build around these positions, keep in 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 caught my ear. I think you said 4 months ago, you would have thought it was more likely than not Hawthorne would have been out of Scotts for a year. But today, that's changed. That's changed your perspective the last 4 months.
Yeah. 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 cannabis. There are publicly traded companies out there that are trading at a fraction of what their value should be. There are low-capex businesses that are trading at a fraction of what they should be. I mean, these are businesses that are generating $hundreds of millions of EBITDA, growing at 8% with ongoing, continuing margins, probably greater than 50% at the gross margin level. That's better trading for 0.25-0.5 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 timelines 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 Hawthorne?" 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. We want it to be a properly enriched company as it moves forward and beneficial to SMG shareholders. That time will come. That is still very much strategy for Hawthorne. 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.
Yeah. Oh, no.
Oh, come on. I can't even force you. The point is, that's the likely outcome that we want to steer away from and ensure that Scotts 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 and talk a little about margins? You kind of alluded to it before. It seems to be this area of focus of a lot of investors, particularly as you look at the rebuild earning 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. Maybe just unpack the drivers embedded in that outlook. And I guess, is there anything nuanced that we need to think about in terms of phasing, just kind of given the sales phasing? The sales phasing, you had to 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 50% 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, it'll be down year-over-year, but second half will be up, right, because of the way that we phased the year. So that plays into it a little bit. But I think gross margin recovery this year is going to be about 250 basis points. The vast majority of that is 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 2023 when gross margins for the company were 23.7%. We've 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 2024 with the 250 basis points. As you move into 2024 and 2025, pardon me, and beyond, what we've pointed to is really two elements. And the two elements are the fact that we are running about 15%-20% below optimal to allow for inventory reductions across the system, buyers 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 to play on pricing versus deflationary factors that are taking place in our cost structure. Remember, through the pandemic, we were able to price inflationary costs 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 want 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." Keep 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, it 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 was, "Give me a breakdown of the 1,000 basis points of when you're going to get it.
That wasn't that question.
Yeah, 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 2025. That fixed cost leveraging will occur in 2025 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 2035 is pretty clear to us. It's the timeline 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 that financial flexibility will be important.
I guess it sounds like I guess I'd just be curious. Let's just say that the sales projections play out as expected this year. Would you expect fixed cost deleverage to kind of go away next year? Because it seems like it.
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 is coming this year, there's 750 left. It's about split relatively evenly between the two. Fixed cost leverage, you know, is going to, 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's got to manage. Yeah, it's got to manage. So yeah, I think it's going to take more than next year to get back to 35%.
Okay. Yeah, 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 called 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, 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. Look, there is extreme pressure to get out of net leverage hell as soon as possible, 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. This year, it's 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 to be.
Okay. That's really helpful. And I guess maybe shifting to cost savings that you're discussing or Project Springboard. I mean, I know some of this was underway before you really joined, but where has the company seen the greatest opportunity to kind of right-size the cost structure? And are there more opportunities as you look ahead, or are we kind of now finished?
Don't think we're ever finished. The bulk of the cost actually, you can't even say the bulk because it's kind of 50/50 between Hawthorne 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 2024. Phase three, you're getting $65 million this year. Out of the $100 million, you might get another 10-15 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 of those things that, frankly, strengthen 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 headcounts. 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 past 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 and block and tackle on every day.
But the benefit of that gets repositioned into the areas where we want to make investments.
Okay. And then as part of that, a question that comes up a lot is just how sustainable is this continued SG&A as a percentage of sales. It sounds like 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, we'll take it: 35% margins, 15%-16% SG&A on a business that's growing kind of 3%-4% top line. That means 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 cost 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. These are our power drivers.
Around 15%-16%, over a long-term duration, we can afford all that by maintaining the efficiencies that we have today.
Okay. 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 this is 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 Aimee scolded me for it, that ends up in a written transcript, by the way. Yeah, 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, like 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.
Yeah. Building on that, just free cash flow. I mean, you just talked about the confidence and the path forward from here.
Yeah. Free cash flow again. Remember, there are a lot of levers. That's $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 in, year out. So we feel good that the target was $1 billion over two years, and we feel confident that we're going to be able to achieve that. And by the way, that's going to allow us to pay down about $350 million in additional debt this year and maintain that deleveraging opportunity that we have.
Okay. I guess last one from me.
That's number 16. Is it 17?
I switched them around. I want to keep you. I keep you. You got your toes here.
16 questions, ma'am?
We worked through it. Just kind of sticking with the earnings recovery narrative, but also kind of thinking through the balance sheet and the deleverage that you've just kind of touched on, right? And it's just something that as I was going through the model, it kind of just stood out to me. I don't want to end on kind of a boring topic on 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%-30% versus historically being 25%. How should we think about those things longer term? Because 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. No. That is brutal, right? What is that, 250-ish share? I mean, that is a massive, massive contribution to EPS. Our tax rate at 29%-30%, this is unnatural, right? It historically has been kind of 26%-27%. Okay, not a huge needle mover, but 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 U.S. business. That's 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, yeah, 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 3-3.5, 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-$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%-16% SG&A, 18%-20% EBITDA margins, and 8%-10% free cash flow growth. That should yield 8%-10% kind of EPS growth.
Oh, sorry, 8%-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, again, like I said, that is a level of urgency that we have. It is the priority of Hagedorn . And that's why we're making aggressive moves and driving positions now and into the future because you get back to doing that, 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 repurchase path, and my margins are kind of 35% on a 3%-4% grower. It's a phenomenal business to be invested in and to manage, by the way.
Great. Well, why don't we leave it there, Matt?
Cool.
Thank you so much for joining us. We wish you nothing but the best of luck moving forward.
Yeah. Absolutely.