The Scotts Miracle-Gro Company
Q3 2011 Earnings Call Transcript

Published: 8 Aug 2011

[Operator:]

At this time, I would like to welcome everyone to the third quarter 2011 earnings conference call. (Operator Instructions) Mr. King, you may begin your conference.

[Jim King:]

Good morning, everyone, and welcome to The Scotts Miracle-Gro third quarter conference call. With me today are Jim Hagedorn, our Chairman and CEO; as well as Dave Evans, our Chief Financial Officer. Jim will start with a review of the current state of the business and also provide some early thoughts about fiscal 2012. Dave will walk through the financials and update our full year outlook. After their prepared remarks, Jim and Dave, and other members of the management team will take your questions. In the interest of time, we ask that you have one question and one follow-up. If you have unanswered questions afterward, I'm glad to spend one-on-one time with you. With that I want to move on to today's call and remind everyone that our comments today will contain forward-looking statements. As such, actual results may differ materially due to that risk Scotts Miracle-Gro encourages investors to review the risk factors outlines in our form 10-K, which is filed with the Securities and Exchange Commission or our most recent 10-Q. As a reminder, the call is being recorded and an archived version of the call will be available on our website, if we make any comments related to non-GAAP financial measures not covered in this morning's press release, we will provide those items on the website as well. With that, let me turn the call over to Jim Hagedorn to discuss our performance.

[Jim Hagedorn:]

Thanks, Jim. Good morning, everybody. I know we have a lot of ground to cover this morning. Our third quarter performance, our full year outlook, and our early thoughts about 2012. But before I address any of those points, I want to make some opening comments. I am not going to sure quote the reality of the season. It's been disappointing to say the least. Some seasons make good weather and some seasons bring challenging weather, but in my entire career, I'm not sure I remember season quite like this. Setting weather aside, competitive issues also impacted the business this year, especially in the mass merchant channel. And frankly, we've also made our own share of mistakes. I'll elaborate on all of these shortly. But whatever the reason, the results were not what we had planned. We revived our full-year guidance and now expect adjusted earnings of $2.95 to $3.05 a share. By no means, am I suggesting you dismiss our results this year, however, I'm also not sure there's much benefit to overanalyzing them. I'll give you my straightforward assessment in a few minutes and then Dave will provide some additional detail. But let me say this first, unlike other shareholders, I have a unique benefit of looking at the business from the inside-out and from the top-down. I can assure you that I remain confident in the fundamental strength of the category, our brands, our strategy and our team. Though we have some cost headwinds to deal with next year, we have tailwinds as well. Weather clearly should be helpful, as should new product introductions, the continued benefits of regionalization, significant SG&A initiatives and improved customer outreach strategies. I also want to stress that our long-term financial goals are unchanged. While we have to push our targets out by at least a year, we are no less committed to those goals. And neither is anyone else around here, including the Board. Their decision to increasing our dividend by 20%, speaks to our continued confidence in the business and our commitment to use our flexibility to fund future growth and return cash to shareholders. So let me switch gears and spend a few minutes talking about the 2011 season from two perspectives. First, the issues that drove our results; and second, and frankly more importantly, the key learning's we took from the season. Let's start with what drove our results. The first and most obvious thing is weather, which I'd say drove at least half of our mess. It doesn't really matter what region you're talking about. The Northern half of the U.S. went from soggy and cold to record heat. And the season never really materialized there. The Southern half of the U.S. started strong. The season got off to a good start, both in Texas and in Florida, but by mid-spring, both markets were seeing severe weather. In fact Texas is in the midst of one of the worse droughts ever. And Pacific Northwest was just lousy all year. But there's good news within the numbers. Although consumer purchases for the year are down 3%, we saw a solid growth throughout May in the first half of June. And remember the consumer purchases were up 13% through mid-March, when the weather cooperated, consumers were engaged in the category. This is especially true in the home center channel, where about 50% of consumer purchases are made each season. Overall, the channel was about flat from last year, not a bad result considering the weather. The problem was that we just couldn't strength together enough consecutive weeks of positive POS to build any momentum. The second issue is that we made some big debts midway through the season that did not pay off. After a slow start, we worked hard in May and early June to jumpstart the season. We put more promotional dollars in place and worked hard with our retail partners. But as I said at the outset, I don't remember a season like this. And the third issue that impacted the season was the performance of our business in the mass merchant channel. All of our research indicates that consumers who shop in this channel want to participate in the category. What was also clear is that a higher percentage of these consumers are economically stressed. As a result, some retailers in this channel put more focus on opening in mid-tier price points than our national brands. That cost us a shelf space in both us and those retailers market share. I'm going to come back to this issue in a few minutes, because we have some major learnings about our presence in this channel and some steps needed to improve. So those were the three root causes of the shortfall this year

[Dave Evans:]

Thanks, Jim, and good morning everyone. As I walk through our results this morning, I'll focus primarily on third quarter adjusted results for continuing operations unless otherwise stated. And as I walk through the numbers, I'll place extra focus on three areas. First, the declining gross margin rate is turning out to be greater than we expected. I'll explain why and give you an update on our early thoughts for 2012. Second, we closed on our new credit facility in the third quarter. I'll provide color on what it means to our interest expense, capital structure and priorities for uses of cash going forward. Third, lower than expected earnings will adversely impact operating cash flow for 2011. While that does not alter our long-term expectations or our commitment to investing in the business and returning cash to shareholders, I’ll provide an update on our expectations for the year. Before I begin my comments on the quarter, I would like to reiterate what Jim said relative to our dividend. The increase approved by our Board is consistent with the long-term capital structure strategy we've described before. It reflects our continued confidence in the structural competitive advantages of our business and continued attractiveness of the overall category. With that brief introduction, I’ll now begin with a quick look at our topline performance. Consumer purchases of our products at our largest retail partners in the U.S. have clearly been softer than originally expected, down 6% for the quarter and 3% on a year-to-date basis. As a result, replenishment has been soft as well, leading to a 10% decline in company-wide net sales for Q3. Global consumer sales declined 12% or 14% when excluding the impact of foreign exchange rate. Scotts Lawn Service increased by 1% and the Corporate and Other segment reported a third quarter sales increase of $19 million. As a reminder, sales reported in the Corporate and Other segment relate to two activities

[Operator:]

(Operator Instructions) Our first question comes from the line of Bill Chappell with Suntrust.

[Bill Chappell:]

First, just looking into what you're seeing at the math retail side and kind of what changes you're expecting going into the next year, have you permanently impaired some of that channel and focused more of your view efforts at more of the Home Depot, Lowe's, or how should we look at that?

[Jim Hagedorn:]

I'll talk for a bit and hand it over to Barry and he can pick it up from there. The answer is no. Mass is an important channel for us and we need to succeed there. The issues in the channel, which I think probably you could say belonged to both us and the retailers, are something that we're in having good dialogue on and making progress on the merchandizing strategy for the channel. But it is something that we can't sort of walk away from and we don't want to and the retailers don't want us to. So I think we're making progress on it, but we're disappointed in it for sure, and I don't think that the channel is happy with the numbers either.

[Barry Sanders:]

I would add two things. One, that channel would have a higher proportion of economically-distressed consumers. So we're evaluating our opening price point in our mid-tear products to give them some better offerings. The other is differentiated merchandizing strategy that tends to be non-destinations, so better convenience items, and a merchandizing strategy that makes sense for the channel. And then the third area is how to effectively promote in that channel given that it's a non-destination channel. Our relationship is good. We intend on winning and we're partnering with them, and we expect that to turn around going forward.

[Bill Chappell:]

Switching gears to kind of gross margin and the outlook for next year, Dave, I understand that you can recover the penny profit, but not the margin in terms of pricing. But I'm just trying to understand why gross margins overall would be pressured, because I would imagine some of this year had to do with the operating leverage and less volume going through which presumably would be recovered with a 6% type growth next year in revenue.

[Dave Evans:]

I agree that part of the sales mix issue we saw this year, we should see some recovery on, assuming normal weather. But I think that where we’re going to be more challenged next year is the commodity cost. Because of the inflation that we're currently expecting, clearly it's pretty volatile right now. That will overwhelm the benefit we'll get from the higher volume that will give us more leverage and the improved mix. It’s a matter of the scale over the numbers that will drive that preclusion.

[Bill Chappell:]

I know you're locking urea starting pretty soon. But do you looking into that kind of oil, diesel, some of the other things that are pulling back now that maybe lock in a little bit longer than you normally would?

[Dave Evans:]

We’re fairly fluid on our strategy for locking in. We’ve been staying on the sidelines until just recently. And I would tell you just in recent days we've now been getting into diesel for next spring. And within the last couple of weeks, we're starting to get into the market for urea. So we have been standing down, and I think that’s proven to be a good strategy based on what I see today. But we’re now engaging try to get those locked in, out of pace, more consistent with where we've historically been.

[Bill Chappell:]

I know you’re not giving specific EPS guidance for next year, but I thought somewhere variable comp kind of related to like 10% earnings growth. So if we’re assuming that variable comp is coming back next year, should that be at least a floor?

[Jim Hagedorn:]

Barry is nodding his head.

[Bill Chappell:]

I hope he is nodding a yes.

[Jim Hagedorn:]

Answer is it doesn’t assume things to stay where they are, put it that way.

[Operator:]

Our next question comes from the line of Olivia Tong with Bank of America.

[Olivia Tong:]

I was wondering if you could give more details on what is going to that 6%-plus sales number. How much would you expect for the new products versus normalized weather yearend and maybe some other things that go into that number?

[Dave Evans:]

At this point, we still feel good about our longer-term guidance of total growth over the course of business cycle 46% annually. Given the pressure we saw from weather this year, we feel confident that we're going to be at the high-end or above the high-end of that range next year. At this stage tough, it'll be in August. We're not prepared to provide a more detailed bridge of a clear range of growth for next year, other than to say we think that we're going to be at the high-end or slightly above the high-end of that range next year.

[Olivia Tong:]

So is it fair to think then that any actions you may take in the mass channel will be more than offset by the easier comp relative to a normalized year?

[Jim Hagedorn:]

Could you say it again?

[Olivia Tong:]

Is it fair to assume that anything that you do next year to sort of built-up the mass channel again, potentially hurting the mix on that side, that's more than the impact of poor weather versus say a normalized weather next year that's enough of an offset?

[Jim Hagedorn:]

I think there's assumption in your question that what we would do it'd be a lower margin to build that up, and I think that's a wrong assumption. And so as we offer them merchandizing and merchandizing strategies, we need to do that effectively at what we would consider good margins for our business. So I don’t think it would be an offset.

[Olivia Tong:]

And then, how do you think about spending next year, again sort of thinking about the mass channel primarily. Do promo levels have to increase next year? And maybe you could give a little bit more color on some of the things that you are thinking about doing for next year realizing that plans are not necessarily in effect yet?

[Jim Hagedorn:]

Well, we are going to be taking cost out of, I think what we called the bureaucracy of the business, but call it Marysville to fund more innovation work and completion of regionalization, all of that's mostly done, and more marketing/advertising. That we are going to do. What was the other part of the question? This is one of the areas that I would say, we're not totally sure of what we're seeing out there. For sure, we believe in the lawn and garden business, there was a lot of promotional activity in fiscal year '11 and that consumers we are taking advantage of that. I think, one of the questions we have is, how easy is to win. So I think what we are looking and saying, the level of promotional activity within the category needs to decline. That money is better spent on I think what we would think is more traditional brand building activities, as opposed to discounting. And I think, generally the retailers agree with that. So I don't see a significant increase in the amount of promotional activity. I think, particularly in mass it has to be done better, more efficiently. And it has to be more impactful on driving volume, which in fiscal year '11, it was not. So I think there's a lot of work going into our Scotts and within our BDTs and our retail partners. And making that promotional spent more production than it has been.

[Dave Evans:]

Olivia, I would say, we'll be less promotional, and like Jim said, we'll put more money into building our brands. But I think as far as our partnership with the retailers, we're going to work hard growing the category rather than trading footsteps, which was I think an issue this year.

[Operator:]

And our next question comes from the line of Joe Altobello with Oppenheimer.

[Joe Altobello:]

Just a couple of quick questions. First for Dave, in terms of the commodity cost you'd locked in for next year, what was percent of your raw materials need is locked in now? And what do that number look like at this time last year?

[Dave Evans:]

Joe, the percent we have locked in right now is south of 10%. The number at this time last year was probably covering around 10%. So a low-single digit this year, we are just starting to begin buying in urea. And we literally just last week started buying into diesel. Last year at this time we were further ahead, because the market looked very different last year. We are much further ahead on urea than we are today.

[Joe Altobello:]

But it's not that much of a difference, it sounds like, versus last year?

[Dave Evans:]

Not that big. I mean historically, urea is the biggest item that we're buying ahead at this time in the year. We generally start with diesel in October. So we're actually starting earlier on diesel, but later on urea.

[Joe Altobello:]

And then in terms of the commodity guidance for next year, it sounds like you're still implying about $60 million, $70 million, $80 million of headwinds next year. Is it fair to assume about half of that is going to be offset by pricing?

[Dave Evans:]

This is $70 million, $80 million based on what we see today. I think it's a combination of both direct and indirect pricing, and revisitation of some of our trade programs are going to cover more than half of that cost increase. And then the balance of that cost increase will be coming from the cost productivity initiatives. I think we've got a long track record delivering cost increases in our supply chain. Those are being further accelerated this year, as we're also exploring some of the other things that we're exploring in our broader SG&A cost structure.

[Joe Altobello:]

So more than half coming from pricing, it sounds like?

[Jim Hagedorn:]

That was a nodding of yes.

[Joe Altobello:]

And just one last one, if I could. In terms of restructuring, could you give us a little more color on what you're doing there and how quickly you might see the $25 million of savings?

[Dave Evans:]

We're currently underway with that. We will take actions this quarter. And we would expect to get that value for next year.

[Operator:]

And our next question comes from the line of Jeff Zekauskas with JPMorgan.

[Jeff Zekauskas:]

Urea is really up quite a lot. And you'd spoke about 6% sales growth next year, but to offset your urea costs you're going to have to raise price about 6%, at least if urea cost stay where they are? So why isn't your sales forecast much higher? Or are you banking on a decline in urea costs?

[Dave Evans:]

Jeff, right now we're looking at the basket of our commodities going up in the range of $70 million to $80 million. So on sales of $3 billion, we'd be looking at just north of 2% to 3% pricing. But what we've told you is just in the last question, we're expecting to cover between pricing and programs something just north of that. I think it gives you a sense that the pricing we're looking at, it is in anything close to, I think you might use the number, 6%. It's a low-single digit pricing.

[Jeff Zekauskas:]

Isn't urea up $200 upon year-over-year?

[Dave Evans:]

Right now, we're seeing urea in between $450 and $500. So last year, as I recall, it is a moving average. But we are probably in the lower 300s. So it's up about $100 to $150 a ton.

[Operator:]

Our next question comes from the line of Alice Longley with Buckingham Research.

[Alice Longley:]

This is fiscal '12. You think gross margins will probably be down and you're going to restore compensation, I guess despite whatever the result are? And your advertising ratio will go up?

[Jim Hagedorn:]

I think we told, Bill, that the answer was not. No matter what the results are. No, I think we are looking to get back on what we around here call the CFO plan. And so there is an expectation of significant progress of getting back to where we should have been. And so the answer is, no. The incentive is based on some relatively challenging goals.

[Alice Longley:]

Are operating margins going to be down next year, it sounds that way?

[Dave Evans:]

Operating margins rates down next year, is that you're asking?

[Alice Longley:]

Percentage of sales?

[Dave Evans:]

We're going to see some pressure in the gross margin rate. And you might see some leverage in the SG&A rate. So I'd say, it's unlikely to see growth next year. I think it's too early to say how much and what the range of any decline would be.

[Alice Longley:]

Probably down, but the SG&A ratio providing some positive leverage, partly offsetting the gross margin decline?

[Dave Evans:]

Yes

[Alice Longley:]

And then, I was unclear about what you were saying with shares outstanding. You said something about 56 million shares. What should we use for shares outstanding for next year, because the number seemed to be quite different from what I've been using?

[Jim Hagedorn:]

Well, what I said was for this year slightly more than 66 million. I didn't give a precise number for fully diluted shares count for next year. But what I said was we start the year with around 61 million shares outstanding. Those are basic shares outstanding, Alice.

[Alice Longley:]

And then you add about 1 million for delusion right?

[Jim Hagedorn:]

Well, there's common stock equivalence that can add it back. And then the other two parts are equity delusion. Then we have an offset for continued share repurchases next year.

[Alice Longley:]

But some of the share repurchases offset the options. Is it good number for next year to use this 62 million diluted shares outstanding or something lower, because the shares repurchased will more than offset the option in exercising maybe?

[Dave Evans:]

This would be very tentative, because we're still making assumptions about a share repurchase program for the next year. But tentatively, I think a number 61.5 million or 62.5 million for next year is probably a reasonable place to be at this early date.

[Alice Longley:]

And what will be interest expense when look like for next year, because I know that's going up. I've been using 63, is that still good?

[Dave Evans:]

So really we're planning on giving detailed one-by-one guidance on this call, going down the P&L. Alice, I'm not sure that anything that I've said in prior conversations and we give longer-term guidance would change at this point. In February, the comments we made are probably still pretty good targets. We saved more this year, because we deferred the facility later in the year, but it really doesn't impact next year. The growth year-over-year is probably going to be a little bit bigger than what we said in February. But the absolute number for next year, that's a good place to start going back to what we said in February.

[Alice Longley:]

And I guess my last question is, obviously, we're all concerned about weak demand right now. And your weak demand is coming along with following commodity prices. In making those comments about gross margin for next year probably being down, are you using old prices sort of where they are now? Or what is your assumption?

[Jim Hagedorn:]

I conditioned caveat in my comments. They've been moving fairly quickly, we're seeing diesel for next spring move, subsequently just in the last three to four business days. The numbers we're using that we've been talking through are now up to eight in terms of the last couple of business days. But I'd also say, it's a little premature and try to read longer-term trends into what's happened in the last two to three business days. But what I did say was that global economic conditions could result in easing of some of our commodities. And so that would be helpful. Although, we have not built that, the last two to three days into these.

[Alice Longley:]

Have you been assuming $90?

[Jim Hagedorn:]

Probably some north of that, Alice. I want to like throw in there this idea of easing demand and maybe you're talking on commodities. I think what's important for everybody to remember is how the business performed when the spring was behaving normally. And so I want to get back to consumer demand, in regard to lawn and garden products. And just say, we went into a call at April 1st, like almost up 15% POS. And I got to say, while gasoline prices went up and I think there was a fall in people's attitude about the world and the economy in general, a lot of what we had expected to see, we did see, when the weather was good. And so our hope is that we're not seeing any sort of fundamental change in consumer demand or attitude toward lawn and garden. In fact, our research shows that people continue to be in lawn and garden as a kind of refuge and something they can do in cocoon, and at home, et cetera. So it is really difficult to read what's happening right now, And because you look at it all based on the weather and we think the major component was weather and sort of a channel issue.

[Alice Longley:]

Well, is that true when POS is on 3% this year, why would you assume it's only up 6% next year? Why would you assume stronger comp on annual sales growth rate over two years?

[Jim Hagedorn:]

I'll tell you what, I remember riding around in a car with you somewhere out in like the Rockies. I think where you said never over-promise, do you remember that?

[Alice Longley:]

Yes.

[Jim Hagedorn:]

So I think this is a number where we feel pretty comfortable with. But listen, we came out of this feeling beat-up pretty hard out of this year, and not used to seeing this. We just got down with the Board meeting where we're trying to explain what happened. I think we feel pretty good about it that we understand it and I hope we do. But there's a lot going on the in the economy right now, and we're just not trying to sort of get ahead of ourselves.

[Alice Longley:]

And just one final thing on the urea. Could you give us an update on this idea that market perhaps is coming on stream, so urea prices will at some point follow that?

[Dave Evans:]

Alice, what we said in the past, we still believe to be the case, which is we see starting later in 2012, more global capacity coming on line, which are holding all other variables constant is going to be a positive in putting some downward pressure for fiscal '13. Because of the way we hedge and the turns we get. As you're aware we always see a delayed impact on that. So yes, it's more realistic to expect that benefit in '13.

[Operator:]

And our next question comes from the line of Jim Barrett with C.L. King & Associates.

[Jim Barrett:]

Jim or Dave could you even in broad strokes attempt to quantify the percentage contribution to the profit shortfall of the weather versus inefficient promotional spending versus your performance in mass merchandisers?

[Jim Hagedorn:]

This is major, major swag. But I think we said that we think that slightly more than half of the midst is related to the weather. Of the reaming called something less than 50%. Probably split about 50-50 between sort of things we worked on and didn't work out as well as we hoped. And my view on that just so we're clear is, the team was highly motivated to try to recapture sales. I think had we seen the weather correct we would have caught that back, it didn't. And so we put it down as a error, but we tried. So if that was about half of the half, I'd say the channel was probably the other half or call about 25% of the midst.

[Jim Barrett:]

And then the follow-up Jim, within mass merchandisers, could you rank order the promotional intensity by category in terms of where the opening price point competition is impacting your business?

[Barry Sanders:]

I would say the primary area would be the bug and weed area. And then a whole different scenario with what happed with grass seed this year.

[Operator:]

Our next question comes from the line of Connie Maneaty with BMO Capital Markets.

[Connie Maneaty:]

I also have questions about the SG&A and restructuring savings. They seem like a very big dollar amount, but there still isn't a whole lot of detail. So what are the projects in restructuring that you're doing? And secondly, you said you were saving $20 million to $25 million in SG&A, but that's separate from the restructuring. So what's happening there and what's the timeframe on those savings?

[Jim Hagedorn:]

I'll deal with the first part of the question, which is what is the detail on first part. We've been working really hard, I'd say with Denise, Barry and Dave Evans, who is responsible for the strategy group now on what we'd call spans and layers. And as we have simplified the business and gotten rid of things that we didn't think were sort of core to us, we've also taken a look at how many bosses do we need around here and what's the span of control. So how many layers do we have and what's the span that each sort of Director has. So the first component, which was approximately $25 million taken the charge in this quarter, that's a headcount, and that is certain. And it's really just related to the project of what we've called spans and layers here. So we think it's important to making the business more controllable and putting the senior folks, including myself, very closer to the action. And so we think the business can be made simpler. We think we can decisions faster. And that agility we think is good for all kinds of reasons and free of money to invest in things that we think are more productive. The other part of that is what we call indirect savings. And, Dave, if you want to take that one?

[Dave Evans:]

So the indirect savings are something that what Jim talked about earlier was that is not something we are expecting to realize entirely in '12. That's going to be more over a two to three-year period. We expect to realize amount up to the equivalent value to the restructuring side. An example of the type of activity we are looking at there is trying to streamline the number of vendors we use across a variety of spending areas where if we do analysis for spend we'll finally bifurcate the spending across a very large population of vendors. It's a simple process of trying to consolidate those leverage or scale and competitively bid out the product or service that we're purchasing. And so it's been a detailed process, going through all of our spending, quantifying and prioritizing these efforts, and then examining how long the current duration of commitments we have are today, which is what allows us to schedule out what we can expect to realize in '12, '13 and what may take even in the '14 to get in that area.

[Connie Maneaty:]

And on reducing the complexity, how many layers of management did you have and what's the headcount reduction number or a percentage that you're going to?

[Barry Sanders:]

As we looked at the layers, we were up to nine layers. We've taken steps to take that down one or two immediately, and we’re going to continue to reevaluate that going forward. What I would also say is it tends to be skewed to the higher level people in our organization. So I am not going to a specific headcount reduction, but it tends to be highly compensated people, as Jim has said, that as we've streamlined our business model and our portfolio, we don’t need as many Director level and above to manage our organization.

[Connie Maneaty:]

There is better price of $29. It seemed to me that when you put it in test, you were looking at price points of $39 to $79 or better. So at this lower price point, did you need to redesign it, are there fewer features, or did you take a lot on the spread and make it up on the bags, I guess, put into it?

[Barry Sanders:]

We did go out of those higher price points, Connie, and what we discovered was that the spreader itself, as we spoke with consumers, was falling more of a durable lifecycle replacement than a new product introduction and other products that we've had. And what we found is that when the consumer buys the product that it's getting phenomenal scores on the satisfaction with what the consumer is actually using the product. And we found that they tend to buy and put down more applications of product than on our traditional bag. What we've said is we need to accelerate getting the number of spreaders out there. It puts them in our franchise. It’s a proprietary interface and will allow us to accelerate the lifecycle of the product and ultimately ramp up the sales much faster than keeping it at that $39 or $49 price point.

[Jim Hagedorn:]

I'd only add that the reason we did test it was to test multiple price points to identify how to maximize the value of the consumer in this franchise. And the number came out to be, if we could get to a net $29.99 number and you have promotion, that’s the number that maximized our total return over the lifetime of the product.

[Operator:]

Our next question comes from the line of Mark Rupe with Longbow Research.

[Mark Rupe:]

A follow-up on the Snap system. I know that when you're testing it, it's obviously a different SKU and the retailer has to probably position it a little bit differently on the floor, different shelf space and the like. The stores and the markets that you tested this year, how did they manage the inventory? Was it any different than your regular business and just expectations on the inventory management of that product as you roll it out nationwide next year?

[Jim Lyski:]

We saw a whole range of ways to merchandise this product, and that was another benefit of conducting the test. We saw everything from just put it on to the shelf, to an encap, to an on-floor and merchandising display. And we saw different takeaway rates at the different display types. So we've identified that there is a couple of good places to help this, i.e., like an encap or kind of an on-floor display where the uptake is much, much stronger. And we've worked with our sales force now to identify those best practices and push those out during the 2012 season.

[Mark Rupe:]

And then on Expand 'n Gro, any learnings on the test that you had in the select markets this year?

[Jim Lyski:]

Yes, we also had learnings from that too. The first one was once again merchandising matters. It's a competitive advantage that we have. And when we merchandise effectively, we have a good takeaway rate with that product. The second one is that we're expanding the Expand 'n Gro test to the State of Texas this year. As you guys probably all know, they've had a very difficult weather year with a 100-year drought. And when Expand 'n Gro is added to the soil and gardens, we see a tremendous performance benefit. And so we're going to be positioning the product to be much more oriented towards soil amendment or just the garden soil next year in the State of Texas. And we'll see how that test goes, but all indications are it will be smash hit in that positioning.

[Barry Sanders:]

I just want to add my two cents. One, I think we are using the product in Europe and saw pretty good results. Second, from an R&D point of view, we have never seen sort of immediate results this good, particularly as a soil amendment. And so this Texas work we're going to do next year, which is to really focus the product a little more on being a soil amendment and sort of reducing the confusion as to what is this product, it's just important to remember this is the product we have seen crazy good results from sort of how plants grow in this product when it's used correctly. So this is a major innovation in home lawn and garden (inaudible). We're just spending a lot of time trying to understand to make sure that consumer understands what the product does and then price it accordingly, because it's a major innovation.

[Mark Rupe:]

And then just lastly, how are you guys or how are the retailers approaching the fall business given the difficult summer?

[Dave Evans:]

From the fall business, it's a brand new season. The weather has taken its toll on the lawns, and I would say that they're going to approach it the same as they have in the past. So we expect that the business will be up this fall again, the way it has been in the past previous years. And part of the advantage of the fall is relative to the spring business, it's always been a much lower size business. And so there is tremendous upside and the consumer gets the best results if they fertilize in the fall. And so we're going out with normal promotional activity and I expect that retailers are going to do the same.

[Operator:]

Our next question comes from the line of Jason Gere with RBC Capital Markets.

[Jason Gere:]

I just want to talk a little bit more about regionalization. Just where you need to keep tweaking the model, it's still in its infancy. Talk about the best practices of some of the regions performing better. I guess the way to look at it is the weather has obviously been in favor and regionalization certainly has played out well in this year. Obviously the weather was adversely playing with you. So regionalization, I just wanted to get a more bigger color like is there bigger tweaks or do you think it's broadly in line with what you said out a couple of years of ago?

[Jim Hagedorn:]

This was a year where we just had terrible weather and everybody was just working really hard to survive. The changes that have to happen as we streamline Marysville and continue to push up the regions gets back to regional products, or really you could the words to local products designed for local consumer needs. That is really just beginning to happen now. And if you look at sort of what Lyski and R&D are working on, on products or within sort of the M&A side that Dave and his group are working on, what you're seeing is a much more of a focus on meeting those needs. And that ultimately is when you're going to see regionalization really work or not is when we have products in the Southeast that are different than the Northwest. And that really hasn't happened yet. So I would say we need a little more ordinary dudes who are not fighting for their life and actually able to demand products that they need, but that Marysville has to change as well to be responsive to those products. And that the work that happens in the regions and the work that's going to happen in our marketing group, as we reckon that money out of sort of bureaucracy of spans and layers into sort of consumer intelligence, which is where we are going to spend more money, is getting smarter on the consumer and both doing that locally and out of Marysville marketing. I think that's when you're really going to see the difference. And that's hugely important. I think that was a pretty good answer.

[Jim Lyski:]

I would say regionalization is in itself changed to our business model going from a centralized organization to a decentralized organization. Two of the five regions in the U.S. were brand new this year. And so they really got their earnings in a really bad business condition. And so I think whether to Jim's point said as back as far as getting to the model and the behaviors that we want. But if you go back to the original business case of what we're trying to accomplish, getting closer to the local consumer, better retailer relationships with the people that are regional retailers and then responsiveness and deploying the ability to manage out into the field, all of those things we remain committed to, plus the original business case of those market share opportunities that are out in the region are still there. And we are building that business model to be able to do that. And so I can go to a list of things that were good this year, much better relationships with the local communities. We're building regional capability to better partner with the states and their regulatory agencies as well as some specific wins across all of the regions with some local retailers. And then to Jim's point, the flow of product ideas that are coming in here, it's a matter of how much capacity do we have, because there are so big of opportunities coming through that we need to prioritize those. So we remain committed. The business case is still there. And we had some learnings this year and we'll move on and make it better next year.

[Operator:]

And our final question comes from the line of Reza Vahabzadeh with Barclays Capital.

[Reza Vahabzadeh:]

Actually my questions have asked and answered.

[Jim King:]

Thank you, everybody, for being with us this morning. If there are follow-up questions or things that we didn't get to, you are free to give me a call. It's Jim King, 937-578-5622. Otherwise we'll talk to you again when we report our yearend results in early November. Thanks and have a great day.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.