The Scotts Miracle-Gro Company
Q3 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

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.

[Jim King:]

Thank you, Jennifer. Good morning, everyone and welcome to the Scotts Miracle-Gro's 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&A session is Mike Lukemire, our President and Chief Operating Officer. In a moment, Jim and Randy will share some brief prepared remarks. Afterwards, 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&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 some 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 the full range of risk factors that could impact our results, those are filed in our Form 10-K, 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 I also want to remind everyone that today's call is being recorded and an archived version of the call will be available on our website.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.

[James Hagedorn:]

Thanks, Jim. Good morning, everyone. As I'm sure most of you know by now, we reported strong third quarter 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 downwards 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 will also elaborate on the progress we're making with Hawthorne. As we wind down the major M&A phase with Hawthorne, we're stepping up our focus on integration. The goals are simple

[Thomas Randal Coleman:]

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&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 will 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&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 250 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 the benefit from product mix. The introduction of our new Roundup for Lawns product was nicely accretive to margins, as an example of innovation that only Scotts Miracle-Gro can bring to the industry. We delivered a new solution to the consumer and expanded offerings 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 mulch 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 finish 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 cost 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 in 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&A remains a good story. While we were up 13% in the quarter, that is primarily a function of acquisitions and the timing of year-on-year accruals for variable pay. On a year-to-date basis however, we're up only 5%. The vast majority of the increase is coming from acquisitions and some startup costs related to a few small corporate initiatives, for example, implementing SAP for Hawthorne acquisitions. My assessment is that we are staying extremely disciplined with SG&A. We've significantly increased our support for Hawthorne. But we are doing so without putting any real pressure on the total company P&L. So, this is a story we can be proud of. Income from continuing operations in the quarter was $231 million compared with $197 million. On an adjusted basis, it was $240 million versus $208 million. Year-to-date income from continuing operations on a reported basis is $388 million, down from $424 million. However, those results include expenses incurred as a part of our pending International sale as well as both restructuring and non-cash amortization cost at TruGreen and also insurance reimbursements related to the Bonus S matter. Excluding all those factors, the number is $413 million year-to-date versus $404 million a year ago. Speaking of TruGreen, let me move to the equity income line. It's a benefit of $7 million in the quarter on a GAAP basis and $12 million on an adjusted basis. Year-to-date, we're showing a loss on that line of $30 million on a GAAP basis and $13 million on an adjusted basis. Last year, the full year net benefit from TruGreen was $5 million, which we expected it would be flat entering the year. You'll recall in February at our Analyst Day event, we revised that outlook and expected that benefit to be zero for the full year. However, we had other offsets at the time that have 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 million to $7 million 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 is 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 are making with TruGreen. When we contributed Scotts LawnService to a JV with TruGreen in April of last year, the two businesses had EBITDA combined of about $120 million. At the end of the first year, that number had improved to $150 million. 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 is 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, TruGreen is planning to re-lever the business at a better interest rate than we have under the current capital structure and then issue a dividend to shareholders. I'm sure the dividend would be almost $90 million on our current planning assumptions. Assuming TruGreen's recapitalization is successful, we'll have received about $290 million to-date while still maintaining our 30% share of the enterprise. Back to our P&L. Interest expense was up $5 million in the quarter and nearly $7 million year-to-date reflecting higher borrowing levels. However, our leverage ratio on a rolling four-quarter basis stood at only 3.0 times at the end of the quarter. We're still half a turn 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 million in the quarter or $2.63 per share. That compares with the $134 million or $2.16 per share last year. Year-to-date, adjusted net income of $269 million translates to $4.44 per share and that compares with $251 million 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 earnings will be solid. As Jim already said, we're opportunistic in May when the stock price fell after our last call. We quickly acquired over $50 million worth of shares and I now expect our repurchase activities for the full year could be as high as $275 million. I would expect repurchases of at least a similar amount next year as well and we expect to return an additional $125 million to shareholders through quarterly dividend payments. Speaking of our dividends, our board of directors just this morning approved a 6% increase on a 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 million. 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 million 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 million to $70 million 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're lagging. In 2016, we finished in the bottom quartile of our consumer product peers with cash flow productivity of about 75%. This year I'd 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.

[Operator:]

Thank you. And we'll go to Jon Andersen from William Blair.

[Jon R. Andersen:]

Hey good morning. Thanks for the question.

[James Hagedorn:]

Hi, Jon.

[Jon R. Andersen:]

Hi. One question, bigger picture, on point-of-sale season to date, can you talk about 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.

[Thomas Randal Coleman:]

Sure. So, Jon, your first question about year-to-date POS, we finished June about 2% down in total. As we sit here today, August 1, August 2, we're little bit better than that, getting close to minus one. 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 and September with a strong finish. As related to Walmart, Luke is probably in better shape to handle that question.

[James Hagedorn:]

Well, I think we are going to work with their strategy and 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.

[Jon R. Andersen:]

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, $3.90 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?

[Thomas Randal Coleman:]

Well, let me try to set expectations just so there is more clarity around that. So I follow your math but once we take out the earnings from Europe and Australia, that will be somewhere in the $3.90, $3.95 range. More than likely, I mean, in the middle range of our guidance for 2017, 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 TruGreen 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 expect that share repurchase amount to be, in addition to what we'd say as part of 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&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&L. But we're feeling good about 2018 as well. And we're really proud of the progress we've made over the last five years here in driving EPS growth every year.

[Jon R. Andersen:]

Absolutely. Thanks a lot.

[Thomas Randal Coleman:]

Thank you.

[Operator:]

Thank you. We will go next to Jason Rodgers from Great Lakes Review.

[Jason A. Rodgers:]

Yes. It was good to see the acceleration in Hawthorne for the quarter. Was there any especially large deals that drove that?

[Thomas Randal Coleman:]

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 Botanicare 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.

[Jason A. Rodgers:]

And what should we expect as far as the tax rate for the fourth quarter and for fiscal 2018?

[Thomas Randal Coleman:]

Well, for the balance of this year, we started out with a 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. Gavita's strong earnings has helped that as well, there being a lower tax rate overseas. And then looking ahead to hopefully 2018, we'll see a benefit from lower tax rate. It appears the border 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.

[Jason A. Rodgers:]

Thank you.

[Operator:]

Thank you. We'll go next to Jason Gere from KeyBanc.

[Jason M. Gere:]

Okay. Thanks. Good morning guys.

[Thomas Randal Coleman:]

Hi, Jason.

[Jason M. Gere:]

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 and 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 fourth quarter? Are you seeing that as well? So just maybe if you could talk about maybe how the retailers are positioned forward and maybe some of the trends you saw end of June and into July as well?

[James Hagedorn:]

Sure. So addressing your first question about retail inventory levels. So home centers is again more 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 reduction 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 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.

[Michael C. Lukemire:]

I think home centers have stayed at the season, and they are 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 a delay. It's really moving through the inventory and extending the season, and it's been so far good for us in home centers.

[Jason M. Gere:]

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 timeframe? Are we thinking two years down the road that it could get closer to the corporate? I mean, I guess what the pro forma corporate average will be once Europe is out of there. So how should we think about the cadence, I guess, of 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?

[Thomas Randal Coleman:]

Jason, this is Randy again. So when it's 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&A and optimizing on 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 months here, they will be very accretive to our operating margin rates. So, for 2018, I'd expect us to make several hundred 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 the 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.

[Jason M. Gere:]

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.

[Thomas Randal Coleman:]

Yeah. So interest expense, we're coming in favorable versus our initial expectations, though our borrowing levels are higher year-over-year. We'll see continued increase in the fourth quarter. But we're really pleased with the way we're managing our capital structure. And looking ahead to next year as well, we will continue to see some increase in interest as we borrow more money and funds 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 will 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 million in 2017.

[Jason M. Gere:]

Okay. Great. Thank you.

[Operator:]

Thank you. We will go next to Chris Carey from Bank of America Merrill Lynch.

[Christopher M. Carey:]

Hey, guys. Thanks for taking the question. So just sticking on Hawthorne, it was a pretty solid quarter. I mean, what are your main priorities for that business? As you think about speeding or you've been accelerating growth, especially as you turn to the core portfolio on some of these deals that are completed, and how do you think about leveraging your current distribution network to expand distribution into additional channels?

[James Hagedorn:]

Right. So it's my first answer.

[Thomas Randal Coleman:]

All right, Jim.

[Michael C. Lukemire:]

All right.

[James Hagedorn:]

Look, I would say if you look at sort of the case that Mike Porter wrote called Scotts North America, and he called 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&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. 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 are tying it together with a single sales force, single billing. This is a very technical business. So tie it together with the 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 Masters level support side on the technical side. 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 is room for efficiency gains in distribution as well, which we are planning on. Mike, I don't know if you'd add anything?

[Michael C. Lukemire:]

No, I think that's pretty clear.

[James Hagedorn:]

So, it's really exciting to see the progress they're doing. Like I think at Hawthorne, they've got about half their business now through SAP. And you know, SAP is not for the faint of heart. I think you don't hear the sort of crazy blowups 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 this 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 how quickly this group of people are maturing as managers. It's – and I think, Randy spoke about how we're supporting it. We've built a what we call soft team here at Scotts that's run by a guy name Mike Hoover. And that does our strategic planning, it does our M&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've would have gone for consulting help when we did that. When we resized the company 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 without adding any incremental consulting cost support to Chris's team. And that has been really helpful. And I have to be complementary of Chris's boss, but I would say that Mike has been a excellent leader for Chris and the Hawthorne team, as he has integrated them into his operating team. So I – what do I think? I think it's all going pretty darn well. I'm sure they are going to stub their toe at some point. But they have done a pretty good job so far. So I'm actually really encouraged about – I think, we have a board meeting on Thursday and 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 – but what they don't seem like anymore is kids. They are definitely seen more like grown – I know, listen, this may sound like, of course, you've invested hundreds of millions of dollars, wouldn't you expect. 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 have 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.

[Michael C. Lukemire:]

No. I like the distribution plan and what they have come up with sales, and they are 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.

[Christopher M. Carey:]

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 on inventory across a number of consumer categories. But it does feel like lawn and garden is a bit more pressured. 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.

[James Hagedorn:]

Listen, I mean, 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 caught our colleagues in the space. And these are 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're 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 better tomorrow' in regards to mass's commitment to lawn and garden. So let me just circle back for a second. People we're talking to have it worse now, it's not better, okay. We are seeing, I think, pretty good results over the summer, the only issue is this is 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 and 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 are 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 live goods, why did we get involved in live goods 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 rodenticide, 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's 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 is growth. I think that our review in 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 call it notionally 2%, and I think, we don't feel particularly challenged doing that. But I think – and I think, we're being realistic and 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 this question. I hope it does.

[Michael C. Lukemire:]

Chris, let me add a little bit more to what Jim said. And just the issue with mass is not a one year phenomenon. So we've seen a shift by consumers away from the mass towards home centers and hardware and independents 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 surprise. But I would say we've – this is not something new to us and we'll continue to manage through it.

[James Hagedorn:]

It's probably not quite as bad as it sounds. I mean, there was 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 this – 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 the 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 has made, and we're – we will and we'll continue to work with them on that.

[Christopher M. Carey:]

Got it. Thanks very much.

[Operator:]

Thank you. And we'll go to next to Joe Altobello from Raymond James.

[Joseph Nicholas Altobello:]

Thanks. Hey, guys. Good morning. So, first question, I just want to go back on TruGreen and the issues there, the spring. It sounds like it's mostly weather. I just want to make sure that, that was indeed the case and there was nothing on the execution front that impacted that business.

[James Hagedorn:]

Weather in the Northeast Midwest, we've seen play out similar to what we've seen in our own business. So, no surprise there. I would say customer account is a bit of 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&R with TruGreen announced the recapitalization and we expect that to be successful as well. So, lot of good news here. And I don't know – I'm glad Mike and I are going to be there in 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.

[Joseph Nicholas Altobello:]

Okay. That's helpful. And then just looking toward 2018 little bit, I think Randy this morning you sort of certainly implied that there is 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?

[Thomas Randal Coleman:]

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 in total to be flat but still more work to do on that. We're not done with our planning, we've got 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 two-thirds locked by the time we have our next earnings call in three months or four months here. So I think we'll provide a lot more specific guidance at that point. But that's our thoughts right now.

[James Hagedorn:]

Mike gave you a face when you said commodity pressure. Mike?

[Michael C. Lukemire:]

Don't push it hard. We're not that pressured but finance lead on (56

[Joseph Nicholas Altobello:]

And just one last one if I could on Hawthorne. I guess if you look at the pro forma growth rate year-to-date, it's 15%. This quarter little bit better than that. I mean, do you guys see that business given what's gone on the legislative front et cetera? Do you see that business accelerating next year?

[Thomas Randal Coleman:]

It's going to be a bit lumpy. If you recall back in our first quarter, we were below double-digits and there were some concern that growth rates were slowing and we explained it as there is some cyclicality to this, whether it's the ordering patterns from distributors or just the lumpy behavior of projects and then we came out Q2, beat our numbers; Q3, the momentum is strong. So I'd expect more of the same when you get back to what we talked about in February when we were in Florida, we're expecting 15% as a normal run rate and that's still our outlook for next year at this point.

[James Hagedorn:]

Joe, if I was to throw out like and say it's a two-year horizon, I would say, yes, I expect acceleration, because I think what we will be doing is, we'll be tying up product line together. We will have sort of looked carefully at our distribution model and our sort of go-to-market, sort of call it orders to cash. I think that in the short term there is 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 if I agree with what Randy is saying, I think over a two-year model, and I'm not concerned in the short-term by the way, on a one year side. I just think that any time you are 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 call it loyalty to customers. But I think it gives us the kind of programs that just make us a valued supplier to professionals.

[Joseph Nicholas Altobello:]

Okay. Got it. Thank you, guys.

[Operator:]

Thank you. We'll go next to Bill Chappell from SunTrust.

[William B. Chappell:]

Thanks, good morning.

[James Hagedorn:]

Hi, Bill.

[Michael C. Lukemire:]

Hey, Bill.

[William B. Chappell:]

Hey. Just a few financial ones maybe to make it quick. Randy, you talked about $275 million 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 $275 million at maybe 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?

[Thomas Randal Coleman:]

When we last spoke about the dilution from Europe, we had combined both acquisitions and share repurchases. At this point because we are further through the pipeline and the acquisitions we were considering have come to bear, we have more confidence to say that those M&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.

[William B. Chappell:]

So you could actually grow EPS faster if we're factoring in kind of the share repurchase?

[Thomas Randal Coleman:]

Yes, faster than we thought three months ago.

[William B. Chappell:]

Okay. And then second, just, I know last year, you 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?

[Thomas Randal Coleman:]

Yes, as far as 2017 price increase, the mulch piece was call it 25% to 35% of that when you just think about our U.S. consumer business. Next year, again we are not done with our planning around pricing at trade programs for next year. But we do expect to take some pricing as we have most every year, mulch will (1

[William B. Chappell:]

But just to understand, are you rolling back the mulch price or you're going to have that headwind to overcome to get overall pricing?

[Thomas Randal Coleman:]

Yes. So that will be a rollback and then on top of that we will have other pricing initiatives.

[William B. Chappell:]

Okay.

[Thomas Randal Coleman:]

And where we net out will be on a gross invoice pricing basis, we'll be no worse than flat just to think about new product pricing and existing product pricing and that reflects the impact of mulch.

[William B. Chappell:]

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 to kind of high single-digits, 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 have 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?

[Thomas Randal Coleman:]

Look, I'll pick that up.

[William B. Chappell:]

I figured you would.

[Thomas Randal Coleman:]

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 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. 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 overoptimistic. 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 late spring, early summer was not bad.

[Thomas Randal Coleman:]

Yeah. I mean, I hate to say I'd go back with anything. So my plan is to compete with their strategy and figure out ways to win. But I'm prepared if it goes the other way as well. But I'm going after the volume will come back and we will win in certain categories, sharpen our pencil and help them with their private label strategy. So we'll see what happens with that. But we'll definitely be aggressive.

[William B. Chappell:]

And, Mike, just to follow-up. So were you expecting the mass channel to be down at least high single-digits this year anyways?

[Michael C. Lukemire:]

No, 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.

[William B. Chappell:]

Okay.

[Michael C. Lukemire:]

I think their initiative with their supply chain is, if you 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 first part of the year, they were participating pretty strongly, and there were some things that listings that got changed or whatever. We're going to try to go win this. So 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 are doing, you're seeing it across the board does it work or not. And our mission is to try to be supportive of that.

[Operator:]

Thank you. And we'll go next to Jim Barrett from C.L. King & Associates.

[Jim Barrett:]

Good morning, everyone.

[Michael C. Lukemire:]

Hey, Jim.

[Jim Barrett:]

Hi. Randy, this is a question for you. The $90 million 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 are 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 de-leverage?

[Thomas Randal Coleman:]

Yeah. 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 the point. We had made plans even at that point in time that we fast forward a year or two that we would likely go back and refinance. So this has been part of the thinking all along. So, nothing new there. Interest rate will be about 100 bps 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 low double-digits. I believe it was about 12%, that we'll able to refinance that debt when we fast forward about another year or 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.

[Jim Barrett:]

Okay. Thank you very much.

[Thomas Randal Coleman:]

Thank you.

[Jim King:]

All right, Jennifer. I think that's all 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 in 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'll talk to you again in early November when we announce our Q4 results. Thanks.

[Operator:]

That does conclude today's conference. Thank you for your participation.