Earnings Call: Q3 2017

Aug 1, 2017

Good day, and welcome to the 2017 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jim King. Please go ahead. Thank you, Jennifer. Good morning, everyone, and welcome to the Scottsmere Pro Group Third Quarter Conference Call. With me this morning in Marysville, Ohio is our Chairman and CEO, Jim Hagedorn our CFO, Randy Coleman and also joining us for the Q and A session is Mike Lukemire, our President and Chief Operating Officer. In a moment, Jim and Randy will share some brief prepared remarks. Afterward, we'll open the call for your questions. In the interest of time, we ask that you keep to one question and one follow-up. I've already scheduled time with many of you later in the day to fill in the gaps, and anyone else who needs some Q and A time afterward can call me directly at 937-578-5622. 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 today. Investors should familiarize themselves with a full range of risk factors that could impact our results. Those are filed in our Form 10 ks, which is filed with the Securities and Exchange Commission. I also want to remind everyone that today's call is being recorded and an archived version of the call will be available on our website. With that, let's get things started and I'll turn the call over to Jim Hagedorn. Thanks, Jim. Good morning, everyone. As I'm sure most of you know by now, we reported strong Q3 results this morning. And as we begin to wind down our efforts for 2017 and move into full planning mode for next season, I want to kick off my remarks by stressing that I remain extremely pleased with how we're executing our strategy. While I'm pleased, I also know it's not been a perfect year. There aren't many things I do differently, but there have been some key learnings from this year that will make us stronger going forward. As you saw in June, we revised our original guidance downward due to the combination of a late start of the season and disappointing results in the mass retail channel. I'm confident we could have overcome either one of those challenges individually, but not both of them. I want to stress, however, there are a lot of good stories in our U. S. Core business if you look behind the numbers, and I'll elaborate on that in a bit. I'll also elaborate on the progress we're making with Hawthorne. As we wind down the major M and A phase for Hawthorne, we're stepping up our focus on integration. The goals are simple. 1st, to become the best supplier of hydroponic growing products in the world to both the consumer and professional markets and second, to leverage the financial synergies that exist within our portfolio to further improve our profitability, while also investing to drive long term growth. On a company wide basis, we're also progressing on our commitment to improve our cash flow. Entering the year, we told you we expected to deliver at least $300,000,000 of operating cash flow. We not only continue to feel comfortable with that number, but we're tracking to over deliver. And finally, we expect to close in the sale of our international business later in the quarter. Once that deal is done, our operating margins will have improved more than 400 basis points in just 2 years. And I can't just move on from that point without saying more. 2 years ago, when we announced Project Focus, we outlined a clear plan that we believe would drive shareholder value. From there, we just put our heads down and we did what we told you we would do. Many of you listening today, most of you, I hope, have benefited from the roughly 50% shareholder returns since we announced Project Focus. As I said on the last call, we're moving into the next phase of this plan. The headline grabbing reconfiguration of our company is mostly behind us. Our job now is to create consistent double digit shareholder returns by generating 3% to 4% organic sales growth per year, getting operating leverage out of the P and L, using our cash to repurchase shares as well as fund well priced bolt on acquisitions and playing a solid dividend to our shareholders. With that broad context, let me shift gears and provide more details on the results we announced this morning. I want to start with Hawthorne. It's hard to see the actual results because Hawthorne is still categorized as other and won't be its own segment until Q4. But if it were its own segment today, you see sales growth of 146 percent in the quarter and 160% year to date. Obviously, the impact of the Gavita and Botanacare acquisitions are driving those numbers. But if you assume we owned both BotanaCare and DaVita a year ago, we would have had sales growth of 21% in the quarter and 15% year to date. And the profitability of the business is ahead of plan so far this year, providing some relief to the corporation from the shortfall we expect in the U. S. Core. Late in the Q3, Hawthorne acquired a lighting company called AgriLux. This transaction broadens our offering and allows us to compete more effectively with a mid tier product in addition to our industry leading Gavita brand. There are still a couple of potential deals in the pipeline, one we hope to have in place within a few weeks and one that will likely take a couple of months longer. From there, I'd say the product portfolio will be in pretty good shape. We'll probably continue to explore tuck in deals here and there, but we'll have most of what we need. It's not just the continued growth curve that has us so encouraged about Hawthorne. We're now moving into an integration phase that will help improve the profitability of the business. Remember, the individual companies we purchased already had about a 20% operating margin. However, the gross margins were roughly 500 basis points below our corporate average and we see a clear pathway to improve. For example, nearly the entire Hawthorne portfolio is currently sold through a 2 step distribution model. There is no doubt we have some room for improvement here, which is prompting us to take a deep look at how to create a better model to drive our growth, while better supporting our retail partners and the professional users of our product. It's important to understand that this will not be a quick fix, rather something that evolves over time. For Hawthorne, taking costs out of the system will do 3 things. 1st, some of that savings will drop to the bottom line, creating an even higher level of profitability. 2nd, it would create a bigger pool of dollars for R and D, marketing and other initiatives that will keep Hawthorne on the leading edge of the industry. And third, it will allow us to develop a more flexible and creative pricing and trade programs that will benefit consumers and our retail partners in a way that helps us maintain a loyal customer base. As we approach our 3rd year in hydroponics, I think we're in a great place. I want to tip my hat to Chris Hagedorn and Ross Haley and the entire team at Hawthorne. They're doing a great job driving the business and navigating what has been an ever changing industry landscape. With that, let's shift over to the core business, which requires a fair amount of explanation to fully understand our performance this season. U. S. Consumer sales in the quarter were up 5%, but were still down 2% on a year to date basis. But if you pull the numbers back, there are more good stories than you'd think. So let me give you that context. The most important place to start is consumer purchases or POS. It's important to remember that about 2 thirds of consumer purchases occur in home centers and hardware stores and only about 12% occur at mass retail. The balance occur in independent retail channels where we don't get POS data. Across the company, POS of our branded products, this excludes mulch, is up 1% when you look at home centers, hardware and mass retail on a combined basis. Home centers and hardware on a standalone basis, however, are up nearly 4%. That means unfortunately that consumer purchases at mass retail are down mid teens. So if you look at our performance by product category only in home centers and hardware, you'll see this year was not so bad. In those channels, every major product category is in positive territory year to date, ranging from a 2% increase in lawn fertilizer, 14% in grass seed, 13% in controls, 12% in tomcat and 2% in soils. This is true even though the season was pushed out as much as a month in parts of the Midwest and Northeast. Unfortunately, each of the categories I just mentioned is down at mass retail so far this year, most of them double digits due to tighter inventory controls and a bigger focus on private label. Those of you who read our SEC filings know that lawn and garden sales have been shifting out of mass retail to home centers and hardware for several years. I want to be clear on 2 fronts. 1st, we are not seeing a shift to private label in home centers, hardware or garden centers. In fact, our brands have gained share in those channels over time. And second, we remain committed to our partners in mass retail and stand ready as the industry leader to help them win in lawn and garden based on the strategy they choose. Clearly, the burden is on us to fully exploit the opportunities that exist with our partners in all channels of retail. Beyond the broad POS and channel story, there are a couple of other highlights we're sharing. First, one of the other challenges to the top line this year was mulch, where we lost volume after taking pricing. This definitely impacted the ability of retailers to use mulch to drive consumers into their stores and is likely a decision we will reverse next year. I know Randy plans to elaborate more on this in a few moments, so I'll leave the rest to him. 2nd, our new Roundup for LAUNS product has been a solid success. We expect sales of roughly $40,000,000 which would be in line with our original target. Retailer support has been strong all season and consumer reviews of the product have been very encouraging. In the traditional Roundup business, consumer purchases in the Midwest and Northeast were more or less in line with the rest of the business. However, we saw our best results in the West Coast, including California, despite some negative PR related to the active ingredient in the traditional Roundup product. While this is an issue that we're watching closely, so far we've not seen a material impact on the business. And third, we've seen some really nice trends lately with Bonnie. On our Q2 call in early May, we told you Bonnie was having a slow start due to weather in the Northeast. Bonnie's business was up about 20% in June July against double digit comp from those same months the year before. This included a 40% increase in herb sales. We've also seen great progress in areas where we've been innovating with Bonnie, premium product lines like larger sized items and projects like Salsa Gardens. As I look out for the remainder of the season, I feel good about our plans and our numbers. In fact, I want to reinforce that we are reaffirming our revised guidance this morning. We've seen positive trends over the past month and have made up ground on a year to date POS numbers. Retailer inventory levels are in good shape and we have good support in place for our fall programs. I'll let Randy elaborate on the details, but we're seeing nice margin improvement again this year, good control over SG and A and a disciplined approach to managing working capital that should allow us to see a material improvement in cash flow. Said another way, and to come full circle where I started, I'm encouraged by the way we're executing the business and remain extremely optimistic about the long term opportunities to drive shareholder value. After our last call, the stock price fell pretty sharply as many investors reacted negatively to the slow start of the season. We were buyers. In the early weeks of May, we took advantage of the pullback and quickly bought $50,000,000 worth of our shares, a level of repurchase that was largely incremental to our repurchase plans at that time. When I think about our strategy and when I look at the ability to create value over the next 3, 5 or even 10 years, I want to acquire more of our company and that's the plan. We're not providing guidance this morning for 2018, but I will tell you that I'm encouraged by the plans that are coming together. As we finish up the line review process with our retailers, we're encouraged by the continued support we expect to see next year. Additionally, we think 2018 will be one of our best innovation years in quite a while. 2018 will also mark an important historical milestone for the Scotts Miracle Gro Company as we celebrate our 150th anniversary. For those of you who don't know, I'm only the 8th CEO in the history of this company. So thinking and behaving long term is in our DNA and long term thinking is what Project Focus is all about. We've embraced the reality that growth in our core business is challenging and saw evidence of that again this year. And that's exactly why we invested in areas like LiveGoods, like rodenticides and like hydroponics. Our investments in these businesses all came at reasonable prices and are delivering what we expected and then some. These are also businesses that are complementary to our core strengths and allowing us to continue to grow. We've also embraced the belief that future value will be driven largely by cash flow. We're executing extremely well against our cash flow goals this year, even with lower top line growth than we expected. This is somewhat of a cultural change for us, but one that has taken hold. We have clearly aligned management incentives against the strategy that requires a higher level of cash flow productivity. So I remain extremely optimistic about where we're headed. I look forward to your questions, but for now, let me turn the call over to Randy to cover the numbers. Thank you, Jim, and good morning, everyone. Our results for the quarter are pretty straightforward as is the path for the updated guidance we provided in June. So I want to pretty quickly walk through the P and L with you and then share some other high level thoughts. Along the way, I'll share a few early thoughts about how things are shaping up and planning for 2018. But I want to be clear that we are not providing 2018 guidance at this time. As it relates to 2017 guidance, I share Jim's confidence in the revised ranges we provided. As I'll describe in a few moments, we've had another minor challenge thrown at us in recent weeks related to our JV with TruGreen, but it should not impact our ability to hit our revised EPS range. With that, let me walk you through the P and L. Jim covered the top line results pretty thoroughly, so I'll just say that 5% growth in the U. S. Core in the quarter was driven mostly by initial sell in as well as solid replenishment in most channels of retail after a slow start to the season. Year to date sales are still down 2% due to the reasons Jim outlined during his remarks. The European Consumer business was down 3% in the quarter and 6% year to date largely due to FX. And as Jim said, the other segment is mostly a Hawthorne story with both the positive impact of acquisitions and organic volume growth that continues to be in the high teens. Year to date, company wide sales are up 4%, a level of growth that is in line with our revised full year guidance. Gross margin remains an extremely good story for us, with our margin rate up 2 50 basis points in the quarter and 100 basis points year to date. Benefits from pricing and reduced trade expense have been essentially offset by acquisitions and lower commodity costs for the most part have been offset by negative conversion costs that were impacted by lower than expected volume. What then rises to the top is a benefit from product mix. The introduction of our new Roundup for lawns product was nicely accretive to margins and is an example of innovation that only Scotts Miracle grow comparing to the industry. We delivered a new solution to the consumer and expanded offering for the retailer and successfully leveraged the value of the Roundup brand. Another piece of good news from a mix perspective has been the relative strength of our high margin fertilizer business. POS is in line with our total POS this year, eliminating a product mix headwind that we've seen in many recent years. Also, we saw a higher percentage of gardeners choose our potting mix products this year, a trade up from the lower margin garden soils. Finally, our gross margin rate benefited from the decline in mulch volume that Jim mentioned a few minutes ago. Jim also said earlier that if we had to start the year over again, there probably wouldn't be many things we would do differently. While I agree, I would also say mulch pricing may be that one thing we would change. The trade off between volume and margin on March this year was a push in terms of gross profit dollars. This is a critical category for both Scotts and our retail partners in driving store traffic and consumer engagement. So I would expect us to reverse that decision next year. That said, we remain committed to improving our margins in this business over time through continued supply chain improvement as well as innovation. But for 2017, all these factors will likely mean we finished the year on the high end of our guidance range for gross margin rate improvement. But as I look into next year, maintaining this year's rate will not be easy. In addition to mulch pricing, commodity costs still look like a slight headwind, maybe worth $0.05 or $0.10 of EPS based on today's market prices. Those costs have been trending favorably in recent months, however, so hopefully it will be a better outcome than that. Also, you heard me say a moment ago that lower trade program expense benefited the margin rate this year. That was not planned, but came our way because certain volume rebates were not earned this year by some of our retail partners. Our assumption entering 2018 is that normal volume levels result in higher trade program expense next year. So the related rate benefit we saw this year will likely reverse. We're still finishing up our budgeting process for next year, so I can't be more specific at this point. But I wanted these issues to be on your radar for when I provide more details during our year end call in November. Getting back to the quarter, SG and A remains a good story. While we're up 13% in the quarter, that is primarily a function of acquisitions and the timing of year over year accruals for variable pay. On a year to date basis, however, we're up only 5% and the vast majority of the increase is coming from acquisitions and some start up costs related to a few small corporate initiatives, for example, implementing SAP for Hawthorne Acquisitions. My assessment is that we're staying extremely disciplined with SG and A. We significantly increased our support of Hawthorne, but we're doing so without putting any real pressure on the total company P and L. So this is a story we can be proud of. Income from continuing operations in the quarter was $231,000,000 compared with 197,000,000 dollars On an adjusted basis, it was $240,000,000 versus $208,000,000 Year to date income from continuing operations on a reported basis is $388,000,000 down from $424,000,000 However, those results include expenses incurred as a part of our pending international sale as well as both restructuring and non cash amortization costs at TruGreen and also insurance reimbursements related to the bonus S matter. Excluding all those factors, the number is $413,000,000 year to date versus $404,000,000 a year ago. Speaking of TruGreen, let me move to the equity income line. It's a benefit of $7,000,000 in the quarter on a GAAP basis and $12,000,000 on an adjusted basis. Year to date, we're showing a loss on that line of $30,000,000 on a GAAP basis and $13,000,000 on an adjusted basis. Last year, the full year net benefit from TruGreen was $5,000,000 which we expected to be flat entering the year. You'll recall in February at our Analyst Day event, we revised that outlook and expected the benefit to be 0 for the full year. However, we had other offsets at the time that made it neutral to our guidance. As our own business saw some challenges at the break of our season, so did TruGreen. In recent weeks, they've adjusted their outlook. We now expect to lose roughly $5,000,000 to $7,000,000 on the equity income line for the full year, which equates to about $0.05 of EPS. At this late stage of our fiscal year, there's little time to respond. But as I said earlier, it should not impact our ability to fall within our revised range. What I don't want to do is lose sight of the great progress we're making with TruGreen. When we contributed Scott's bond service to a JV with TruGreen in April of last year, the two businesses had EBITDA combined of about $120,000,000 At the end of the 1st year, that number had improved to $150,000,000 And at the end of this year, we expect EBITDA to increase significantly once again. The cost synergies we expected are on track to be realized and the restructuring of the business is largely behind us. While there have been a few operational hiccups here and there, the overall performance has been solid given the complexity of putting these two businesses together. I continue to believe this was an outstanding transaction for us. I would encourage investors to remember there's a significant amount of value that is locked up in our 30% ownership of this business, value that we believe we can realize in a very tangible way at the right time. In the meantime, as announced yesterday, Trig Green is planning to relever the business at a better interest rate than we have under the current capital structure and then issue a dividend to shareholders. Our share of the dividend would be almost $90,000,000 in our current planning assumptions. Assuming triggering recapitalization is successful, we have received about $290,000,000 to date while still maintaining our 30% share of the enterprise. Back to our P and L. Interest expense was up $5,000,000 in the quarter and nearly $7,000,000 year to date reflecting higher borrowing levels. However, our leverage ratio on a rolling 4 quarter basis stood at only 3.0x at the end of the quarter. We're still a half turn of leverage below our target, which gives us plenty of flexibility to fund some tuck in acquisitions or return more cash to shareholders. When we take everything down to the bottom line, adjusted net income was $158,000,000 in the quarter or $2.63 per share. That compares with $134,000,000 or $2.16 per share last year. Year to date, adjusted net income of $269,000,000 translates to $4.44 per share, and that compares with $251,000,000 or $4.04 per share last year. Obviously, these numbers suggest we'll report a greater year over year loss in Q4 in order to fall into our guidance range. Other than equity income, the real potential headwind for the balance of the year will be volume. I expect we'll continue to see nice improvement on the gross margin line as well as strong expense control. So the quality of the earnings will be solid. As Jim already said, we were opportunistic in May when the stock price fell after our last call. We quickly acquired over $50,000,000 worth of shares, and I now expect our repurchase activities for the full year could be as high as $275,000,000 I would expect repurchases of at least a similar amount next year as well, and we expect to return an additional $125,000,000 to shareholders through quarterly dividend payments. Speaking of our dividends, our Board of Directors just this morning approved a 6% increase on our quarterly dividend to $0.53 per share or $2.12 on an annualized basis. Part of what's enabling those activities is the strong improvement we're seeing in cash flow. I said earlier in the year that operating cash flow would exceed $300,000,000 In fact, free cash flow may actually approach that number this year. At the end of Q3, inventory was essentially flat on a year over year basis and this includes the impact of acquisitions. We remain on target to reduce working capital by roughly $30,000,000 in the core business this year, even with lower than expected sales. In the years ahead, I continue to believe we can take out another $60,000,000 to $70,000,000 of working capital. Jim mentioned earlier that we're beginning to focus more intently on cash flow productivity as a key financial metric, so let me elaborate. When I look at our performance versus our peer group on this front, we are lagging. In 2016, we finished in the bottom quartile of our consumer product peers with cash flow productivity of about 75%. This year, I would expect that number to easily surpass 100%. That's my goal for next year as well. From there, we need to track closer to 90% to 100% every year. I share Jim's goal of driving for a double digit shareholder return every year. In the current growth environment, that will require continued repurchase of our shares, and that obviously means staying focused on cash. Whether it's cash flow or the operating margin improvement that Jim referenced in his remarks, we continue to make good progress on the key financial metrics that we're tracking. So I'm convinced we're doing all the right things to drive shareholder value. I would call 2017 a solid year, one impacted by unanticipated issues and not from poor execution. In fact, I tip my hat to the entire team here for the way we've managed through some of the challenges that were thrown our way. With that, let me open the call for your questions. Thank you. Thank And we'll go to Jon Andersen from William Blair. Hey, good morning. Thanks for the question. Hi, Jon. Hi. One question, bigger picture on point of sale season to date. Can you talk about the kind of the all in level of point of sale that you've seen season to date, not kind of channel specific? And then with respect to the mass channel more specifically, how are your kind of initial discussions going and how are you thinking about that business relative to 2018 and beyond? Thanks. Sure. So, John, your first question about year to date POS, we finished June about 2% down in total as we sit here today, August 1, August 2nd. We are a little bit better than that, getting close to minus 1. So we've had a really strong July and we think we're going to see the same kind of outlook as we look at August September with a strong finish. Related to Walmart, Luke's probably better shape to handle that question. Well, I think we're going to work with their strategy and the balance of private label and what they're going to do for the season. And the discussions are happening as we speak. So I really don't want to get too far out ahead of what we're going to do. Okay. The follow-up question is and I know you're not giving guidance per se for 2018 at this point, But when I think about the outlook for 2017 and then introduce the sale of Europe, So you take kind of let's take the midpoint of the range $4.10 take $0.20 off that. We're kind of running at a $3.90 base. And then Randy, given your commentary around low single digit growth in the core, more challenging perhaps year in 2018 to drive gross margin improvement over 2017. How should we be thinking about it just seems like there may be a disconnect if I kind of think about it that way, $390,000,000 is the earnings base post the sale of Europe, kind of low single digit core top line growth and flattish gross margin next year. It seems that there's a bit of a disconnect with respect to Street expectations in 2018 relative to how you've talked about the complexion of the business. Is that fair? Well, let me try to set expectation just so there is more clarity around that. So I follow your math that once we take out the earnings from Europe and Australia that will be somewhere in the $3.90, dollars 3.95 range, more than likely something in the middle range of our guidance for 'seventeen like you said. At that point, we think about the cash that we'll realize from the sale of Europe here probably in the next 30 days or so. We'll be able to use that cash and essentially replace a lot of the lost earnings. So at that point, call it pretty even, also the dividend that we expect to receive on triggering will help fund some of these deals as well. So we'll be in a really good positive cash position that we'll be able to use to fund these deals. In addition to that, we plan to continue repurchasing shares. At this point, I'd expect that share repurchase amount to be in addition to what we'd say as far as replacing the international earnings. And then again, like you said, the core business will likely have some gross margin challenges next year. I think we're feeling good about our top line outlook for next year. And we still have a lot of work to do as far as managing through the P and L and we're actively in that planning mode for next year right now. But we'll be more specific when we come back in a few months here, provide more specificity around each line of the P and L. But we're feeling good about 2018 as well, and we're really proud of the progress we've made over the last 5 years here in driving EPS growth every year. Absolutely. Thanks a lot. Thank you. Thank you. And we'll go next to Jason Rodgers from Great Lakes Review. Yes. It was good to see the acceleration at Hawthorne for the quarter. Was there any specialty large deals that drove that? When we pull apart the numbers, just on an organic apples to apples basis, we were up very solidly year over year. When you look at the deals that were consummated, the Gavita deal, which is the largest individual business that we've purchased to date is performing very strongly. But Botanica and GH, which are more in the liquid nutrients and other pieces of our hydroponics business, they're performing in the teens as well. So whether you look at it apples to apples or look at it with all the acquisitions rolled in, really strong performance, but we continue to expect more of the same and we think we'll land in the mid to high teens as we close out the year. And what should we expect as far as the tax rate for the Q4 and or fiscal 'eighteen? For the balance of this year, we started out with the effective tax rate of about 35.5%. We brought that down a little bit this year just due to the mix of earnings across the globe. Kavita's strong earnings has helped that as well, there'd be a lower tax rate overseas. And then looking ahead to hopefully 2018, we'll see a benefit from lower tax rates. It appears that the forward adjustment tax notion seems to not be happening at this point. So we're optimistic that we'll see a big tax benefit on our rate hopefully as early as 2018. Thank you. Thank you. We'll go next to Jason Gere from KeyBanc. Okay. Thanks. Good morning, guys. Hey, Jason. Hey, Jason. I guess I want to follow-up maybe on just some of the inventory that you're seeing out there. Maybe if you could talk about DIY in the home center. When you saw kind of the better trends coming in, in June July, I was just wondering if you could talk about the controls business. Obviously, I think you talked about that you had some strength in there. How much of that is share gains coming from some of the new innovation with Roundup coming through. We've heard your competition talk a little bit about some of the delays into the Q4. Are you seeing that as well? So just maybe if we could talk about maybe how the retailers are positioned for it and maybe some of the trends you saw end of June and into July as well? Sure. So addressing your first question about retail inventory levels, so home centers again are more of the same. So, whether you look at them individually or in total, we're about flat, maybe up a little bit, whether you're talking into June or into July, and I think we're well positioned to drive POS for the rest of the year. On the mass side, it is a bit of a different story that retail inventories are down quite a bit, and that's been the case for the last few months. We don't expect continued reductions in retail inventory levels, at least on a percentage basis as we close out the year. And as like Luke said, we're working actively with all our mass retailers to drive the business next year and embrace whatever strategy they want to employ, so that we're working together with them. Well, I think home centers have stated the season and they're having good results. And as Jim talked about Bonnie and that growth, we're seeing the same thing in controls and other categories. We had a really good July. And so I don't really see so much of delay. It's really moving through the inventory and extending the season, and it's been so far good for us at home centers. Okay, great. And then the second question, I guess, just on the Hawthorne margin. Obviously, it was low double digit now, but the potential there, it sounds like as you make some of these acquisitions and you're making the investments, what do you think is a realistic time frame? Are we thinking 2 years down the road that it could get closer to corporate? I mean, I guess what the pro form a corporate average will be once Europe is out of there. So how should we think about the cadence, I guess, Hawthorne's kind of margins improving over the next couple of years, like quickly or just kind of like more reinvestment that it will gradually get there as you build scale? Jason, this is Randy again. So when it comes to the supply chain, I think it will be more gradual, but the numbers are going to be big. When you think about SG and A and optimizing all the businesses, I think we're starting some of that work, but it's a little bit further down the road as well. But I think in the immediate future, just thinking about 2018, the deals that we've consummated to date and that we plan to complete over the next couple of months here, they'll be very accretive to our operating margin rate. So for 2018, I'd expect us to make several 100 basis points improvement over time. I think that business should be in par with our U. S. Consumer business, but that's probably a few years down the road. And then again, a lot of investments we made upfront here in 2017. Some of those will roll off next year as well, for example, the implementation of SAP and some of the startups related to that. So big improvement over time. I'd say 8% to 10% improvement by the time we're done from where we are today. Okay, great. And Randy, just if I missed the housekeeping, did you say where interest expense would be for the year? Just I know it came in a little bit higher and obviously you've had some acquisitions, but what should be the range we think about for this year and maybe for next year? Thanks. Yes. So interest expense were coming in favorable versus our initial expectations. So our borrowing levels are higher year over year. We'll see continued increase in the Q4, but we're really pleased with the way we're managing our capital structure. And looking ahead to next year as well, we'll continue to see some increase in interest as we borrow more money and fund some of the repurchases and some of the deals. But we're really pleased with not only the share repurchase levels, but also this unexpected to a degree inflow of cash that we'll get from the TruGreen dividend is going to help us quite a bit as well. And then total interest expense for the year, Jason, is going to be about $80,000,000 Okay, great. Thank you. 17. Thank you. We'll go next to Chris Carey from Bank of America Merrill Lynch. Hey, guys. Thanks for taking the question. So just sticking on Hawthorne, it was a pretty solid quarter. What are your main priorities for that business? As you think about staining or even accelerating growth, especially as you turn to the core portfolio once some of these deals are completed and how you think about leveraging your current distribution network to expand distribution into additional channels? All right. So it's my first answer. All right, Jim. All right. Look, I would say if you look at sort of the case that Mike Porter wrote, called Scotts North America, and you call this Hawthorne Hydroponics, I think it's pretty much the same story. So if you look at kind of what we're up to, I think we're really kind of playing the same storyline that we did with Scotts, put together the market leading brands and then consolidating and call it one face to the customer. And I think that that if you say what is the power of Hawthorne, it is not just that we bought a bunch of good brands with good P and Ls, it's converting that into the best supplier to a professional industry that I think has ever been seen at least in this space. And I think we know how to do that. We remember we did this with our professional horticulture business and we've done it with our Scotts business. But to be a sort of great partner to people who use these products, And that means that you're putting the whole line together, you're tying it together with a single sales force, single billing, a technical this is a very technical business, so tied together with a technical support system that is both in the field and at the headquarters level, so that we just become this fabulous vendor, innovate. I think Randy talked about kind of what he views as the aspirations and I agree with that from a margin point of view is that we think we can take money out of the system, tie these brands together as a leading vendor, maybe the leading vendor in the space and put it together with a tech support line on the professional side that is I think extremely necessary in this space that's still fairly undeveloped from sort of a PhD and master's level support side on the technical side. So I and I think we're doing a lot of work to get ready for that. And I think we're seeing sort of major steps forward, particularly in Canada, where we're starting to act as sort of one company and we're seeing a very positive reaction from the user community up there for that. I think within that part of your question is, I think we're looking at the sort of layers of distribution that occur within that space between us and the ultimate user. And that's something we're going to continue to focus on and look to make it the best for us and the user, while still maintaining relationships with our distribution partners. So I think that this is one area that is pretty sensitive. But I think there's room for efficiency gains in distribution as well, which we are planning on. Mike, I don't know if you'd add anything. No, I think that's pretty clear. Got it's really exciting to see the progress they're doing. I think at Hawthorne, they've got about half their business now through SAP. And SAP is not for the faint of heart. I think you don't hear the sort of crazy blow ups that you used to hear back when people were putting enterprise systems in. But for a group of sort of young people who aren't used to the sort of level of sort of technical, financial reporting, having these businesses get successfully through these SAP implementations, I think just tells you something about the how quickly this group of people are maturing as managers. I think Randy spoke about how we're supporting it. We built a what we call a soft team here at Scotts that's run by a guy named Mike Hoover. And that does our strategic planning. It does our M and A work, and it also does what I call bandwidth support. And if we want to run our businesses pretty skinny, there are times where they can outrun their ability to support themselves. And generally in the past, we would have gone out for consulting help when we did that. When we resized the company a couple of years ago, we kept sort of the best of our young folks, put them in Mike's unit and they've been providing sort of without adding any incremental consulting cost support to Chris' team and that has been really helpful and I have to be complimentary of Chris's boss. But I would say that Mike has been an excellent leader for Chris and the Hawthorne team as he's integrated them into his operating team. So what do I think? I think it's all going pretty darn well. I am sure they're going to stub their toe at some point, but they've done a pretty good job so far. And so I'm actually really encouraged about I think we have a Board meeting on Thursday Friday of this week, up in Vermont. And Chris will be presenting again, sort of changes since, our January meeting of the strategy. And we mentioned in the scripts that it's kind of a changing landscape. And so I think they're adapting well to that and I really look forward to what Chris is going to be presenting to us. And I'm very thankful of what I've seen so far and sort of Mike's work sort of what they don't seem like anymore is kids. They're definitely seem more like growing. I know, listen, listen, this may sound like, of course, you've invested 100 of 1,000,000 of dollars, wouldn't you but it is kind of a business that's been really scattered and very depending on the businesses, less disciplined than others on sort of the finances. So for them to have gotten where they've gotten to and have a strategic plan that I think they know where they're going, is pretty impressive for I think it gives me faith in young people, I should say. No, I like the distribution plan and what they've come up with sales and they're on the beginning of a journey. And since I've been through a lot of this before with Jim, I'm pretty confident we're going to get there. So but they are progressing along. Got it. I really appreciate the comprehensive answer. If I could squeeze in one follow-up. Just on the mass channel, this is something we're seeing more pressure on price inventory across a number of consumer categories, but it does feel like lawn and garden is a bit more pressured. And I know you're still putting together the fiscal 2018 plan, but why wouldn't this level of magnitude this magnitude of decline be a bit more lasting? Because it seems like it has worsened for a number of categories in 2017 specifically. Listen, let me first of all, we have teams in Bentonville right now. So I do not want to piss anybody off in Bentonville on the customer side and throw my own folks or Mike's folks under the bus. We are, I think, pretty active with sort of, call it, our colleagues in the space. And these are the other well known brand consumer companies. And I think actually, I think because to us, mass is less of a percent of our total sales, We are actually in better shape than they are. I'm not going to sort of attempt to sort of understand really to be honest their strategy. It's their strategy. It's not mine. It's not ours. We need to live with it. And who knows if it will be successful. I got to say that. I haven't seen it before, but it's possible that this will be for them a successful strategy and we want to play with them in that. And that it's good for us and we will play and we'll play hard to win and help them win because that's kind of our job. I would say, I'm not sure in my advice to my team to say, oh, everything is going to be better tomorrow, in regard to Mass' commitment to lawn and garden. So let me just circle back for a second. People we're talking to have it worse than us, not better, okay? We are seeing, I think, pretty good results over the summer. The only issue is it's not going to get much better. They tend to have a shorter season because they're not as committed into the fall as sort of DIY and hardware is. But I think we did see pretty decent recovery during the late spring early summer with mass. So but what do I think? I think right now they're going to continue on this approach. And my encouragement to Mike and the team is to look at all of our and I think I made this comment, and it was on purpose, all of our opportunities for distribution to consumers. And I think we're seeing accounts that are growing very well and we want to continue to support them and we will continue to wholeheartedly support Walmart. But I think we've got to if we're not going to say this is over, then we've got to do what we've done in other parts of our business. If you look at LiveGoods, why did we get involved in LiveGoods? Because it's growing 2x or 3x what our core is. Why did we get into hydro? Because it's growing like 5x what our core is. Why did we get into rodenticides? Because it's growing like 2x what our core is. So I think if we look at channel, we've got to also invest behind channels that are growing above average, and there are plenty of them. So I think what it means is, I don't think we're the ones that are going to change Walmart strategy. I think Walmart defines what it is and it's up to us to play along with that. And we'll do that happily, okay. But I think we'll also be looking to invest in channels of trade that are growing faster than average, and we will also happily do that, okay. So we're pretty agnostic to where growth is. We believe there's growth. I think that our view on the core and this gets to the point of I think we'd look at kind of I would say 0% to 4% on the core. And so called notionally 2%. And I think we don't feel particularly challenged doing that. But I think and I think we're being realistic in embracing our reality on mass as well. So it's not like we're saying everything is going to be wonderful tomorrow. So I think that answers the question. I hope it does. Yes. And Chris, let me add a little bit more to what Jim said. Just the issue with mass is not a 1 year phenomenon. So we've seen a shift by consumers away from mass towards home centers and hardware and independence for several years, and we've been managing through that successfully for a long period of time. This year, it's a bit larger than years past and it's a bit more of a surprise. But I would say we've this is not something new to us and we'll continue to manage through it. Got it. It's probably not quite as bad as it sounds. I mean, there were definitely some inventory issues. I would also say, remember that mass just in general has got a more truncated season. And so they don't get quite the advantage of other retailers that stick into the because what are we seeing? And we haven't really talked about it, but I think we're seeing it for sure with our business and Bonnie's business is really like the best July we've ever seen, okay? And so for people who are basically looking to exit and get into back to school so early, I think it does mean that if you have kind of a bogus spring, the ability to recover from that will make this look a little worse. The inventory reduction will make it a little worse. And there were some commodity SKUs in our numbers, on a sort of garden soil side that also made it look a little worse. So it's not like the end of the world, but it is definitely reflective of decisions that Walmart's made and we will and we'll continue to work with them on that. Got it. Thanks very much. Thank you. And we'll go next to Joe Adebelo from Raymond James. Thanks. Hey, guys. Good morning. So first question, just want to go back on TruGreen and the issues there this spring. It sounds like it's mostly weather. Just want to make sure that that was indeed the case and there was nothing on the execution front that impacted that business. Weather in the Northeast Midwest, we've seen play out similar to what we've seen in our own business. So no real surprise there. I would say, customer count is a bit of a challenge, just putting together both businesses. So that's something that we're having to manage through. But synergies are on track. The outlook for the year still is pretty good. Just yesterday, CD and R with TruGreen announced the recapitalization, and we expect that to be successful as well. So a lot of good news here. And I don't know, I'm glad Mike and I are going to be there in a couple of weeks for the next Board meeting, and we'll get the latest up to date news. But I think the outlook is bright. Okay. That's helpful. And then just looking toward 2018 a little bit, I think, Randy, this morning, you've sort of strongly implied that there's going to be some margin pressures obviously next year. Should we model gross margins down next year at this point? Or do you think you could still see some expansion? I'd say it's too early to model anything that precise, but I think down slightly to up slightly is probably what we're thinking right now and kind of expecting gross margin and total to be flat, but still more work to do on that. We're not done with our planning. We've had a lot of supply chain savings initiatives are in place. Commodities. We're hoping we'll still get a little bit better. Urea is a really good story for us right now. And we're in a pretty good position like we typically are at this point where we'll be about 2 thirds locked by the time we have our call, our next earnings call in 3 or 4 months here. So I think we'll provide a lot more specific against that point, but that's those are our thinking, our thoughts right now. Mike gave you a face when you said commodity pressure. Mike, what do you I'm going to push it hard for not to have pressure, but I'll follow my finance lead on what he said tells everybody. And just one last one, if I could, on Hawthorne. I guess, if you look at the pro form a growth rate year to date, it's 21% or 15%. This quarter a little bit better than that. I mean do you guys see that business given what's going on the legislative front, etcetera? You see that business accelerating next year? Well, it's going to be a bit lumpy. If you recall back in our first quarter, we were below double digits and there was some concern that growth rates were slowing and we explained it as there's some cyclicality to this as well as the ordering patterns from distributors or just the lumpy behavior of projects. Then we came out Q2, beat our numbers. Q3, the momentum is strong. So I'd expect more of the same when you go back to what we talked about in February when we were in Florida. We're expecting 15% as a normal run rate. That's still our outlook for next year at this point. Joe, if I was to throw out like and say it's a 2 year horizon, I would say, yes, I expect acceleration because I think what we'll be doing is we'll be tying a product line together. We will have sort of looked carefully at our distribution model and our sort of go to market sort of orders to cash. I think that in the short term, there's potential for disruption as we change our distribution model. And that's not a threat to anybody, by the way. But what it says is that I agree with what Randy is saying. I think over a 2 year model and I'm not concerned in the short term by the way, on a 1 year side. I just think that anytime you're changing things, you have the ability to sort of say, I'm not totally sure how well that's going to work. But I think in the long term, it's very much positive because what it will do is it will enable a one face to the customer. And that's so important because it not only is funding innovation, it's funding your sort of tech support group, and it's funding programs that really I think we called it loyalty to customers, but I think it gives us the kind of programs that just make us a valued supplier to professionals. Okay, got it. Thank you, guys. Thank you. We'll go next to Bill Chappell from SunTrust. Thanks. Good morning. Hi, Bill. Hey, just a few financial ones maybe to make it quick. Randy, you talked about $275,000,000 of share repurchase next year and you also talked about share repurchase and acquisitions offsetting the $0.20 dilution from the divestiture of Europe. So should we assume the $2.75 maybe at roughly $95 gets you part of the way there and then the accretion from the acquisitions planned or already done gets the other $0.20 Is that the math I should be doing? When we last spoke about the dilution from Europe, we had combined both acquisitions and share repurchases. At this point, because we're further through the pipeline and the acquisitions we were considering have come to bear, Way more confidence to say that those M and A deals combined should offset the impact from Europe and Australia coming out of our business. And then at that point, the share repurchase impact will be incremental to that. So you could actually grow EPS faster if we're factoring in kind of the share repurchase? Yes. Faster than we thought 3 months ago. Okay. And then second, just I know last year, we put in roughly a 1% price increase. Not sure how much of that was driven by mulch pricing, but if the thought is you're going to roll that back to some extent, do you expect price increase in 2018 overall? Yes. If our 2017 price increase, the mulch piece was 25% to 35% of that when you just think about our U. S. Consumer business. Next year, again, we're not done with our planning around pricing and trade programs for next year. But we do expect to take some pricing as we have most every year. Mulca obviously be an offset to that. But at this point, we don't have our plans complete and we'll have a lot more details again in 3 months. But just to understand, are you rolling back the multi price or you're going to have to have that headwind to overcome to get overall pricing? Yes. So that will be a rollback. And then on top of that, we'll have other pricing initiatives. Okay. And where we net out will be on a gross invoice pricing basis, will be no worse than flat. Just think about new product pricing and existing product pricing and that reflects the impact of malls. Okay. And then the last one, just to make sure I understand kind of how you're viewing mass. I mean, are you assuming that the mass channel will continue to be down kind of high single digit, low double digits for the foreseeable future as they shift away or change their plans? I mean, as you look to 2018 or is there something that you see now that the I guess, looking back, it's always been a disconnect between mass and the other channels. This was a bigger disconnect than we've seen, I think, ever. And so is it this is the new regime, new plan, and so kind of a double digit decline at mass is kind of the go forward rate? Look, I'll pick that up and I think the answer that Mike would give you would be a lot easier to hear than the answer I would give you. And it's not because I know more. In fact, Mike knows more. So I think it's I think you're dealing with the season. I think they were late in Texas coming in. I mean, I think you can add a lot of stuff up and say, you can probably explain half of that just by inventory reductions, soil lineup, Texas, I'll bet Mike I'm pretty close on that. And so but I think it is new regime, new plan. My view is just embrace the reality, don't assume it's over and let's build our growth plans embracing the reality that this may be not the end. That said, as we've talked about this and we've talked about it a lot, it is a briefing item that Mike, I think, has got 2.5 hours on, on Friday, which is channel, is I think Mike's view is it's a lesser number. I'm just trying to basically say, let's be prepared, let's not be flat footed on this, and let's not try to be over optimistic. But I don't think we know what it is. I think if we have a normal season last year, we've been through the inventory change that's happened. I think it's likely to be way less than what we've seen this year. And as I said, their actual POS in the summer was or late spring, early summer was not bad. Yes. I mean, I hate to say I go backwards with anything. So my plan is to compete with their strategy and figure out ways to win. So but I'm prepared if it goes the other way as well. So but I'm going after that the volume will come back and go win in certain categories, sharpen our pencil and help them with the private label strategy. So we'll see what happens with that. So but we'll definitely be aggressive. And Mike, just to follow-up, so were you expecting the mass channel to be down at least high single digits this year anyways? No, I was actually they were pushing us to go higher on volume. So I think the bigger surprise is how early they exited the season. And I think that's a result of having severe markdowns from the previous year. And so I think their initiative with their supply chain is it could take inventory out and be in stock. So I don't think that's bad on their part. I'd be kudos to their supply chain to be able to do that. So if they go out of stock, we'll supply. I would say in the 1st part of the year, they were participating pretty strongly. And so there were some things that listings that got changed or whatever, we're going to try to go win those. So but I mean I understand their strategy and what they're trying to do. And so I think there's some things we can do better. I think there's some adjustments from their part. Whether that's a destination for consumers ultimately, that will be totally up to them. But we'll certainly play as hard as we can in that channel and support them. So it's not a critique on what they're doing overall, it's what they're doing. You're seeing it across the board, does it work or not. Our mission is to try to be supportive of that. Thank you. And we'll go next to Jim Barrett from C. L. King and Associates. Good morning, everyone. Hey, Jim. Hi. Randy, this is a question for you. The $90,000,000 dividend from TruGreen, should I assume that it's going to be funded by debt? And if so, could you talk about what the interest is on that debt, whether it's non recourse and whether and presumably I would assume you're re leveraging up the JV and how does that affect your longer term outlook on the JV? Is the plan to maintain it highly leveraged? Or is it to then deleverage? Yes. So, Jim, back when we formed the joint venture April last year, if you recall, the credit markets were in a bit of turmoil. So, we weren't very happy with the rate at that point. We had made plans even at that point in time that we fast forward a year or 2 that we would likely go back and refinance. So this has been part of the thinking all along. So nothing new there. The interest rate will be about 100 100 to 150 bps better than the existing rate. And if you recall as well, we loaned some money back to the JV along with a few others with a rate that in the high double or low double digits, I believe it's about 12%, that we'll be able to refinance that debt when we fast forward about another year. So does it indicate in the long run that there's any change in plan? I'd say no. And we're going to continue to execute the business. And as that EBITDA grows, we'll have a lot more options collectively to figure out what the next step is going to be. Jennifer, I think that's all of the questions we have this morning or time for this morning. So we appreciate everybody's time today. If there are follow ups or gaps and things that we have not covered, feel free to give me a call later in the day. If I can't get you today, we'll make it work tomorrow. You can reach me at 937-578 5622. Otherwise, thanks everybody for joining us, and we will talk to you again in early November when we announce our Q4 results. Thanks. That does conclude today's conference. Thank you for your participation.