Good day, and thank you for standing by. Welcome to SMG's First Quarter 2024 Earnings Presentation. I would now like to hand it over to Aimee DeLuca, Head of Investor Relations. Please proceed.

Good morning. I'm Aimee DeLuca, Head of Investor Relations at the Scotts Miracle-Gro Company. Welcome to our first quarter 2024 earnings presentation and business update. During our review, we will make forward-looking statements. Please be aware that our actual results could differ materially from what we share today. Please refer to our Form 10-K filed with the SEC for details of the full range of risk factors that could impact our results. We will also discuss certain non-GAAP financial measures during our remarks. These measures should not be considered a replacement for and should be read together with our results under GAAP. With me for this morning's webcast are Chairman, President and CEO, Jim Hagedorn; and Chief Financial and Administrative Officer, Matt Garth. Jim will provide an overall business update, followed by Matt with a brief review of our financial results through the first quarter and our outlook for the full year. Following the webcast, Chief Operating Officer, Nate Baxter; and Hawthorne Division President, Chris Hagedorn, will join Jim and Matt for an audio-only Q&A session. To listen to the Q&A, simply remain on this webcast. If you wish to ask a question, please pre-register via the audio link shared in our press release for call-in details and a unique pin. Please note that today's session will be recorded. An archived version will be published on our website at investor.scotts.com. For further discussion after the call, you are invited to e-mail or call me directly. With that, let's get started with Jim's business update.

Welcome, everyone. I'm Jim Hagedorn, here. I'm in my office in Marysville, Ohio. We're opening our doors to let you see the people behind our company. We'll also share visuals and charts to help you gain a better understanding of what we're up to. We really love this company, and the better we communicate what we're all about, the better you can share our view. Let me kick things off by expressing how pleased I am with the progress we've made and the direction we're headed in. We're in a different place from last year. We're running the business the way it should be operated. And that's a good thing. I want to give a lot of credit to the management team, which is entirely new from about a year ago. The team has created a solid plan for 2024 and is developing great strategies for 2025 and beyond. They're coalescing and working together well. And that's a good thing too. We're all aligned to driving top line growth, tightly controlling expenses and delivering on fiscal 2024 goals that I outlined on our last call, and Matt will discuss later. Real progress is being made every day. And in fiscal 2024, here's what we have to do: make meaningful headway on gross margin improvement; increase investments in marketing, sales, R&D and our other most competitive advantages; continue to generate strong free cash flow; allocate the bulk of this cash flow to significant reduction in our debt and leverage ratios while paying the quarterly dividend. The results of Q1 are an early indicator we're on the right path. POS was up over 8% in dollars and units, and we picked up 300 basis points of unit market share in key categories. The lift is due to conservative but favorable pricing actions, along with extended Fall promotions and media investment across Scotts and Tomcat. SG&A was down 11%, the result of effectively balancing cost control with investments in high-value programs and initiatives. Free cash flow, gross margin and net sales were ahead of our operating plan, setting us up well into the peak of our Q2 load-in. As for Q1 sales, I want to emphasize that last year's sales cadence is not a predictor of how retailer load will go in this year. We're shifting back to a more normal load. Retailers are happy about this, and so are we. Inventories are in good shape, and order flows are strong through Q2, where we need to be. There's a lot to feel good about in our consumer business. Everything is reaffirming our outlook for high single-digit growth. Much of this growth can be tied to a top-to-bottom relationship that we have with our retail partners. It's no secret that retailers have been pushing for vendors to reduce prices. We agree that as commodities ease, prices for consumers should come down. In fact, our fertilizer and grass seed products were getting pretty pricey last year. We didn't see people trading down because of our pricing. They instead walked away, adopting an attitude their lawns looked good enough. Pricing does matter to consumers, and margins matter to us. We emerged from the post-COVID years with a margin decline. The best we can tell is retailers came out of this period with significantly higher margins, ours down by a similar amount. We're committed to significant margin recovery starting with a minimum of 250 basis points this year. This limits our ability to reduce prices. We cannot participate in a lot of cost cuts until we get our margins back in the customary mid-30% range. The good news is retailers understand our need to balance price reductions with margin improvement because our investment in brands, sales and innovation is good for lawn and garden and the category's growth. This is the basis of the compromise we struck with them. In exchange for price reductions on select high-margin fertilizer, grass seed and soil SKUs, they're giving us more merchandising opportunities with new listings and increased shelf space. These actions will contribute to incremental volume gains. Some of the growth will also come from price reductions, some of which we put into place last fall and will expand in the spring. We know lower pricing did drive incremental POS last fall. I'll shift to spring. With durable sales and foot traffic being challenged at retailers, lawn and garden is critically important to their growth. And this is a space that we own. We'll invest heavily in our brands and sales support to drive engagement and takeaway. These include high-impact programming and creative, highly focused engagement with our core consumers, messaging delivered by influential celebrities with consumer credibility, and lots of repetition starting in March on mass media, television, streaming platforms, cable, entertainment and radio around major sporting and news events. The impact of our spending and approach is substantial. Each brand will reach its target core consumer audience at least 17 times. We've increased working media significantly over last year. Miracle-Gro will get 80% more marketing support. And through collaboration with Bayer, Roundup will spend 20% more. With Scotts, we'll adjust the timing of our advertising and promotions for better lift. We'll allocate 33% more of our spend to peak weeks for Scotts. We are supporting the advertising blitz with powerful creative and celebrities. Miracle-Gro has an exciting new partnership with home and garden icon, Martha Stewart. She is a multi-generational talent who epitomizes gardening and is the most authentic and influential personality in the space. Martha is an enthusiastic user of our products and is a true believer in Scotts Miracle-Gro. In lawns, we'll build upon the success of our Scott for Scotts campaign starring Kristofer Hivju from Game of Thrones. Our data shows the creative approach drove strong levels of awareness and breakthrough that are keys for our seasonal business. The significant build to this year's campaign includes the launch of Scotts Healthy Plus Lawn Food. It promotes overall lawn health through year-round preventive and curative disease control with fertilizer for deep greening. This product will replace SummerGuard, creating a wider application window and incremental POS opportunities. On the sales front, there's no one better than us, period. To this end, we'll continue to invest in our field sales team and have 10% more merchandisers than last year. We've taken the power of our sales force and hooked it up with Bonnie's team to increase attachment. Innovation gives us an opportunity for other incremental gains. Miracle-Gro this year is launching an important new organics line. And later in the season, we'll heavily promote the new healthy fertilizer. Hawthorne was cash flow positive in fiscal 2023 and will be again in 2024. Over this two-year period, it's on pace to be cash flow positive by more than $120 million. Hawthorne is a major contributor to our debt pay down. We have a two-pronged strategy with this business. First is short-term profit improvement and cash flow generation. Hawthorne has the best collection of brands in the industry. And we continue to restructure its product line to focus on the higher margin and more profitable Hawthorne-owned Signature portfolio. Second is the long-term solution to recapture as much of our investment in Hawthorne as possible and unlock its future value as the market matures. We're exploring value-creating options and potential partnerships that we expect will happen in phases, especially as progress is made on the regulatory front. The federal government is moving closer to rescheduling cannabis as a Schedule III drug to make the justice system more fair and reduce taxes on plant-touching business by over 50%. This can be a major catalyst to cultivators reinvesting in their operations. Adoption of the Safer Banking Act is on the table as well, which would give the industry access to normal bank capital. These are potentially significant tailwinds for Hawthorne. In the run-up to our Annual Shareholder Meeting last month, we reached out to shareholders on proxy issues and for general feedback. They indicated they are pleased with our progress. They want to know if we could accelerate our recovery by about 12 months. Matt and I continue to evolve our multi-year financial strategy. There is agreement at corporate and among the operating teams as to what the financials should look like. Here's what to expect: 3% annual top line growth, gross margin in the mid-30% range, and free cash flow directed to debt pay down that drives financial flexibility and shareholder-friendly actions. We'll share more about our long-term financial plans later this year. Just as promising as the fact that consumers are engaged, based on recent surveys, they intend to participate at consistently high levels. I'll remind everyone that we outperformed the category in fiscal 2023 and this last quarter. All the work we're doing now is the building block of the future. And it's the basis for our optimism. In closing, I want to thank everyone for their support, commitment, and hard work. Most importantly, I'm grateful for the collective belief in Scotts Miracle-Gro and our vision to help people of all ages express themselves on their own piece of the earth. It's a reminder that what we do matters to people, the environment, and communities. Thank you, and I'll turn it over to Matt.

Thank you, Jim, and hello, everyone. I'd like to start by sharing some perspective on how the first quarter fits into our full year. Q1 typically represents less than 15% of our annual POS and sales. However, it is an early indicator of how well we're tracking our plan. It's the quarter that lays the foundation for the start of our season and provides important insight into how well our stores sets, load in, and advertising are coming together. Season readiness is our focus right now. And I can say that based on the execution of our marketing, sales, and supply chain teams, we're in a good place. Overall, first quarter 2024 exceeded our expectations, mostly due to the strength of the U.S. Consumer business, which more than offset a slower pace of Hawthorne sales. U.S. Consumer POS was 8% above last year in both dollars and units. This is a reflection of a strong fall, along with the conservative but favorable price elasticity on key items, such as fertilizers and soils. The takeaway is consumer engagement is pacing well. As for invoice sales, we were below Q1 of 2023, but this was expected and in line with projections that this first quarter would have shipment levels similar to pre-COVID historic patterns. Again, the aberration in shipments was last year when we had a heavy early season load-in in cooperation with retailers. Bottom line, we are aggressively managing what is in our control, helping us to return to a more normal state of operating. Now let's dive into the quarter. Net sales on a company-wide basis were down 22% versus Q1 last year, with a decline of 39% at Hawthorne and U.S. Consumer sales down 17%. Again, the reduction in U.S. Consumer sales is due to the change in shipping cadence. Retail inventories are well positioned for the second quarter load-in following the strong first-quarter POS. Retailer inventory units ended down low double-digit percentage in Q1 versus the prior year, which is consistent with our plan. Hawthorne sales pace has performed similarly to what we saw at the end of last year. While there is no uptick in underlying market conditions to point to, the team is executing on its strategy to narrow the product portfolio to fewer but more profitable brands. This lowers the top line but improves overall margins. So far, this initiative has improved Hawthorne's portfolio mix to 77% signature versus distributed brands from 65% a year ago. Turning to the full year outlook. We are reaffirming our guidance of high single-digit growth in the core U.S. Consumer business. Our original guidance estimated Hawthorne net sales would be down low single-digit percentages for the full year. That outlook is under review. To be clear, we will continue to make adjustments to target breakeven or better adjusted EBITDA for the segment. The adjustments are already having an impact. Jim talked about how the segment is cash flow positive. Additionally, the sales run rate for signature brands is outpacing distributed brands by two times. Here are a few other points from the first quarter. Gross margin improved 400 basis points year-over-year. Consumables mix increased 400 basis points versus durables mix and stands at 54%. Given the rapid pace of change in the business and our ongoing actions, we are working on a guidance update to share with you. This includes an update on discussions with potential partners as part of our effort to redesign the business and create maximum shareholder value. Now let's take a look at gross margins. The year-to-date adjusted gross margin rate for the total company ended the quarter at 13.7% of sales versus 20.1% last year. The reduction was driven by lower volumes and absorption in both operating segments, along with sales of higher-cost inventory. We continue to expect the full year adjusted gross margin rate will improve by at least 250 basis points as we realize significant Project Springboard savings, lower our distribution costs, and drive a favorable segment and product mix. Material costs and fixed cost leverage are also expected to improve slightly towards the back half of the year after we work through approximately $275 million of higher-cost inventories that are mainly in the US Consumer business. We will have further runway in fiscal 2025 to improve the total company gross margin rate when we are back to full production, driving fixed cost leverage and benefiting from lower-cost inventories. At this point, commodity-sensitive materials are about 65% locked for the year, and total cost of goods sold are about 70% locked, giving us fairly good visibility for the remainder of the year. Turning to SG&A. The first quarter was down 11% versus Q1 last year and down 26% on a two-year basis. This reflects Project Springboard progress and significant headcount and project spend reductions. We still expect company SG&A expenses between 15% and 16% of net sales for the current and future years. As Jim said, we are redirecting some savings into activities that drive value. This includes U.S. Consumer investments directly focused on brand marketing, which will increase $10 million or 12% year-over-year in support of the media strategy. Interest expense was flat to last year, and we continue to expect it to remain flat for the full year as the benefit of lower net debt is offset by higher interest rates. Interest rates are 72% fixed as of the end of the first quarter under a combination of long-term fixed-rate notes and interest rate swap agreements. Note that $2.2 million in other income and expense is associated with the new accounts receivable sale facility. The adjusted effective tax rate in the quarter was 29.5%, and we anticipate full year ETR to be between 29% and 30%. Finishing up the P&L. Our net loss for the quarter was $81 million or $1.42 per share on a GAAP basis compared to a loss of $65 million or $1.17 per share last year. On an adjusted basis, which excludes impairment, restructuring, and other non-recurring items, we reported a loss of $82 million or $1.45 per share compared with a loss of $56 million or $1.02 per share a year ago. Non-GAAP adjusted EBITDA for the quarter was a loss of $26 million versus income of $21 million last year, primarily driven by lower volume and gross margin rates across both operating segments. The decline is primarily related to the phasing we have discussed. We are reaffirming our total company EBITDA target of $575 million for the full year. Now continuing with the balance sheet. We ended the quarter with net leverage at 7.2 times adjusted EBITDA, comfortably below the covenant maximum of 8.25 times. As is typical with our seasonality, we expect working capital needs and associated leverage to peak at the end of the second quarter, when our covenant maximum will be 7.75 times, followed by 6.5 times for Q3, and 6 times for Q4. Note that we expect to end the year comfortably below the maximum covenant and into the 4s. Liquidity is strong with over $1 billion of available capacity under our revolving credit and AR sales facilities. As we head into Q2, outstanding debt of $3 billion as of quarter end represents a $384 million reduction year-over-year from reduced working capital needs and reduction of previously purchased inventories. Planned CapEx for fiscal 2024 was $70 million, a decrease of more than $20 million versus fiscal 2023, with the majority of projects expected to generate favorable ROIC. We are directing free cash flow to debt paydown and maintenance of our quarterly dividend. As mentioned, free cash flow is expected to meet or exceed $560 million, the balance of $1 billion over two years, driven by sustainable annual free cash flow of more than $300 million plus one-time improvements in net working capital balances. I remind you that everything we're doing across Scotts Miracle-Gro is centered on driving value. This is grounded in our three 2024 objectives; generate $575 million in adjusted EBITDA through top line growth; 250 basis points of gross margin rate improvement; and a continued tight rein on SG&A; deliver $560 million of free cash flow, the balance of our goal of $1 billion over two years. This includes managing total company inventory to fiscal 2019 levels of around $600 million. This cash will allow us to deleverage by $350 million or more, along with retaining our quarterly dividend. And determining a solution for Hawthorne that will capitalize on the future potential of the industry and create maximum value for shareholders. We are making meaningful progress on each of these objectives. And in doing so, laying the groundwork for sustainable shareholder value creation. Two notes to finish up on. First, you will find a summary of our annual guidance in the appendix of today's presentation. And second, I look forward to providing you an update on our second quarter at the Raymond James 45th Annual Institutional Investors Conference, March 4th in Orlando, Florida. And with that, we can move to questions. Thank you.

Our first question comes from Joe Altobello with Raymond James. Your line is open.

Thanks. Hey guys, good morning. First question, I know it's a small quarter, but maybe talk about some of the drivers of that 8% POS growth. And I guess a follow-up on that, is the full year outlook still flattish? Or is that improving as well?

Is the full year outlook for POS?

POS, yes.

Look, here's the thing. I think I've been outspoken that I was really unhappy with our deployment of those marketing support dollars in the fourth quarter. There is a view coming out of the Fall that it worked; I don't buy that. I think, Joe, what happened is we had started making deals with retailers and to get some cost out of particularly lawn products, seed products, and I guess, some soil products. Those prices went into effect in the Fall. The promotion for the Fall, I think, was extended in a good way, mostly the retailers. But the price adjustments really worked. And so if someone was to say what was driving that, I would say sort of good promotions at the retail level, our people doing their jobs to make sure the products are in and ready to go. But the price reductions were pretty immediate. And so I think when you listen to Matt and my words, you heard this price elasticity, price adjustments. Those were negative price adjustments that were part of merchandising plans we were putting together for 2024. Those prices went into effect at retail, and I think they worked really well. So that's what happened.

And then when you take a look, Joe, so specific movements year-over-year in the fourth quarter, that 8% lift on POS, as Jim said, driven by yes, some elasticity that helped us. That was good. And then also the extended positions we had with our retail partners that began in the fourth quarter. You'll see that really pick up as we move into the second quarter. For the full year, remember, what we said is high single-digit growth on the top line for the company, which is comprised of POS at the core consumer level staying relatively flat year-over-year. The main drivers are those extended positions that we're getting of new listings and new promotions. Price will be down. That continues, and we've seen that here in the first quarter. You saw that. But that's being offset by that elasticity. So that still leaves us in the high single digits range.

And still accreting our gross margins by at least 250 basis points. So we actually feel pretty good about it. And I think if you look at the share in Q1, I think that's also a reflection of different merchandising programs at the retail level.

Got it. Very helpful. And maybe just to shift over to Hawthorne. Obviously, the revenue guidance is under review. But has your outlook on that segment's profitability changed since you left your EBITDA guide unchanged at $575 million?

I want to address your note from this morning regarding our withdrawn guidance. I regret that decision because we expect profitability to be higher and margins to improve. However, our cash flow targets remain unchanged, which is a key focus for us. I’m not sure if you stated that profits are consistent or increasing, but cash flow is crucial for our business, and we are currently working on refining our go-to-market strategy. Looking at our signature brands, performance is solid. It seems we are transitioning away from distributed brands, and the numbers reflect some challenges related to market recovery. It has been noted that the recovery in hydroponics continues to be difficult, which is further complicated by our strategic choices regarding what products we promote and sell. Chris, do you have anything to add?

Yes, of course. Jim already mentioned it, but the decline in revenue is really a result of us carefully evaluating our portfolio and making strategic decisions to focus on brands and products that yield higher profits for us. In most cases, these are our signature products. It's about streamlining our offerings, ensuring we are promoting brands that are financially beneficial and that we can support effectively, while also assessing the overall health of the business from this perspective.

Joe, I believe that the operating team, led by Chris and Tom, along with their group, is clearly improving the business's profitability. They are focused on being the best Hawthorne possible given the current state of the business. I remain optimistic, especially since a significant part of our business revolves around lighting. When we discuss shifting toward consumables instead of durables, it highlights the lack of capital needed to enhance growth facilities. Assuming the rescheduling to Schedule III occurs, which seems likely with support from the President, it wouldn't be perfect, but it would address the 280E issue. Instead of facing tax rates exceeding 80 percent, we'd revert to approximately 20 percent federally, which would greatly boost the profitability of legal growers. This is a substantial benefit. Furthermore, if Safe Banking passes, it would provide access to capital at more reasonable prices compared to what alternative credit markets currently offer. Both of these developments would positively impact our business, as we anticipate that years of overdue capital investment in growth facilities are critical. My concern is that Chris, Tom, and their teams are committed to being good citizens, diligently working to enhance profitability. However, I worry that we must not overlook essential innovations, particularly in lighting, nutrients, and genetics, which are vital for the future. The business currently exists in a unique, politically influenced environment where legal operations struggle to achieve profitability. Hence, it's crucial to focus on the future. This creates a tension between myself and the operating team, with Matt often finding himself in the middle.

I have to tell you, actually, the way that you just went through that and the conversations we've been having internally, I think it's fair to share with everyone. We put out a long-term model for what Scotts Miracle-Gro is, right? 3% top line growth, we can get into that. Margins back into the 30s, we really didn't talk about Hawthorne. It's because there's so much future potential that exists. And by and large, it's kind of being ignored today. And ignored in our equity, ignored in others' equities. And it's a construct of a very difficult environment to make money in. And like we said, the ability to apply capital in that marketplace is very difficult right now. So opportunity abounds as you move forward, but it is hard to put into place right now what's right. But what we do know, whether it's the Scotts model or the Hawthorne model, investing in the future, the things that we know, innovation, marketing, our sales force, those pay off.

And Joe, I apologize for the lengthy response, but this is a topic we've discussed extensively. We had a Board meeting last week, and we believe in the future. Chris and Tom are focused on the present, which is more short-term thinking. This doesn’t reflect their intentions, but they need to navigate within our family and community, and they aim to contribute positively. Regarding cash flow, we expect to see over $120 million in free cash flow from Hawthorne over the next two years, which is a significant asset for us. This is not out of context. The business is set to improve. We have many initiatives underway, some of which we cannot disclose at this moment, but you will start seeing developments soon. I want to ensure that our business does not become trivial, where we allow ourselves to shrink to the point of becoming irrelevant and miss out on future value opportunities. I am discussing this during the earnings call because I believe it’s important. The decisions made by Tom, the team, and myself aim to ensure we are good corporate citizens while generating a sustainable level of profitability for the enterprise. We are very mindful of what has made Hawthorne unique and successful in the hydroponics industry, and we are committed to preserving those qualities. This includes our focus on innovation, investment in our brands and sales team, and our collaboration with Scotts on government relations to facilitate changes that Jim has mentioned regarding rescheduling. We are dedicated to upholding the unique aspects of our business, which are essential for Hawthorne to thrive, even amid the current results. We are making deliberate choices, but there is a constant tension between achieving healthy short-term profitability and not compromising the business's future potential. As Jim noted, this will be accomplished through partnerships that we cannot discuss yet, but we believe they hold significant promise to support us during this period without losing our integrity.

I appreciate that. Thank you.

One moment for our next question. Our next question comes from William Carter with Stifel.

Hey, thanks. Good morning. This is Andrew on for William. Just wanted to really quickly ask, and maybe I'm nitpicking here on the SG&A guidance that you said. I think you said 15% to 16%. I thought it was 14.5% to 15% last quarter. So was that a change through either some incremental marketing dollars or whatever and that would have to be a stronger US consumer profit performance that you've got modeled in there? And did that influence the higher advertising? Thanks.

We will be at the low end of the 15% to 16% range. This is part of how we are structuring our long-term model for the company, which targets 15% to 16% of sales, aiming to return to a normal conversation rhythm. You're correct that we will be at the very low end of that range. This reflects the factors we have discussed, including an increase in sales this year and a rise in SG&A dollars. The main drivers for this are our focus on marketing, innovation, and our sales force. We are actively working to maintain or reduce other SG&A expenses, which allows us to keep that percentage of sales low both currently and in the long term while supporting investments in areas that create value for the company.

Thank you. And the second question I wanted to ask because you're now at, I think you said 77% of Hawthorne is signature brands. I guess, first off, just to help us with the roadmap of 30%, not sure if you'll break it out. Could you give us the margin differential between US Consumer and Hawthorne and then also signature and distributed? And then the second piece is, do you still see value in being in the third-party distribution business? I think when you bought something like in 2018, a lot of that was due to visibility to get more scale, but is there still value with how the category has changed over the last six years? Thanks.

Yeah. And I think, Andrew, look, we don't break out a lot of that that you just asked. But let me give some trajectory here. Right now, the overall margins for the company are by and large, reflective of the U.S. Consumer business. And as we guide for the full year, that will be the case as well. Hawthorne coming through the period last year when you saw us with an EBITDA loss of about $48 million, moving to breakeven or profitability. And as Chris said, they're driving towards profitability. That will create some positive gross margin that is going to be in the kind of, call it, mid-single digits. And that's not guidance; do not model that out. That is a waypoint on where that business should be, which is much closer to the overall corporate margins, but that will take time. So, that's kind of the lay of the road on the margin side. You asked a lot of questions on some decisions that Chris and the team have made. So, I'll let Chris speak about that.

Yes, Andrew. We are not opposed to being a distributor of third-party brands, but we are focused on making money from our work. There are several brands in the category, some of which we still distribute and some that we no longer do, that have had extremely low, zero, or even negative margins for us. Initially, when we did the Sunlight deal and experienced significant growth in 2020 and 2021, those products did help increase basket size and provided additional benefits. However, as the category has contracted, our considerations have changed. It is not that we are philosophically against distributing third-party products; we simply need to have programs in place that ensure profitability on those products. We have encountered challenges in this area. Ideally, we want to partner with third-party vendors to create programs that are profitable for the vendor, the manufacturer, us, and ultimately the retailer while remaining competitive. However, the tightening of conditions has forced us to make tough decisions. Ultimately, we are focused on profitability, and without going into specifics, our signature portfolio is significantly more profitable than most of our distributable brands.

And Andrew, Jim here. First of all, that was a really good question. I'm not sure we're fully ready to answer it yet. However, as we prepare to announce new partnerships, things should start to become clearer. We have been looking for strategic partnerships for Hawthorne and have spoken to the usual industry players. The interesting thing is that everyone seems to be looking for the same outcome: fewer SKUs, higher gross margins, and lower inventory. So, I believe it's a valid question, and you will likely hear more about this in the upcoming calls as we clarify our direction. We've been open about what we want to achieve, and I hope there's no misunderstanding about our current situation. What is evident is that Hawthorne plays a crucial role in our cannabis business, especially on the supply side. Finding solutions for ourselves and potential partners has proven to be quite complex. My intention is not for anyone to feel misled by our statements. We're actively working on the challenges like a Rubik's Cube, collaborating with other key players to find mutually beneficial solutions. We're making good progress, even though we aren't ready to make announcements just yet. Our relationship with RIV has touched various parts of our business, and there's advancement on both sides that I believe people will find noteworthy. We're navigating these complexities with others, not in isolation. In this regard, I'd like to highlight the impressive work being done by Chris, Tom, Matt, and Dimiter, as I'm also involved in the vision aspect of it. It's challenging, sometimes resembling speed dating. However, we understand the essence of Hawthorne. Looking back, our distribution decisions involve addressing short-term profitability, which is significantly impacted by factors like the Rubik’s Cube analogy. We have to operate in today's environment, as everyone involved is facing similar challenges. When discussing potential collaborations, it's important that these conversations feel constructive rather than confusing. In summary, there's a lot of valuable work happening, and thank you for the excellent question.

Thanks. I'll pass it on.

One moment for our next question. Our next question comes from Peter Grom with UBS. Your line is open.

Hey, guys. Good morning. Hope you are doing well. So maybe just one clarification to one of Jon's questions just on the phasing. So the 40% to 43% of full year sales in 2Q in U.S. Consumer, does that kind of imply like a mid to kind of high single-digit decline? I just want to make sure I heard that right. And then just kind of bigger picture, the mid-30% gross margin target, just in the context of where we've been, it's a pretty remarkable improvement. Can you maybe provide some guardrails or thoughts on an appropriate timeline and on kind of when that can be achieved? Thanks.

Okay. Phasing first. First half of this year, we'll do kind of 52%. First half of last year, we did 61%. I gave the breakdowns on Q1 versus Q2 this year and last year. So yes, that, and you heard it in our prepared remarks, was the driver of the volumes down year-over-year in the first quarter. They will be year-over-year in the first half. So you have that right. The margin build is, as Jim said, something we discuss almost every single day. So there is a heavy discussion and emphasis right now on scenario planning around what the future of Scotts can be. And you saw us today put some markers into place as to what that looks like: 3% top line annual growth. We'll get into what that 3% really is probably at our Investor Day later this year. The margin build is actually a little more pedantic. It's a little less exciting, frankly, because we will have some natural releases from where we stand today on a raw material basis and on a fixed cost leverage basis. So let me give you the big blocks here. 23.7 last year, we said up 250 basis points. I say up 250 basis points, Jim says, up 250 basis points plus. Don't read into that; he just wants more, which we all agree we're going to drive for more. That leaves you around 26%. You guys can do the final math. So therefore, to get back into that mid-30s for the company, you need to see that fixed cost leverage piece, which includes everything from distribution to absorption, to just being much more efficient across every single facet of the operation, that will be roughly half of the closure to bridging that gap. The other piece is really the raw material release. And you've heard Jim talk about it in his prepared remarks. We have been able to, over the past few years through COVID, price for raw materials, but we haven't priced for the margin that we typically have. And so that's in itself been margin dilutive to the company. As those raw materials are now declining, we are going to maintain as much pricing as possible so that we can accrete back as much of that margin as possible. And that's the other gap closure to getting back to where our target margins are.

Got it. Thanks so much. I’ll pass it on.

One moment before our next question. Our next question comes from William Reuter with Bank of America. Your line is open.

Good morning. I just have two quick ones, hopefully. The first is in terms of your long-term leverage target, I don't think I heard the number 3.5 times on this call. Does that continue to be that target? And what is the timing of when you think that you could achieve that goal? That's all.

I'll let Matt provide clarification. During our Board meeting last week, I asked Matt about the positive developments in the American business, particularly regarding changes in the Hawthorne and cannabis sectors. We had extensive discussions during that meeting, using January as a preparation time for our August presentation of an updated three-year strategic plan. It's important to focus on the three-year aspect, as it will be significant moving forward. When I initially reviewed the agenda, it appeared to be a standard Board meeting, but I wanted it to be more profound—a real dialogue about our upcoming initiatives over that three-year timeline. Some aspects have evolved, including a new leader for the consumer business and various activities on the Hawthorne front. Matt has been part of the team for about a year, and I emphasized that this was his opportunity to outline his vision for our financials, likely extending beyond just a three-year outlook. It’s crucial that the operating team is on board, meaning it has to be a collaborative strategy that everyone supports, reflecting Matt's influence on our financial approach. He demonstrated a strong understanding of our goals and dynamics, and it plays a key role in our current discussions. My awareness of this topic has sharpened due to our ongoing conversations. While I don't want to speculate prematurely, I believe that by the end of the three-year period, the financial targets could be around 3.5. If we consider expediting this by 12 months, it implies an additional improvement in our leverage, aiming to move from the current plan's projected 3.5 to 2.5. It's important to assess what this acceleration will require from us, and I anticipate needing between $60 million and $100 million in incremental EBIT. I made it clear that I only want to hear about it if it's achievable and if we can devise actionable plans. The team has embraced this challenge, though we may not have all the plans finalized yet. This speaks to the question of our current targets compared to the accelerated ones, which aim to address feedback from our shareholders, including my own family, who are urging us to progress swiftly. We're also engaged in significant discussions right now with our compensation and work committee about establishing long-term incentives tied to these objectives. Matt, I'd like to pass it to you for further insights.

Everything is aligned. This is a significant statement regarding our vision for driving shareholder value into the future and achieving our net leverage target, which was previously 3.5. Jim and I have discussed, considering the volatility of the environment and the risks associated with inflation rates, whether aiming for a target of 2.5 to 3 would be more advantageous. Of course, it would be. Therefore, we are putting plans in place to not only accelerate de-leveraging but also to reach a lower target level, settling around 3 to 3.5. That's our mission. But what opportunities does this create for us? This goes beyond just a financial strategy; it's about the Scotts model, which excites us greatly. Jim and I have been communicating to Nate and his team the importance of sustainably providing resources so that we can reinvest in Scotts Miracle-Gro. Our purpose is to grow more good, enabling everyone to appreciate their own piece of the earth and enjoy it to the fullest. Achieving this requires innovation, effective marketing, and a differentiated sales force—these are our advantages. Strategically, this approach results in an exceptionally high free cash flow yield that Scotts Miracle-Gro can provide. Our plan is to reduce debt in the short term and then to engage in shareholder-friendly activities and investments that will sustainably enhance free cash flow in the future. This will ultimately allow for more actions that benefit shareholders. We feel very optimistic about the near term and are particularly excited about the future of Scotts Miracle-Gro and our ability to create value for both our consumers and our shareholders. That is the essence of our long-term plan. And everyone in this room is in agreement with that.

We are making a strategic investment in the business. Our plan includes an assumption of at least a 50% increase in brand support and at least a 50% increase in innovation support. These are substantial figures, indicating that this is a long-term approach rather than a short-term one. Historically, a mid-30s range is where we should be, so we are not trying to reinvent the wheel. Coming out of COVID, demand was somewhat uncertain, especially in the cannabis sector, and we faced significant cost pressures. As we see recovery, we will naturally adjust. Based on the calculations shared, we are facing about 900 basis points of margin while making these investments. It's important to emphasize that although not everything is software-related, we are clear about our key focus areas, and we are being transparent about our direction. The team is collaborating exceptionally well. I felt sad about Mike and Denise leaving, and I was uncertain about how the situation would unfold, but the team has really unified. I am eager to showcase this amazing team. This extends beyond just the individuals present; many others have emerged strong from last year's challenges, despite facing tough circumstances like incentive losses and declining equity. We've made significant personnel changes, particularly at the senior level. There’s a renewed energy within the business. The current atmosphere is quite positive and we have plans aimed at creating value for all stakeholders. Ultimately, no one wants to see the stock price stagnate, and we understand what needs to be done. If the market behaves rationally, we should recover a significant portion of our share price, which aligns with our goals. Our focus remains on executing effectively, enhancing our sales force, and strengthening our relationships with retailers, all the way to the CEO level. We have strong brands and we will be investing in them. If you're looking for growth in these areas, be mindful of potential challenges if you reduce spending. Much of that groundwork has been laid, and as for our future investments, we are poised to make strides ahead.

Great. Thanks so much.

Ladies and gentlemen, this does conclude the Q&A portion of today's conference, and it also concludes the conference call itself. We thank you for your participation. You may all disconnect and have a wonderful day.