The Scotts Miracle-Gro Company
Q4 2014 Earnings Call Transcript

Published: 5 Nov 2014

[Operator:]

Good day, and welcome to Scotts Miracle-Gro Fourth Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. King. Please go ahead.

[Jim King:]

Thanks, Katie. Good morning all of your, and thanks for joining us on our Q4 conference call. With me this morning here in Marysville are Jim Hagedorn, our Chairman and CEO; Barry Sanders, our President and Chief Operating Officer; as well as Randy Coleman, our Chief Financial Officer, and several other members of the management team. Jim, Barry and Randy will each share some prepared remarks related to our 2014 performance and our outlook for 2015. At that point we will open the call up for your questions. We have a lot to cover this morning so we’ll try to be as comprehensive as possible in our prepared remarks, but in the interest of time, I’d like to request you ask only one question and one follow-up. We might not get to everything but I’ve already scheduled calls with quite a few people this afternoon to cover up any blue sense [ph]. Of course our comments this morning will contain forward-looking statements and so our actual results could differ materially from what we discuss. For that reason we suggest that investors review our risk factors which are listed in the press release this morning and spelled out in more detail in our Form 10-K which is filed with the SEC. Two bits of housekeeping before we begin. Randy Coleman and I will be attending the Morgan Stanley Global Consumer & Retail Conference November 19th in New York. Please work through Morgan Stanley if anyone has interest in scheduling one-on-one meetings. Also that presentation we make that day will be available via webcast and available on our IR website, investor.scotts.com. One final item, we’re having major Analyst Day event this year in New York in December like we normally do, please schedule us formal affair in popular town [ph] Florida, most likely on February 19th. Many of you know that, that week is also the week of Cagney’s major event for the year. We are managing our schedule so that it does not interfere with the Cagney conference. As moving to meeting to Florida, we’ll be able to conduct store walks at the break of the season and give you a better sense of our go-to-market approach for 2015. Obviously more details will follow from our investor relations team in the weeks ahead but we hope to see as many of you as possible for this event. With that, let’s move on the news of the day, the discussion of our 2014 results, and our 2015 outlook. So let me turn the call over to Jim Hagedorn to get us started.

[Jim Hagedorn:]

Thanks, Jim. And good morning, everybody. As we begin preparing for this call it’s been a lot of time looking at our numbers, analyzing what they meant, and thinking about what I wanted to say to all of you this morning. And what I determine to listen is there is two ways to look at the results. You can narrowly look at different numbers themselves, in doing so you’ve seen extremely strong second half that allows to exceed our guidance for the second straight year. And through that lens, it’s a pretty good story or you can look at it more broadly at what we accomplished, and when you do that this is what you’d see. In 2014 we called an expensive tranche of debt early in the year allowing us to lower our overall barn [ph] cost. We improved our margin rate by 100 basis points for a second straight year despite unexpected distribution challenges and unfavorable product mix. We returned $350 million to shareholders to recurring and one-time dividends, as well as share repurchases. We made a strategic tucking acquisitions to fit our long term growth objectives in four different areas of the business. We began our process that we have more to go in reviewing literally every dollar of SG&A in order to reallocate investment dollars to fund long term growth. And we did all this while navigating still uncertain consumer environment that continues to make growth difficult to achieve. Over the last two years we’ve also generated about $550 million of operating cash flow and with a leverage ratio of only 2.2 times, we maintain the financial flexibility to continue funding smart investments in the business, and returning cash to shareholders. More importantly, over the past two year’s we developed a higher level of discipline to avoid chasing growth that isn’t there. We’ve returned the business to a proper level of profitability, we’ve run the business to recognize that in the end its cash flow and not EPS that actually drives value. And most importantly, we embraced the real beauty of this business and that beauty is knowing that if we properly strongest brands in lawn and garden, if we stay focused, if we know when to invest hard and when it makes more sense to pull back a bit then we can maintain our momentum and continue to build upon the kind of returns we delivered to our shareholders. We can further improve our return on invested capital now at 50% higher than our weighted average cost to capital, and also continue delivering high quality earnings. So no matter whether you’re an investor who looks at the world on a quarter-to-quarter basis or whether you look through a longer and more strategic lands, one thing was crystal clear as we were preparing for this call, that the news we announced this morning is pretty darn good. The strong performance in 2014 is a testament to this team, the commitment of our retail partners and the resilience of this category and our brands. Those who know me also know I don’t sugarcoat things, not everything went perfectly in 2014. In addition to lousy spring weather, we were caught off-guard like a lot of people by a tighter afraid market. We suffered some competitive losses in Norco, and we continue to see pressure in the mass retail channel. But overall, the good outweighed the bad. Europe had its best year ever, good weather, good planning and good execution allowed them to grow the top line and they benefited in the bottom line from the effort made last year to reduce their G&A by 10%. Consumers purchases in The United States, after a slow start were extremely strong in the second half of the year in nearly every category against double digit comps. We continue to see solid performance in home centers, hardware, independent garden centers and clubs. And the new products we launched were tested left us highly encouraged as we begin planning for the next year. I’m going to leave the details of the business and financials to Barry and Randy to discuss. I want to spend just a few minutes talking about a few other things you won’t see in the P&L, the things we did in 2014 that set us up for the future. There are four specific initiatives I’ll call out. First and most importantly, we stepped up the support of our brands. In our core U.S. business we had the first opportunity to put our marketing skills to use behind the Tomcat acquisition we made at beginning of the year. Our marketing team delivered an extremely creative advertising campaign, and the early indication show a nearly 30% improvement in consumer purchases of Tomcat products compared to last year. The creative approach to Tomcat was risky but it’s working, and what you will see next year in one of our flagship brands, Miracle-Gro, will also be a completely new approach. In fact we’ll continue to push the envelope with all of our major brands recognizing the need to stay relevant with today’s evolving consumer. As you will hear from Barry, we saw real momentum from new products. Roundup 365 was a first year success and we promise to do even better going forward. Our new Boneset fertilizer product did extremely well in floor test markets leaving us optimistic about a full scale launch next year of this new and highly innovative product. And we also made our biggest drives yet in the natural and organic space. After a full year of product testing we’re highly encouraged by the potential of a national launch of our Miracle-Gro’s Nature Care product line next year. Second, we made some good acquisitions, deals that fit in nicely with existing parts of the business and allow us to better execute our long term plans. I won’t go through each of them in the interest of time but I will caught the purchase of Fafard in Canada. The numbers on Fafard in and over themselves are pretty good. It will add about $40 million of topline in a margin rate that’s consistent with the rest of the business, but it’s the diversity of Fafard that makes it a clever and compelling story. In addition to the consumer business they have in Canada, Fafard also gives us an opportunity to participate in the professional Growing Media business. Most importantly, by acquiring Fafard we’ve become basic in what is an increasingly one of the most important commodities in our business. While most of you tend to focus on inputs like urea and resin, no one really pays close attention to pith which is suffering from a real imbalance of supply and demand and cost us nearly as much as each of the other two inputs every year. Third, as many of you probably saw we announced last week the formation of Hawthorne Gardening Company. Based in New York this team will be responsible for driving our entry into the urban and indoor gardening market. They are currently managing the Whitney Farms brand, as well as the AeroGrow business, which as you saw in the press release were now consolidating into our financials. AeroGrow has turned out to be a tremendous investment for us and we’re expecting the Christmas season to be a big success for this product. As we look ahead, the Hawthorne team is actively exploring opportunities to make meaningful acquisitions in the hydroponic space that would build up the success we’ve had with AeroGrow. Additionally in the days ahead, the Hawthorne team will likely be announcing a small acquisition of a niche organic brand. And fourth, in addition to the acquisitions we’ve made this year, we better positioned our core business for growth. During the second half of the year we analyzed every dollar we spent throughout the corporation. As a result we’ve already identified about $40 million that can be reallocated to become more productive. The majority of that money will go to Mike Lukemire in the North American consumer business that will have the capacity to better support our brands, continue to focus on innovation, and import talent that will make our team stronger for years to come. While I like the investments we’re making to grow, I’m not ready to change my outlook for the core business. Yes, I remain confident that our core consumer remains healthy and engaged, and yes, I remain positive about how we’re executing against the things that we can control. But as I spend time with other CEOs, and when I watch another earning season unfold, I still see no evidence of the significant improvement in consumer spending. So going in the next year we continue to manage for our consumer business to grow 1% or 2% though I hope we can do better. When adding SOS and acquisitions to the mix we expect 4% or 5% topline growth next year. That is a change from the past two years but is consistent with the goal outlined in December to return the business to a sustainable level of growth ranging from 3% to 5% per year. And while we won’t see the kind of P&L leverage in 2015 that we’ve seen over the past two years, that’s not surprising and I’m not concerned. We expect to maintain our gross margin and would expect EPS to improve a few points more than sales growth next year. I’ll leave the details to Randy to explain. Some of you have been asking about the recent acquisitions and whether they signal a change in our plans around our uses of cash. I’ll preface my answer by saying that our overall philosophy remains the same, to execute a capital allocation strategy that’s focused on delivering the highest level of return to our shareholders. Over the past two years, reinvesting about one-third of our cash in the business and returning the rest to our shareholders. We also said we’d allocate about $100 million a year to acquisitions but that amount could be lumpy over a three to four year period of time. As you can see by the actions we’ve taken in the past six months, the M&A pipeline is pretty healthy. So if we continue to see good acquisition opportunities, then our one-third, two-thirds may shift a bit and look a little more like 50-50 but we’re only going to invest in acquisitions if we believe they are an easy fit for our business and offer a better return for our shareholders than spending the money home. So if the M&A pipeline dries up, or we don’t like the economics of the deals, then we’ll return the cash, and we have excess borrowing capacity then we may once again do what we did two months ago and used the balance sheet to return cash as well. Before I turn things over to Barry, I want to take a couple of minutes and talk to you about our associates. Six months ago we were way behind plan and we began signaling that we would likely miss our topline guidance. So to sit here this morning and talk about actually exceeding our numbers is extremely gratifying. To get this into my office surrounded by other senior people in the business and tell you how great we are, Wall Street applauds us, and media reports will quote media or other members of my team, but the people in this room are not the ones that deserve the credit. We’ve got 8,000 people working here at the peak of the season, our marketing, sales, and supply chain teams all rallied this year to deliver the results that we announced today. And the support team here not only helped them to get it done but also spend the year positioning us for continued success going forward. So I’d be running [ph] this if I didn’t recognize them for their work, if I could, I’d list them all by name, but let me just say that I’m proud to have them on our team, better yet, I’m proud to be a member of their team. So with that, let me turn the call over to Barry.

[Barry Sanders:]

Thanks, Jim. I want to elaborate just briefly on how we finished the year in each business. Then I’ll turn to 2015 and build upon some of what you just heard from Jim. I’ll cover where I think we stand coming out of line reviews with our retailers. I’ll give you my overall sense of the consumer environment, and I’ll talk about some of the new products and programs for next year. And I’ll give you my overall sense of the consumer [ph] before I turn the call over to Randy. Let’s start with a quick wrap up for 2014. As Jim said a few minutes ago, consumer purchases of our products at our largest retailers were down 1% on a full year basis, but there were some solid success stories to build upon. Let me start with lawn fertilizer. Despite an extremely slow break to the season, our lawn fertilizer business was slightly positive for the year. I consider that a pretty good result given the circumstances. As many of you know, the fertilizer category had seen several years in a row of unit volume declines, we reversed that trend last year and then held the ground in 2014. This is a critical category for us and we have some pretty good fertilizer innovation coming through the pipeline next year. I’ll talk in more detail on a few minutes but I was glad to see the resilience of this category in a pretty tough year. Overall, our growing media operations also had a solid year, good but not great. Soils had a slight decline of 3% that was offset by a 13% increase in our mulch business. I don’t think we’ve ever had a year in which mulch did not grow by double digits, and our expectations for next year is that the growth will be even better. As we shared in the past, mulch created some headwinds for us on the margin line. As mulch has lower margins than the rest of the portfolio but it’s a critical category for our consumers and our retail partners. We continue to work to improve the margin structure but we’re extremely happy with the support and growth we continue to see in the mulch category. In our controls business, Roundup was down 1% but we are extremely pleased with the launch of Roundup 365. This is a product that offers yearlong week control and exceeded our first year expectations for sales. And 60% of the 365 sales were incremental to our weed control business. Retailer support for the product remains extremely strong and we expect another good year in 2015. The one area of concern was in Ortho, which was down by about 10%. We talked about this on our last call and there was really no material change on a year-to-date basis here. Essentially our competitors got aggressive on pricing and benefited from good product placement in the store as well. By mid-year we had begun to stem the impact but we’re not happy with the result here. For obvious reasons, I’m not going to share the details of our plans for Ortho next year but I will share the headlines. We’re planning an aggressive response and we’re looking to recapture the share we lost in the category as quickly as possible. Two other quick items in North America, first, our animal repellant business had a strong year and we not only gained market share in this space but we drove category growth as well. We continue to see this as a nice incremental opportunity with long term upside. Second, I’m really pleased by what we’re seeing with Tomcat, we quickly and successfully integrated this business into our organization. And as Jim said, we’ve taken an extremely creative approach with our advertising. Tomcat had strong sharp presence when we brought it but we believed the support we’re putting behind it will take this brand to a new level. In Q4, consumer purchases of Tomcat products were up 19%. If you look at the overall fall season, our entire rodent portfolio is up 22% through October including the 28% increase in Tomcat. The news in our international business was good across the Board as we had record results on both the top and bottom line. The business benefited from an early and strong start to the season and maintain its momentum all year. The topline performance was bolstered by the restructuring effort we undertook the year before as we saw a quick bottom line payback on the changes we instituted. In fact, every line of the international P&L showed improvement. While Jim thanked all of our associates for their work, I want to take a moment to focus on this team in particular. They’ve had a tough ride for the last several years but have remained focused and committed to improving. Their performance this year was outstanding and I want to thank our leadership and the team for getting the job done. Finally, let me move into Scotts lawn service, there is really a tale of two seasons. In the back half of the fiscal year they did fine and their 5% growth in Q4 has been back on the right trajectory. However, unlike the DIY business, service has a tougher time making ground after a slower start to the season. Once the first fertilizer application for home center gets pushed back then the rest of them generally get pushed back as well. As a result we’ve known for several months that SOS would miss their original targets and we’ve been sharing that with you since the middle of the year. So while the numbers may not be great due to the late spring, the overall direction of SOS remains strong. I’m not going to spend any more time talking about 2014. If you have more questions we’ll take them up during Q&A. Instead I’ll tell you how I feel really good about our plans for 2015, especially in the North America business. Our team had good line reviews with our retailers over the past few months. Whether retailers had a positive or negative results in 2014, all of them are building aggressive plans for next year. I’m encouraged by the programs we’re working on with our retailers and I’m confident we’ll see nice growth as a result. In terms of the consumer let me build upon what Jim said. Those consumer shopping in the destination channels like home center, hardware, and garden centers remain highly engaged but the consumer and mass retail remains challenged. However, the retailers themselves remain committed to this category and supportive of our brands and are building good programs for next year. Part of what all of our retailers are continuing – are counting on is our innovation pipeline. So there are three specific things I want to call out on the new product front for 2015. First, all year we talked about the strong consumer response to our improved Bonus S as weed and feed product in our floor-to-test markets. Next year we’re introducing this product throughout all of the relevant markets in the South and expect the strong response to continue. This is the most effective Bonus S product we’ve ever produced and its weed control capabilities are far better than the old product. In addition, the environmental profile of this product is better as well. Second, also under the Scotts brand we will be launching a new dirt cleaning product that will be co-branded with OxiClean. This partnership is a couple of years old and the product that we’ve developed is far better than anything you’ll see on the market. Unlike most competitors, the Scotts OxiClean dirt cleaner will not harm your grass or plant which is an extremely important selling point to the consumers to take on this test themselves. We’ve got good support for the product in 2015 and we expect to gaining steam as this product rolls on. And third, we’re excited about the national launch of Miracle-Gro’s Nature Care. Organic products are part of nearly all consumer categories and they especially make sense in our space. You will recall that they test market Natures Care in ten markets this year and the response was very encouraging. Retailers are extremely supportive and our launch will be made stronger by good and store product placement in our national advertising program. Speaking of advertising, as always we will have a lot of new creative for next year, we’ll show you all of that when we meet in person in February. As Jim said, a lot of the reallocation of spending will go to North America business next year, and a fair amount of those funds will be used to better support our brands with these new campaigns. In the interest of time I want to wrap things up, but before I do, I want to reiterate some of what you’ve heard from Jim. The last two years have been a great journey for us and we’ve accomplished nearly everything we set out to do. But the most important part of what we’ve done is to better position ourselves for the future. We’re not reaching for the stars next year in terms of growth but we do believe that the tide is beginning to turn for this category. Our consumer remains highly engaged and our retailers do as well. So I like where we are right now and look forward to sharing our success with you over the course of the next year. With that, I’ll turn it over to Randy.

[Randy Coleman:]

Thanks, Barry, and hello, again to everyone. As Jim said at the outset, all of us are encouraged by the results announced this morning and feel good about our businesses as we begin to execute our plans for fiscal 2015. I know most of you are more interested in our outlook for 2015 and a detailed review of the fourth quarter results, so I’m not going to spend too much time going through the details of the P&L. Frankly, not much has changed over the past 90 days and the results we announced today and very much in line where we would be as in third quarter. The primary exception is our gain on investment in the AeroGrow business which I’ll discuss in a minute. The one highlight I want to focus on during the quarter was sales growth in the global consumer segment. Sales increased 5% to $355 million as we saw solid performance in both, the U.S. and international businesses. As Jim said, we’re managing this segment assuming 1% to 2% organic growth next year but the momentum we’ve had in the back half of this year is certainly encouraging. As many of you recall, the slow start to this season then it just impact the core consumer business, Scotts lawn service got off to a slow start as well. We entered the year expecting that business to grow 4% to 6%. While it feel short of that goal with 2% growth for the full year, 5% growth they reported in the fourth quarter was also encouraging, and reflects the continued touch up on customer account and production as the year progressed. And on a full year basis finishing with companywide sales growth of 2% at $2.84 billion was a really good story for us given the weather we saw in March which April. Moving onto gross margin, entering the year we expected to be up about 100 basis points, and that’s exactly where we ended. You may recall that gross margin rate was up 290 basis points through the first half but significant mix and distribution pressures in Q3 offset many of the gains we saw throughout here, but the fourth quarter, the gross margin rate improved 90 basis points versus year ago, similar to our full year result. There is not much to cover in SG&A, the number came in similar to our guidance, up 3% for the year. You will notice that SG&A was up 11% in the quarter. There were three items that really drove this; timing of U.S. marketing costs, the start-up costs associated with the Hawthorne Gardening Company, and the cost associated with closing the Fafard and Solus transaction. To anticipate a couple of your questions, media spending was relatively flat at $144 million, although marketing spend was higher due to new packaging as we rebranded our Miracle-Gro line this year, as well as start-up marketing cost related to the Hawthorne business unit. Variable compensation was up slightly for the year but not enough to really move the needle. The one line on the P&L that we really spent time discussing is other income, but it definitely merits discussion this quarter. The $6.2 million of other income in Q4 include the $3.3 million gain on investment in AeroGrow International which we consolidated in Q4. You might recall that we purchased a minority stake in this business last year with a flexibility to own up to 80% of it overtime. In addition, we realized a slightly lower onetime benefit in the third quarter related to the increased value of warrants issued when we made our initial investment. Although these were separate onetime non-cash benefits, our continued support of AeroGrow is important to our long term growth strategy that is why we included these in our adjusted operating results. That said, I believe the more realistic operating baseline EPS for 2014 is actually $3.23 and not $3.29 per share. Moving on, we had told you earlier in the year that we expected slightly better result in interest expense and effective tax rate than our original guidance indicated back in December. Our result on both of these lines was pretty much spot on with that revised guidance. The balance sheet also is consistent with what we had anticipated. The increase in receivables is consistent with sales growth and the quality of the receivables remained extremely strong. Also you might recall that we had originally expected year-end inventory to be improved from last year but adjusted that downward up to the slow start to season. The increase in inventory is in line with our revised forecast and the good news is that we’re expecting improvement here for 2015. We also note that long term debt is more than $200 million higher than last year. We said entering the year that we were willing to use that to fund growth in the business and also return cash to shareholders but our current leverage ratio of 2.2 times on a rolling fourth quarter basis is exactly in line with our capital structure strategy and continues to leave us with more than enough flexibility to meet the needs of the business. Before I set the stage for 2015, I want to reiterate what you heard from both, Jim and Barry. We had good momentum of the business right now and we’re encouraged by what we saw coming out by reviews with our retailers. We also had some meaningful new products coming in the market next year. All that played a role as we thought about the guidance we’re providing for 2015. Before I walk you through our outlook I want to provide some context about what these numbers represent. In my first call with all of you in May I said I believed in honest and straightforward communications. So as it relates to our 2016 outlook, let me say this, we have not built a lot of wiggle room between our guidance and our internal plans. The high-end of our EPS range is consistent with our internal bonus plans, and in fact, if we hit the high-end of the EPS range, the management is scheduled to be paid almost to the penny, the same amount it earned in 2014. In other words, our first line of defense and delivery and our commitment to shareholders in 2015 will be our own pay. So here is how we see next year coming together. On the topline our outlook of 4% to 5% growth assumes 3% growth from the acquisitions that Jim mentioned earlier, and 1% to 2% growth from the current portfolio. As all of you know, we’ve had back-to-back years in which we started slowly due to weather. I like to believe that we’re overdue for good spring, but I’m a finance guy and not a weatherman, but I’m not doing any assumptions about favorable weather into our plan. Understand though that any topline growth in the core business will be almost entirely based on unit volume. We’re taking a surcharge related to higher distribution cost but no other net pricing increases are baked in our plans as increases for certain product lines are being offset by targeted price reductions and also promotional increases for other SKUs. And so that brings me to gross margins. For 2015, we’re looking at gross margin range to being flat, commodities will be up slightly, probably about $10 million, and that pressure will be offset by other cost initiative. Right now we still think distribution cost will be a headwind but the search charges were [indiscernible] set that pressure. We currently have about two-thirds of our commodities locked for 2015 and we’re on 75% locked by the end of the calendar year. I know many of you are interested in how declining oil prices will impact us. We don’t face significant tailwinds, since almost 70% of our fuel is locked for 2015 and the correlation between oil prices and our commodity is historically not very strong. On a percentage basis, SG&A should increase slightly less than sales in a range of 3% to 4%. As we discussed in the previous quarter, the SG&A reductions identified going into next year will be reinvested in additional brand support as well as long term growth initiatives like Hawthorne, bond service, and Nature’s R&D. Below EBITDA interest will be about $5 million higher and rate savings in the first quarter will be more than offset by higher borrowing levels during the year. The tax rates return to a more normal historical level of about 36%. And we’re modeling for share account to be flat to down about 750,000 shares depending on the level of repurchase activity during the year. That translates into EPS guidance in the range of $3.40 to $3.60 per share, the midpoint mean about 8% higher than 2014, once adjusted for the impact of the AeroGrow gains. Normally I would expect to see a great amount of leverage either P&L than we are guiding for next year but let me explain. Both Fafard and Action Pest acquisitions are slightly accretive next year, the acquisitions of Solus will be negative in year one. We purchased this business out of bankruptcy in the U.K. and we believe it will be a good long term asset. From the $1 million we acquired a business that will contribute about $30 million in revenue but at that cost we also inherited a few problems. As we begun the integration process, we now really saw it represents a headwind of $0.03 to $0.05 per share in 2015. By no means is that instrumental [ph] but it does offset the year one benefits from the two other deals. Beginning in 2016 we see substantial upside to all three of these transactions, each fits nicely in the different portions of our existing portfolio and represent compelling investment cases over the long run. The purpose of this explanation is to make clear that literally all the earnings growth next year is coming from the core business. So when you exclude the onetime benefit from AeroGrow and look at the business on an apples-to-apples basis, we’re turning organic sales guidance of 1% to 2% into high single digit improvement in EPS. And I do find that kind of leverage in the P&L to be a good result. So let’s move on. In terms of working capital for next year, we expect inventory to be better and no material change in either receivables or payables. Operating cash flow for 2014 was roughly $240 million, and I would expect this number to be between $275 million and $300 million next year. Right now I have no reason to believe that our leverage will move outside of our target range to 2 to 2.5 times. Jim mentioned that the M&A pipeline is pretty active right now, whether it’s not been on the horizon that would take it out of that range but we’re willing to go higher than that temporarily if there is an opportunity that’s in the best interest of our shareholders. So the outlook for 2015 is pretty straightforward. As Jim King mentioned at the outset, we are now planning to have an Analyst meeting in this December. As we thought about it, we determined having store-walks at the break of the season, it made more sense to us. But as many of you know, Jim King and I have been busy travelling over the past three months as I’ve tried to meet as many of our shareholders as possible. However, plenty of our shareholders that I’ve still have not had the chance to sit down and meet, so we’ll be out on the road again, sharing our plans for the end of the calendar year. I look forward to meeting more of you face-to-face. Now with that, I’ll turn the call back over to operator to take your questions. Thank you.

[Operator:]

Thank you. (Operator Instructions) We’ll go first to Jason Gere with KeyBanc.

[Jason Gere:]

Good morning. I guess the first question, I know you’ve said in the past that if you grew 3% to 5%, you would get some good overhead leverage. So can you just talk maybe, I mean, I know you’ve gone through a lot of the details here but a little bit more specifically what you would need to see to get more of the leverage coming to next year because it seems with the sales guidance one to two on the core, it seemed a little bit conservative. So I’m just wondering how that would translate upside on sales, maybe to the SG&A. That’s the first question.

[Jim Hagedorn:]

Sure. Jason, we’ve spend quite a lot of time over the summer what we call project growth internally, so we’ve identified about $40 million of SG&A spending across the business including Europe and those savings are being redirected into the business in long term growth initiatives for next year and areas like Lawn Service and areas like Hawthorne where we have big long term plans for our urban and indoor business, and areas like Naturals where we think there is a lot of long term growth. So at this point we’re not planning to taking the savings and drop them to the bottom line which I – much different within the plan that we’ve executed over 2013 and 2014 but that’s what you will see in 2015. Again, if we do get higher sales growth which I think would be largely dependent on whether it be on the guidance we’re providing you would see on a rate basis better leverage but for now I’m real comfortable with the guidance that we’re providing.

[Jason Gere:]

Okay. And just as a follow-up with that, I mean you guys have been very diligent with just taking out the structural costs there. So I mean, in what inning do you think you might be in terms of rebalancing the SG&A and again, how you’re allocating to some of the strategic spending or eventually falling to the bottom line?

[Jim Hagedorn:]

So we’ve made a lot of progress over the last two years but we think there is continued progress to be made, we continue to work on project growth and we think we’re halfway through that initiative. When I think about it beyond SG&A, I think there is a lot of long term savings that we can drive from our supply chain and the distribution network, our warehousing, freight, etcetera, so maybe less people dependent than what we’ve done over the last couple of years and more thoughtful and more supply chain strategy driven but we think there is still a lot of savings going forward.

[Jason Gere:]

Okay. And then just a quick follow-up here is just on – can you talk a little bit more about international, obviously you’ve had a pretty good year this year but can you just talk about the international opportunity in terms of market, the expansion plans out there, obviously it’s a smaller piece, the story people tend to focus on the North America consumer but I was just wondering if you could maybe talk about the next three to five year kind of outlook on that business. Thank you.

[Barry Sanders:]

Sure, Jason, this is Barry Sanders. The business had a good year, some of that was weather driven, some of that was – the team did a good job and the marketing programs they put out and then quite frankly they’ve gone through the same cost exercise so I think we’ve got our cost structure in place. And so what I would say is, we call it international but the business primarily is the U.K. and France, and both of those markets are doing well and I think we should treat those businesses like they are core opportunities, just like similarly positioned that we have in the U.S. So going forward I think there is geographic opportunities, we have a new leader in Germany, we were very pleased with what he has done this year, we have low market share, so I think there is upside there. Our Australian business reports him through international, we also have a new leader there, we’re extremely pleased with the way that business is performing, so both of those have opportunities to grow. And then there is other markets that we can look at, and just like we’re evaluating here, taking acquisitions, we’ll evaluate the European market the same way and say is there a small product taking acquisitions we can make or is there a geographic opportunities that we have to expand and invest some money. So I think that’s relative to international.

[Operator:]

(Operator Instructions) We’ll take our next question from Olivia Tong with Bank of America.

[Olivia Tong:]

Thanks, good morning.

[Jim Hagedorn:]

Hi Olivia.

[Olivia Tong:]

Hi, I just want to talk about you alluding to mass retail sluggishness a couple of times because we’ve heard from quite a few companies through this reporting season about U.S. backdrop perking up. So just kind of curious why you think it hasn’t necessarily shown up in your category or is it just a matter of timing or something else that’s driving that?

[Jim Hagedorn:]

I think it’s a matter of timing and quite frankly, I think we’re lagging a bit relative to spring but what I would tell you Olivia is, they are pacing right on track with everybody else in the fall and we’re very pleased with the results and I think looking into next year they are positive and I think they have good programs going into 2015. So I’d expect them to catch up pretty rapidly.

[Olivia Tong:]

Got it. And then on the commodities, I know you mentioned that you’ve walked in quite a bit of oil already, so to maybe not capitalizing on the recent decline in crude prices but is it possible to lock in more now for future use or has that ship sailed in and commodity what they offer in 2015 and it’s hard to lock in initially for 2016 at this point?

[Randy Coleman:]

Olivia this is Randy again, typically we – at data point we’re about 70% locked to any one [ph] month but at this point we’re going up to 80% to 85% for 2015, in fact we’re also looking at 2016 to get ahead. So with that carry some mark-to-market risk during the year but we think in the long term, that’s the right economic decision given current fuel prices.

[Olivia Tong:]

Got it. And then just on some of the additions and changes that you’ve made to the business, first with pest control service business. Do you – is that still primarily in test mode or do you feel like you now have the ground working place for a much larger expansion of that? And then on Hawthorne, can you give us a little bit of detail why you structured it the way that you did as opposed to just building out that particular piece of that business. I know you guys have been talking about it for some time but just an incremental detail on why you structured it the way that you did? Thank you.

[Jim Hagedorn:]

Sure. First with the pest, Olivia I would say pest is more – this is scaling the test, it’s not a long run test because I think we’ve acquired very nice business, now it’s a matter of scaling it and making sure that we get that right, and that we can roll it out across the market. So I’d say we’ve moved beyond test and this is the first acquisition we’ll make – we’ll make sure that we get that right once again before we go and get a lot more scale. On Hawthorne, I would say we have tried some of those things here in Marysville, I think we have a fabulous business, but I would say our business here is focused on big box suburban consumer with 5,000 to 7,000 square foot lawn. The nature of this business is, it’s a different consumer, it’s different channels, it’s indoor, it’s urban, it tends to skew younger, so rather than dilute the efforts here that are going very well we thought that it was better to have a different team that would be focused on a different consumer. It’s a smaller business that could get lost in the shuffle here and make sure that they are focused on the brands that Jim talked about and make sure that they are developing the business. So we just felt it was better to separate it than have a different unit. We have been trying to get it done here in Marysville.

[Randy Coleman:]

Olivia this is Randy again. I’d add, when we think about Hawthorne, we think about it similar to the bear business where you have the big national player that have their own businesses that are somewhat separate and different marketing teams, different structure, so that’s really – I was thinking about from a structural perspective. I’ve been trying to let Barry do the Q&A here. It was nice, we used to say in the Air Force, know the enemy, know yourself, I think that’s the answer, know the enemy, know yourself. And for doing outside of this building where I think we kind of view anything less than $10 million is like wait the dime, is completely inconsistent with what we’re trying to build there, and doing it in more urban setting in New York, I think we also view and it is a younger different team than the kind of folks we tend to collect here.

[Olivia Tong:]

Got it, thank you very much.

[Operator:]

We’ll go next to Bill Chappell with SunTrust.

[Bill Chappell:]

Good morning, thanks.

[Jim Hagedorn:]

Hi, Bill.

[Bill Chappell:]

Can you talk a little bit just on the worth of business, I mean, I think by now you’re – at least you’re going through the listing process with the retailers or maybe already through. Tell me, do you have some confidence that you will get the increased listings and things can improve there, I mean, or maybe giving little color on how you take back that share?

[Jim Hagedorn:]

I’d say its two focuses Bill. First is, we’re confident with what we’ve done with the retailer. So the listings and the promotions and the plans we have in place, so we’re happy with the plan but the real test will be when the rubber meets the road, next spring when the consumer goes into the retailer we’re confident that what we’ve done with the entire program will be highly competitive in the consumers eyes and we’ll get that share back not only through what we’ve done with the retailer but the consumer executing the plan that we have in place.

[Bill Chappell:]

Got it. And then with regards to Hawthorne, just trying to understand what are the growth prospects for that business, I mean are there any big players that have similar size that are already there and does it make sense for Hawthorne to have kind of an M&A strategy to kind of build it out?

[Jim Hagedorn:]

Yes.

[Bill Chappell:]

That’s all I had I think.

[Jim Hagedorn:]

No, it was nice. I think it’s a very exciting business opportunity that reports directly to Barry, and I’m very pleased with it, I think that management and the work and the M&A process is something that I – and I know Randy as well take a lot of interest in making sure it goes well and we don’t sort of shoot ourselves in the foot. I think that some of these deals tend to be a little bit unusual like the AeroGrow deal but that’s one where if you were to speak to – I think those folks, they would say it’s kind of gone exactly the way, we’ve really been able to add value, we have not only been able to add capital but I think whether it’s the supply chain R&D, marketing ideas, just a lot – they have the kind of thing where you say that’s the real first foot in the door and I think it’s gone really well, I mean otherwise we wouldn’t be writing it up. So I feel good about that M&A is a major part of what’s going to happen there and it’s a major focus of the management team there.

[Randy Coleman:]

So I would say one part of your question if there is a big acquisition out there in the space there is no big ones, it will be a series of smaller ones and to-date some of the focus that we’ve had is exactly what Jim said, which is more of a private equity partnership focus where we make an investment, we’re investing in people that have either good products, good brands, we’ve given the advantage that we have a scaling capability but we let that team run it independent of this business and that’s working very well for us.

[Bill Chappell:]

Got it. And then last one, Randy, maybe help me understand, AeroGrow, both in the quarter and in the guidance for next year, so was it the consolidated earnings for the full year in this quarter and then is it treated in above the operating income line going into next year or is it still going to be below the line?

[Randy Coleman:]

No, we consolidated in the fourth quarter and the results were immaterial for the quarter. The biggest quarter is the one coming up so Q1 or October through December, preparing for the holiday season, that will potentially be a tale on how that business performs for the full year. But we will consolidate going forward so results will be entirely included in our P&L but because we still only own it by one-third of that business, two-thirds of the earnings will be send back to the other shareholders below the line.

[Bill Chappell:]

Okay.

[Randy Coleman:]

So for 2015, we’re expecting sales to be in the range of $20 million and earnings to be relatively zero, we’ll get back to the shareholders.

[Bill Chappell:]

So the other income won’t have anything from it?

[Randy Coleman:]

No longer.

[Bill Chappell:]

Okay, great. Thanks so much.

[Operator:]

(Operator Instructions) We’ll take our next question from Connie Maneaty with BMO Capital Markets.

[Connie Maneaty:]

Good morning. I have a couple of housekeeping questions, one for Barry. When you are giving sales increases, were those for the full year or the quarter and where was the data POS or your sales growth?

[Barry Sanders:]

The data was POS not our sales, and the number I believe was for the full year.

[Connie Maneaty:]

Okay, fine. On rollout of the new Bonus S in the Southeast, first of all, what percentage of fertilizer sales does the Southeast represent, how important the new product do you think it is and where is the price rate relative to regular Bonus S?

[Jim Hagedorn:]

Let me just – because they are sort of preparing their data Connie. Bonus S for the Southeast is every month the more single important product to have. So for the Southeast region Bonus S is the product that – not the only one but it’s the most important twelve months a year.

[Barry Sanders:]

Bonus S, and this is not a geographic split Connie, but Bonus S is 10% of our overall fertilizer sales.

[Connie Maneaty:]

Okay.

[Barry Sanders:]

And I would tell you that business has been declining for a number of years and that we expect that to be decent growth for that business next year.

[Connie Maneaty:]

And what’s the pricing like?

[Jim Hagedorn:]

Pricing is the same as…

[Barry Sanders:]

Yes, it’s going to be consistent with what we’ve had, we did not take a price increase for the product.

[Connie Maneaty:]

So is it higher margin for you or equal margin, just better for consumer?

[Jim Hagedorn:]

Equal margin.

[Barry Sanders:]

Equal margin, significantly better performance with the consumer.

[Connie Maneaty:]

Okay. What did you find out about Solus that you didn’t know before you made the acquisition? And I guess how can it be so dilutive?

[Randy Coleman:]

Connie, this is Randy again. We’ve worked through this deal in picks and starts, couple of times we thought about walking away, atonally the business went into bankruptcy when we decided that we weren’t going to invest a lot of money upfront. We eventually bought it out of bankruptcy, plus some working capital and inventory that we’re liquidating right now but the fact that we paid $1 million for a few brands that right about $30 million at topline for next year. So what happened you know, and honestly we didn’t do the diligence and integration plan as well as we could have – it wasn’t complete from start to finish and once we owned it and really dug in deeply we realized there is something’s here that when you invest upfront, whether it’s warehousing, perhaps in people, and some other areas. So again, it’s unfortunate because we felt really good about the other acquisitions that we’ve done and it’s the one that’s going to take us a year or two to dig out but once we do we still think about the scale benefits to the U.K., the team there is really excited in the long run, and going forward we just need to make sure that we don’t have a similar situation like this one.

[Jim Hagedorn:]

I’ll throw in mine only because I think everybody in the company knows my view. It’s a lesson of how not to do things and the opportunity when you say, pretty much you’re going to have it for free. I think it was pretty compelling and caused people not to be as careful as they are going to be going forward or there is going to be major problems with me. It’s just increased a whole that we hadn’t planned on our budget, I think everybody struggled through it and it’s fine, but it was not a sort of big win that we cannot be happy with and there is going to be corrections going forward to make sure that little deals like this cannot become big problems.

[Connie Maneaty:]

Okay. Can you just tell me what’s in the product line, what kind of products is it?

[Jim Hagedorn:]

There is a series of different, so it’s everything from water supplies to long handle pools, really nice tools that in the long run we could expand beyond U.K. and Europe, we think we could even import them into the U.S. and sell them perhaps even through our Big Box, our retailer. So there is a sourcing capability from major two that we didn’t have in the past and that was a big aspect of why we wanted to…

[Randy Coleman:]

Connie, I would say tools and burning, and burning unlike sort of nasty commodities in The United States which is a much more difficult market I think. Burning in the U.K. is a pretty rational market, and so the big areas here are tools and birding, there is a bunch offshore sourced stuff that goes into that and these have good market share over there. It just was a – I’m going to say improperly done deal but I think largely because it was attractive, but I think it’s in an interesting bunch of categories that we actually like, we just didn’t plan on having to do a lot of work to sort of get it back up to speed.

[Connie Maneaty:]

Okay. Thank you very much.

[Operator:]

We’ll take our next question from Jon Andersen with William Blair.

[Jon Andersen:]

Good morning, everybody.

[Jim Hagedorn:]

Hi, Jon.

[Jon Andersen:]

So my question is around pricing and long term margin expectations, the way that you have portrayed 2015, there will not be pricing. So the first question is why no pricing every year?

[Jim Hagedorn:]

In particular, we are taking price increases in a couple of categories where either commodity pressures or based on our analytics we felt like it was pricing opportunity but we’re also rolling prices back in a couple of other categories where we made a lot share or we felt like there was a sweet spot where if we get to a magic price point, the consumer takeaway is a lot better, and the overall value created by producing a price as a little bit makes more sense. So we’re taking no net pricing, net of increases and decreases in 2015 but we are taking increases where we thought it was appropriate. So I’d say 2015 is a little bit of an aberration versus our long term plan for sure.

[Jon Andersen:]

Okay, that’s helpful, if I can ask one follow-up on the mulch business. I think it was little over year ago you talked about enhancements you were making to the supply chain there to improve the margin structure of that business which we have indicated as well below the corporate average, where are you or how far along are you in that process and more to come in that area?

[Jim Hagedorn:]

Yes, we are going to continue to invest capital in our mulch business to drive manufacturing productivity and we have seen that even in 2014 although the next margin results compare that out but it’s kind of a tale two worlds in that. While our manufacturing productivity has improved, it was really the distribution headwinds this year that we didn’t see coming at the start of the year in April, May, and even into June that really brought our margins back to the same starting point. Our gross margins are still in the low teens, and if we can get those gross margins into the high teens just because there is less investment below gross margin, we’ll get operating margins for the mulch business equivalent to the company average and at that point we’ll feel really good about that being a solid part of the portfolio. So there is still work to be done and we’re going to continue doing that work.

[Jon Andersen:]

Thanks a lot.

[Operator:]

We’ll take our final question from Alice Longley with Buckingham Research.

[Alice Longley:]

Hi, good morning. My question is on store traffic, can you comment on your discussions with the home centers, big box retailers, and what they are saying about store traffic. And I know that’s not important to you right now but when we get into this spring, if store traffic is improving because some of the macro changes that are happening in the economy, what’s the history of that converting to better store traffic for lawn and garden whether being neutral?

[Jim Hagedorn:]

I’ll violate my role here and take a little bit – good morning, Alice. Look I think that – I continue to be – continue is probably not the right word because you would actually think I mean that but not really understanding the numbers overtime since 2007-2008, I think there is so many variables that have gone into sort of retail and point sale movement but here is what we do now, everywhere when weather is good, I mean so that if you looked at how bad sort of the business was in the first half of the season, the weather turns around and we had just a really nice kind of relatively cool summer, and a lot of to make up a boat load of time, and so when you look at our freight negativity, particularly in the growing media business which occurs sort of the second half, it’s logic that store volume went bananas, and I was having this discussion yesterday with one of our retailers is that we were doing what we had to do to keep people in stock but it was that crazy and really ran down inventories on our multi-side and involved a lot of freight. So I think we can – while you can say, we’ve been doing a lot of good things in Europe, Europe had good weather, and so I think this is a lesson – you maybe the analyst that’s been around with us for the longest, I don’t view that – it’s not a negative. I think what it means is that the most important single thing to our business is weather, and so I think when people are buying lawn and garden products, lawn and garden is the most department in the channel and they continue to – and I know this to be the case, they continue to be able to harvest good returns from lawn and garden customers that are in lawn centers. So it’s pretty much a win-win but I think it’s very much weather related, although, again I would say in my discussions with senior management, everybody is concerned in this country about growth rates, and how do we get above low single digit growth rates, and I sort of can’t leave last night without saying I’m hopeful that Washington will start to focus on things that drive sort of economic activity in this country. But I think weather and maybe a little bit of benefit from DC would be useful.

[Alice Longley:]

So the store traffic is up improved and buying other things in home centers in lawn and garden, that doesn’t necessarily – it’s still over to better home and garden?

[Jim Hagedorn:]

Alice, I would say specific to foot traffic I would say there is three elements we’re working on with the retailers; one is foot traffic, the other is transactions, and then market basket size. So far category, specifically in home centers, lawn and garden is the destination category in the spring. And so increases in foot traffic is probably and most likely driven by our category. So if we do see increased foot traffic, next spring, which is the intent, you will see better lawn and garden sales. We also track how that converge the transactions and so we’re measuring that and then we’re doing a much better job of partnering within that transaction, what are they buying. So to make sure that we’re selling them the appropriate market basket and the complimentary items and some of the promotions you’ve even seen us do in the last couple of years is buy this and then buy the next thing that goes along with that. So our promotional efforts are driving market basket, and then we’re also saying how do we drive attachments and drive the project. And so long wind the answer is, if foot traffic is up, that is a fantastic thing for lawn and garden next spring.

[Alice Longley:]

Okay. And a separate question is, how do you – was mix, I think you said mix was negative this year in terms of its impact on gross margin because of the growth in mulch. And is that likely to be the case as well in fiscal 2015?

[Jim Hagedorn:]

Yes, it will be. The contributor to why we’re guiding to flat margin rates. We’ll see, again pricing will be effectively neutral, our commodities will be up a little bit, we have more supply chain savings and then it will see a headwind from continued growth in mulch. Alice, I don’t know the answer completely to sort of mulch, it’s become a super important commodity within sort of the value opportunity for consumers. It’s – on the Black Friday events, it’s if the turner value for – what turned your home for $20, you get a turn of value. We’re in – I’m in deep discussions with our retailers on how to make it a great value but without it impacting our margins as much as it is, and part of that work we’re doing but part of it is, how do we do it with retailers so that we’re staging inventory better, we have less sort of need to rush freight around all over the country to try to keep people in stock. So there is a lot of planning on saying everybody has got to watch pricing on this product because it’s tremendous value and we’ve got to look for inefficiencies in the system because I don’t see the value proposition going away, it’s just too powerful. But we’re in discussions with sort of everybody that’s involved in the supply chain here and sort of the interface with the consumer to provide a great value but find ways to make it less margin eluder [ph] for everybody.

[Alice Longley:]

And when you said distribution costs were pressure in fiscal 2015 that was because you had to rush out mulch, a lot of mulch fast I guess, and wouldn’t you be able to plan better now for fiscal 2015 or why did you say distribution expenses will again be a pressure in fiscal 2015?

[Randy Coleman:]

I don’t think we said that, I think we said we continue to – so the answer is, to the first part is yes, we would like not to repeat that stuff and therefore a lot of work doing to avoid that. The second part is on the gross margin front, I think what Randy is saying is, we expect mulch to sort of be at the high end of all the products we sell as far as sales growth. So that to itself it not completely useful. I also want to just throw out there and it’s we’re saying at the end of the call that we’re not planning on great weather, if weathers good, that’s good for us, okay. We are looking because this is a year where we’re playing harvest less off the P&L, we’re trying to build some conservatives into our numbers, and therefore some of the stuff is not going to fall into the bottom line. We’re just – we’re trying to build some space in this for us so that – again Alice, the most important thing I ever learned from you is don’t over promise. We’re trying not to do that and so when you say how come if you don’t make as many mistakes. I think if we have good weather we make fewer mistakes, we’ll make more money.

[Barry Sanders:]

Alice, I would add a specific to the comments on distribution like Jim said, we will do a better job of planning specifically for mulch and some growing media but what Randy did say was we expect upward pressure on freight cost and it’s not just relative to Scotts, I think it’s the entire industry as I talk to other vendors and other categories, both availability of trucking, as well as cost of trucking, everybody is seeing issues and you’re having the plan for just having the trucks and the trucks are costing a bit more these days. So the main part we have to look at is, to be a little more flexible with our retailers, so that if freight does go up that we can manage that with them, whether it’s figuring out how to get it there or freight charge, freight surcharges that it will have to pass along.

[Alice Longley:]

Okay, super, thanks. And congratulations on a good year overall.

[Barry Sanders:]

Thank you.

[Jim Hagedorn:]

Thank you, Alice.

[Operator:]

That concludes our question-and-answer session. At this time I’d like to turn the conference back over to Mr. King for any additional or closing remarks.

[Jim King:]

Thanks, Katie. Thanks everybody again for joining us. Again, just a quick reminder, we will be at the Morgan Stanley Conference on November 19th that will be webcast. And for those of you who joined us late, we’ll be sponsoring an Analyst Day event in [indiscernible] on February 19th and we’ll be giving out more information about that event in the weeks ahead. If anybody has got follow-up calls, feel free to give me a call directly. You can reach me at 937-578-5622937-578-5622. Otherwise, thanks to everybody, and have a great day.

[Operator:]

That concludes today’s conference. We appreciate your participation.