Earnings Call Transcript - SMG Q1 2025

Brad Shelton, Unidentified Company Representative

Good morning. I'm Brad Shelton; I would like to welcome you to the Scotts Miracle-Gro First Quarter Earnings Conference Call. I have recently stepped in to lead Investor Relations after 17 years at Scotts in a variety of finance leadership roles. I am grateful to succeed Aimee DeLuca, who will retire from Scotts Miracle-Gro at the end of this month after a 23-year career at the company. I've appreciated the opportunity to meet many of you already and I look forward to meeting all of you over the coming months. Speaking today are Chairman and CEO, Jim Hagedorn; and Interim Chief Financial Officer and Chief Accounting Officer, Mark Scheiwer. Jim will provide a business update, followed by Mark with a review of our financial results. Following the webcast, President and Chief Operating Officer, Nate Baxter; and Executive Vice President and Chief of Staff, Chris Hagedorn, will join Jim and Mark for an audio-only Q&A session. To listen to the Q&A, simply remain on this webcast. To participate, please join by the audio link shared in our press release. As always, 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 An archived version will be published on our website at investor.scotts.com.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, please email or call me directly. Now, I'm going to turn it over to a special guest that Jim has invited to provide commentary regarding Safe Harbor and forward-looking statements.

Jim Hagedorn, Chairman and CEO

Good morning. I hope you enjoy the mouse's intro to our call. I'll begin with how pleased I am with our first quarter results. We're off to a very good start. We delivered on the metrics that form the foundation of our fiscal '25 plan and we feel very comfortable with our Q2 sales load-in as retailers prepare for the lawn and garden season. They are just as bullish, if not more, on this year's season. All of this gives us great confidence in our fiscal '25 EBITDA guidance and our outlook through fiscal '27. Mark will walk through the financials as I want to discuss how we're building the company for the future. I've often said we're on a journey. And this one began when we emerged from COVID under severe financial constraints and were forced into crisis management. We've restored the financial stability of the company and we're set for growth and continued progress. This journey gave us an opportunity to reflect on the future of Scotts Miracle-Gro and what we want our company to be. In the Air Force, we'd say change often results from a significant emotional event and that's what happened to us. We're at an inflection point where we're making changes to transform our organization. Let me tell you where we're going, what it means and how we'll get there. All of our transformation work starts with our core convictions. Many years ago, we developed these core convictions to guide our associates in driving, protecting and nurturing our very special and unique consumer business. Everyone in our company carries the core convictions on their employee badge but we've fallen into the habit of not paying much attention to them. Our future is about bringing them to the forefront again and doubling down on our consumer franchise. We are further evolving into a consumer marketing powerhouse with competitive advantages that exceed what we already have today. We're narrowing our focus and optimizing our franchise, investing in it. This is our mission. And we have a new leadership team that's aligned to it and is driving that change. Accomplishing this mission will have a significant and positive impact on our future financials. It will enable us to consistently do the following four things: one, deliver sustained sales growth of at least 3% annually that is built on higher-margin products and innovation across all channels within our consumer business. Two, be the lowest cost manufacturer of high-performance products, giving us flexibility in pricing discussions with retailers and the ability to provide both differentiated and affordable solutions for our consumers. Three, drive gross margin up to 35% with mid- to high single-digit EBITDA percent growth; and four, generate strong free cash flow for more shareholder-friendly actions. These include a long-term commitment to significantly reduce our share count and potentially issuing special dividends down the road. There is a simple answer to why these things are achievable. Our consumer franchise is unmatched and in a category with substantial growth potential. From a demographic point of view, we have a tailwind. Homeownership is as important as ever. And there's a shift happening where millennials are becoming the largest group meeting and buying homes. This younger generation is our emerging consumer. Our advantage over our competitors are our superpowers, our brands, supply chain, in-store sales force, our relationship with the largest home and garden retailers in North America, R&D and our ability to generate significant cash flow. Our marketing is our jet fuel. We also have the most engaging creative, whether it's the Tomcat mouse you just met, to Icon Martha Stewart or actor, Christopher Hive at the center of our campaigns and they bring our brands to life. And when we integrate our advertising with our retailer programs, we drive foot traffic and in-store consumer activation at unprecedented levels. This stuff works. We also operate within an environment where very few retailers play. Lawn and garden is absolutely essential to these retailers, representing about one-fifth of their total sales and roughly 40% of their spring foot traffic. Our ability to bring consumers into their stores is critical to their success. They rely on us and we rely on them and we work together to drive consumer takeaway. It would be hard for anybody to build a franchise like ours. Now let me give you examples of the investments we're making to strengthen our franchise to gain market share, bring new consumers into our world and deliver growth. This year, we're putting an additional $40 million into our business, from brand support to innovation, the vast majority of it going to advertising. We're expanding our demographic reach to a broader consumer base. This includes the Hispanic population which is a growing influence in lawn and garden. We'll launch bilingual advertising on digital media and mainstream Spanish television in conjunction with our traditional campaigns. At the same time, we're spending more on consumer activation programs run by our retailers. These programs represent a sizable annual investment in excess of 10% of our net sales. When you combine these retailer programs with what we're investing in our own advertising and brand support, that total investment nears 20% of sales. This might sound like a lot and it is. And we're going to continue to spend even more here over the years going forward. Let me tell you why. In exchange for our investments, retailers give us more listings, share of shelf and off-shelf displays. For every dollar we give them to promote our products, they spend even more in activation and promotion of our brands. The impact of our integrated efforts is evident in the nearly 10% POS lift we had last year. We outperformed the category by 3x, even more if you include live goods. We'll see growth again in these areas this year. It started in Q1 with double-digit POS increases and material share gains. You may wonder how we can afford all this and make our numbers. This is where transformation comes in and it begins with being the lowest cost, high-performance manufacturer. This will require us to take out cost and drive more efficiencies. At a time when pricing is hard to get and rightly so given today's state of the consumer, our ability to reduce our cost structure and realize operational savings is more important than ever. We're being relentless in scrutinizing our organization with an eye towards optimization and savings. We're experienced at this. Our multiyear Project Springboard initiative yielded $400 million in annual savings, of which we put $100 million back into the business for growth. In fiscal '25, we'll take at least $75 million out of our supply chain. That's half of the $150 million in supply chain costs that we've targeted by fiscal '27. I've asked Nate to get another $30 million in savings in other aspects of our company by eliminating anything that doesn't add value. Cross-functional work streams are examining processes for streamlining and simplification. I want to stress that we will balance cost out with key infrastructure investments in things like technology and automation. To this end, our CapEx will increase by $25 million to $100 million this year. We're also building innovation road maps that are 5 to 10 years out. Nate and his team are challenging the status quo to simplify and modernize the portfolio with a priority focus on higher-margin products. The Scotch fertilizer business is an example. It's a high-margin business and we're the market leader but our unit volume and that of the category have declined for more than a decade. Some of this is our doing. We know our pricing has gotten out of whack and we've complicated things by getting away from the annual multistep solutions. We and our retail partners poured money into the spring with big events on single bag solutions. This year, we're shifting back to educating consumers on the value of fertilizing multiple times a year. Climate change is also making spring weather more volatile which impacts our long fertilizer business more than any other. So we'll spread our loan spend throughout the year and put more into the fall when the weather window is more favorable and open. From a product perspective, Nate's team, supported by our strategy group is developing a strategy for longer-term success. Among the things we're exploring in new formulations, natural fertilizers and liquids. When we think about growth, we're more committed than ever to channel expansion, a whole group of consumers buys only online and a lot of them are new to our category. We have a team dedicated to maximizing our POS this year on all retailer e-com sites. We're underpenetrated here and we aim to turbocharge POS at the retailer.com channel. In parallel, the consumer team is reimagining our consumer-facing digital assets with the launch of a refreshed Scotts Miracle-Gro brand website by year-end. It will position us as a house of brands with direct-to-consumer functionality. Direct-to-consumer is our chance to expand our subscription and our loyalty programs. With this reinvigorated focus on our business, we're getting back to basics. And that raises a question, what about our cannabis investments? We believe that moving Hawthorne out of Scotts Miracle-Gro is better for everyone. For our shareholders, this would eliminate the volatility of the cannabis sector and generate a significant uplift in gross margin. We and our banks think it would make it clearer what our equity represents and could expand our price-to-earnings multiple. Moving Hawthorne Gardening into a dedicated marijuana business would bring tax benefits and credit capacity to that company. It would also allow the plant-touching business to work alongside Hawthorne's world-class management team with formal relationships to Scotts Miracle-Gro. I know you've heard us talk about the separation before and you may recall that we moved off of it last year because we couldn't find a suitable partner. The difference today is there are more promising opportunities Hawthorne is now in a position of strength after the hard work to return it to profitability. The timing is right and we believe we can make the shifts while still meeting our 2025 guidance. I want to talk about another aspect of transformation. We've completely remade the management team and it's led to new approaches and ideas. Shire is the most recent addition and his integration has been seamless. And he's taken a collaborative approach to working with Nate, Chris and the rest of the team. And just this week, we're poised to continue with a refresh of our Board of Directors. Tom Kelly, a long-time director, has announced that he will retire from our Board effective January 31. Tom has done great work for almost 20 years and he'll certainly be missed. I want to thank him for his service. Later this week, I plan to nominate Nick Miaritis, Chief Client Officer at VaynerMedia as Tom's replacement. Nick has extensive consumer brand and digital marketing experience. Nick's appointment would continue our efforts to bring new skills and perspectives to the board, along with more diversity in terms of age, ethnicity, gender and sexual orientation. In the past three years, we've added five Board members with expertise in leveraged finance, fast-moving consumer goods, retail, market-leading brands, growth strategies, general management and C-suite level leadership. These changes reflect where we're headed. Giving us the skill sets that align with the strategy that I've described today. Good things are happening at SMG. We're driving growth and margin recovery. We continue to improve our financials. We're strengthening the most powerful franchise in lawn and garden. Scotts is an iconic American company with a rich history of market-leading brands spanning nearly 160 years. We built this category that has extraordinary financial upside and we're continuing to define it. For our shareholders, this translates into greater value creation and sustainable growth. My management team and I are completely committed to this. I want to thank our retail partners, our banks, my leadership team and our associates for their commitment. Most of all, I appreciate our shareholders for sticking with us and supporting us as we take our business to the next level. Now, I'll turn it over to Mark.

Mark Scheiwer, Interim CFO and Chief Accounting Officer

Thank you, Jim, and hello, everyone. Before I get into the first-quarter financials, I'll add to Jim's comments about the transition and how well it's going. Throughout my 13-year career with Scotts Miracle-Gro, I've worked in many facets of finance for strong relationships with our external partners and collaborated with the executive team and business leads. I'm a believer in being open and transparent and I look forward to developing relationships with the investor community. I've built on this approach in my early tenure and look forward to helping the team make progress towards our fiscal '25 and three-year growth plans. My passion for growing this business and driving value is rooted in my own lawn and gardening experiences. I'm an avid consumer and I can personally attest that Scotts Miracle-Gro has the best brands in the business. Shifting to the quarter, we are off to a great start. I am pleased that the strong first-quarter results are well ahead of expectations. While we're optimistic for the year, we are maintaining our guidance, especially since the first quarter represents less than 10% of our total POS. Our second and third quarters will be the biggest contributors to our full-year performance. So you can expect us to revisit guidance later in the fiscal year, as we usually do, once the season is in full swing. What we know from our first-quarter performance is that we have positive momentum. And our retail partners are highly engaged. We are positioned to drive consumer takeaway with the right strategies and investments. In addition, our first-quarter results reflect the hard work by our supply chain team in order to achieve our full-year target of $75 million of cost savings which, as a reminder, is a part of our $150 million three-year target that Jim outlined earlier. Now let's take a look at the top line. During the first quarter, sales on a company-wide basis were $417 million, up from $410 million. U.S. consumer volume gains increased 11% to $341 million from $307 million, offsetting planned softness in Hawthorne. This included the strength of higher consumer engagement in the fall and earlier retailer load-in for the spring season. We expect retailer load-in to be the strongest in Q1 and Q2 which typically account for a little more than half of our expected full-year net sales. Replenishment orders in Q3 and Q4 will be dependent upon the level of consumer sell-through during the peak spring and summer selling season. As previously shared, for the full year, we expect low single-digit core growth in U.S. consumer sales which excludes the impact of non-repeating fiscal '24 sales for AeroGarden and bulk seed and fertilizer raw materials. POS is another healthy story with an increase of 12% in dollars and 13% in units. Consumer takeaway was driven by our fall advertising and promotional investment along with more positive macroeconomic factors. Hawthorne sales declined 35% to $52 million compared to $80 million last year. A significant decline was expected because of the strategic shift Hawthorne made in April '24, to exit low-margin third-party distribution and focus on its more profitable proprietary brands. For the full year, we expect mid-single-digit decline in Hawthorne sales. While Hawthorne's top line was down, its profitability improved significantly in the quarter and we continue to expect that Hawthorne will contribute approximately $20 million of EBITDA for the full year. Add it all up and from a full-year total company perspective, we expect our full-year net sales to be around flat to prior year. Now, moving to gross margin. We achieved over 750 basis points of improvement in both GAAP and non-GAAP adjusted gross margin rates. The GAAP rate was 22.7% versus 15.2% in prior year, and the non-GAAP adjusted gross margin rate was 24% versus 13.7%. The primary drivers include lower material costs, favorable fixed cost leverage, improved product and segment mix and lower distribution costs from our prior year warehouse closures. As I mentioned earlier, we expect the $75 million of supply chain savings to contribute to our near 30% gross margin rate target for the full year. In terms of timing, about two-thirds of the fiscal '25 gross margin rate improvement will come in the first half of the year. Due to favorable material costs and the benefit of last year's warehouse and other facility closures. The remainder will mainly come in Q4 as we lap one-time inventory write-offs taken in the fiscal fourth quarter of last year. Total commodity needs for fiscal '25 are approximately 60% locked as of the end of the quarter. So we have high visibility on input costs through the remainder of the year. All in, we are tracking well to our full-year 30% gross margin rate target. Moving down the P&L. SG&A was $125 million, an increase of 9% from $115 million a year ago. The increase was mainly driven by our planned investments in our media, technology and people. As previously shared, our year-end SG&A target includes $40 million of additional investments in our business that Jim talked about. Along with higher performance-based incentives, these investments will drive our current year SG&A to approximately 17% of net sales versus 16% last year. Adjusted EBITDA improved by nearly $30 million. For the quarter, it was income of $3.8 million versus a loss of $25.8 million last year. This reflects our Q1 gross margin recovery coupled with strong fall POS results and higher retailer shipments ahead of spring. Below the line, interest expense was down 21% to $34 million, on lower debt balances and more favorable interest rates. We continue to use strong cash flow generation and working capital management to further reduce debt. We now expect interest expense for the full year to be lower by $15 million to $20 million versus prior year. For Q1, the non-GAAP adjusted tax rate was 31.4%, due to the impact of the seasonal pre-tax quarterly loss and the timing of discrete items. For the full year, the non-GAAP adjusted tax rate is still expected to be in a range of 27% to 29%. Also, because Q1 is typically a lost quarter, given the seasonal nature of our business, the company is required to use the basic share count to calculate EPS. For the current quarter, this was $57.3 million compared to $56.7 million in the prior year. The increase in share count is attributable to share-based compensation and is expected to increase to approximately 59 million shares on a diluted basis by fiscal year-end. The first-quarter GAAP net loss was $69.5 million or $1.21 per share compared with the prior year loss of $80.5 million or $1.42 per share. Non-GAAP adjusted loss which excludes impairment, restructuring and other nonrecurring items, improved significantly to $51 million or $0.89 per share, versus a loss of $82.2 million or $1.45 per share a year ago. Now, moving on to certain adjustments to our GAAP numbers. For the quarter, we had $21.7 million in impairment, restructuring and other nonrecurring items. This activity included the following: first, employee severance costs, including those related to executive team changes; second, valuation losses from our fiscal '21 investment in RIV Capital; and third, the final phase of our Project Springboard cost reductions that began in fiscal '22. You may recall that our Hawthorne Collective subsidiary provided an investment in the form of convertible notes to RIV capital which has legal cannabis operations in the state of New York. Late in our first quarter, RIV Capital merged with a consortium. As a result, we converted those notes to nonvoting exchangeable shares in the consortium. Going forward, these shares in the consortium will be accounted for as an equity investment with our proportionate share of Consortium's net profit or loss being recorded with an equity earnings line in our P&L. We plan to record this activity on a lag starting in our third quarter of this fiscal year. Next, I'll move to free cash flow and the balance sheet. We continue to focus on free cash flow to further strengthen our balance sheet. And in Q1, our total debt was lower versus prior year by $337 million. Free cash flow usage for the quarter of $475 million reflects our normal seasonal build of working capital. Our strong financial results, along with the cash flow management have helped reduce our leverage ratio another quarter turn. For the first quarter, our leverage ratio was 4.52x net debt to adjusted EBITDA. This is well below the covenant maximum of 5.5x. Note that our covenant maximum will fall throughout the year, decreasing to 5.25x in the second quarter, 5x in the third quarter and 4.75x in the fourth quarter of this fiscal year. Our expected leverage ratio will also continue on a declining path and we have line of sight to achieving leverage in the low 4s by fiscal year-end. As I wrap up, I want to recap our three big financial objectives this fiscal year. They include, first, invest in our brands to maintain and build upon the sales growth in fiscal '24 from additional listings and share gains. Second, drive margin recovery through sales growth and supply chain cost savings and last, strengthen the balance sheet through further debt paydown and a focus on returning to a more flexible capital allocation strategy. We will continue to make substantial progress on each of these in '25 and remain on track to our three-year growth plan. Lastly, we are tightly managing costs and to echo Jim's comments, we are strengthening our core consumer franchise and what he calls our superpowers. Most importantly, we are future focused building on greater value and creating a more shareholder-friendly environment. Thank you and we can now start the Q&A. I'll turn it over to the operator.

Operator, Operator

Our first question comes from Chris Carey with Wells Fargo Securities.

Chris Carey, Analyst

There was a comment in the press release about strong fall season across all categories and some early retailer load-in for the spring season. Do you envision any timing shift from the March quarter into the December quarter? Are there any implications for the March quarter, number one? And then secondly, as we sit here going into February, maybe expand a bit on early reads that you're seeing in markets. I suppose there's no markets that are breaking but how you're feeling across the country right now going into spring? And maybe just sprinkle in any comments on your exposure to the West Coast and Los Angeles County specifically. So, just a little timing shift on the December versus March quarter than some early season reads.

Jim Hagedorn, Chairman and CEO

There's a lot to cover. Starting with the fall, it went really well. We have a Board meeting in Florida after this call on Thursday and Friday. The weather forecast is looking good, with temperatures near 80% for the next 5 or 6 days. This indicates that the country is progressing positively from a lawn and garden perspective, and the point-of-sale numbers continue to look promising. Last week, Nate and I spoke with a senior merchant about my comments today, specifically regarding program dollars. We discussed how their point-of-sale performance looks, based on the business they are seeing this fall and the early spring markets that are starting to open. They believe they have data that suggests a positive outlook, not just for lawn and garden but for their overall sales. They feel this is a strong indication that consumers are enthusiastic and willing to spend. Since this is a home improvement retailer, that is encouraging for us. Their main concern is whether they have enough inventory available in the stores. What this indicates is that there are no significant issues with inventory levels. Based on their point-of-sale data across the chain, consumers seem to be in a good position to make purchases, which has historically been a positive sign. I believe it, and I wanted to believe it too, so I think that's a healthy outlook. I'm not sure what I might have missed, Nate, regarding my points.

Nate Baxter, President and COO

No, I'll add a little more color. So coming out of last summer, there was a lot of lawn damage in particular. And I think the fall POS really showed that consumers were engaged. We know historically that not all consumers come back and fix things in the fall. So I think that gives us a little more confidence in the spring. Coming on the West Coast, it is really a non-factor for us. We're obviously deeply concerned about what's happening in those communities. But from a business perspective, it is not going to be material. And of course, our teams will be out there helping folks when the time is right to rebuild. I would add likewise, this winter weather we've had, especially in the Southeast on the East Coast, I think the conventional wisdom among our retail partners is that will be good for lawn and garden. There will be a lot of necessary repair work. Overall, between what we saw in the fall and the load-in that's supported by our Q1 numbers from our retail partners, we feel like we're as established as we can be for a decent spring, and we'll see what happens.

Jim Hagedorn, Chairman and CEO

And then, Chris, to follow up on the sales phasing, the low single-digit U.S. consumer guidance we provided suggests that we expect the first half and the second half of our fiscal year to exhibit a similar pattern of sales growth. There may have been some earlier load-in than what your models predicted. However, generally, we should anticipate that low single-digit growth in both halves of the year. Traditional sales patterns indicate a return to our pre-COVID norms, with approximately 55% of sales occurring in the first half of the year and 45% in the latter half. Thus, we are returning to a more typical sales pattern.

Chris Carey, Analyst

Okay, great. Comprehensive. My follow-up is on Hawthorne. Jim, I think the concept of a strategic alternative for Hawthorne has been contemplated for a long while now and there have been logistical challenges with actually getting something done, right? And so I guess, in a way, I think there's always been some desire or increasing desire to do something with the asset over time. And so I guess the question is, are you feeling like the logistical side of actually being able to do something with the asset is getting better? Or are you simply saying you remain committed to finding an alternative for this business?

Jim Hagedorn, Chairman and CEO

I believe it’s both. Matt and I might not have been in exactly the same position during his time here. His perspective is that if it's profitable, it’s good news, especially since Hawthorne has returned to profitability, which is beneficial for our equity given our PEs are higher compared to the troubled public cannabis equities. This increases value. My viewpoint is a bit forward-looking because recent months have required us to focus internally on cutting expenses and optimizing operations. We are confident in reaching the $20 million target, and my Board is on board with me on this for Hawthorne. This is a larger figure than what Mark includes in our strategic plan, indicating that while it's challenging, it's achievable. There’s been notable progress made, but it’s a comparatively small target. The shareholders may feel uncertainty due to this mix of good and bad news. I communicated with some external advisors and noted that our equity could hold far more value in a dedicated cannabis venture than in our current structure. We're not looking to divest from it, but rather to concentrate our investments in the best possible arrangement for our shareholders. Chris plays a key role in guiding this business, and I believe authority is important in this situation. Once I reached a decision, it wasn’t solely mine; I sought consensus from my entire leadership team to ensure we were all aligned on this strategy. Logistically, although it was manageable, we had to assess whether it was beneficial to proceed with the current structure. Keeping it positive is essential, especially as this is a legal business. Transitioning to a profitable model changes the conversation significantly. Once we all agreed on the direction, I requested the team to tackle the logistical challenges. We plan to discuss this with the Board, who will need to authorize and collaborate with banks for approval. I anticipate this will progress in the upcoming months, and you might see initial moves soon since we are considering various assets. Changes could take place within a month or two. I believe we are well-positioned for action. The leadership team is united, and we simply need the Board’s final authorization and for Mark to secure banking approvals. After that, we’ll be ready to act, so from decision-making and logistics, I feel we are moving forward.

Operator, Operator

Our next question comes from Bill Chappell with Truist Securities.

Bill Chappell, Analyst

I have a question for Nate and the management team. Over the 20-plus years I've followed the company, we've talked about increasing marketing, advertising, and new R&D to boost sales. However, I'm trying to understand your business better. There are two main ways to grow revenue: one is by increasing the number of regular users, and the other is by getting users to spend more each year. Is there a measurable opportunity in either of these areas, and which one presents a greater opportunity? How are you working to expand in those areas?

Jim Hagedorn, Chairman and CEO

I'm going to jump in just at the beginning part because part of this is revisiting our core convictions and investing in the brand. Bill, I think if we look at sort of the market last year, probably, I think, 3%. I think the numbers are worse if you include live goods within the total market. We grew at about 3x that. A lot of that was a lot of share gain in there. This was coming out of a period where we probably wanted to get the program dollars back; retailers resisted that. We talked about that have created probably a lot of confusion on this discussion last year. In exchange for leaving those program dollars at the levels they were at, we picked up a lot more shelf space and a higher percent of promotion that occurred in the departments. So that was really good for us and we see that occurring pretty much at the same levels this coming year in sort of POS units. Now it's a very fair question to say how long can that keep going, how much share is there to take? I think Nate has been very much focused on where there is additional business where we are under-penetrated. And do you want to take that?

Nate Baxter, President and COO

Yes, Bill. That's a great question. The key point is that both aspects are important, but let me explain it this way. As we move into the spring, our messaging will concentrate on frequency. For instance, with lawn fertilizer plant food, there are clear opportunities. We've strayed from our messaging regarding multistep and the necessity of feeding, so that will be a primary focus this year to help increase basket size. We're also looking into cross-brand initiatives. Jim mentioned our new website, and we're collaborating with retailers on programs where liquid controls can be attached to some of our fertilizers. Engaging the next segment of users is crucial, as Jim highlighted in his opening remarks. Overall household penetration for lawn and garden is under 50%. Looking at trends over the past decade, the number of users, including those leaving the category and new homeowners lacking confidence, is on the rise, which I see as an opportunity. Though we've gained share recently through innovation, listings, and retailer programs, we need to do more by focusing on education and engagement, as these are significant levers. Each 1% increase in household penetration represents an additional $50 million in fertilizer revenue for us. Additionally, each increase of one-tenth in frequency, or the average number of applications, is similarly valuable. Therefore, there is substantial opportunity in both areas. In the short term, our focus will be on increasing frequency, while in the mid- to long term, we aim to engage consumers we currently don't reach. Furthermore, I see potential in the do-it-for-me space—not from a service perspective right now, but attracting consumers who opt for professional services to use our products. This is also something we'll consider in the midterm.

Jim Hagedorn, Chairman and CEO

I think we should discuss the dot-com aspect. As we assess the business, we have a new team managing our brands who are eager, enthusiastic, and youthful, and I appreciate their efforts. It's evident that we are underrepresented in the dot-com space, whether it's with retailer websites or the Amazon marketplace. We're strong in retail, but not as prominent online, which indicates the need for some product redesigns, particularly in the controls market. This represents hundreds of millions of dollars. Competitors are active in this space; for instance, Procter is engaging with Evo. We are looking at opportunities exceeding $100 million multiple times. This is clearly accessible for us, but we need to pursue it vigorously. The young team working with Nate, who is enthusiastically supporting them, sees this as a significant opportunity. However, I have some concerns about the scale of the opportunity; Nate mentioned it could reach nearly $1 billion. I suggested we aim for a more manageable figure to ensure we maintain focus on our investments and avoid chasing after too broad of a target, but there is undoubtedly substantial potential there. The retailer.com aspect is crucial, especially among younger consumers who prefer online shopping over visiting physical stores. This is aligned with our largest retailers, who are keen on our support for their online presence. There is significant potential for us to increase our penetration in this area. Unfortunately, we have allowed competitors to establish themselves here, and we need to assert that this business should be ours. Therefore, we will pursue it actively.

Mark Scheiwer, Interim CFO and Chief Accounting Officer

Just real quickly, Bill, on the investment side as they've talked about that. I mean, to me, it's very much kind of folds into our superpowers. I don't foresee this being a massive amount of long-term investment. We will continue to invest as part of our longer-term plan. But things that Nate has talked about. I mean we've got incredible supply chain facilities, incredible distribution capabilities. We have a lot of that already in stock that should yield a pretty good return on our investment. Will we have to invest, sure, but I think it could be easily managed.

Bill Chappell, Analyst

That's great. Just a follow-up, it's sometimes challenging for us to notice the changes in market share at the retail level during the season; we typically get that information at the end. Is there a specific area, like lawn food, soils, or mulch, where you're particularly excited, feeling geared up to capture significant market share and grow quickly? Or is it more of a general sense that we have overall momentum?

Jim Hagedorn, Chairman and CEO

If you don't mind, we can both respond to that. It's another good question. If you examine the business, it's easy to see that the current focus on controls and gardens is beneficial for us. This is a high-margin sector, and we are observing double-digit growth which we anticipate will continue. This is where we expect to capture more market share as we remain in a strong position, which is great for us. We are not losing ground in the lawn sector; in fact, I believe we're in a very favorable position. Many are now recognizing the need to reinvest in unit purchases. Although there hasn't been a significant decrease in dollar sales in lawns, primarily due to our pricing strategies, we have reached the upper limits of those strategies, particularly with consumers. This has proven to be a lucrative segment for us. We have a solid plan in place for our multistep bag offerings, which is foundational to our business in Marysville. The team is committed to taking a critical look at market dynamics and is receptive to making necessary changes. Overall, I believe this openness is constructive. There’s nothing alarming here; instead, it encourages critical evaluation of the lawn market, which can be challenging to address. I consider unit volume a crucial metric to focus on moving forward. If you were to ask me about the top three priorities we’re pursuing, I would emphasize ongoing recovery, investment in margins for our lawn business, and optimizing our Hawthorne assets to maximize value. That's where my focus lies.

Operator, Operator

Our next question comes from Jon Andersen with William Blair.

Jon Andersen, Analyst

Boy, there's a lot to chew on here. I did want to say that I didn't have the mouse on my bingo card this morning.

Unidentified Company Representative, Unidentified Company Representative

You've got a bingo card. That's cool.

Jon Andersen, Analyst

I'd like to hear more about the expected timeline for gross margin improvement in 2025, as well as your three-year goal of returning to the mid-30s. Jim, you mentioned that achieving the last third of this goal, which is projected for after 2025, will be the most challenging part. Can you provide any updates on the 2027 objective and your thoughts on overcoming these challenges to reach that level?

Jim Hagedorn, Chairman and CEO

Before Mark begins, I want to address the pressure I've been receiving from my board to outline a longer strategic plan beyond 2027. I've pushed back on this mainly because I want us to reach a new position before we start complicating things with long-term goals. While these goals are important, we still have some significant work to do to fix our business and achieve what I've discussed. I don't necessarily believe it's as challenging as it may seem. Our team, especially Shire, is doing an excellent job working alongside the finance and operations groups. We can clearly see the path to achieving our goals. It's going to involve making tough decisions, but we're committed to pushing for higher performance than where we currently stand, which is normal and what we should aim for. Achieving our target of at least $700 million in EBITDA by 2027 requires us to critically assess our operations and make some hard choices. We also need to invest in our brand to ensure its long-term strength. I believe we have a uniquely valuable consumer franchise. Considering the valuation multiples of leading consumer brand companies like Procter & Gamble, Clorox, Colgate, and Church & Dwight, it’s evident there's a significant potential for multiple expansion compared to our current position. Given the challenges we've faced, we're fortunate things aren't worse. We are determined to achieve this growth, which includes not only producing financial results but also making the necessary investments in our brand to ensure its viability.

Mark Scheiwer, Interim CFO and Chief Accounting Officer

Jon, to follow up on your specific questions about phasing and long-term expectations. For this year's gross margin, we anticipate achieving $75 million in cost reductions, which we have a clear view on. As Jim mentioned, the team is striving to exceed that target within the fiscal year. Overall, approximately two-thirds of that $75 million will be realized in the first half of the year, with the remaining one-third expected in the latter half. This front-loading is primarily due to our effective inventory acquisition at lower prices. Year-over-year, we are experiencing deflation and are now utilizing that cheaper inventory, bringing us to a more balanced status for the rest of the year. In the first half of the year, we were still addressing higher inventory costs from last year, which contributes to the year-over-year benefits from lower inventory expenses. I expect to see further gross margin improvements in Q2 compared to the previous year, again roughly two-thirds as mentioned. The third quarter should be similar, while in Q4, we will begin to see the benefits from the $29 million in excess and obsolete charges taken last year, providing a favorable year-over-year comparison. Regarding long-term projections, we are targeting around 30% for the full year, with the core business exceeding that, especially in lawn and garden, which remains robust. We are continually engaged in our 6Q savings projects, focusing on long-term cost reduction strategies, and are developing plans to achieve an additional $150 million in supply chain savings, with another $75 million anticipated in '26 and '27. We are still finalizing the timing for that, which will be linked to targeted projects and activities. Transformation is part of our strategy, and we have integrated it into our core operations. Historically, pre-COVID, our U.S. consumer margins hovered around 35%, and we believe we can return to that level as we optimize our supply chain. We see this long-term goal as pivotal, and our approach will be as agile as possible, emphasizing the importance of transformation. I regard '25 as a stepping stone toward achieving mid-30% margins, particularly highlighted by our first-quarter results. I hope this provides you with added confidence. Nate, do you have anything else to add?

Nate Baxter, President and COO

Yes, not to repeat, but I think a few details, Jon. I've got my business units looking at three main things. First of all, Jim referenced simplification. I guess, we'll call it a SKU effectiveness project. It's been a long time since we've taken a hard look at the margins on a SKU by SKU level. I'm not saying we're going to massively strip the portfolio down, but I think my GMs need to know where their margins are. That's the first piece. Innovation will drive margin acclamation, and we've been trying to get that innovation turned back on. During the pandemic and our challenges afterwards, we were really focused on cost out. We've made some nice additions to the team to think out 5, 10 years. Of course, the supply chain efficiencies also play a role. We are not going to do this at the expense of retailer margins. They're our partners, and we're going to work with them to make sure that programs we put in place drive win-win for both of us. It is all task, but I told Jim, he asked me, can we get to 35%? I don't think I skip a beat. I think we'll get there. I don't have every step in the way mapped out, but directionally, I'm pretty confident.

Jim Hagedorn, Chairman and CEO

I also want to emphasize that the entire organization will play a role in this. It's like giving everyone a chance to step back after the Board meeting and start refining their plans. Many teams are actively involved right now. It's not just Nate contributing; when we look at the overall investments, much of it is coming from our operations, which is significant because that's where a lot of our expenses are. It's appropriate, and the corporation will also be involved in this process. We are asking ourselves important questions about our future and how we can create value. Mark can speak to the financial aspects since he oversees those details, but I believe that number is not concerning at all. What do you think?

Mark Scheiwer, Interim CFO and Chief Accounting Officer

No, not at all. I think to your point, it will come also at corporate and SG&A. Some of it might get reinvested as Jim talked about on super power; some might drop to the bottom line. I think it just allows us some flexibility as we continue to do our '26 planning which we already have started and have been focused on even while we're in season. So yes, we'll all participate in that process. There's plenty of opportunity there. I think there's a lot of technology over the past 5, 7 years that have allowed us to do our jobs a lot easier and I think get more efficient. I think we've got some good ideas.

Operator, Operator

Our next question comes from Jonathan Matuszewski with Jefferies.

Jonathan Matuszewski, Analyst

Nice results. First one was on innovation. In your prepared remarks, you referenced natural fertilizers and liquids as part of the product road map ahead. So just curious how you see those contributing to the 3% sales growth over the medium term and how you think about innovation as a contributor to U.S. consumer segment growth ahead relative to history?

Jim Hagedorn, Chairman and CEO

Yes, Jim, I’m going to take the lead on this. It’s really Nate’s area of expertise, but I want to emphasize that one of my key priorities is to see progress in unit volume and lawns. We are not losing market share; this issue is widespread across the category. Young people are particularly concerned about the chemicals used in yards. I believe that organic options can help alleviate those concerns, and we know how to implement this effectively. However, even when we offer organic products, they often don't sell well to consumers. One reason for this is people's apprehension about chemicals. We want to provide products that educate consumers on the benefits of fertilizing multiple times each year. Climate change is causing spring weather to be more unpredictable, which has a greater effect on our lawn care business than on others. This situation calls for genuine innovation; we can enhance performance in control products and fertilizers. Innovation will be central to our strategy for expanding the overall consumer segment.

Nate Baxter, President and COO

I mean, look, I'll break it down to how we look at innovation which is easy use for the consumer effectiveness, value and safety. Depending on your consumer, those things, the rank order of importance changes, but I think Jim talked about it. This year, we've got our full Miracle-Gro Company, organics line coming out. That's been a big hit in gardening and we know that that's important. We have new innovations in lawns coming out. We have our OM Scotts, pesticide, herbicide-free, straight food, straight seeds; it's going to be in a curve recyclable bag. So, we're playing around with new form factors. I mean, I certainly would like to see less plastic in the world, but it has to work. We've got an all-natural product that is going to compete with the P&G offering coming out this summer. I want to be able to offer whatever the consumer wants. If we want to have a consumer that wants to be all-natural, we will have products; but we're also going to have really smart products that are effective and safe to use that contain active ingredients. We need to communicate with consumers about how to use these things in order for them to be successful. That's going to be a big piece of it. We'll also engage with some of our active suppliers, some of the big ag companies. We are looking 10 years out. We are looking at biologicals. We engage in some of the crystal research they are doing looking for more natural ways to improve the performance, whether it's controls products or fertilizer plant food. If we stick to these priorities, I'm pretty confident that we'll be leading the pack with innovation.

Jim Hagedorn, Chairman and CEO

I went to announce your new partner on the innovation committee.

Nate Baxter, President and COO

So Rob Candalino, outstanding new board member. He will be taking over for Tom Kelly. My team has a lot of respect for him. He's probably given us more insights in the last few months than we've had in a long time just because he's a working CEO and he's still out there fighting the good fight. A really great addition to the board. While I'm deeply sorry to see Tom Kelly go, we need to give Tom a lot of credit for this company's been over the last couple of decades. We've got an all-new team and I'm pretty excited about that.

Jonathan Matuszewski, Analyst

That's great color. Just a quick follow-up. A lot of references to the opportunity in the dot-com channel with some of your major retail partners. Is there any way to dimensionalize where you stand today in terms of penetration? And just help clarify the step for executing on that opportunity. I think it was referenced maybe some optimization of product sizes to work in that channel, but is there any?

Nate Baxter, President and COO

Yes. I'll just say broadly, in DIY brick-and-mortar, on a unit basis, we're roughly 40% market share across all our categories. We are barely in the double digits when it comes to the e-comm play, so there's a tremendous opportunity. Here's the thing. We've built a beautiful franchise around DIY, brick-and-mortar lawn and garden. We are not at all giving up on that. There is growth. But to operate effectively, whether it's in e-com or omnichannel, we need to offer smaller, lighter packaging that suits the online consumers. We're already working on that. The team is working diligently on this and my only mandate for my team is that we do not impose the way we do things today on those growth opportunities.

Jim Hagedorn, Chairman and CEO

Jonathan, maybe just to dimensionalize. Just a follow-up on that. You talked about around 10% or so; it ranges single digits for some categories, slightly above into the low double digits in other categories, so it just depends category to category. To his point, there is a lot of great opportunity that we can do there, especially on the form factor and different types of offerings.

Operator, Operator

Ladies and gentlemen, that concludes today's presentation. We thank you for your participation. You may now disconnect and have a wonderful day.