Earnings Call: Q4 2018

Nov 7, 2018

Good day, and welcome to the 2018 4th Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jim King. Please go ahead, sir. Thank you, Rochelle. Good morning, everyone, and thanks for joining the Scottsmere Grove 4th quarter year end conference call. With me here in Marysville, Ohio this morning are Jim Hagedorn, our Chairman and CEO Randy Coleman, our Chief Financial Officer Mike Lukemire, our President and COO as well as several other members of the management team. We'll get started in a moment with prepared remarks from Jim and Randy. Afterward, we'll open the call to your questions. I know that many of you have other earnings calls this morning, so we'll try to move through the queue as quickly as we can. To help us do that, we ask that you keep to one primary question and one follow-up. If there are questions left unanswered, I'm glad to follow-up with any of you later today or tomorrow. One bit of housekeeping before we move forward. Next Tuesday, November 13, Randy and I will be participating in the Morgan Stanley Global Consumer and Retail Conference at the Crowne Plaza Times Square in New York. We will be participating in a webcast Q and A session at 8 am that day. However, there is no formal presentation associated with this conference, so there will be no materials related to the event that are posted on our website. With that, let's move on to today's call. As always, we expect to make forward looking statements this morning, so I want to caution you that our actual results could differ materially from what we say here today. Investors should familiarize themselves with the full risk and range of risk factors that can impact our results, which are filed in our Form 10 ks with the SEC. I also want to remind everyone that today's call is being recorded and an archived version of call will be available later today on our website. With that, let's get things started and I'll turn things over to Jim Hagedorn. Thanks, Jim. Good morning, everyone. I'll get right to the point. I'm glad that fiscal 2018 is behind us. In fact, it's probably not been since 20 12 that I've been as relieved as I was this year to turn the page. But I have a much different mindset today than I did back then. That year, our performance ultimately led us down a path to adjust our strategy and to reconfigure the company. I see 2018 through a far different lens. The results of our reconfiguration has left us with a stronger portfolio. Categories like hydroponics, rodenticides and live goods have far better long term growth potential, even if some of them took a step backwards last year. Additionally, today we're a company with better margin and cash flow potential, metrics that ultimately drive shareholder value. The factors that impacted us in 2018 were mostly external and mostly beyond our control and have done nothing to diminish my confidence in our overall strategy. But confidence is one thing, results are another. So I'm not going to sit here and make excuses all morning. We understand the job ahead of us, and that's to execute, to make up lost ground and to drive better outcome for our shareholders, our associates and all of our stakeholders. As we enter fiscal 2019, we have a lot of things working in our favor. In the United States consumer business, we have innovation on our side next year with new organic products in both the gardening and weed control categories. We also were successful in getting price increases where we were seeking to cover commodity distribution inflation as well as higher plan investments in people and brands. Additionally, our line reviews were successful and we expect strong support of our brands again next year by our retail partners in all channels of trade. In Hawthorne, the integration of Sunlight is on schedule and we expect to achieve 100% of the synergies we've discussed in the past. We remain optimistic that Hawthorne will return to growth in the months ahead, and both the social and political environment continues to improve. Just yesterday, Utah, Missouri, and Michigan voted to broaden authorized cannabis use. Additionally, we believe the change of leadership in the United States House of Representatives enhances the likelihood for more compromised federal legislation that will make it easier for companies to navigate the cannabis market in states where its production, sale and use has become legal. To a greater degree than most of you probably realize, we've been a leading voice at all levels of government in shaping policy discussions. At the federal level in particular, I'm confident in saying that our engagement has helped sway opinions in both political parties, and we look forward to continuing our dialogue with the incoming House leadership team. From a financial perspective, we're confident we can get our earnings back on track in 2019. We will also continue to improve our working capital management with the goal of another strong year of cash flow performance. I'll come back to all these points in a few moments. But first, let me put a wrap on 2018. I want to start by recognizing the efforts of the entire team in our U. S. Consumer business. We finished the year with consumer purchase of our products flat on a year over year basis at our top 4 retailers. That alone was a big win given the delay we saw across nearly the entire country at the start of the lawn and garden season. In the home center and hardware channels combined, POS increased by nearly 3%. As you may recall, POS for the entire U. S. Business was down 15% in mid April. When the weather finally broke, the lawn and garden season also broke, and it broke hard. We won on a 6 week mid season terror across all categories that was unprecedented. By the end of the year, we had positive POS numbers in branded fertilizer, grass seed, soils, mulch, live goods and rodenticides. Once again, innovation made a big difference. Our lawns category enjoyed the best innovation year in more than a decade due to the success of Scotts Turf Builder Triple Action products as well as Turf Builder Thicker. As a result, our branded fertilizer business increased nearly 2% this year despite the slow start to the early part of the season. We also maintained our aggregate market share. I know some of you have been asking questions about the battle against private label, so let me address the issue head on. Private label has always been our primary competitor in key categories like lawn fertilizer and growing media. This is nothing new. Neither is the fact that we're winning. Investors often ask why we've been able to compete effectively against private label. There are 2 primary reasons. 1st, in a category where performance is critical, our products outperform the private label. We know that and so do our consumers. That's why continued innovation matters so much in this space. 2nd, because of our strong relationship with consumers, our brands drive foot traffic into stores. We know that and so do our retail partners. That's why we continue to invest heavily in both advertising and trade programs. Before I move on to discuss Hawthorne, I know many of you have questions about Roundup and the implications of the San Francisco jury verdict during the quarter. Here's what you need to know. 1st, I want to stress that we are committed to the Roundup brand and the consumer Roundup business. We also continue to believe fully that glyphosate containing Roundup branded products are safe for consumers when used as directed. The body of science evaluating the active ingredient glyphosate is immense and that scientific record supports the safety. That's why U. S. EPA and major regulatory agencies around the world have approved its use. If I felt any different, then we would not continue to serve as Bayer's marketing agent for Consumer Roundup. Our relationship with buyers since the Monsanto transaction closed has been a productive one. We respect their role as the owner of the brand and they respect their understanding of the consumer marketplace. 2nd, it's obvious that the scientific evidence supporting glyphosate safety has not prevented Bayer from facing a groundswell of litigation. I also want you to know that the litigation issues are theirs, not ours, and we are indemnified for any glyphosate litigation in our role as their marketing agent. 3rd, consumer purchases of Roundup since this verdict have actually been positive. We acknowledge that sales in this period may not be fully representative as it covers a time of year when consumers aren't buying a lot of weed killers. Still, we're carefully monitoring consumer sentiment for brand reputation or other sides of headwind. 4th, in the event the Roundup brand reputation and performance would see a significant decline, our agreements provide for potential remedies. And 5th, the diversity of our product offerings serves us well. To the extent that negative publicity might discourage certain consumers, we have other options available under our own brands in the non selective weed control category. I don't want to provide too many details this morning other than say we're introducing our own Ortho GroundClear and non selective weed control product. This is a product that is certified for use in organic gardens and does an outstanding job, especially on patios, sidewalks and driveways. We have the only U. S. EPA registration for the ready to use application of this product. It's worth stressing that we could have introduced older synthetic chemicals, but we like the idea of further expanding our organic product line. Our consumer data tells us that a non selective weed control product that has an organic certification will have a great deal of appeal and will be a welcome complement to the existing non selective products and actually expand the category. With that, let me switch gears and address the most recent results at Hawthorne as well as some encouraging signs we've seen of late. Overall sales increased 65% in the quarter. Obviously, most of that growth was driven by the Sunlight deal. However, Aerogro grew more than 50% and our European professional horticulture business increased by more than 30%. North American hydro business was down approximately 30% when making certain adjustments to create an apples to apples comparison, but there are some underlying facts here that are encouraging. First of all, the overall rate of decline has improved. When we make the same adjustments to Q3, the decline was nearly 40%. Randy will elaborate on this point in a few minutes. 2nd, remember that the Q4 of 2017 for Hawthorne included an extremely difficult comp of more than 30%. 3rd, the average daily shipments we've seen over the past several months has been steadily improving. If those trends continue, we should start seeing positive growth again in the new calendar year. 4th, we've made solid progress over the past several months as our business and customer base continues to evolve. We've upgraded our sales force and put a more intense focus on Canada than ever before. And 5th, the integration of Sunlight is on plan, and we expect to see 100% of our expected synergies to materialize by the end of fiscal 2019. I don't want to suggest we've totally turned the corner because we still have work to do. There is a strong possibility that December quarter will also show negative top line results. But based on the current trends, we currently believe we'll be back in positive territory sometime during the March quarter, which is our Q2. In discussing Hawthorne, I want to briefly revisit comments I made during our previous call. During the Q and A session, I referred to the team as gun shy. Some of you interpreted those comments to suggest a lack of confidence in the team and in the business. Rest assured, that's not the case. Here's what I was getting at. After unexpected declines in the first half of twenty eighteen, we asked the team for an updated plan for the second half of the year. Those forecasts also missed the mark. This was frustrating for all of us, and I know our shareholders were frustrated as well. The team reacted the same way I would have. They became even more conservative in their planning assumptions over the past several months. Their confidence in the business is unaffected and the same goes for me. But overpromising at this stage of the game just doesn't help anyone. But that doesn't mean we're sitting back and just waiting for recovery to come to us. We're getting after it and hard. Since our last call, we've made further organizational and leadership changes at Hawthorne, primarily in sales, marketing and strategic planning. Additionally, Chris Hagedorn and several of his direct reports are now based in Ohio, not New York or Portland. This allows them to more fully and easily leverage the assets of the entire organization, whether it's marketing, legal, HR, finance, supply chain, or Mike Lukemeyer or myself. I want to reiterate my confidence in this team, the portfolio we built and the opportunities that lie ahead of us for this business. While the market was clearly softer than we expected in 2018, we still made great progress. Our product portfolio got stronger, so did our supply chain, so did our data systems, and so did the team. I just reminded everyone that was only a year ago when we were seeing organic volume growth of more than 30%. We've talked several times on these calls about the overproduction of cannabis in the West Coast and the resulting pressure on legally authorized production. Several media reports have since validated our remarks. We've also talked about the undue regulatory burden that took effect in California at the beginning of the year. There is no doubt the hydro market has been reset going into 2019. We can't do anything about that. You probably noticed in our press release that we took a $95,000,000 non cash impairment charge in the quarter based on Hawthorne valuation. I'll elaborate on this later, but it's essentially a math driven exercise that starts with how we performed in 2018. Obviously, we're far from our original target, and it will take longer to reach the overall level of profitability we assumed when we purchased the businesses. That said, I would challenge any of you to name another company in the hydroponic space that's better positioned than Hawthorne. Yes, the market is changing faster than we and others expected, but that actually works to our benefit. Our use of language in the past may have led to confusion on this point, so let me clear some things up. When we use the word hobbyist, we are not simply referring people to grow cannabis for their own personal consumption. That's actually a tiny portion of the overall marketplace. Our use of the term mostly refers to small professional growers who happen to buy their growing equipment in retail channels. Now are those small professional growers facing stiffer competition from larger growers? Yes. But it's just another kind of professional grower. What's unique about Hawthorne is that we're the only player in the space that is fully able to meet the needs of all growers. Our challenge is pretty straightforward at this point. It's all about execution. As we look into 2019 for Hawthorne, in addition to the Sunlight, we expect organic sales of Hydro Products to increase in the mid single digits. We expect strong gross margin improvement and overall segment profit of roughly $60,000,000 Before I turn things over to Randy, I want to come full circle and talk about the U. S. Consumer business and our outlook for next year. You'll see that our guidance assumes sales growth of 1% to 2% in the segment. Embedded in that number is 3 points of pricing on a consolidated basis, which includes increases in some categories as high as 5% and others flat. We're also expecting strong results from Miracle Gro Performance Organics, our new line of organic plant food and grow media products. We believe this is the 1st organic product line that delivers poor performance on par with synthetic products. I believe performance organics is the most important new product we've created in years and has the potential to transform the gardening industry category and bring new consumers into the space. While we have several things driving the U. S. Consumer business next year, we also expect a gap between consumer POS and our sell on to the retailer. Let me help you understand the offsets. 1st, due to the way the Roundup agency agreement is structured, profits from that relationship will be lower next year by $20,000,000 This should not be a surprise to anyone. Those of you who understand the accounting for Roundup also know that the profit from that business flows through the sales line. So even if actual sales to product are flat, the impact on the top line will be a negative $20,000,000 That said, because of the current uncertainties about the upcoming season, we've engaged the buyer team about this structure and we're encouraged so far by their response. We also ended the year cautiously optimistic about the the potential for improvement in the mass retail channel. I recently had the benefit of a top to top meeting at 1 of the major players in this channel. We're both aligned in our commitment to drive improved performance in 2019 for the mutual benefit of both of our companies and the consumer. Does that mean we expect growth out of this channel in 2019? I hope so. At a minimum, I believe we'll find ourselves in a situation where we're working more collaboratively and finding more ways to win. So I see this as a good sign. With all the puts and takes, we expect consumer POS growth of 3% to 5% next year on like for like products. So the underlying health of our consumers and their support of our brands remains solid. We're done looking back on the challenges we've seen over the past year. In fact, in the closing months of 2018, we proactively dealt with pending litigation, questions about impairment and other subjective non operating issues that we could simply get behind us. We did this because I want our focus in 2019 to be only on one thing, looking forward, on getting our business back on track that we've been traveling and rebuilding our credibility with all of you. I believe we've taken a thoughtful and conservative approach to our guidance in 2019, and Randy can give you more insights on that shortly. But when it comes to running the business, Mike and the operating team are pushing hard. We are aggressively protecting our margins in the face of higher costs. We are bringing game changing innovation to the marketplace, and we continue to refine the Hawthorne operating model and plan to take advantage of this quickly evolving new market opportunity. With all of this said, it would be disingenuous for me to ignore the share price and the impact our performance has had on shareholders this year. After all, I didn't shy away from the issue a year ago when we were trading at an all time high. I want to remind everyone listening that my family is the largest shareholder, so I'm no happier than any of you. But I'm committed and look forward to having a more positive story to share with all of you in 2019. With that, let me turn things over to Randy. Thank you, Jim, and good morning, everyone. Jim H. Has already covered a lot of important ground and the results we announced today are pretty much in line with the updated guidance we provided in June. So my plan is to explain some of the nuances around our Q4 and full year results and then discuss our 2019 guidance. So let's move on. The top line results in the U. S. Consumer segment for both Q4 and the full year are consistent with our guidance. There were no material changes in the performance of the business during the quarter, so I won't dwell. Jim already dissected the Hawthorne numbers, but I do want to add some color here. AeroGrow's results were slightly better than we expected. The base is not huge, so it's easy to get a big percentage gain. We're also extremely pleased with our European professional horticulture business, which is almost exclusively lighting. Remember, both the Gavita and AgriLux brands started in Europe and remain extremely popular with growers in several key markets. These two positives helped to offset the continued softness within the U. S. Hydroponics business. Jim mentioned an approximate 30% decline in the U. S. Hydroponics sales on an apples to apples basis. This is an area where understanding the approach we took to the Sunlight transaction is helpful. You may recall we said that market disruptions after the deal could lead to about $0.10 of additional dilution. What we weren't saying publicly at that time for competitive reasons is that we intended to end Hawthorne sales to other distributors. Those distributors were sitting on Hawthorne inventory after we stopped selling to them and they moved aggressively to sell our products to retailers. We expected that to happen and knew we would likely lose some sales in the near term as a result. As a reminder, we guided to a $0.30 to $0.40 dilution in 2018 from the deal, and our actual results landed in the middle of that range. We also previously outlined a $0.60 to $0.80 EPS increase for Hawthorne in 2019 and we continue to expect an increase at the lower end of this range when including interest and amortization expenses that are incremental to the company but outside segment operating income. So when you exclude all their distribution in both Q3 and Q4, you see a decline approaching 40% in Q3 and slightly more than 30% in Q4. We've also been telling investors that we expected the consumable side of Hawthorne, mostly nutrients and growing media, to see a recovery before we saw that happen with durable products. That prediction has proven correct. While growing media and nutrients declined by about 15% in Q4, this was a significant improvement from what we saw in Q3. I agree with Jim's assessment. There are several encouraging signs that we're starting to see at Hawthorne. But I also agree that it's too soon to declare a turnaround here. The December quarter is likely to show a decline as well. Let's move on to the gross margin line. This is the one area of our revised guidance where we missed. In June, we said we expected a decline in the rate for the year up to 300 basis points. As you can see, the actual decline was 3 60 basis points. Within the quarter, we saw a significant and unexpected margin issue develop in our Canadian professional business. This is not affiliated with Hawthorne. This issue, which was largely caused by distribution challenges and is now behind us, was the primary driver in Mission guidance. The primary drivers in the overall decline in adjusted gross margin rate for the year were higher overall distribution and commodity expenses, unfavorable fixed cost absorption and acquisitions impact from Hawthorne and higher trade programs expense that was planned at the start of the year. We expect commodities and distribution to continue to be headwinds in 2019, but we believe our pricing actions will offset those challenges. I'll come back to this in a few minutes. In terms of SG and A, the 6% increase in the quarter was largely driven by the Sunlight transaction. Overall, SG and A was down 2% for the year despite acquisitions. Going into the year, we did some restructuring, so those benefits helped. Also, about $10,000,000 of advertising expense was spent collaborating with retailers and therefore were reclassified to trade programs, which are netted against invoice sales. In addition, annual variable compensation was about half of last year's levels, but this was mostly offset by higher long term incentive expense, primarily tied to our expected cumulative free cash flow over a multiyear period. Our 2017 2018 performance and our confidence about the future caused us to accrue more in the current year. On a non GAAP basis, EPS came in on the low end of the range we set when we adjusted guidance in June, primarily because of the Canadian issue I mentioned earlier. For Q4, the non GAAP adjusted loss was $41,600,000 or $0.75 per share compared with a loss of $14,900,000 or $0.26 per share. On a GAAP basis, the loss was $130,600,000 or $2.36 per share compared with $42,300,000 or $0.72 per share. GAAP income from continuing operations for the full year was $127,600,000 or $2.23 per share compared with $198,300,000 or $3.29 per share. Non GAAP adjusted earnings were $211,600,000 or $3.71 per share compared with $236,900,000 or $3.94 per share a year ago. The full year diluted share count was $57,100,000 compared with $60,200,000 reflecting share repurchase activity of $328,000,000 for the year. Jim already mentioned the Hawthorne impairment of $95,000,000 which is excluded from the adjusted numbers. Also excluded was an additional charge of $20,000,000 related to a litigation matter associated with our former Wild Bird Food business. Remember that we also took a $65,000,000 charge in the 3rd quarter related to the same matter. We're in the final stages of settling that case, which is a class action lawsuit and look forward to getting it behind us. The last topic I want to reinforce is cash flow. We've said repeatedly that we consider cash flow our most important metric, and I think we proved that again in 2018. Our operating cash flow came in at $343,000,000 not far off of what we saw last year despite the sharp decline in earnings. No doubt the benefit from lower taxes helped, but I'm particularly pleased with our working capital management, especially inventory. Despite lower than expected sales in our U. S. Consumer segment, we still lowered our inventory levels in this business by $20,000,000 I still believe we have further room for improvement and the changes we made to our compensation programs are keeping the organization focused on this metric. We've also talked more frequently over the last year about free cash flow productivity, which we calculate by dividing free cash flow by GAAP net income. In our press release financials, we include a reconciliation of this non GAAP disclosure item. The ratio was 134% in 2017 and 4 31% in 2018, which obviously requires some explanation. The 2018 ratio is impacted by certain non cash items that reduce our GAAP net income. If we exclude our non cash impairment, restructuring and other items and the non cash accruals for litigation matters, the productivity number is more consistent with what we saw in 2017. Looking ahead to 2019, on an apples to apples comparison, the 4 31% in 2018 will likely fall below 100% due to the timing of expected payments for these litigation matters. However, excluding payments on the litigation matters, our goal is to have at least 100% productivity once again on operating cash flow of $290,000,000 to $300,000,000 and free cash flow of $220,000,000 to $230,000,000 With that, let's shift gears and talk about 2019 P and L guidance. On a company wide basis, we're expecting 10% to 11% sales growth with 1% to 2% from U. S. Consumer, about 8 points from Sunlight and another one point from organic copper and growth. Jim already bridged the U. S. Consumer number, but I want to applaud the team for staying focused on getting the price increases we needed to offset the cost pressures we're seeing. No one expects relief in the freight market next year, and every commodity we're purchasing is up over last year. The combination of these pressures is upwards of $30,000,000 Recall that we did not take pricing in 2018. That was a decision that hurt us when commodities and distribution expense were more unfavorable than we expected. The pricing we're taking in 2019 will provide some improvement to the gross margin rate next year in the U. S. Consumer segment. However, we expect that improvement to be offset by the mix impact from Sunlight. So on a full year companywide basis, we expect the rate to be about flat. Let me also take a few moments to address tariffs. Our full year impact is currently estimated to less than $10,000,000 after mitigation plans, and most of this amount stems from the 4th round of tariffs that largely impact our Hawthorne segment. We are planning a small price increase on certain SKUs to offset this impact. In SG and A, there are a lot of moving pieces. The 8 incremental months of Sunlight obviously will result in higher expense. And the advertising dollars that were spent in customer trade programs in 2018 will be put back into SG and A in 2019. We're also expecting higher investments in people. Like most companies, we're starting to see wage inflation and retaining our best people in this robust economy requires us to take a look at both compensation and benefit dollars. We are also planning for higher annual bonuses in 2019 tied to expectations of much higher profitability and continued strong free cash flow. When everything nets out, we see SG and A up 5% to 6% higher. I think that's actually a good place to land given the impact of acquisitions. Next year, we'll also see the full year impact of the Sunlight deal on our interest expense. Our best estimate is that interest will come in somewhere between $100,000,000 to $110,000,000 for the full year. Our leverage ratio at the end of fiscal 2018 was 4.2 times and I would expect that ratio to only decrease slightly in 2019 before falling more dramatically in 2020. Due to the back half timing of our operating cash flow and the pro form a nature of the leverage calculation, which currently already includes Hawthorne Synergies. We're guiding to an effective tax rate of 25% for 2019 and a share count of roughly 56,500,000 shares. As we focus on leverage, it's unlikely we'll be repurchasing shares in 2019. If we do, I would expect it to have only a modest impact on next year's share count. Bringing all this to the bottom line, our adjusted EPS guidance for next year is $4.10 to $4.30 per share. Before we open the call to your questions, I want to say that I'm aligned with Jim as it relates to our job for 2019. It's all about execution. I believe our guidance represents our best estimate for 2019 based on our current thinking. We are not getting overly aggressive in our growth assumptions and we're realistically thinking about some of the cost pressures we expect to see over the course of next year. I'm also aligned with Jim H when it comes to driving value for our shareholders. I spent a lot of time sitting across the table from dozens of former and current shareholders this year. The hard questions you asked were well deserved and we've done our best to help you understand the challenges. I've also spent a lot of time with prospective shareholders. I agree with most of you who see SMG as a strong long term opportunity right now. I've been here almost 20 years. I know this company and I know this team. We have a strong core business that generates significant cash flow and Hawthorne remains an investment with great potential. And so I'm confident, but as Jim said, confidence is one thing and results are another. We owe you results and we're committed to delivering it in 2019. With that, let me turn things back to the operator to take your questions. Thanks. Thank you. The question and answer session will be conducted electronically. And we'll first hear from Joe Altobello with Raymond James. Thank you, guys. Good morning. So first question, I want to go back to a comment you made this morning and also in your release about focused inventory productivity efforts for certain key retail accounts. What does that refer to? And I guess, did you guys experience any changes in shelf space in light of the price increases you're taking next year? Joe, I think your first question is related to 2018. And we did see a lot of inventory productivity focus from retailers more than we've seen in prior years. So mass channel was similar to what we saw in 2017 and we largely expected that. On the home center side, I'd say there was more focus in the Q4 than what we'd seen the year before. And that was a little bit surprising for compared to what we would have expected back in June. But going forward, I think that's the second part of your question. We expect to see continued focus on retailer inventories and productivity. I think they're being prudent in trying to drive their cash flows just like we are. I think they're trying to find the most productive SKUs that they can push the hardest and those are largely the brands. So I think related to our pricing, 3%, I think it's a terrific outcome. I think it's higher than our competitive set marginally. And I think it shows the strength of our brands. And I think when it comes to decisions made by retailers, they may be pruning some of their less productive SKUs next year, but I don't necessarily associate that with pricing. I think it's just a focus on being more productive, running the business better, and that's the way I'd run my business as well. Yes. I would add to that. Is that across the category? It depends on category, Joe. We've seen a tighter control on the controls business going to 2 brands versus 3. So there have been adjustments there. And Lowe's closed some stores, there's an effect there. OSHA is out of the picture. So there's a lot of things that are affecting inventory. And so you look at that as far Joe, I don't think it's anything to do with pricing, to be honest. Not that I'm aware of anyway. And Joe, this is Randy again. When you compare that to market share, we've maintained our market share again this year. So looking ahead to next year, I think we'll see a little bit of decline in our units, which we've debated internally whether we'll see that or not. But I think it's a prudent way to go just because retailers, I think, will be focused on trying to drive inventories down and continue to drive POS up, and that's a good ratio for them. And they'll be adjusting their promotional strategies as well. Joe, I would not make too big a deal out of this. I think to some extent, I don't know what's real about it or not. We know one thing that a lot of retailers overwinter with quite a bit of product. That to me, we have tried to work with retailers to sort of focus on their gross margin return on investment and that our ability to react and distribute products allows them to reduce their inventory in the off season. I don't sense that any of them, including mass, are disinclined to invest in the season when it really matters. I think actually quite the opposite. So I think I don't know what it all means. I know one thing, everybody was really happy how this year ended given how grim it looked in mid April. And I think it probably affects their psychology when it comes to inventory. But it's I think as Randy said, it's not a bad thing. And if I were them, it's an easy way to improve your Gimroy is just saying, selling a bunch of stuff for 7 months a year and then selling sort of squat except sort of indoor, but sitting on a bunch of inventory for 5 months, is just a kind of a gimroy problem. And the fact that they're focusing on it and making sure that in the off season they're there, that actually works to our benefit because I don't think anybody can respond like we can. So I'd ask to say, we've had a lot of really productive conversations with our retailers over the last few weeks and I think there's a lot of energy and excitement about next year And maybe internally, we're feeling really good. We just had our annual sales conference just a few weeks ago, and I'd say the team is ready to go and get after it in 'nineteen. Yes, I'm more optimistic, though. I'm not allowed to share that. So, I hope that was really helpful. Don't tell me your gun shy. That was my order for this morning. You got something else? It's hard to follow that up. But so consumer sales, just help me with the math there. Sales up 1% to 2%, pricing gets you 3%, the Roundup agreement is a negative 1%. So you should be talking about volumes being kind of flat to down 1% next year with the price elasticity and with the potential inventory reductions at retail effectively? I'd say that captures it well. I'd also say that related elasticity, our products are purchased so infrequently that consumers don't really have price points in their minds. So we haven't seen tremendous elasticity over time other than the year. If you go back almost 10 years ago when we took a 30% price increase on lawn fertilizers, there was a lot of elasticity at that point. But year to year, when we're talking about mid single digit price increases, we're not really concerned about elasticity coming out of that. I'd put it sort of the opposite, Joe. We're more concerned about our gross margin line eroding than we are about sort of what I would say is very slight peers. I totally agree with what Randy said is that on sort of once or twice per year purchased products when you're dealing with 3%. I just this environment where freight alone, I think we looked at and said freight is up 20% in 2 years with us. And basically our raws are up. We got these taxes from bringing shit in from Asia. I just think it's one of those things where that was more important to us, I think, than this sort of minor fear. And I think people who aren't taking pricing right now, they're just eroding their P and L. And I don't see them benefiting from it. And I see the strength that we have by maintaining the sort of quality of our earnings as actually being more important. Okay, understood. Thanks guys. And next we'll move to Bill Chappell with SunTrust. Thanks. Good morning. Hi, Bill. Just to try to make it more simple on the earnings guidance for next year, you did $3.70 in EPS. You're saying 0.60 dollars to $0.80 from Hawthorne Synergies, so and the low end of that $0.60 So that gets me to $4.30 I think I'm doing my math right. So does that just imply the core business is a negative $0.10 to a negative to get to the midpoint and a negative $0.20 to the low point? Yes, that's the math, Bill. I'd say $0.60 is our estimate now for Hawthorne for next year rather than $0.60 to $0.60 So let's call it $0.60 And with the round of commission moving backwards, even with 3% pricing, we have more commodity headwinds, distribution. We don't expect that to be turned around anytime soon. We talked earlier in the last couple of calls about labor inflation that we're seeing. That's showing up more in the gross margin rate and less in SG and A than what we would have modeled if you go back 6 months ago. But when you factor in all those headwinds and net that against pricing, your math is right. And just to finish, I think you've said that you didn't price for variable comp going into next year, but you believe you can earn that. I mean, does that do you by having the core business as a negative, you can still earn a variable comp? At this point, if we were to hit the midpoint of our range, we'd actually be paying out below target next year, Bill. So yes, it will be higher year over year, but it won't be back to target levels and we expect to try to beat that number. But I think where we're at right now in early November, I think very appropriate guidance to provide. And then on early and I understand that. I understand we're a few months away. On that kind of comments on the hydro business, As we're looking, I understand you're thinking the December quarter will still be down. Are you seeing it flip as we move into November where it's actually growing on a monthly basis? Okay. I'm going to for the first time, we're introducing young yes. No, no, I'm actually not going to answer it. I'm going to give it to Chris Hagedorn to answer it. I think he has answered himself. Hey, guys. So this is Chris. I'm sorry, my voice is a little scratchy. I got a cold. So the short answer is, yes, we're starting to see some positive really encouraging results as we move into November. And it's particularly when you look at the business by particular categories, we're seeing some bounce back in the U. S. Kind of hydro market, which is still largely a retail market for us. As Jim made the point earlier about sort of hobbyist, that retail market is still serving the kind of what I would call smaller scale professional kind of commercial growers. But the bounce back we're seeing is encouraging not only right now for this quarter, but certainly for the long term outlook for me is we're seeing really strong results as Jim mentioned in our European and Russian ProHort business continues to over perform. Those guys are the most professional growers in the world. They're Dutch and Russian indoor growers who've been doing this for 100 of years. The other thing that makes me feel pretty confident about this is the results we're seeing up in Canada. As Jim mentioned, we're putting an increased focus on our sales up there and our relationships with the larger scale LPs. So there's oftentimes big publicly traded guys like Canopy or Aurora, very large professional companies. The progress that we've made with an increased focus up there, establishing top to top relationships as well as dealing with the guys that are actually growing these plants, We're seeing really encouraging results. We've over delivered there sort of early results yet for this fiscal year obviously. But again, the numbers that are rolling in are better than we expected. And that makes me pretty confident for the future here in the U. S. As well as if we look at Canada largely as kind of a proxy for what America will be whenever we see larger scale legalization. And last night was a good night for us in terms of legalization. Feel pretty confident that we can win in that structure because we're winning in that environment right now up in Canada. That's helpful. And I guess last just follow-up on that. Is California stable as a market or is it still year over year decline? California is beginning to stabilize. Our outlook for this year is positive for California, but it's not particularly explosive. I mean, we're looking at I mean, can I share what we're looking at? Yes, we're looking at 2% year over year growth for California. So again, conservative, but I think we'll see that business start to stabilize and hopefully slowly bounce back. But the real growth that we're looking at this business is Canada and then other parts of the U. S. That really haven't seen the growth that California had already seen leading into this year, so places like the Northeast. Great. Thanks so much. And next we'll move on to Chris Carey with Bank of America Merrill Lynch. Good morning. So just following up on that line of questioning actually, You mentioned you're serving the retail or excuse me, at the retail side of the hydroponic distribution channel still serving that mid to scale grower or excuse me, small to mid scale grower. So how exactly do you serve the larger scale grower because you are still precluded from dealing directly with that consumer, are you not? And then do you not have that same constraint in Canada because it's federally legal? So, Chris, let me start with Canada. We don't have the same kind of constraints because of federal legalization in Canada. So, much easier to do business there and we're making a lot of progress there over the last few months particularly. When it comes to the U. S, yes, we have to be extremely careful due to legal issues, due to banking concerns and how we go to business. So while we can talk to certain growers, we can't sell to them directly and we have to bill through third parties or through our existing retailers. So that's how we're going to business. So we can still develop relationships, but we can't do is sell or ship to them directly. But we've seen a lot of progress like Chris pointed out and I think we're starting to turn probably not this quarter, but looking out over the balance of 2019, we do think things are going to start getting better. Look, I would say that from we have been really careful with sort of making sure the lawyers, both our external and internal plus our treasury group and finance in general are involved in our sort of go to market strategies for the U. S. They presented a plan to me that I saw this week that puts together a group of sort of 3rd party resellers that is sort of our way to sort of provide insulation to that. And I know Randy is going to be talking to our banks and taking them through that plan as well. But I put it up as sort of required, but I'd put it in the sort of frictional loss category of why the rules in this country need to be fixed and starts with Congress. And I don't expect our sort of banks to lead into this. I do expect the Congress to lead into this. And I think the results last night were really important for that. And while I'm not a big supporter of the Democratic Party in general, I think when it comes to our issues in the House, you've already seen with Cory Gardner, Senator from Colorado, what he calls the States Act, which I think is fairly well supported within the Senate. It just didn't get a lot of traction on the House side to push it forward. I think that's over. And I think within that, you'll probably see a move to include reform on the banking side or selling where in states where it's legal. And so I'm very confident of that. In the interim, we will develop insulation that satisfies the lawyers and the bankers. But hopefully, we can move through that like Canada, where it's a much more direct relationship in time. And the other thing, Chris, I'd point out is the great, great majority of our sales still go through retailer and our retail partners have been terrific. It's been a challenging time for us, but challenging time for retail as well. Our retailers are sticking with us. The legacy businesses that we purchased going back 3 plus years ago, the relationships we had are strong. And then the business that we acquired with Sunlight Supply, strong retail relationships as well. So that's really where we ship to today. And I think we need to say thanks to all the people who have stuck with us. Yes. So I totally agree with what Jim and Randy said. This is Chris again. Hey, Chris. How's it going? So just to reiterate that last point that Randy made. Look, the reality is the marketplace is evolving in the way that these larger scale more professional growers are going to get their products. It's going to continue to evolve as well. But my hope and our hope here and what we've been working hard with our retail partners is to help the retailer evolve along with us and the grower. In the future, I think there's definitely a place for retail, but just like the rest of us, retail is going to have to evolve along with the rest of the marketplace. So we are trying to help and encourage our retailers to do that. We've seen a lot of them really happily kind of join us on that journey. So I'm hoping that continues, but it's good so far. Okay, got it. Thanks. So California plus 2, obviously that would imply other markets growing faster. It strikes me that Canada still has a ton of production capacity that they're building out. You have the Canadian LPs also looking at Europe. So I guess I'm trying to reconcile all that with the confidence on Hawthorne turning positive in the back half of the year, next year or the fiscal year anyways. I mean, mind? Or Or is this more about kind of stabilization efforts? Do you have contracts with growers that are building out in Canada, for example, anything like that that you could provide a little bit of incremental color on this, the turn that you expect? Sure, Chris. So like you point out, still a lot of opportunity in Canada. We're getting after that much more. We've actually co oped some of our existing salespeople and our Canadian business to start becoming salespeople for Hawthorne. So we're seeing success from that right now. We're not expecting a tremendous rebound right now in California or the West Coast. We think a lot of the growth will come out of Florida, East Coast and some of these new states. And again, we're trying to be conservative on California, same plus 2. I think inevitably, the entire market should come back to levels that we saw 18 months ago. But we're not planning for that for next year until we start seeing positive quarters. And I think once we start seeing positive quarters and get the momentum back, the margins will improve, the valuation will improve and everything will work out fine. Yes. And I think just to add to that, a little bit more detail on what Randy was saying. So some of the states that we're looking at where we expect to see some pretty positive results for this year are some of the more what I would consider more unexpected states. Everyone knows Michigan. We had a really good result there in the vote last night. So Michigan should be big for us. We're counting on that. Oklahoma is a pretty explosive growth state for us at this point. A lot of new retails open it up. So a lot of volumes move through that state of Florida as well. So I think we're seeing a lot of activity in newer states that are coming online with the expectations again that the Northeast will explode starting with everyone expects New Jersey will kind of lead the charge on that. Got it. Thanks so much. And then just one kind of final, I guess modeling question or in a way. Did I hear that you expect POS of 3% to 5% in U. S. Consumer next year? And if so, it feels like that's maybe a bit ahead of where you had been talking to that business in the 2% to 4%. So if you could talk to why you have like incrementally positive expectations there? Thank you. Sure. So Chris, with 3% pricing, we have that baked into that 3% to 5% number. So same units going out the doors with 3% pricing plus units. We do think though on a shipments basis, units will be back a little bit just because of the retailer productivity conversation we had previously. So that will put a little drag on shipments. But POS is how the retailers measure their business. And we think that's going to be really positive next year. And innovation, add innovation to it. So with the performance organics, 2nd year of thicker and turf builder. The new ground clear line. The new ground clear line. So we have lots of opportunity. Okay, understood. Thanks so much. And next we'll move to Eric Bosshard with Cleveland Research Company. Good morning. Hi, Hugh. A couple of things. First of all, curious if you could I guess, Chris, perhaps you're the right guy to answer the question. The customer mix of Hawthorne today, I understand it's been helpful to hear you characterize what the market looks like and what a hobbyist looks like. But what does your customer mix look like today within the business? Customer mix between large scale retail or excuse me large scale commercial growers, small scale, I mean can you be a little bit more specific question? Yes, I don't and I don't know enough to characterize between the hobbyist in retail and direct to the pro. You probably know the segments better than me. So how you think about your customer mix? Yes. So look, the vast majority of our business, as we said in some of the previous questions, still goes through retail. It's a difficult question to really put up too fine a point on as the grower base continues to evolve. I would say from a perfect if you look at these growers professional versus hobby, what I would consider hobbyist, which is people growing for their own consumption, it's probably 95 plus percent professional growers. Up in Canada, obviously, those are extremely large scale, large staffs of people, 100 of 1000 square feet of growing space. Here in the U. S, it really varies state to state. I'm not sure if that helps answer your question at all. In your mix, is that the market you just spoke to or is that your is that the Hawthorne mix? It's really both. I think our customer mix is pretty indicative of the grower base overall. Okay. And then just getting to Eric's question, the shift toward larger growers sort of coming out of sort of more investment kind of professional investment in the space, do you see that shifting? Yes, absolutely. Yes, it's definitely a shift from look, I would say we've been selling to professional growers this entire time. The businesses that we've acquired were selling professional growers long before we owned them. But those smaller scale growers and we've I think we've kind of hid from the word black market for a long time. But realistically these were smaller scale professional black market growers growing at basement or garage. A lot of those guys are graduating now to becoming what I would call larger scale sort of more mature professional growers who are growing in greenhouses or larger indoor setups. So that evolution has taken place and that's the one that I think has happened a little bit more quickly than we or anyone else frankly in the industry than anticipated. What gives me confidence is we are we've grown up at Scotts Miracle Gro with a professional business, serving a professional customer. It's something we understand pretty well. We still have a lot of people on our staff, folks we brought back in Hawthorne who are with Scott's professional business prior. So it's been a transition that's taken place a little bit more rapidly than we anticipated, but I still am certain that we are the best position to take advantage of it. Within that, I guess to follow-up that your market share with professionals in your core business is lower than with DIY customers in the traditional lawn and garden business. Within the cannabis business, within the hydro business, do you have a competitive advantage or disadvantage to have more success with the pro customer? Again, I know it's an evolving market, but if you compare and contrast those 2? Yes. I'm glad you asked because the answer absolutely is we absolutely have an advantage there. The way I look at this is say, look, there is no one in our space who has the breadth of whether it's product offering, knowledge, service, just sort of operational maturity that we have. There are folks that are entering up. I've heard people speculating to say, do the large scale growers care about brands? The answer is yes. They are growing a very valuable crop. What they care about is their ability to remain profitable and operate efficiently. And the products that we sell and the brands that we sell are Outside of that, there Outside of that, there are horticulture and agriculture distributors who I'm sure are and will continue to make pushes into this space. What they don't have that we do is a knowledge of this particular plant. It's not hard to grow a cannabis plant. It's really hard to grow a good cannabis plant. And it's especially hard to grow a good cannabis plant consistently harvest after harvest year in, year out. That's what we can bring people. And it's the ability to look at not just a Nutrien or a Light or a growing media product, but look at all of those products in sort of in an ecosystem understand how they affect each other. And from an innovation perspective, a product development perspective, no one has that perspective that we do. So that's I think is a pretty significant competitive advantage for us. Okay. And then 2 other shorter questions. The organic growth assumption for Hawthorne, it sounds like you're talking about 5 percent in 2019. What should we think about normalized growth? Obviously 2019 is a transition year. What normalized organic growth should this portfolio be able to generate from a medium term perspective? Yes. So when we look beyond 2019, we look more at end consumer demand and what that model would look like over time. So we know penetration or per capita usage is increasing 5%, 6%, 7% annually. On top of that, the shift from outdoor growing somewhat to it's going to be almost exclusively indoor unless you're talking about the West Coast is it's a tailwind for us. We know that the mix of products and concentrated products or edibles require more product as well. So we think all those tailwinds should get us in the long run, mid term, long run back into a number that we could easily talk ourselves into double digits again. Just for 2019 until we start seeing positive quarters, we're not going to lead you down that road. But our long term thinking is that's exactly where it is. Okay. And then lastly, I was a bit confused. You talked about it sounded like you said an upside longer term variable comp payout. And I'm interested in how you contrast that with the write off within Hawthorne. Those 2 seem to be in opposition. There's really no relation one to the other. So we established a 5 year long term incentive plan a couple of years ago. It's 2 thirds based on cumulative free cash flow over a 5 year period and 1 third based on total shareholder return proxy more or less. Through 2 years, we're doing well on free cash flow. We're not doing very well on the TSR proxy. But as we look out for the next 3 years and determine what we should accrue, we've had a positive first couple of years on cash flow, even though this year was a challenge on earnings. And given our focus and our plans, we expect that cash flow focus to continue. And we're excited about the future and we think our P and L will rebound again and 2019 will be a down payment on that. So that's the way the plan is constructed. It does sort of get caught in the crawl. I sort of understand that. But what I try to do is view this as a positive as opposed to negative because if we don't turn stuff around, it ain't going to pay off for squat, okay? So I but it's when you're actually putting money into it and from an accounting point of view, It is based on our basically projections of free cash flow and driving value back into the business. So what it says is that our forward view is consistent with an above average payout in that plan. In spite of the fact that you look at today and say, dude, really? And I get that. But it is based on our pretty seriously on our cash flow forecast going forward. And I've said many times on these calls that I think that the ultimate driver of the value for business is sort of excess free cash. It is something that we've done okay on, I mean, maybe better than okay, but I think we've got to do a lot better, and that's one of the reasons we did Hawthorne, was to do that. So I think the accounting exercise of sort of charging the account, call it, for our future thing. It's just the math that the finance group is doing saying, if you think this is true, there's going to be an above target payout and we've got a charge for that. So that's what it means. So I would instead of looking at this and saying, what the heck, I think notice I didn't use a bad word there, what the heck, it really says something about our view of the future, which is positive. And our cash flow is very much driven by our U. S. Consumer core business with EBITDA of 500,000,000 dollars or so. Right now, Hawthorne is 10% or so of that. So that's what's driving our productivity on the long term plan. Again, our PSR return this year is suffering because of Hawthorne and back to your question about impairment, but that's the way the plant is constructed. I think we're running our core well and we expect havron to turn around as well. Okay. Thank you. And our final question today will come from David Staten with Great Lakes Review. Hi. Thanks for taking the question. Really quick, back to the core business, you talked about your private label being your primary competitors. And is there any opportunity or do you already have some of your products as private labels or would you be able to move into private labels as an offering? Sure, David. So right now, we do probably 2 thirds or maybe 75% of the total category private label if you look across the whole landscape, the lawn and garden, then there is probably an opportunity to do more going forward. Every retailer has its own way of going about private label and how they choose who they select as a vendor and how they merchandise their products and that may evolve and it's evolved a lot in the short run and within mass within the last couple of years. But if you look at the last 10 years or 5 years or 3 years, we've maintained share, actually grown share versus private label. And the only place that we've lost has just been in the last 2 years at one particular retailer. And we don't think that's a consumer driven situation at all. It's simply a merchandising decision and we haven't seen that drip over in any other customers at this point. But we're happy to make private label for people, and we are doing that. Yes, I would go farther, which is we know private label is an important part of sort of the profit stream of and if you look at over time, at least in lawn and garden, where we participate, it's probably 60% of the dollars are on the branded side and about probably 50% of the units are private label. And that's been pretty consistent over the years if you look at it. I know there are some retailers who think Scotts is already sort of big enough. Why should we put more in and I'll tell you why, if a retailer is listening right now. Nobody's got the footprint we have to private label. And I don't think there's anybody who can beat our price, who's a legitimate player. And so I challenge any retailer to talk to us about using our footprint, our manufacturing and supply chain footprint for their benefit and deliver everything together on one truckload. And no one else can do that. And so I make that offer and challenge to all retailers who we aren't already doing business with and say, I can help you make more money. Great. Thanks. And then I guess to kind of segue that same question over to the Hawthorne business. I think, Chris, you mentioned that cannabis is fairly easy to grow, but difficult to grow well, which is your competitive advantage against the more horticultural businesses. But I think that horticultural people would say that's true for all plants. A lot of plants are easy to grow, but difficult to grow well. And is there a potential there to get your products into the more horticultural based businesses as a private label to expand your market? Absolutely. We've been looking at cannabis. It's a huge opportunity and one that we're focused on pretty singularly at the moment. But our long term plan here is, look, we want to take in as much advantage of the this past year, notwithstanding the explosive growth that we've seen. But long term, this business is going to unlock technology, allow us to enter sort of the food supply side of things on what I would like to see on a global scale. So the answer is yes. I think we're learning how to grow plants in a really high performance method here that not a lot of other people have had the margin to sort of allow them the luxury of. The hope is long term as we can bring costs out of our products, we can apply those techniques and products to the broader food market on a global scale. So the answer is yes. But I'd also hope just because we're sort of talking strategy out loud here that Hawthorne will be open to own retailer brands participating on the private label as well and offering your sort of manufacturing footprint to the benefit of other resellers. Yes. Yes. I appreciate all the insight. Thank you very much. Thank you. And that will conclude today's question and answer session. At this time, I would like to turn the call back over to Mr. Jim King for any additional or closing remarks. All right. Thank you, Rochelle. If we didn't get to anybody today or if there are follow-up questions, feel free to call me directly. I'm at 937-578-5622. Also as a reminder, Randy and I will be on a webcast Q and A event on Tuesday morning. You'll be able to find a link to that session on our Investor Relations website that morning. Other than that, we're all wrapped up this morning. So thanks for joining us, and we'll talk to you again soon. And that will conclude today's call. We thank you for your participation.