Good morning everyone, welcome to the UBS Global Consumer and Retail Conference here in New York City. My name is Peter Grom. I'm the U.S. UBS U.S. Beverages and Household Products Analyst. We are very excited to have joining us this morning from Scotts Miracle-Gro, Chief Financial Officer and Executive Vice President, Matt Garth. The past few years for Scotts Miracle-Gro have been volatile, to say the least, with the company seeing outside top and bottom line growth during the pandemic, with performance, you know, recently a bit more challenged as a result of demand normalization across a number of different categories, outsized cost inflation, inventory dynamics, you know, a whole slew of things.
You know, 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 from this. There seems to be, there's just a view kind of a light at the end of the tunnel. We have a lot of ground to cover today. I have, you know, a series of questions that I plan to run through for, you know, roughly 35 minutes of the 45 minutes we have here today. The last 10 to 15 minutes, we'll kind of open it up to audience Q&A. I think you all have received questions on how to submit questions more on, they'll kind of show up here on this iPad.
If not, if you'd rather just raise your hand and I'll just call on you, and I'll just repeat the question if it makes it a little bit easier, happy to do that. 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. Actual results may differ materially. Sorry. As such, please familiarize yourself with Scotts', full range of risk factors, which can be found in their quarterly and annual file reports with the SEC.
Woo!
That's a lot. With that, why don't we get started, Matt? I mean, 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. I think it would be helpful to just kinda get a sense of kinda what attracted you to Scotts, you know, especially kind of just given the point of uncertainty that the company was at a few months back.
Yeah. I really appreciate. First of all, thank you everyone. Love being at the conference, love this format, that we can just do it informally.
Yeah.
Thank you for that. I also appreciated how you entered the conversation for the company because we have been through a period of challenge, 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, you know, 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 wanna 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. I am very blessed to have had a lot of that work already done, or in the process of being completed.
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's 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. The power of that was evident to me in the interview process. You probably know this by now, I'm a lifelong Scotts customer. I am a avid lawn and gardener, and I use the products.
When the opportunity came up to match sort of a personal passion with professional capability skill set, I don't wanna say this is my first rodeo, but I've been through a number of company situations that are similar to this previously. Navigating with the banks, with investors to show the future value capability of the company, I felt very comfortable with. Personal passion, professional passion, all meeting. The upside to it is my daughter's a freshman at Ohio State University, and so I get to see her more frequently, much to her chagrin. Yeah.
A few football games in there, I'm sure, too, right?
Exactly.
I guess, you know, starting with the U.S. consumer, I'd love to just get some long-term perspective. You know, Matt, a little less than 2 years ago, the company held a virtual investor day that was kind of outlining the growth objectives. I think one of the things that was really emphasized a couple years ago was just kind of the, how the view of the U.S. consumer business has really changed, right? I think at the time, you know, there was just, you know, new interests, millennials, you know, having greater interest in the category, household formation.
I think the view was that it was, you know, the U.S. consumer could grow 2%-4% per year, which I think was about 200 basis points, kind of ahead of your prior expectations. I know the world's evolved quite a bit over the last two years. You know, I guess, how are you thinking about the growth potential for U.S. consumer looking ahead? Is that kind of 2%-4% still a reasonable target?
Yeah. Let's start with the underlying reasons why. I think the growth strategies, the three pillars that relate to the consumer business are very much in place. 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. That base, we think, is pretty sticky. Amy likes to say it's about 70%-80% sticky, and we're seeing that in our volume trends 2022 into 2023. The market size has grown. Pricing, we've also taken some significant moves in pricing. 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. Then live plants. Live plants is a very exciting category for us, right? Bonnie is our real entrant and foray into that. 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. We are obviously supplying those.
You go inside the garden center, all the soils, all the grow media, all the mulches, we supply that. You go to the controls category, that's all us. Then fruits and seeds, that's all us as well. A very strong position, and live plants is the first thing that the consumer sees. Then getting Miracle-Gro in there to sustain and grow those plants, that's the full solution. Live plants also a great important growing component for us. Underlying pillars intact, that 2%-3% growth, I call it GDP plus. The reason I say GDP plus is 'cause, yes, we're gonna grow as sort of the economy grows and as consumer grows and how households grow. Embedded in that is your ongoing low single digits volume growth rate. Pricing remains very strong in that GDP plus capability.
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. That creates the rest of that kind of 2%-4%, kind of 1% from innovation and the rest is GDP. GDP plus.
Okay, that's helpful. I guess I kinda wanna. You know, you alluded to it earlier and you kinda just touched on it now in terms of household formation. We've seen this kind of play out a little bit in other CPG categories where you've had this explosive growth and then you had a, kind of retrenchment, if you will, right? I guess I wanna talk about, you know, we've seen household formation kinda come in or household penetration in the data we look at come in a little bit off the peak, but still well above kind of pre-COVID levels, right? I guess, you know, can you just talk about your comfort that you can sustain that level, and we're not gonna just kinda return to where the category was in 2019?
Yeah. 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. 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, I think anybody who's turned on a TV, a radio, opened up your laptop and gone to the internet lately, you've probably seen our DayLawn Savings campaign. Now, DayLawn Savings, extremely important, right? It is a measurable benefit to the consumer. Off of a 12,000 sq ft bag of Triple Action, they're getting $20 off. That's very powerful.
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 at an early part of the season where they normally wouldn't. We're seeing a very good response from that DayLawn 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 2 x more across the rest of the season.
Incentivizing them to come in, yes, activating them, reminding them to come in and use our product, very important. 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. 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. maybe sticking with that, right? I mean, I know 1 Q is a seasonably small quarter, but off to a really strong start. 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.
Yeah.
Maybe just in markets where, you know, spring's a bit earlier, you know, like Texas or Florida, what are you seeing there? I guess kind of just getting on that point, right? You know, how do you kinda know for sure that it's really, you know, a result of kind of this early season activation versus?
Sure.
saying, well, you know, for, you know, a lot of this country, you know, January was pretty warm.
Yeah.
Right? I mean, how do you kinda disaggregate that to make sure that it's really just related to the you know, activation that you're doing versus saying, "Well, you know, it's a little bit warmer out, I need to kinda get my lawn going.
Okay. A lot built into that question. Okay. I'll take. It's, yeah, a lot of back to school references today. One question with 27 sub parts. Remember, the first half of the year for us is a load out and load in to the retailers. 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 in plan, I apologize, with our retailers is pretty much bought in, right? We knew that coming into the season. Having strong performance against that, the retailers being fully engaged in that plan, in 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. 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. We were in Orlando last week, and it resonated with people down there.
You could take two regions outside of Orlando, one in which we do media marketing, reminding consumers now's the time to buy, the benefits of buying early in the season to your lawn and the beautification of your property. A market where we don't do that. The foot traffic, the buy-in, and the results are about 200% higher in those markets where we actually do the media. Very powerful performance based on reminding the consumer, engaging with them to get into the store. Weather does help. We're not expecting a outsized, crazy good weather season. We're expecting normal. From a broader perspective on the consumer side, we're looking at the season as kinda we were down 20% in fruits and seeds, 22 versus 21 volume. We're taking about 10% of that back this year in our view.
Not getting back to the 22 levels, just getting back a bit higher, calling back half of what we lost, then every other category essentially staying flat. Jim would say, Jim's the chairman, would say, "Maybe that's a little conservative." We would say it's reasonable, conservative, to how we're approaching the year. Weather, normal. Outlook for the year, reasonable. 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. The benefits of some early warmer season markets warming up, the benefits of media is impacting the consumer and having them come in. By the way, Florida, Texas, California would be kinda coming all on-online right now too, but the weather events there have probably delayed that a bit. They represent those three markets, kind of 25% of our overall volume, significant to see.
No, that's really helpful. I guess, you know, it's still really early here in the spring, but, you know, every incremental week starts to kind of matter more, right?
Yes.
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. Sunny or not, 50-degree weather, people are coming in. Yeah. I guess, I mean, you know, it's been cold there. I mean, I'm in New Jersey. It's snowed more times this month than all winter. Just, you know.
Normal, by the way.
True.
I'm just saying, like, we expect March to be cold and snowy. I mean, anyway.
No, no, that's very fair. I guess it's just, you know, it's just, I guess, to your point, things are progressing in March the way you kind of would've thought from a weather perspective. The colder, you know, weather we've seen isn't necessarily kind of a risk. You haven't really seen any changes. That's fair.
This is the load in, right? Getting product into. 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 to your point, if you have kinda three, four days, two days, three days of foul weather that stops shipments, well, we're shipping kind of $30 million-$40 million a day. That could have a meaningful impact, to your point, right? Where's the risk? That's the risk. Now we're talking three, four days where we're pretty much committed to the load in. We're seeing good POS, this is kind of a end of quarter thing versus the broader picture is still pretty much is very much intact.
Yeah. No, that makes a lot of sense. It, it seems like the POS has been great, which is, which is good to see. You know, maybe building on the point on it being conservative or, or prudent or what, whatever the word-
Reasonable.
Reasonable, sorry. Help us, you know, you know. I guess I wanna go, maybe go into just like, help us understand why it would be conservative, I guess, in some ways. I guess, like, walk through kind of the, like a scenario analysis, right? If we get like an actually a good spring, like what could the upside look like? I guess, you know, how do you think of or prepare for like a spring like last year again? Like, just kinda given where you are from a financial position perspective, like how do you think about that and how do you kinda prepare for that? Because you can't really control it, unfortunately.
No, you can't control it, a lot of the things that we're doing, go back to the early part of the conversation. The consumer response is very high, right? When we activate the consumer, it is a very logarithmic type output. Positive around that. We didn't really have to do that during the pandemic, by the way. Last year, we're actually spending 25%+ more in media, activation media this year than we did last year. 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%, we're running out inventory.
Retailers are also looking to get to a lower inventory position. 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. We will get on that very quickly if things go lower or if the consumer doesn't come in the way we expected.
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 this thing called the turn. 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 pulling more inventory. Guess what? We could be somewhat topped 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. Then I guess just rounding out the top line questions, you know, Hawthorne has been a bit of a challenge. maybe speak to what you're seeing there and kind of, you know, when you think about the long term, right? I mean, obviously the category's seen a lot of retrenchment, you know, growth expectations have come in. I guess how would you frame kind of a realistic long-term growth expectation for Hawthorne, you know, once you kind of get past this, or once you can maybe return to normal, if you will?
Okay. Let me split that into two pieces. The first is what is the market? The second is what is Hawthorne? Okay? My viewpoint, the cannabis market, $100 billion + a year, basically mature. Here in New York City, other types of elements, right? There's 1,300 liquor licenses, there's 1,500 dispensaries, only one of them legal, right, in New York City. 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 + % growth came from the development of the legalization of the market, which would've led to all types of capital efficiencies, all types of improvements in 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.
That's sort of what you've seen in this development curve. 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 creates a change intermediately for what the market looks like. In a more normal basis, legalization provides a path to kind of 7%-8% growth, CAGR. Right now the market is kind of separated 25% legal, 75% illicit. Again, a mature market.
Yeah.
Operating, capital inefficient. Over time, that will change. As legalization happens, and it will happen, you're gonna move to a market that's 75%+ legal and very, very little illicit. There's a lot of factors that go into that. That's the market, and that's how it'll evolve over time. Legalization matters to us because of those capital efficiencies, because the market is gonna move to a lot of similarities to beer and alcohol, mass and premium brands. 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 plant, 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 grow. 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. Working with customers to create the lowest cost grow opportunities is where Hawthorne fits in. Right now, when you've seen wholesale prices for cannabis drop by two-thirds from kind of pre-pandemic levels, right, that's extremely important. Partnering with people on creative ways to reduce cost.
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. 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. We have a unique offering, I think it enables us to exit this period of time much, much stronger on the Hawthorne side.
No, that's great and very, very helpful. I wanna shift to gross margin. You know, you've kind of outlined an expectation for down low single digits, and I think last week you kind of put around, you know, some parameters of that, some puts and takes. Maybe go over that again. I guess, you know, as we think about, you know, the phasing of the years, 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?
Yeah. For 2023, a few big components on the margin line. One, and I talked about it earlier, the leveraging of our fixed costs. We are down 15% in production this year versus last year. 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. Those are really two 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. I'm gonna talk U.S. consumer right now. What should U.S. consumer be versus where it is? The delta there is kinda 800 basis points-900 basis points. What we've seen is 1/3 of that is raw materials.
Just to put this in perspective, about 30% of our COGS are inflationary raw materials. That used to be 25%, but because of inflation, it's grown. 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 gonna take us some time to work it through. Not an immediate benefit, but that third that's related to those inflationary raw materials, that's gonna come out over time and reestablish itself.
The next third is this deleveraging of our fixed cost base. That we control, but it's, as we talked about earlier, somewhat market-driven. 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 third of climbing back to the levels that we've seen historically.
No, that's helpful. I mean, maybe talking about the first third, right? Commodities, you know, you've gone from, you know, now 1/3 of your cost basket. I mean, what are you seeing from a cost perspective at this point? I think, it'd be 'cause I mean, I think we can clearly see a lot of the spot prices are moving lower for some of your key commodities. 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. Let's use urea as a descriptor for what's going on right now. Again, 30% of your COGS in 2023 were by and large locked, urea and a lot of the other inflationary factors. When you came into 2023 and through 2022, kinda urea was in the $600 per ton range. Now it's trending in the $400 per ton range. 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. Remember I said we're all working inventory out of the system, us and retailers.
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. It's gonna take us a little bit of time to recover those costs that are coming through. Yes, you're right. You are seeing benefits on a lower inflationary raw material perspective.
Okay. I guess, you know, you kind of alluded to kind of the gap from a U.S. consumer's perspective, but I wanna just think about it from a, from a consolidated standpoint, right? You kind of take your guidance for this year, you're kind of looking at gross margin, call it 25%-26%, right? Nice, you know, and, you know, you were to compare that to fiscal 2019 or whatnot, which is, you know, I think in the low 30s%, it just still implies, you know, quite a bit of recovery, right?
Sure.
You know, I guess just maybe more of an open-ended question. Like, how would you characterize the gross margin recapture opportunity? You know, is that, you know, 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 a, you know, like a timeline that we should kind of expect it to get back to, if it is a reasonable target.
I absolutely think it's a reasonable target. It's the timeline 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? That's not something you're gonna overcome quickly. You do need to see, and we just talked about sort of the timeline of how those inflationary costs are gonna work through our cost structure. Inflationary costs, and I said that 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 third. To me, that's in our control, right?
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. 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'll continue.
Okay. We have about 10 minutes left. I wanna make sure there. Are there any questions? There's nothing on the iPad, but if anyone has a question.
Go ahead.
Hi. you noted that.
It's a great question. Normal weather is what we had called for. Remember, what we are looking for is, and I'm gonna go units in U.S. consumer. Again, POS up 10% in fruits and seeds, everything else flat. Pricing is actually coming higher. 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. 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 gonna show up. 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? That we're approaching. We tend to do better in those periods as well because people stay at home, improve in place and wanna beautify their properties. It's predicated on the takeaways in the second half. I mean, that's actually. 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? All right. Well, I, you know, Matt, I kinda wanna talk about Project Springboard, and I know it's already underway and it was kind of underway when you joined, right? But, you know, $185 million of savings is a pretty substantial amount when you just kinda look at the overall profitability of the company. Can you just talk about Project Springboard, where the company saw the greatest opportunities and is there, you know, kind of room for further opportunities ahead?
Remember there's two components to Springboard. The first was $100 million and the second $85 million. That was easy math. Overall, about 50% of that is coming through Hawthorne. Remember, Hawthorne at the time was kinda 20% of the portfolio if you look at 2022. 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 were proving out. Should legalization have happened, likely would have sustained, maybe at a lower level.
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. The $185 million, a lot of that is coming out of SG&A. 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?
Yeah.
That being said, in Hawthorne, and I think I'm gonna 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. Realigning that business delivered through the Springboard effort. 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? If you think about savings commensurate with the trajectory of revenues, that's what we're gonna have to do. 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.
I guess, you know, thinking about that SG&A number that you kind of outlined, kind of that mid-teens, right? You know, 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, you know, if commodities moderate and you're getting your fixed cost leverage back into the P&L, you know, do you just kinda, you know, keep that SG&A, you know, call it 15%? Or do you kinda look to reinvest some of those savings to kinda rebuild it back up to kind of, you know, maybe not to, maybe, but not all the way back to 19%?
I'm using 15%-16% deliberately.
Yeah.
'Cause 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 it is revenue dependent. We know that when we work media and when we work on consumer initiatives, it drives revenue. I think as revenue comes back, you'll see some additional spend dollar-wise, but we're gonna try and maintain the percentage within that realm, and we know where to spend that has the highest payoff.
Yep. Okay.
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. That just shows you the commitment and the importance that the company has in driving value through those processes.
No, that makes a lot of sense. We have a few minutes left here. I do wanna ask about cash flow and leverage have been, you know, key topics of discussion over the past few months. The company's outlined a plan for, you know, $1 billion of free cash flow over the next two years. You know, can you just walk through the building blocks of that? You know, is that split 50/50 this year, next year? Clearly, you know, deleverage is a priority kind of here in the near term. How would you think about capital allocation once you kind of achieve your target leverage ratio?
Sure. It's $1 billion over two years. 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 gonna improve that over time, I want to. The additional inventory working capital improvements that we talked about earlier in this conversation, they're gonna deliver about $200 million a year. 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.
Okay. Well, we only have a few-.
Let me just finish. I'm sorry. I know you're very excited, Peter. Let me go through the capital allocation approach because You know, Jim and I spend a lot of time talking about, okay, in the immediate term, and I'm gonna call that at kinda like the next 18 months, the use of capital, and you said debt pay down, it's pretty transparent to everyone.
Yeah.
Right? We're gonna manage this quarter, this second quarter, this is the tight quarter for us, right? Maximum working capital build, loading in, and, you know, trailing 12 months EBITDA, not really where we wanted it to be. This will be the tightest against our net leverage covenant. That being said, 6.5, 6.51, 6.52, 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. 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?
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? 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? Again, that's kinda 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.
Well, we're basically at time here, why don't we leave it here. 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 a weather perspective.
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