The Scotts Miracle-Gro Company
Q1 2015 Earnings Call Transcript

Published: 4 Feb 2015

[Operator:]

Good day, and welcome to The Scotts Miracle-Gro Quarter One Earnings Conference. 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:]

Thanks, Eli. Good morning everyone and welcome to our first quarter conference call. With me this morning in Marysville, Ohio is our Chairman and CEO, Jim Hagedorn; and our Chief Financial Officer, Randy Coleman. Also present is Mike Lukemire, our Chief Operating Officer as well as other members of our management team. In a moment, Jim and Randy will share some brief prepared remarks. Afterward, we’ll open the call for your questions. In the interest of time, we ask that you keep to one question and to one follow-up. I’ve already scheduled time with many of you later today to fill in the gaps. Anyone else who needs a follow-up call can call me directly at 937-578-5622. Before we begin, I want to remind everyone that we will be hosting an Investor Day event on February 18 in Florida at the Boca Raton Marriott. If you haven’t responded to us yet and would like to attend, please call my office by next Tuesday so we can include you in the event. We will start that meeting at 8 am and have roughly two hours of presentations primarily from Mike and his North American operating team. Shortly after 10 am, we’ll depart to visit local garden centers and return to the hotel roughly 11.45 for lunch and a Q&A session with management. For those listening via webcast, we will be live during the presentations as well as the Q&A portion of the meeting, which we would expect to begin at roughly 12.15. There will be a link on our Investor Relations Web site that allows you to participate. Our goal would be to conclude the meeting by 1.30. With that, let’s move on to today’s call. As always, we expect to make forward-looking statements this morning, so I want to caution that our actual results could differ materially from what we say. Investors should familiarize themselves with full range of risk factors that could impact our results. Those our 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 archive version of the call will be available on our Web site over the next year. With that, let’s get started and I’ll turn the call over to Jim Hagedorn.

[James Hagedorn:]

Thanks, Jim. Good morning, everyone. As the other Jim just said, two weeks from now, we’ll give you a better look at the state of the business. We’ll show you our new products, we’ll give you a look of our new digital platforms and new advertising campaigns, and you’ll see the strong presence we have at our largest retail partners. In addition, I’ll provide a brief strategic update. Randy will do the same as it relates to our financial strategy and Mike Lukemire will give you a high-level overview of the approach he’s taking as Chief Operating Officer. I think that we’re executing extremely well right now and I hope you’ll come away from that meeting with the same belief. Given the close proximity of that discussion to today’s announcement, I’m going to keep my comments today pretty brief. As most of you know, the first quarter typically constitutes less than 10% of sales for the year and about 5% of consumer purchases, most of which date back to October. So if you’re just looking at the numbers, there isn’t much to take away from our release today as it relates to our full year outlook for 2015. With that said, I like what I see. Consumer purchases on a fiscal year-to-date basis are up 1%, but we’re up 11% since the first of the year. Better yet, we’re positive in all channels of retail. The profitability of the business is right where we expected it to be. SG&A is well under control, our balance sheet is strong and we’re getting close on some acquisitions that will add about another 2% of growth on an annualized basis. From a big picture perspective, it’s hard not to be optimistic. It’s been years since we’ve seen a healthy consumer, an engaged retailer base and a stable cost structure all at the same time. So I remain confident that we can deliver on the growth assumptions we outlined during the last call. While we’re still forecasting only about 1% to 2% organic growth, if the spring brings us an opportunity to exceed those numbers, we plan to take full advantage of it. As it relates to the retailer environment, support of the category and for our brands remains extremely strong. We are well positioned both on-shelf and off-shelf and we expect our retailers to once again lead with our brands as they kickoff the season. In Europe, despite all of the macroeconomic challenges, we continue to see improvement in our business. Currency is really a non-issue for us and I’ll let Randy provide more color on that in a few minutes. In Scotts LawnService, we’re ending the new calendar year with record levels of customer retention and higher customer accounts even before we get into the peak of the selling season. But it’s February. We’re still two or three months away from the peak of the season, so the wildcard as always is that whether Mother Nature cooperates. As all of you know, we’ve had two back-to-back years of record bad weather. So I’m not going to jinx myself right now. I want to shift gears and talk about some of the recent organizational changes and restructuring efforts we’ve undertaken here. When we announced Barry’s departure, we said we had some further streamlining to do and in January, we picked up where we left off. We made a change to the leadership of our UK business and eliminated two other roles in the international headquarters including the boss. Previously, each country reported to an international Chief, Michel Gasnier, who then reported back to Marysville. Going forward, each country will report directly to Phil Jones, a British national who has extensive experience here and in Europe. Phil, who worked for Monsanto and competed well against us at one point, has had numerous assignments over the years including President of our West Coast region. He’s based here in Ohio and reports directly to Mike. Remember, our international business had record profits last year so the changes we made were not because the model was broken. The changes were made because we were convinced the model could be improved. In fact, that’s been our mindset throughout the entire company over the past two years. Our efforts since 2012 have been to focus on streamlining the executive ranks, improving our decision making, improving the quality of our financials and reshaping our corporate culture. Those efforts are aimed at allowing us to consistently grow the core 1% to 3% and add another point or two from smart acquisitions. That level of growth coupled with leverage in the P&L and a smart capital allocation strategy is designed to achieve double-digit shareholder returns in most years. So what do I see? I see us succeeding. Whether it’s been in the headquarters functions, North American operations or international, we’ve reduced layers and we’ve become more nimble. Our executive ranks have been trimmed by 45% and we’re working more collaboratively to prioritize spending and eliminate waste. The results of these efforts has been the creation of a $40 million pool that we’re reinvesting in the business. About half that money is going back to the core to better support our brands. The rest of it is going to emerging areas like SLS and the Hawthorne Gardening Company where we have opportunities with urban and indoor gardening, through an increased focus on hydroponics, organics and other niche products. So that transitions nicely into an overview of what you’ll hear from us in Boca. We’ll provide an overview that is less focused on what we’re doing and more focused on how we’re doing it. Mike and I will provide an overview of how the organizational structure has evolved. What you’ll see is that we’re approaching the business with a new philosophy; one team. We’ve essentially shattered the old paradigm. We have moved away from a philosophy that corporate sits in a silo at one end of the building and the operators sit in a silo at the other. As I said when Barry departed, we’re not GE or Proctor. We don’t need a big infrastructure. We work better when we’re all focused on strategic goals and operating as a single team. Mike will also talk to you more about the near-term opportunities that we see in North America. In doing so, we’ll have brief presentations from a few members of his team. We’ll talk about the new products we’re rolling out this year. You’ll see some of the new creative and digital assets that we’re developing to speak to consumers. You’ll get a first-hand look of how the business is coming together in the stores. While it may not feel like it to those of us buried in the snow in the Midwest and the Northeast, spring is already happening in Florida. During our store walks, you’ll see garden centers full of live goods and I’m confident that you’ll be impressed by the strong support of our retail partners that they continue to give to the lawn and garden category in general and our brands in particular. As I said at the outset, I feel good about where we are right now. We obviously don’t have the ability to impact the weather, so we’ll just have to wait for the season to break, but I’m encouraged by the progress we’re making in those areas that we do control. If we keep executing against the strategy we’ve outlined in the past, I’m confident shareholders will continue to benefit from the strong short-term returns and a company that is better positioned for long-term success. Just in case you’re wondering, it’s been 70s in Florida, so get out of the snow and come spend a day with us. I look forward to seeing as many of you as possible on the 18th and I think that you’ll find it time well spent. Thanks. Let me turn the call over to Randy to discuss the numbers.

[Randy Coleman:]

Thank you, Jim, and good morning, everyone. I want to start by picking up on the optimistic tone that Jim struck in his remarks. In addition to having a good plan and good retailer support entering the year, we’re also in strong financial shape with respect to both our current guidance for 2015 and also long-term growth. As Jim said, our strong balance sheet and cash flow continued to give us great flexibility to fund the needs of the business and also return cash to shareholders. Specifically focusing on our 2015 outlook, I want to anticipate questions you might have related to what other companies are reporting and what all of us keep reading in the business press. First, unlike many other consumer product companies, currency is a very small issue for us given the modest earnings we derive from outside of the U.S. On a year-over-year basis, currency will negatively impact our top line by about 2% and our bottom line by $0.03 to $0.05. But some of that impact was already build into our assumptions entering the year. Second, concerning commodity costs, falling commodity prices occurred too late in the year to provide much upside for 2015 but our risk from input cost this year has been greatly diminished. Now let’s get into the details for our first quarter results. As is the case every year in the first quarter, it’s easy to look at the numbers and get carried away by what you see, both good and bad. As Jim said, less than 10% of our sales and 5% of consumer activity for the year hits in Q1. Given the small base, there are often unusual looking variances in Q1 versus the prior year that will begin to normalize as we get further into the year. For example, sales in the quarter were up 14% or 216 million. That was driven by an 18% improvement in the Global Consumer segment while Scotts LawnService was up 1%. However, acquisitions accounted for nearly all of the growth in Global Consumer. Recall that we expect acquisitions for the full year to account for about three points of growth. We expect another 1% to 2% from the existing portfolio. The other number that stands out is the gross margin rate, which was down 430 basis points to 13.6%. We had a little less than $8 million of negative mark-to-market adjustments related to our fuel hedges in the quarter. And off of such a small sales base, the rate is skewed. So if you exclude those hedges from both this year and last year, the gross margin rate would have been down only about 30 basis points, which was in line with our internal projections. This modest decline is consistent with higher warehousing costs tied to our inventory build, which I’ll explain when I discuss the balance sheet. Before I move on, I want to provide a bit more color on our fuel hedges. Currently, we have locked about 80% of our fuel cost for 2015 and about 20% for 2016. I would anticipate our gross margin rate getting back to last year’s levels by the end of the third quarter, which is consistent with our full year guidance as the mark-to-market impact is offset once our shipments accelerate with the season and we’ve began to see the benefit of lower year-over-year fuel cost. But that is based on the assumption that we don’t lock more costs and that fuel rates don’t continue to decline. Obviously, the mark-to-market risk could negatively impact the full year gross margin rate when we lock in more cost for 2016 and if we see even more downward pressure on fuel prices. Of course, the flipside of locking in more cost now would be a lower overall cost structure once all the accounting noise settles itself out. We’re already further locked for 2016 fuel cost that we would normally be at this time of year. The conversation about how much more to lock in our cost for next year is one that is happening in real-time and I’ll likely be able to elaborate a bit further on this two weeks from now when we’re in Boca Raton. Let’s move on to SG&A. As Jim already said, spending is well under control, up 2% in the quarter and I feel good about what I’m seeing right now. If you just look at the face of the P&L, it looks like there’s not much of a story here. However, when you look beyond it, the story is actually a pretty good one. The increase in spending in the quarter is in line with the increased advertising support of our Tomcat brand this fall. And with consumer purchases for Tomcat up more than 20% in the quarter, we feel good about the impact of our new creative and also new listings in this category. But remember that we also inherited SG&A from the acquisitions we’ve made over the past year. We were able to offset those acquired expenses by strong SG&A controls associated with the smart spending decisions that Jim mentioned earlier and also reduced compensation expense from our restructuring efforts. As many of you know, I’ve been at Scotts for over 15 years. I have always said we are disciplined around SG&A as we needed to be but the focus we’ve had over the past two years has become ingrained in the culture and I continue to be optimistic that we can responsibly invest for long-term growth while maintaining strong discipline around SG&A. We had restructuring costs of 9.6 million in the quarter, most of it driven by some of the organizational changes that Jim talked about. We would expect as much as 5 million of incremental restructuring in Q2 largely related to our international business. Our goal is to conclude our restructuring efforts by the end of Q2 though it is possible that a small amount of the associated cost could spill over into the second half of the year. Interest expense in the quarter was 9.7 million versus 13.9 million a year ago. The improvement driven by lower average interest rates due to the bonds we called during Q2 of last year as well as $2 million acceleration in Q1 of 2014 from interest rate swap accounting. Our leverage ratio at the end of the quarter was 2.4 times. Finally, we ended the quarter with a basic share count of 60.8 million shares. During the quarter, we repurchased slightly less than $15 million of our own stock. Taking it all to the bottom line, our adjusted loss for the quarter was 68.5 million or $1.13 per share. Without the mark-to-market impact on fuel hedges, the adjusted loss would have been $1.04 per share. That compares to 65.5 million or $1.06 per share last year. On a GAAP basis, loss attributable to controlling interest from continuing operations was 74.6 million or $1.23 per share compared to 65.7 million or $1.06 per share. There’s really only one item on the balance sheet that I want to focus on and that is inventory. As you see, the overall number is up about 77 million from last year. About half of that amount is due to acquisitions. The majority of the rest is due to a decision we made last year to accelerate the production of our growing media and mulch manufacturing in order to better meet the market demands into spring. Assuming we meet our full year sales targets, I expect inventory will decline by 20 million to 30 million for us this year allowing working capital to be a modest source of cash for us by the end of the year. I’m glad to get into more details related to the financials during Q&A, but there’s not much to really add at this early point in the season. So before I turn the call over to the operator, let me briefly outline what I’ll be sharing with you during our Investor Day event in Boca. There’s really no point of going through the quarter or our full year guidance since nothing will change significantly between now and then. So my comments will be pretty brief. In addition to talking about our hedging strategy, I’ll share an update with you about our philosophy around uses of cash as well as leverage. You certainly won’t hear any radical departures from what we’ve said in the past. I agree with Jim that we can and should continue to return cash to shareholders. But as the economy continues to strengthen, we need to be flexible in maintaining the right balance between investing the long-term growth and using cash for near-term returns. I look forward to seeing you on February 18 and now I’d like to turn the call over to the operator for your questions. Thank you.

[Operator:]

Thank you. [Operator Instructions]. We’ll go to our first question from Josh Borstein with Longbow Research.

[Joshua Borstein:]

Hi. Good morning, Jim, Randy, Mike and Jim and everyone else there. Thanks for taking my questions. Good morning to you. Just a question, with falling gas prices putting a little extra money into everyone’s pocket, do you have any reason to believe that some of that extra money might trickle into the lawn and garden products this year?

[James Hagedorn:]

I think we believe that – if you go through the sort of versions of the script, I really try to reduce the size of the script as we kind of went through various versions of it. So we did have it in there that we viewed it as a positive. So I think the answer is yes.

[Randy Coleman:]

I’d say when you look at consumer confidence, gas prices, general economic majors, I think it does make us have more confidence on our 1% to 2% organic number for the year.

[James Hagedorn:]

Put it this way, it’s better than the alternative.

[Joshua Borstein:]

Good point. And the conversely, do you have concerns about what’s going on in Texas and the economy there? And could you remind us how Texas ranks in terms of your markets in the U.S.?

[Randy Coleman:]

Texas is one of our top three, so California, Florida and Texas are all pretty similar. Given where we are with oil prices being down in the economy there, I think it is a watch out, but as we like to say, it’s a very big country, plenty of big states. When Midwest, Northeast has an off year, it seems like California and Florida make up for it. So we’re not especially concerned about the big picture, but I think Texas is an area that probably will have some economic --

[James Hagedorn:]

I just want to throw out there that I do think weather probably matters more and I think drought relief and I think they’ve had a pretty good winter. And if you look at the long-term weather forecast, I think it calls for a slightly above average amount of rain in Southwest. So I think those are actually healthy for us. So I would say, if weather is good and they’re not in the middle of terrible drought, I would say that’s probably more valuable to us than sort of low oil prices and its effect on that economy.

[Joshua Borstein:]

Okay, great. And just one follow up for me. Looking ahead this spring, I know one thing you guys have been working on is increasing the market basket and some of that has to do with promoting related items together. How did that strategy work for you in 2014? And should we expect to see more of that in 2015?

[Michael Lukemire:]

It worked very well but we’re even doing more. And so I would say that I am highly optimistic about the spring Black Fridays that will be occurring in the market and our share of shelf with those activities.

[James Hagedorn:]

I think that this is one of the areas that – if you look at yourself in the mirror and you say, what if we were really good, I would think we’d be making consumers an offer they couldn’t refuse with all the brands that we have and our presence in the stores, and a lot of things that we do that other people can’t as far as innovation and space. You would think that we would tie stuff together whether it’s the brands we have plus our service business and really make it so that the consumers like doing business with us and kind of know if they’re in the system. And we just never have been able to really get that right. I think we’ve done better, but I think our ability to sort of cross-promote across our brands has been, in a large part because we tend to run our brands as separate businesses and so nobody really wants to spend the money to do a deal where if I’m a local grower, I want to do a deal with Ortho or you know what I mean. So people in spite of the fact and I think that Mike and some of the changes we’re going to make in sort of the marketing organization that we know what we’re doing, just not ready to announce yet, I think we’re going to get closer to a more virtuous place but it’s a big opportunity for us and I don’t think we’ve been sort of at all on it. So whatever we’ve been doing up until now, if you guys think you have noticed the difference and I guess Mike does, that’s great. It’s just think about how great this could be if somebody buys this and they know they can get a deal on this, it keeps people into sort of the family of brands that we own.

[Michael Lukemire:]

Yes, I would agree with what Jim said there. So we put together a cross-branding group which was different and so we’ve made incremental progress. We have bigger plans in that that we’ll be talking about later.

[Joshua Borstein:]

Good luck on the upcoming season.

[Jim King:]

Thank you, sir.

[Operator:]

We’ll go to our next question from Jason Gere with KeyBanc Capital Markets.

[Jason Gere:]

Good morning, guys.

[James Hagedorn:]

Good morning.

[Jason Gere:]

Just I guess one question and then just kind of a clarification question. So if you could talk a little bit about the advertising spending. I know the last two years, it’s been flat after the step down in 2012, which was the step up from 2011. And I know you’re going to talk in a couple of weeks more about the evolution of the digital platform, but I was just wondering if you could provide a little bit of color how we should think about advertising this year? How it’s going to be spread out more maybe national versus regional? And just a little bit about the evolution of digital at this point?

[James Hagedorn:]

You guys ask such complicated questions. So what do I think? I think that the – even when we took that big increase, I think it was in '12 and we brought it back down and it wasn’t that it didn’t work, by the way. It was sort of too devastating to the P&L if you didn’t get the sales you needed to sort of justify it. But remember, we saw like 200 basis points of share gain. I think on our branded products, like a 6% increase. It was just kind of too expensive. And what you’re seeing differently now is we’re actually cutting expenses other parts of the organization to spend more. But even after '12, we didn’t go back to that lower level. We still stepped it up. So even though it’s looked flat, it was still at a level above where it had been in '11, so kind of point number one. I think that a lot of what we’re doing now is that the changes we made in the company, we’re not – Randy and I aren’t taking that money. That’s money we’re giving Mike to use to drive business. I mean, he’s carrying a pen or wears it all the time now. Just can you turn it, so I can read it. The pen says, we must grow and he’s crossed it out and put we will grow. So remember, this is all about saying I don’t think we just – I think that we won’t be able to sustain our equity value if we can’t ultimately show that we can grow our business. And so in '12, what we did and said, we’re just going to make a bet that we can spend more without kind of reducing our expenses and then it will all be virtuous and it will work great, and it didn’t. That’s not to say we don’t believe in sort of advertising and marketing and promotional support and working with our retailers. All the things that we do I think actually pretty uniquely at least in our space and maybe in DIY. So, what we’re doing is saying we’ll cut our expenses and do it responsibly, a little bit like what I think this country should do. But we control our business and we’re saying if we’re going to be good stewards of this business, we’re going to cut expenses. So, now let’s talk about how will this year compare it to last year and maybe, Randy, you want to take that.

[Randy Coleman:]

Sure. So in dollar terms, our plan is to take some of the money that we’ve harvested elsewhere that Jim pointed out and increase our U.S. media spend by $10 million to $15 million. And unlike 2012 that Jim referenced where we’ve essentially spent the money on more of a peanut butter approach across our entire business, it’s really targeted behind three main initiatives; one being Tomcat that we saw this fall. It worked extremely well as well as our Naturals rollout. That’s going to be more on a national basis this year after testing in 10 markets last year. And then our cleaners have a product rollout, which is going to be brand new for 2015. So, I think the way we’re spending the money is very targeted and makes a lot of sense and the fact that it doesn’t have to payout in year one I think is also very reassuring from being able to protect the bottom line while we’re also growing the business.

[James Hagedorn:]

In addition, our existing advertising is going to be significantly more competitive than it has been, so I’d say standby for that. That should be fun for us. I think Mike was just saying that he looks forward to this year. I don’t know if you want to --

[Michael Lukemire:]

I think the effectiveness of our messaging is a difference and we’ll talk about that down in Boca, and then how we have complete campaigns and I think with the pricing and all the things we have out in the marketplace, I think we’re going to be very competitive. And so, I’m actually anxious for – as Jim reminded me, spring has started, but we’re seeing good indicators early and I’m excited --

[James Hagedorn:]

Yes, I think that’s important. So our early season markets pretty much Florida, Southern California are really doing well so far.

[Jason Gere:]

Okay, great. And then just the other question, it’s just more of a clarification. I know in the press release, I think on the call too, you guys reiterated that 4% to 5% net sales and organic is 1% to 2% and you said acquisitions 3%, but you also said FX I think would be a 2% drag. So, what am I missing in terms of how you’re calculating?

[Randy Coleman:]

I think you got the numbers right. Our original guidance we said 1% to 2% organic and about 3% inorganic from the deals we did. We do think that there will be some softness from FX in Europe and Canada, but when you further that down to the bottom line, it’s fairly material in overall scheme of things and won’t give us any reason to question our original bottom line guidance of 3.40 to 3.60. So it could have a little bit of impact on the top line. It won’t drop to the bottom line. And given again the external factors we talked about as well as our internal plans, we still feel like 4% to 5% is a reasonable place to be.

[Jason Gere:]

So does that mean that 4% to 5% could come in but it’d probably be organic, maybe a little bit better but the FX is still 2%?

[Randy Coleman:]

Yes. And part of that FX, we assumed a little bit of that going into the year, so it’s not all a complete surprise by any means.

[Jason Gere:]

Okay. That’s great. And then just of that 1% to 2% organic, how – pricing last year, I think was 1%. I was just wondering how pricing kind of plays into the outlook you have in there, what you have in place for this year? And then I promise to leave.

[Randy Coleman:]

Sure. So we have a slight impact that’s a benefit in Q1 just from pricing that’s rolled over from last year that really goes into effect in January for the most part. Our net pricing for 2015 though going forward and on a full year basis is essentially flat. So we did take pricing in certain categories around freight costs that we incurred last year and certain categories where we did see some cost run up. But we’ve also taken some very targeted and specific price decreases in other categories where we have a lot of analysis that says we’ll be much more competitive and we’ll payback to do that or in the case of our Snap Spreader product, we’ve tested this over years. Initially, we tested as high as $70 price point and we found that 29.99 on almost every day low price basis is a sweet spot. We make all the money on the Snap Packs, similar to the razorblade model. So, we’ve changed the way we’re pricing that product for 2015 and on a pricing basis --

[James Hagedorn:]

But not quite impacting pricing.

[Randy Coleman:]

But you hedge it all out and I think we’re taking increases where we should and we’re taking decreases just because we’ve good analysis that says we should be doing that.

[James Hagedorn:]

And taking some additional cost out.

[Jason Gere:]

Okay, great. Thanks a lot for the questions.

[James Hagedorn:]

Thank you.

[Operator:]

We’ll go to our next question from Olivia Tong with Bank of America Merrill Lynch.

[Olivia Tong:]

Great. Thanks. Good morning. First just quickly, can you give us the actual dollar impact of the acquisitions to sales? And then my real question is just around the mark-to-market hedges. Do you have any sense on what – whether your competitors had a similar impact? And also in terms of the retailers, are they coming to you saying with oil down as much as it is, with price at the pump down, where is sort of our benefit coming through? Thanks.

[James Hagedorn:]

Again, this is complicated. Listen, I would say – so the real question, the other one is not a real question --

[Olivia Tong:]

A bigger picture question.

[James Hagedorn:]

On hedges, no, we haven’t had retailers shake us down, probably will after this question, thank you. We’re pretty shaken down – Mike and I are shaking down our own people finding out there’s more benefit that we can get. But look, when Randy talks in his script about real time, trying to figure out where we go with fuel hedging out into '16 and maybe even beyond that, I am a believer in it. We hedge our interest rates. I think we’ve been taking sort of charges on those interest rate – I think we call it fixing our interest. But it’s effectively an interest rate hedge that Evans and I sort of were just buying out about as far as we can in sort of the twos and thinking like even if we lose a little money in those hedges, at the end of the day it’s like terrific insurance. And I think pretty much that’s how we’ve looked [indiscernible] folks like you is it’s important for us to understand what our actual cost is going to be. This is why we do hedge. The mark-to-markets go away at the end of the year since we’re 20% uncovered, there’s going to be some benefit from the 20% we’re not hedged on that’s better than budget. So we won’t be worst than budget, we’ll be better than budget on fuel but at least we know what our costs are. And when things are going the other way, we feel a lot better about it. Personally, I like our interest rate hedges and I think we should be buying out farther. If we could know we could be buying $50 oil at a diesel price, which has not moved quite as well as oil has, I think we should do it. But that’s a discussion that Randy and I continue to have and I think make progress on. But the answer is, no, we haven’t as of yet gotten any sort of tree shaking where retailers have tried to sort of say since cost are down. We wouldn’t have much to give them at this point.

[Randy Coleman:]

Olivia, when you look at the favorable variances that we expect this year from where we’re not hedged, it’s a few pennies that again in my mind I’m more or less not that against our FX issues, which are a few pennies and more or less call it neutral at that point.

[Michael Lukemire:]

We really didn’t take pricing this year, it was only targeted where we really had a problem. So I think that the --

[James Hagedorn:]

So what was the first part of the question?

[Randy Coleman:]

First question was what’s the impact of M&A in sales for the quarter and the year. So for the quarter, Olivia, it’s about $24 million and for the year we’re expecting $80 million to $100 million of top line benefit year-over-year, a lot of that driven by the Fafard deal in Canada, we did a Solus deal in the UK, we did an Action Pest deal in LawnService. Those are the big hitters for the most part. AeroGarden, also we consolidated initially in the fourth quarter last year and add to that roughly $20 million of sales for us for the year.

[James Hagedorn:]

But I think you’ll continue to see M&A focused on growing media opportunities, hydroponic opportunities and some supply chain acquisitions of manufacturing sites that I think the group has – which we’re not reporting at on this quarter, but actually have occurred in the second quarter. So, we continue to make I think really smart sort of opportunistic acquisitions plus some strategic stuff that you’ll hear about later in the year we hope.

[Olivia Tong:]

Got it. Thanks, guys. I appreciate it.

[Operator:]

We’ll go to our next question from Joe Altobello with Raymond James.

[Joe Altobello:]

Hi, guys. Good morning. First, in terms of the mass channel, how does that look in terms of the merchandizing positioning this year versus where they were last year and the year before?

[Michael Lukemire:]

The merchandizing of our products is going to be – we actually gained in a lot of placements in almost every retailer. And so I think the placement of our products is going to be even greater than before.

[James Hagedorn:]

Mike is really – he’s one of these guys that’s just happy dude, but he’s acting very happy about the mass channel and I think one of the big retailers there asked him to join their counsel or whatever they call it, and I think he feels pretty positive about that. I put that into the he’s a happy dude category and it will be nice to actually see if they can achieve. But Mike you’re view on sort of mass in particular?

[Michael Lukemire:]

I think they are engaged and they want to participate and I think with the consumer confidence, I think early indications is they’re up.

[Joe Altobello:]

Okay.

[James Hagedorn:]

I think they’re actually performing pretty well so far in the calendar year, which is it’s early but it’s positive.

[Joe Altobello:]

Okay, that’s good to hear.

[James Hagedorn:]

I think this is always one of those issues with mass is, do they get set in time.

[Michael Lukemire:]

They’ve actually accelerated being in the stores and putting inventory in the stores more so than ever. Our fourth quarter was good with them and I think the first quarter looks promising as well.

[Joe Altobello:]

Okay, great. And then secondly in terms of the new pricing at Ortho, have you seen any uplift in volumes from that? I know it’s probably early but --

[Michael Lukemire:]

Yes, we’ve seen in markets that it’s hit double-digit increases.

[Joe Altobello:]

Okay, great. Thanks, guys.

[Operator:]

We’ll go to our next question from Jeff Zekauskas with JPMorgan.

[Jeff Zekauskas:]

Hi. Good morning.

[James Hagedorn:]

Hi.

[Jeff Zekauskas:]

In rough terms, do you buy 20 million gallons of fuel oil and diesel fuel annually or about maybe $60 million worth, something like that last year?

[Randy Coleman:]

Yes, that’s a fair number. It’s in the right range with the $60 million number.

[Jeff Zekauskas:]

Right. And so you’ve hedged out – I guess that means you’ve bought forward, is that right?

[Randy Coleman:]

Yes, for 80% of 2015.

[Jeff Zekauskas:]

Okay. And did you complete your buy forward before the end of 2014 or when did you buy the bulk of your forward buy?

[Randy Coleman:]

Typically within a year when we look at Q1 general, we’re 40% to 60% and we’ve been a little bit higher like 65% in certain years and we were toward the high end of that range as we closed out '14 looking at '15 as fuel prices were coming down, just not down to $50 a barrel --

[James Hagedorn:]

What I would say is probably in the second half of last year.

[Jeff Zekauskas:]

Right, okay. And your urea cost should be down too, right?

[Randy Coleman:]

They are down marginally but very much in line with our expectations internally, so no surprises there.

[James Hagedorn:]

This is an area where I’ve actually asked the guys to go back and take a look at the primary ingredients in urea, ammonia and natural gas and see if urea prices are moving with ammonia and natural gas. You might be able to answer the question, but I know that people are working on here and trying to understand the correlation within the entire universe of commodities with natural gas, ammonia and just other ag chems to kind of in general, but I think that there’s more demand sort of features within sort of pricing on urea that we’re seeing right now. That was kind of the quick answer that I got back. I don’t know if you buy that. I don’t want to turn the question around, but yes it’s slightly positive I would say and within where we’ve forecast.

[Jeff Zekauskas:]

And just lastly, do you expect your average product pricing this year to be up or down or flat?

[James Hagedorn:]

Our pricing for this year or for next --

[Jeff Zekauskas:]

For everything for 2015.

[James Hagedorn:]

Our cost to manufacturer or you’re saying our selling price to --

[Jeff Zekauskas:]

Your selling prices at retail.

[James Hagedorn:]

I would say for this year pretty much flat except for some targeted changes that reflect freight or raw material increases that we were just not willing to cover or some reductions on some areas where, for competitive reasons, we thought we needed to be more competitive.

[Jeff Zekauskas:]

Okay, great. Thank you so much.

[James Hagedorn:]

But I think net-net, just about flat. You bet. Thank you.

[Operator:]

We’ll go to our next question from Bill Chappell with SunTrust.

[William Chappell:]

Good morning. Thanks.

[James Hagedorn:]

Hi, Bill.

[William Chappell:]

How are you? A little bit on the pest service side, I mean just going back five, six months ago, I think the thought was make an acquisition, kind of test out the concept. And then if it did work, by now maybe move full steam ahead. And I know you announced the second acquisition recently. So maybe can you help us understand how that’s playing out, if it is living up to expectations? And maybe over the next 12 to 18 months, what we should be seeing out of that?

[James Hagedorn:]

So I’ll start by saying it’s a good and timely question. The answer is I think we kind of putting English on the ball that was what you said. And I would say what’s a little different is Randy is becoming more I think confident in the job and figuring out how he adds value to sort of owning the checkbook for the company. And he and I are absolutely in agreement on kind of what we’re doing and it is slightly different I think than the body English we’ve out on. And it goes something like this, which is I think we do like pest, okay. I think we like what we’ve been able to do organically with pest and we’re optimistic about the Action Pest deal that we did. The only thing that I would say is these pest deals tend to be pretty expensive. And what we’re looking for I think within the business is to understand sort of the cost to build a deep presence in pest versus continuing to become a bigger player in, call it on lawn. And not that they’re mutual exclusive because I don’t think they are, but I think it’s a focus issue and given I think our view that we want to continue to be shareholder friendly and that I think there is opportunities in a lot of areas to sort of solidify our business and make acquisitions, both kind of easy bolt-on deals that same buyers, same sales force, branded products with hopefully better margins than what we average. So we definitely have the ability to spend money there and I think for us to kind of have a conversation like we’re having where we’re saying, yes, I figured about 100 million in the year, I don’t know – I think that’s about what you said. That’s different for us. So there’s more competition for dollars that we still believe we ought to have a bias towards shareholder friendly. And so within our service business, we’re trying to look and say, wow, those are expensive deals. I mean they’re pretty competitive, they’re strategic, we like them but I think there’s a multiple at which you say this company has never been able to make money. And my view of what a deal when you overpay enough, even the innocent get fired. And so I think they’re pretty pricy deals, I think this was major strategically important, the Action Pest one, because it was pretty material at least for that company acquisition and it gives them a chance to do kind of what you said and what we’ve said, which is let’s do it and see how it goes. I think Randy and I are also a little bit more standoffish in saying, yes, but where do we go with lawn and where do we go with pest and how do we balance that with the fact that kind of the core business and hydroponics and organics all want money and we also see opportunities within sort of our growing media side on both manufacturing and supply side to spend money there. So we’re just trying to be careful and I think it is probably going to cause us to slow down a little bit on the pest side.

[William Chappell:]

Okay. So it’s not the opportunity isn’t there or it’s just you can maybe get a better ROI on your cash in other areas right now based on the purchase prices. Is that fair?

[James Hagedorn:]

I think that’s fair.

[William Chappell:]

Okay. And then second just on the management restructuring or streamlining, I think at least some of the announcements were done since you last gave guidance. So was this already baked into your EPS guidance for this year in terms of streamlining the management team?

[James Hagedorn:]

No. We would call this sort of continued – I don’t know if we call that project growth or project max. I think that if you looked at where we have been on restructuring that we initially announced to you guys a couple of years ago, I think we’re actually pretty well under spent on that. So I think that we’re going to end up coming in probably at about what we had originally said to you guys. And I would say if you want more detail on that, because I just don’t remember what the original guidance we gave you was, but I know we were well under spent on it. I think we’re going to come in more close to what we had said, but I think we would probably put that in non-GAAP and call it an adjustment.

[William Chappell:]

Got it. Okay, great. We’ll see you in a couple of weeks.

[James Hagedorn:]

Yes.

[Operator:]

We’ll go to our next question from Carla Casella with JPMorgan.

[Carla Casella:]

Hi. My question was related to [indiscernible] you spent some more on working capital earlier in the season. Can you give us how much the use of working capital or were there any big numbers from the CapEx to acquisition this quarter or call-outs?

[James Hagedorn:]

Yes. First of all, your phone line, if you’re on a cell phone, is sketchy. I think we got about three-quarters of the words, so Randy you want to take that.

[Randy Coleman:]

Right. So Carla, I’m going to try and interpret what I heard about every other word, but I think you’re asking about working capital within the quarter and related to our inventory build. So our inventory is up almost 80 million this quarter versus the year ago. About half of that is from the deals that we’ve recently done and about half was a conscious decision to build inventory in our growing media and mulch businesses ahead of the spring so that we can avoid some of the distribution, excess charges that we had to incur last year. So we think we’re well positioned to do that. We have a much tighter, much better plan. We have 31, 32 plants across the country and I’m confident that the teams’ on top of things much more than a year ago.

[James Hagedorn:]

I just want to kind of go back to this point that Randy just made in regard to if we were on our early season load inventory, call it, too skinny, I think what we’ve seen in the last like at least two years where we’ve had kind of just poor weather years but then we have these insane, like just last year Memorial Day was insane. And we end up running our inventory down low, so we end up shipping all over the place to try to keep retailers in stock, it just is one of the things that we have to do. And the incremental cost of that sort of on normal freight, it’s like a dime. And so part of what we’re trying to do is say, we build a little more, can we avoid these sort of exceptional expenses as we try to keep retailers in stock and we have these very violent jumps in demand based on good weather, sort of Black Friday events or advertising as hitting, all happening at kind of one time. So this just trying to be just a little bit smarter than we have been and that is going to – so part of the M&A you’re seeing is also to sort of expand our growing media distribution footprint, which doesn’t necessarily mean manufacturing but it means storage sites like in New York where we can – we have a major percent of our sales occur and we just don’t have that many footprints where we can keep stuff. So, part of this is all a plan to sort of say, can we avoid like out-of-budget expenses that are worth like $10 million.

[Randy Coleman:]

I think we lost her.

[James Hagedorn:]

Okay. Well, everybody else got the answer even if Carla didn’t get it.

[Operator:]

We’ll go to our next question from Connie Maneaty with BMO Capital.

[Connie Maneaty:]

Good morning. Just two quick ones. On the hedging, as the gross margin normalizes, I think you said towards the end of the third quarter, what does that imply for it in the second and third quarter? Is the sales base big enough, it probably is, to offset the impact of the mark-to-markets?

[Randy Coleman:]

Yes, just because our first quarter is so small, the actual savings we’re realizing on freight – we’re realizing it, but very small shipments. So as it ramps up especially in March and into April and May, but the time we get to the end of June, it should all work itself out regardless of whether using oil as a proxy, whether it’s at $100 or $50, it will work itself out as we net the savings against the hedges.

[Connie Maneaty:]

Okay. And then I haven’t had time to calculate it, but was organic sales growth up or down in Q1?

[Randy Coleman:]

Organic sales growth was up about 4%, excluding pricing and excluding FX and that was largely in Europe and Canada.

[Connie Maneaty:]

And excluding the acquisition?

[Randy Coleman:]

And excluding acquisitions, yes.

[Connie Maneaty:]

So organic sales growth was 4%.

[Randy Coleman:]

Yes.

[Connie Maneaty:]

Okay, great. Thank you.

[Randy Coleman:]

Thank you.

[Operator:]

We’ll go to our next question from Eric Bossard with Cleveland Research.

[Eric Bossard:]

Good morning. A question for you. The $40 million of SG&A savings through all the work that you’re doing, interested in your thoughts on the payback from where you’re spending that? I can see where you’re allocating at the two different buckets, but curious on the thoughts on what payback you get from that and why not feed some of that back to margin?

[James Hagedorn:]

Well, somewhat complicated answer probably more than you’d like, but what I would say is remember that we are not promising you kind of what we think we’re doing. So we’re trying to kind of under promise and over deliver and I think we feel pretty good about that. We’re also trying not to over promise our Board, so we’re trying not to be in the wrong side of incentives there. So I don’t think – and what that all means is we feel pretty good about the business right now. And I don’t think we feel like we need to, I personally feel and this is part of where kind of we got to the reason we felt like we need to make some changes in the company about other consumer marketing companies how they support their brands. Here’s my view. If we believe, kind of call it the 0% to 2% we’ve talked about in a flat world, that doesn’t mean things couldn’t get better but a conservative kind of flat world for consumer products, we’re talking like 0% to 2%. I think we think if we do things just a little bit better, meaning just be a little less dumb that we can pick up another 100 to 200 basis points of growth and I think that the payout for that far exceeds the sort of short-term opportunity to say, oh, we’ll just pocket that, okay. That’s kind of one. And I think if we look at our stewardship of the brands, I think we’d say we’re under investing. We tend to invest in the big new products and all that shit and put the – we do that properly, but I think that if you look at the sort of day-to-day, I think you’d look at – there’s lots of parts of the businesses that are not being supported properly and I think that generally if you look at sort of just to say academic issue, when we don’t support our brands, we tend to not be able to get pricing. We see more competitive people attacking us and I think we view it as not virtuous. It’s destructive. So I think that we’re trying to be good stewards of our brands and so I’d put it that and that I don’t think we need the money to sort of keep the street and the shareholders sort of saying this is a good company. And so I think we can be a little more long term, I guess that’s what I’m saying. The other part of that is sort of the other half of the business, which is some of the growth areas that we have to spend money in. I mean this goes back to saying there are opportunities out there for us to actually grow our business in sort of indoor, urban, more into sort of crafty naturals, hydroponics. That requires us to invest by building out a management team ahead of the opportunity in order to say, okay, now we’ll go buy some stuff there or grow it organically which we’re doing both by the way. And so some of this money we know we have to spend and we’re just basically saying instead of making it a negative because of the P&L, we’ll just cut expenses and redeploy that money into areas we know we want to spend money to grow. And so I don’t know, Eric, if that answered the question but I feel pretty strongly about it and I think it’s a reasonable answer. I don’t know if you do.

[Eric Bossard:]

Yes, I guess. The only other question is as you look at where the growth opportunities are and you talk about indoor and urban and naturals and that, is there more of an opportunity – obviously, you’ve saw within management to reallocate where you’re spending money. Is there more of an opportunity within the portfolio and with advertising in the organization to reduce the investments in the areas where there is not as much growth and redeploy? In other words, if we wake up a year from now, there will be another 40 million you found that you could shake out of the organization and redeploy?

[James Hagedorn:]

Listen, I think that if you were to sit around with us and gave us truth serum, I think we’d say that we believe there is continued opportunities to streamline this business and reinvest or send it to the bottom line. I think it’s a really good question that you’re asking, which is what if you look at parts of – and I would say read Europe. Do we believe this is an area where we’d say, oh, we’re just going to like send them a bunch of money because they say they can get growth. I think what you’re seeing over there is reasonable weather and pretty significant cuts to the expense structure and that’s a lot of what you’re seeing. It’s not that they’re being dumb. I don’t think that at all, but I think that Europe is a hard place to sort of say, I want to invest money. I wouldn’t say we’re milking it, but that is part of how we look at it. If we were to look at significant parts of the core of the North American business to say no matter what we do, we can’t get growth, I think we would harvest, okay. And I don’t think that’s the wrong thing to say, but I don’t think we’re there yet. So I would say if you could give us like 12 months to sort of be a little more coherent on it but also to try some stuff out, I think we’ll be in a much better position to answer the question.

[Randy Coleman:]

Eric, this is Randy again. I’d add unlike 2012 where we essentially made a bet that we would grow the category and would payback and we did grow the category and we took share, but it didn’t pay back. We went through a very collaborative effort looking across all the areas where we felt like the return wasn’t commensurate with the spending. So it was areas like world headquarter overheads, it was somewhat in international, somewhat in supply chain, looking at our sale force, areas that we could nip and tuck a little bit. In other areas of marketing and we were able to redeploy all that money and I talked earlier about media whether it was in Tomcat, which is a business we feel really good about; Naturals, which we feel really strongly about what we’re going to be able to do there this year; our LawnService business, the Hawthorne Group which is more or less an incubator for start-up businesses and something that we’ve never done extremely well in the past. I think the way that’s organized is going to play out really well. So we’re trying to think long term, but I think we can still show really significant growth this year and somewhat have our cake and eat it too. And then once we get beyond 2015, like Jim said, we’ll keep thinking about what to do and we’re starting right now thinking about 2016.

[Eric Bossard:]

That’s helpful. Thank you.

[Operator:]

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

[Jon Andersen:]

Good morning. I just have two quick ones. First, Jim, did I hear you say that you’re close to closing additional acquisitions that could add a couple of percentage points to the top line? If so, what areas that may be that effort may be focused on? And then second, is there any kind of early read you’ve gotten on some of the major new products, like Bonus S, the Naturals, and I guess the co-branded cleaning product, and some of the early markets that would kind of indicate those are going to be good innovations for '15? Thanks.

[James Hagedorn:]

I’m going to go because my memory is so bad, I’m going to sort of do the part. On the new products, remember we spent behind and the new Bonus S product that was in two markets in Florida last year, which is now all – the whole Southeast will have that, the new Bonus S product. And we saw really good growth rates, I mean double-digit, on what used to be I think was a declining market in those test markets. So, we’re seeing very good performance, I’m going to call it calendar year-to-date, which I think is what matters with that new Bonus S product and in Florida we’re seeing it as well. So, I think last year where we test marketed good results, we saw good results in the overall market as well because remember we spent more on the new product launch in that, it was Fort Myers and Jacksonville where we pushed in last year. But even the old Bonus S products sold better in areas where they were getting overlapped from the increased media. And so I think we feel pretty good about that. The listing support on the Nature’s Care line has been really good. So, I’m not sure we have enough to be able to say whether it’s doing anything. So if the listing support is a positive, because remember there is only a certain amount of concrete to put pallets, so the listing support is important and it was very good. On to acquisitions, I would say sort of standby. Would I say it’s going to sort of double what Randy has already talked about as far as acquisitions that have already been bedded down or that have occurred in Q1 that you’ll start to see in the Q that I just approved this morning that I don’t know when that gets published. When does the Q get filed?

[Randy Coleman:]

Thursday.

[James Hagedorn:]

And so some of the stuff that’s occurred after this reporting period, at least after January 1 are in there without sort of names. But again very much growing media oriented I think is what you’re going to see. It goes back to sort of manufacturing, some sales and footprint. In the areas of growth, I think you will see I hope some important, not huge but important acquisitions that are probably for the remainder of the year, less than 1% I think by the time we close. So I don’t think it’s going to add a huge amount to the year and it’s just not huge to begin with, but I think it’s an effort that the entire corporation whether it’s the sort of corporate side or the operating side of the business are very much aligned on these areas of growth. And just to repeat that urban, indoor, hydroponic, crafty naturals are very much a focus area. And so I wouldn’t be surprised to see something happen in that space.

[Jon Andersen:]

Thanks. I’ll see you in a couple of weeks.

[Operator:]

It appears there are no further questions. At this time, I would like to turn the conference back to Jim King for any additional or closing remarks.

[Jim King:]

All right. Thanks, Eli. Just a reminder, February 18 in Boca Raton at the Boca Raton Marriott starting at 8 am. If you’re still interested in joining us for that day and you haven’t RSVP yet, please call my office, [phone] and we hope to see you there. Have a great day.

[Operator:]

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