The Scotts Miracle-Gro - Earnings Call - Q1 2012

Transcript

Speaker 7

Good morning and welcome to the first quarter of 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, Jim King. You may begin your conference.

Speaker 4

Thanks, Amber. Good morning, everyone, and welcome to our first quarter conference call. I'm joined here in Ohio this morning by Jim Hagedorn, our Chairman and CEO, Dave Evans, our CFO, as well as Barry Sanders, our President and Chief Operating Officer. In a few moments, Jim and Dave will share some prepared remarks, and then Jim, Dave, and Barry will be available to answer your question. In the interest of time, we request that you ask one question and one follow-up so that we can move quickly through the queue. I'll share with you in advance that our comments this morning will be pretty much contained to our Q1 results. Because our analyst day is only a week away, we will wait until then to provide more detail on our full-year outlook and business plans.

Speaking of our analyst day, if you have not registered yet, we would encourage you to do so. Our meeting will be held next Tuesday, February 14, at the Waldorf Astoria in New York. Our presentations will start at 9:00 A.M. and will continue shortly past noon. At that point, our management team will host a luncheon and will close the day with an extended Q&A session. We're already very close to full capacity at this time, so if you've not registered, we would ask you to do so by the end of the day Thursday. You can do so one of two ways. You can call my line directly. That's 937-578-5622. Or you can send us an email at [email protected]. If you can't attend the event in person, you can listen and follow the slides via webcast. The webcast will be available on our IR site, investor.scotts.com.

If you subscribe to services from Thomson Financial, you can also listen to the webcast from your StreetEvents site. It also will be available on Thomson's retail networks, which include Yahoo Finance, Google Finance, and MarketWatch. With that, let's move on to the business at hand, our Q1 results. I want to remind everyone that our comments today will contain forward-looking statements, and as such, we recognize that our actual results could differ materially from what we discuss here today. We encourage investors to read the complete set of risk factors that are outlined in our Form 10-K, which is filed with the Securities and Exchange Commission. I also want to remind you that we will provide a reconciliation on our website of any comments we make this morning related to non-GAAP financial measures that are not already discussed in today's press release.

With that, let me turn the call over to our Chairman and CEO, Jim Hagedorn.

Speaker 0

Thanks, Jim. Morning, everyone. I'm going to keep my comments brief this morning for two reasons. First, Q1 represents less than 10% of our year, and we've already communicated the results we expected in the quarter, so there's not much new news in today's release. Second, as Jim just mentioned, we have our analyst day just a week from today in New York. I'd rather wait until then to elaborate on how our plans are coming together and what it all means for the full year. I will tell you we're operating the business hard right now in anticipation of a strong season. Our supply chain team is working nonstop on building product and getting it to the right place. Our sales team is spending a lot of time in the stores working with our retail partners and getting displays up.

Our marketing team is in the midst of launching one advertising campaign and finalizing another. While we're still a few weeks away from the peak of the season, you'd never know it from walking around the halls here, we're going at full throttle. As it relates to our Q1 results, I'll tell you that I'm pleased with what we saw. The numbers came in just a bit better than we expected. On the top line, you'll notice that the global consumer segment was down 21% from last year. Let me provide some color. You'll all remember that our fall business last year was pretty weak. Hurricanes in September and snowstorms in October really shut down consumer activity. There wasn't a lot of replenishment happening in the early part of the quarter. In addition to that, our retail partners worked to end their fiscal years clean from an inventory perspective.

The combination of all that played itself out in the results we're reporting this morning. The other thing to keep in mind is while the % decline looks substantial, the dollar decline of roughly $40 million is not. To put that number in perspective, it would represent a single strong day of shipments during the peak of the season. We see this as nothing more than a timing shift and not something that causes concern. While it's not reflected in our Q1 results, we're seeing a very strong start to the current lawn and garden season, which in the South really starts with the calendar year. Since January 1, we're seeing some really positive trends in the early breaking warm weather markets. Consumer purchases of our products at our major retailers are up more than 20% during that time, driven by strong starts both in Florida and Texas.

By the way, POS was up 20% in December as well. While it's still early, it's always good to have a strong start. We expect POS for the full year to be up in the high single digits, which should drive sales growth of 6% or better. In Florida, about one quarter of consumer purchases for the season have already occurred. Weeds are growing, bugs are out, and consumers are out in the stores. In fact, we're seeing stores that are noticeably more crowded than a year ago, and products like BugBegone, FireAntKiller, WeedBegone, Combination Fertilizers, and Roundup are doing very well. As a result, early season POS in Florida is up more than 25%. We're also cautiously optimistic about what we're seeing in Texas right now. While we're only 10% or 15% into the season, we're seeing strong consumer demand across the board.

Two weeks ago in Texas, we actually saw a triple-digit year-over-year improvement in POS. While they're still in a deep drought, they've had rain seven weeks in a row, and consumers are almost immediately re-engaged in the category. It's too early to call it a trend, but POS in Texas is up well over 50% for the first five weeks of the new season. As a result, we're moving up the timing of some of our advertising spend, and retailers are moving up some of their plans as well. Due to mild weather, annual and perennial flowers, which we refer to around here as color, are in the stores a full three weeks ahead of last year. I don't want to be too specific about our full-year plans for Texas, but I think we're well positioned for either weather scenario, that is dry or normal.

We're hoping for even more rain and would like to see things growing again. While it's still early, I'm sharing these data points with you because I think once again demonstrates the resiliency of our category and the strength of our brands. I should point out that POS growth we've seen so far is occurring without the benefit of major advertising support. Our media is beginning to ramp up in Florida and will peak over the next couple of weeks. It will quickly gain momentum in other markets from there. Speaking of media, I want to shift gears and give you a hint of what you'll hear and see from us next week in New York. Our Chief Marketing Officer, Jim Lyski, will be one of the speakers. In fact, we're allocating him nearly one-third of the agenda.

While he'll show new campaigns we have in place for the season, his presentation will be light on show and tell. Instead, he'll spend most of his time discussing the type of analysis we're using to drive our marketing decisions. As you know, I announced in November our intention to increase our advertising investment by $40 million for this upcoming season. Jim will explain to you how we arrived at that number, how we plan to invest it, and how we plan to measure the success of that investment. I'm confident you'll walk away from that presentation convinced we've made a great deal of progress in improving our marketing efforts since our analyst day meeting last year. In addition to Jim Lyski, Barry will provide more detailed explanation of where we see the opportunities for growth.

He'll focus on key initiatives underway this year with each channel of trade and the steps we're taking to drive sales in several of our product categories. Barry's comments will not be confined to the U.S. business, but will also outline opportunities abroad. We've committed resources in 2012 to grow our business in Germany and launch a product line in China. We're excited by both, and he'll provide more detail. Barry will also outline substantial opportunities we believe exist in Scotts Lawn Service. This business continues to deliver outstanding performance. While we've been primarily focused on improving the SLS business model over the past several years, we're now switching our focus to leverage that model. From me, you'll hear a pretty formal briefing on the steps we're taking as our strategy continues to evolve. That will include a thorough explanation of our pricing philosophy going forward.

I will give you a headline now in case you're thinking differently. Pricing will remain a tool as we move forward. Just because we're taking a conservative approach in 2012 does not mean we plan to do the same in the future. I'll also provide, along with Dave, an explanation of how we've overhauled our incentive compensation programs. The changes are designed to drive category growth and market share in the near term and shareholder value over the long term. A substantial portion of our long-term compensation, which is paid in equity, will now be tied to return on invested capital. While we're not providing more details specific to our full-year guidance this morning, Dave does plan to provide more color next week, as well as a better understanding of our long-term financial goals and objectives. I trust you'll find the time well spent.

We're almost at capacity but still have a few seats available. Please let our IR team know if you plan to attend. With that, let me turn things over to Dave.

Speaker 6

Thanks, Jim, and good morning, everyone. As we've already said, with our analyst day scheduled in one week, I'll keep my comments brief, focusing on the quarter's results and then taking your questions. Next week, we'll have a more robust discussion on 2012 and the longer-term outlook. The headline for the quarter is that results are in line or even slightly better ahead of what we guided to in early December and on track with our full-year plan. Overall, company-wide sales for the first quarter were $211 million, as compared with $230 million a year earlier. While down 8% to prior year, they're on track with internal plans, which assume full-year growth of at least 6%. Changes in currency rates had a small dilutive impact to the quarter, about 20 basis points.

If current exchange rates remained unchanged for the balance of the year, they would reduce the planned rate of sales growth for the full year by about 100 basis points and negatively impact earnings by about $0.05 a share. While incorporating FX risk into our plan, we have no intent to revise our guidance at this early stage, given other modest cost tailwinds. As you can see in our press release, global consumer sales were down 21%. Sales within the U.S. were down 25%, principally as an outcome of pushing shipments closer to the season. Sales outside the U.S. were down 10%, or about 9%, excluding the impact of FX. The decrease in international was primarily seen in France, where we are increasingly shifting from two-step distribution through distributors to direct to retail distribution.

This change, which will ultimately result in a more value-efficient supply chain, results in shipments being moved closer to the season, following a pattern more similar to the U.S. Scotts Lawn Service sales were up 1% to $37.6 million. Customer count was up 2.5% to last year. Cancels have been lower than prior years since August, and customer satisfaction metrics continue to improve. Sales growth trailed customer count, principally due to weather in the Northeast and Texas, both of which resulted in the loss of some extra service revenue. As was the case in the second half of 2011, sales within corporate and other were up sharply from a year ago. Hopefully, you recall that sales in corporate and other are attributable to two activities: our supply agreements with ICL and sales of professional grass seed outside of Europe.

About two-thirds of the increase in Q1 was attributable to our ICL supply agreement. The remaining one-third resulted from increased sales of pro-grass seed. We are aggressively moving the grass seed inventory, consistent with our plan to exit the professional grass seed category by the end of 2012. Moving on to gross margin, the year-over-year decline in adjusted margin rate of 1,000 basis points was consistent with our expectation and primarily attributable to three items. First, growth in low or no margin ICL and pro-seed sales contributed 130 basis points to the decline. The ICL supply agreement was initiated in February 2011, so this headwind will anniversary later this month. Second, consistent with our expectations, commodity cost increases, including fuel, contributed 430 basis points to the rate decline. Increases primarily related to bird food and growing media inputs, as well as empty packaging.

Cost increases in Q1 were in line with our plan. We expect the dilutive impact of commodities and margin rate to decline over the balance of the year as year-over-year comparisons become less unfavorable. Third, lower sales reduce leverage of fixed warehousing costs, contributing an additional 320 basis points to the first quarter decline in margin rate. Given the seasonally low sales, there's greater sensitivity to changes in volume in our first quarter than in any other quarter. This will reverse itself and eventually turn positive by the end of the year. I'll now move on to SG&A, which declined $20 million to $123 million. Recall that on a full-year basis, we expect SG&A to be higher in 2011, with the increases driven by media and variable comp. Let me explain why SG&A declined in the first quarter.

First, we had two benefits in the quarter's year-over-year comparison: non-recurrence of 2011 severance costs, primarily related to Mark Baker's departure, and benefits in 2012 from the restructuring program we initiated last calendar year. The second reason for the favorable SG&A comparison was that the two increases we'll see for the full year, media and variable comp, are loaded in the last three quarters of this fiscal year. You should realize that despite the favorability in Q1, we're still planning for a meaningful increase in SG&A for the full year, details which I'll share next week. Interest expense was in line with what we expected and keeps us on track for a $10 to $12 million increase for the full year. In the quarter, interest was $15.3 million, nearly $6 million higher than a year earlier.

This was attributable to both higher average debt and higher rate spreads associated with our new financing structure. Recall that we have a higher spread on the senior secured credit facility we entered last June, as well as the $200 million tranche of senior notes we issued last December. The adjusted net loss from continuing operations for Q1 was $72.1 million, or $1.18 per share. That compares with a loss of $65.6 million, or $0.99 a share last year. Note that the basic share count in the quarter was 60.9 million versus 66.3 million shares in the first quarter last year. We still expect the average number of diluted shares for the year to be about 62 million. Remember, we don't use diluted share count in Q1 or Q4 because they are lost quarters, and therefore no dilution from an accounting perspective.

On a GAAP basis, the net loss in the quarter was $73.9 million, or $1.21 per share, compared with $66.7 million, or $1 per share last year. One additional note here. You will recall that much of the charges we have been excluding from our adjusted results have been related to product recall and registration issues. This dates back to two separate incidents from 2008. The first related to a recall of certain wild bird food products, the second related to the recall of several lawn and garden products when it was discovered that a former associate allegedly created fraudulent documents related to the federal registration of those products with the EPA. Late last month, the company filed a plea agreement in federal court here in Ohio related to several misdemeanor charges associated with these incidents.

In total, we agreed to pay $4.5 million in fines, money that we'd reserved for last year. We've yet to settle with the EPA regarding potential civil penalties, and as a result, we'll continue to exclude these costs from our earnings until the entire matter has been resolved. There's one item on the balance sheet I want to discuss, and that's inventory, which is up $88 million to last year. There are three principal reasons for the increase. First, higher commodity costs. Second, inventory build to support sales growth planned for the back three quarters of fiscal 2012. Third, an accelerated procurement of certain long lead time components sourced from Asia to ensure high service. We expect inventory levels to settle back to more historic norms in the back half of the fiscal year. That concludes my prepared remarks. Jim already touched upon our agenda for next week.

As we said, I'm planning to provide additional color on our 2012 guidance and discuss our longer-term financial goals and objectives in New York. As a result, we would ask that you hold your questions on these topics to next week. With that, I'll turn it back to the operator for your questions.

Speaker 7

At this time, if you would like to ask an audio question, please press star followed by the number one on your keypad. Your first question comes from Leah Villalobos with Longbow Research.

Speaker 4

Hi, yes, this is Josh in for Leah. Just a quick question on commodities. You know, your REIT has dropped pretty significantly here in December, and I think some people may be a little surprised it didn't alter your outlook for commodity cost inflation for the year. Was that drop already built into your original assumptions?

Speaker 6

Josh, recall that we had gotten ahead and locked in about 90% of our urea in the December timeframe. We're benefiting a bit from the continued decline, but I would say that if the decline continues or moderates at the current levels, it's really going to be more of a benefit looking into 2013 than 2012 at this particular stage.

Speaker 4

Okay, great. Just one follow-up, sticking with commodities on the bird seed products, rising costs of commodities there. How should we think about that product longer term? Do you think you'll be able to achieve the same margin on those products as you do on the global consumer segment products?

Speaker 0

Josh, as a hot potato, I'm not sure anybody wants it. My view is probably not. This is something that Barry, Dave, and I talk about a bunch, which is ultimately where can we get to profitability? Definitely more profitable than it is. Do I think we can get it up to our sort of consumer average? No, I don't think so, and I don't think anybody else could either. Barry, anything you'd add on that?

Speaker 1

No, there's going to be, it's from a mixed standpoint, a substantial part of the business is big bag commodity business, and so the mix will hurt it. I do think we can drive some innovation that will improve the margins, but I don't think it will get up to our average of what our consumer business is.

Speaker 4

Okay, great. I appreciate the time. Thanks.

Speaker 7

Your next question comes from Jeff Sacagos with J.P. Morgan.

Speaker 2

Hi, good morning. Can you tell me what your shares would have been if you had made money in the quarter, your diluted shares, and how much did you repurchase any shares in the quarter?

Speaker 6

Yeah, Jeff, the first question, I don't have the data to answer a question because we just don't, we don't calculate it because it's a lost quarter. I don't, it's not a number that's on the top of my head. With respect to the number of shares we purchased in the quarter, my recollection is around $17 million of share repurchases this quarter in Q1.

Speaker 2

Okay. For my follow-up, Jim began the call by saying that our pricing policies this year may not be the same as our pricing policies in future years. I was wondering if you could elaborate on that. That is why your pricing policies this year might be more mild and why your pricing policies in the future might be more aggressive, if that's what you meant.

Speaker 0

That's what I did mean. To start with, I'll maybe hand it over to Barry to see if he can correct anything I screw up, but start by saying I think we have been modestly aggressive. I think that where we are this year in regard to our advertising spend and our pricing decisions were really sort of my view coming out of the summer that I really wanted to basically work on consumer demand, and I didn't want to create any issues to it. This would be particularly true in sort of urea-containing products like lawn fertilizer, where we have seen a decline over time on our units sold. This is, again, not a share loss.

This is not a sort of a dollar decline, but it is a unit volume decline and something that I just wanted to sort of put a stick in the sand and say, look, we're not taking pricing and we're increasing our advertising. You know, so far I feel pretty good about that. I feel confident that our sales force agreed that that was the right decision, that our marketers agreed it was the right decision, and that our retail partners. This is sort of in advance of the season, so we'll see what the consumers think. I'd say so far so good. Going forward, we do understand that gross margin is our, you know, our gross margin profit dollars is the jet fuel we use to operate our business.

When we talk about what our advertising ought to be, one of the things we'll talk about next week is what I call my core convictions, which is something I felt obliged to provide sort of to our internal community here. One of those is advertising works. I think that we have not really been putting the money behind, you know, putting our sort of putting our money where our mouths were when it comes to sort of advertising spend. To do that, it requires, I think, it requires our margin to be higher. I think proper valuation of this business requires our margins to be higher. If commodities are going up, this is strictly kind of a holding pattern to sort of regroup and get down on the consumer and get our business model where I think it needs to be.

This is not an abdication of saying we can't take pricing. It was really a holding pattern I put us into to say, here's what we're going to do. We're going to take all noise out of the system, and we're going to incentivize, and we'll talk about that next week, the entire company on sales growth and market share. These are areas where we're going to prove we can grow this business to you all and to ourselves. This was really part of a holding pattern and does not, you know, and shouldn't be viewed as basically saying we can't take pricing. I don't know. Anything you want to add to this, Barry?

Speaker 1

Yeah, just one thing is that, Jeff, this is the first year we're looking at pricing, decoupling it from commodity cost, that we're looking at the value provided to the consumer, the elasticity of demand. What you hear Jim Lyski talk about next week is how we're going to view how we price for our brands, the value that we provide for the consumer, and our ability to price for innovation and continue to drive the innovation. If you look at historically where we've been, we've been in a secular increase in the cost of commodities over the last five years.

As Jim said, we're breaking that mold to say we're going to drive unit volume, we're going to drive share, and we're going to continue to drive margin and not look at our brands as just a cost-plus basis, but look more at the premium nature of our brands and how we can drive value to our shareholders that way.

Speaker 2

Okay, thanks very much.

Speaker 1

You bet.

Speaker 7

Your next question comes from Joe Altabella with Oppenheimer.

Speaker 8

Thanks. Good morning, guys. Just a couple of quick ones. I guess first, you said a number of times that weather accounted for only about half of the top line shortfall that you had last year. Could you guys give us an update on the other issues that you saw last year, at least at this early stage? Secondly, and somewhat related, if you could break down POS maybe between mass versus home center?

Speaker 1

Joe, I would say we don't break it down that way in respect to our customers. I can speak specifically. We said about 50% weather-related, and we said we had some difficulties with a couple of our customers. I would say the weather's turned around, and I think we're in great shape with all of our customers. I think you're seeing the outcome of us having better account plans at some of our bigger customers this year.

Speaker 8

Okay, thanks, Barry. In terms of the POS, I wasn't looking for, you know, specific numbers, but in general, are you seeing?

Speaker 1

Oh, a divergence? No, I would say all of our customers, you know, the numbers Jim talked about, they're with plus or minus a few points of each other.

Speaker 8

Oh, let me just add a little bit to this because we've been sort of prepping for next week with you all. As we prepped for this call, we got into quite a bit of the detail. If you look at like Florida in particular, Texas as well, all channels are doing well. We've put a lot of time into sort of correcting, I think, issues that we felt on both sides at Walmart. I think we're on a way better track. The performance we're seeing year to date, call it in mass, but you know, that's code for Walmart, is really good. I think things so far are going well, and I think we're all much more confident than we sort of felt sort of midway through last year. Gotcha. Okay.

Secondly, in terms of the timing shift you saw this quarter, obviously you did talk about that back in December, so it wasn't a surprise. You guys have been talking about timing shifts in terms of delivering product later or actually closer to the start of the season for a number of years now. I'm just curious, are we almost at just in time at this point, or are there still opportunities to push those shipments back even further?

Speaker 0

Look, you know, that's a hard one to predict because about the time you say it's just where it should be, they'll say we want to go scan-based. We're not in discussions on going scan-based. Look, I think as long as Scotts Miracle-Gro can excel in our supply chain and deliver on time, it makes sense. If I was taking, Joe, if I was taking you through sort of giveaway, which would be a sort of normal metric they would use, which is sell a lot of stuff and turn it hard in season and sit on as little as possible in the off-season, which would be a major opportunity area for improving giveaway. I think retailers continue to look for opportunities to improve their returns by taking inventory out in sort of the off-season. I think that that will probably continue to occur.

The good news is POS looks fantastic. We're in service. I think this is an area where Scotts Miracle-Gro can show why the hundreds of millions of dollars we've invested in our supply chain and our sales force can pay off and why we're kind of unique in the vendor community, if you want to call it that, and especially in big box DIY to provide in a very violent sort of season really pristine performance without losing any sales. I don't know. I think that probably it doesn't, you know, it probably continues to go until they're sitting on sort of $0 in the off-season, but we feel fine about it.

Speaker 8

Okay, thanks, guys. I'll see you next week.

Speaker 0

Yeah.

Speaker 7

Your next question comes from Carla Casella with JP Morgan.

Speaker 5

Hi, just a couple of quick ones. One on the marketing spend that you're upping this year. How much of that is going to be the regionalization following the regionalization strategy versus a national marketing?

Speaker 0

I will hand it to Jim, but I think it's probably both. I think what we learned big time last year was there's more efficient ways to do it than we did last year. I think we can sort of do both. Jim, you want to?

Speaker 1

I'd say right now we anticipate somewhere between 30% to 40% of our media spend to have regional messaging flexibility. That doesn't necessarily mean we bought it regionally. It just means that we can vary the message to match the POS curves in each region.

Speaker 5

Okay, great. Given how poor the weather was last year, are you seeing much a pickup in the, I guess, the competitive situation as everyone tries to build for a better 2012 season?

Speaker 0

You know, listen, from my point of view, and I was on the road yesterday, I think lawn and garden departments are looking pretty good. I think everybody's kind of ready for it. Do I think the world is more competitive than it probably was two, three years ago? Yeah, I do. I think that's helping us, and it's making us a better competitor as well. Do I think that there's big gaps where certain people look terrible? No, I think everybody's looking pretty good, and the departments, especially in the warm season markets, look pretty well set. I think the whole environment is good. Listen, maybe other people are showing the POS gains that we're seeing. I think we're doing really well. What I don't know is if we're outperforming sort of those markets down south. I suspect we are, but I don't know that for sure.

Speaker 5

Okay, but no retailers you think have cut back any of their space given how bad last year was?

Speaker 0

No, it's been really one of the really important and gratifying things is that as we've spoken to these retailers, and I've been meeting with many more Senior Management of our biggest retailers, is that almost to a person, they are extremely committed to lawn and garden as a category that really leads them into the new year and not at all a sort of diminished sort of presence or commitment as a result of a poor season. I think they just see it for what it was. I mean, most people who've been in lawn and garden recognize this: if the weather sucks, it's just going to be hard to have a great year.

Speaker 1

I would, the only thing I would add is, you know, what Jim said is they were positive going in. With these early good results, it's just gaining momentum and everybody has a renewed focus on it. I think it's all good.

Speaker 5

Okay, great. Thanks.

Speaker 0

You bet.

Speaker 7

Your next question comes from Eric Bosshard with Cleveland Research.

Speaker 0

Oh, good morning. Hey, man.

Speaker 8

Two things. One, you commented that for the year you thought POS would be up high single digits, I guess 7 to 9%, and your sales would be up six plus. What can you help us understand the difference between that and what the assumption is in regards to inventory in the channel through the year? Also, what the assumption is for either your market share or the category performance?

Speaker 1

Eric, this is Barry Sanders. As continued, and Jim already fielded one of these questions, we believe that we need to continue to take inventory down at year end for them not to overwinter the inventory. Our calculation would say their POS would be up higher, but then we would take the inventory out at the end of the year. Part of that's what's happened in Q1 as well, we made sure that they were in good shape going into Q2.

Speaker 8

Your thoughts of the POS, is the 7 to 9% your POS or the industry POS? How do you feel about, I guess, how differently do you think you hold, gain, or lose share relative to the industry this year?

Speaker 6

Eric, our plan would say is that 7 to 9 is our POS, and then implicit in that would be some growth or gain in market share by Scotts this year.

Speaker 8

The last question, I know you affirmed that $80 million or reaffirmed the $80 million input cost pressure for the year. Can you just remind us of what the assumption is about how you offset that? I know that you're talking about less price than normal, but can you give us a little sense of what's on the other side of that to get you to, it sounds like, a little bit of gross margin pressure for the year?

Speaker 6

Eric, I'll have a lot more detail to that next week. I think what we've said so far is that we do expect gross margin rate pressure because as we've been very public about, while we took some pricing and we did drive some increased productivity out of trade programs, it wasn't sufficient to cover the commodities. There will be margin rate pressure relative to the commodity cost increase. I'll talk more to that next week, as well as kind of our longer-term outlook for that.

Speaker 8

Okay, very good. Thank you.

Speaker 7

Your next question comes from Olivia Tong with Bank of America Merrill Lynch.

Speaker 5

Good morning, thanks. I want to talk a little bit about the POS improvement. While small numbers since it's the beginning of the season, what do you think drove that? Is it more the fact that the weather has been better or are there early signs from, have you already launched some programs associated with the marketing expenditure increase? Further, on top of that in mass, you mentioned that the rates of growth between the home centers and mass has sort of normalized. Can you give some color and some specifics on what you're doing differently to drive that turnaround?

Speaker 0

All right. You want to, which one do you want to do first, Barry? Why don't we do the mass one first, and then we'll go into the second ones?

Speaker 1

Could you repeat the question on mass?

Speaker 5

Sure, just what you're doing differently at mass to get those results better this year.

Speaker 1

I think they've had a new management team in place that we're very pleased with. They're very aggressively driving sales. We're partnering with them very well. I think we've both come to terms with what the opportunity is for us to grow the business this year. They are as aggressive as we are of going after it. I think it's a good plan, a good partnership, and our goals are aligned. I think the results are in line with what we expected.

Speaker 0

No, but I'd add on that I think our off-shelf display is going to be significantly better than it was last year and our tab support. This is support we're putting behind it and then support that Walmart's putting behind lawn and garden in general is going to be enhanced from where it was last year. I think that a lot of this stuff is all to come. Based on the POS we're seeing now, plus what we know is coming down the road in regard to tab support and display support, there's good reason to be optimistic. In regard to just generally what's happening, because, you know, Olivia, I would say that these are not small numbers right now.

To be 25% into the seasonal year in Florida and to be up more than 25%, you're starting to get into the point where you're saying it might actually mean something. What do I think? Hey, listen, I think things economically are somewhat better in Florida. I mean, I think people are feeling a little more relaxed. I think that a lot of the cheapest foreclosure stuff has been swept out. I think the weather has been superb. Given the fact that our advertising, we had wanted to pull it up hard, but based on the amount of political activity that was occurring in the state of Florida prior to the Republican primary, we just couldn't compete with that. We went into the market and are in the market now right after the primaries were over. The results we're seeing really have not had any impact from advertising.

The advertising is going to be substantially higher. If you believe, and we do, advertising works, then I think most of it is just due to somewhat more favorable economics just generally out there and to just terrific weather. Now with the advertising going up, it's a little bit like the discussion about Walmart. There's a lot of good things coming down the pike. What we do is really coming into effect now. It's so far, so good.

Speaker 1

I would add to what Jim said. This is year three of regionalization in the Southeast and the Southwest. Our teams are doing an excellent job. You couple exactly what Jim said, good account plans, and then what I would say is the best execution we've ever had in those regions. You put that scenario together, it all combines to get the results.

Speaker 0

No, Barry's totally right. I neglected to mention the sort of really good efforts that are happening because regionalization, if anything occurred last year in the stress of just complete crap weather, the result of it was, I think, a much better execution plan going into 2012 than we've had and a much more aggressive leadership profile from the regional presidents. That's also happening. I neglected to say that.

Speaker 5

Got it. Thanks. Just following up on that, you mentioned in the press release you're doing an updated look at your longer-term financial goals and objectives. Should we be reading anything into that, or is that just we're having an analyst day? We're obviously going to update you on the longer term.

Speaker 0

It's exciting. That's what I would say is that, you know, Dave, in addition to the financial side of the house, the strategic side is also reporting to him. As Barry and I have been really focused on sort of our operating profile, call it, Dave has been highly focused on what our financial objectives ought to be as we try to create value. Really what you're going to hear is an emerging of, I think, a really good sort of operational strategy tied to, I'm going to say some modestly to maybe more modestly, you know, more aggressive financial objectives that I think drive value. I think you'll view it as a positive, and we'll find out next week.

Speaker 5

Got it. Thank you.

Speaker 7

Your next question comes from Bill Chappell with SunTrust.

Speaker 2

This is Mike filling in for Bill. Morning.

Speaker 0

Hey, Mike.

Speaker 2

Hey, I just wanted to ask a question around advertising. I know you're going to provide more color next week, but given some of the commentary in your prepared marks about moving the timing or shifting the timing of your ad spend forward due to some of the favorable weather you're seeing, could you maybe give us some more color on the cadence of your advertising marketing spend this year? Is that in, you know, how that differs maybe from prior years?

Speaker 0

Mike, this is Jim Lyski. What we're trying to do this year is to lead our POS curves by geography approximately two weeks out so that we're building both the awareness and recognition levels that we need as you get into a peak environment. It's kind of like leading the bird when you go out shooting. That's what we're doing as far as the cadence goes, and then trying to be able to match that through the season. I'd say that's what we meant by changing the cadence.

Speaker 2

Okay, great. A follow-up.

Speaker 0

I just want to add on that because remember what we had by weather, we had a very significant portion of our spend last year weather triggered. The problem is the weather was so long poor that it really ended up delaying that spend. Instead of sort of leading the bird, we kind of trailed the bird. What we found out was that while weather triggered, I think still is an important sort of arrow in the quiver, you can't go 100% that or a majority of that, or you're going to find out in sort of a poor season that none of that brand building effort in advance of the season could hurt you. I think that this is really a move back to what Jim described, which is not that new for Scotts Miracle-Gro, but we had moved very much into sort of weather triggered.

Speaker 2

Okay, great. A follow-up on advertising. Given what you're seeing with POS thus far and understanding that we're only a month into the season and we haven't hit the heart of the season, if you continue to see strong double-digit POS this season, would you have the ability or the opportunity to maybe roll back or scale back some of that advertising spend, or is that something that's already booked for the year regardless of how POS does?

Speaker 0

Oh, you're talking to the wrong dude, man. If it was me, I'd spend more. You know, just pour gasoline on the fire. I don't know if Jim would say that.

Speaker 1

I would absolutely agree with my CEO on that one.

Speaker 2

All right, great. Thanks, guys.

Speaker 7

Your next question comes from Sam Dockatash with Raymond James.

Speaker 2

Morning, Jim. Dave, Barry, how are you?

Speaker 1

Good morning, Sam.

Speaker 2

Most of my questions have been asked and answered. There's only so much we can ask here in February. A couple of things, and at the risk of, again, paying so much attention to only maybe 2% or 3% of the season sales, you mentioned Florida and Texas, very strong POS. You didn't mention Southern California, which it looks like the weather's been fairly normal out there. Are there issues there with POS early in the season?

Speaker 0

We know that our national POS is up 20% since January 1. Within that, the numbers are not as good as Florida and Texas, but the whole national program is not bad.

Speaker 1

Yeah, Sam, Southern California is around flat, and as you go north, it gets a little worse than that. I would say that's primarily driven by a replenishment strategy of trying to get closer to the season. Plus, they've had a little bit of rain out there. California, not as good as Florida and Texas, but I would say as good a shape as we've seen California in. I think from a marketing plan standpoint, we have expectations that California will be equal or better to what we're saying is, which is high single digits for the year.

Speaker 0

All right, let me give a little bit of color as people are sort of walking around the table here. Arizona's plus 22. Arizona's good. You know, to me, California is, you know, we can sort of tap dance around it or we can say, have we really figured out how to big time move the needle in California like we have the East? For that matter, has anyone figured out how to really move the needle in California? I think everybody's challenged a little bit with California, and I want to make sure that our Regional President out there, Phil Jones, has the tools to get it done because part of what we're looking to do this year is show that we can drive top line numbers.

California, I think, has been, you know, it's part of the whole regional approach to the business, saying, have we seen the kind of growth we've seen in the East? Is it as responsive to advertising or the same messages? The answer is no. It is a challenge. I'm not going to walk away from it. The West is not doing poorly. Southern California is not terrible. It's not great, but it's one of those things where we're really focused on it and making sure that our folks out there have the tools to get the job done. I think, you know, four months from now, we'll be talking about this and saying, okay, how'd we do out there?

Speaker 2

My second question would be, it looks, if my memory serves, your comparisons on mix and volumes do not begin to get easy until April and beyond. With the higher marketing spend and with the higher discretionary spend, would there be a reason why Q2 wouldn't be down on a year-on-year basis in earnings?

Speaker 6

Hey, so Sam, here's what I would say is that I think directionally you're correct. You know, as we've done in the past, we're not going to try to start calling guidance by quarter. What I will tell you, and I think we'll talk about this a little bit more next week, is that if you look at our historic pattern of shipments and take it over a four-year average, if you apply that to our expectations for full-year sales this year, I think you'd get to a reasonably good outlook for what we're planning for this season, which is kind of average weather. You're correct in that we have some more challenging comps from last year over the next several handful of weeks.

As you probably remember from last year, the season just kind of tailed off, and it got to be, it'll be easier comps then for the balance of the year. That'd be kind of the direction I'd provide you on that.

Speaker 1

Yeah, the only thing I would add, Sam, this is Barry, is that it was in April. It went negative comps last year started in week 11 in March, and it was downhill from there. It starts getting better kind of mid-March from really easy comps going forward.

Speaker 6

Okay, thank you.

Speaker 7

Your next question comes from Reza Vahabzadeh with Barclays Capital.

Speaker 6

Good morning.

Speaker 0

Morning.

Speaker 6

Just following up on that last question. Would you generally anticipate for the entire fiscal year sales mix to be favorable for you?

Speaker 1

This year, if you're talking product mix, we would expect it to be positive because, as Jim said, we're going to grow units and fertilizer, and last year was not a very good fertilizer season given the Midwest and the Northeast, all the rain that we had. What we're seeing in the southern markets is it's kicking off and fertilizer is positive, and we expect the same thing as the season rolls south to north.

Speaker 6

Would that sales mix being favorable also contribute to better gross margin?

Speaker 1

Yeah.

Speaker 6

Or not necessarily?

Speaker 1

Yeah, that in isolation should. If you remember last year, we did talk about mix from a negative perspective, and it was what we said was last year where we saw the greatest declines was in lawn products. Lawn fertilizer and weed control, as well as non-selective weed control, which related to Roundup. Those are all things that last year we were providing as explanations for our margin rate deterioration. If we have a normal year, which is what the plan is, we would see some tailwinds this year to our margin rate from a positive mix. There are a lot of other variables affecting rate this year, but that in isolation should be a positive.

Speaker 6

Fair enough. As far as the use of free cash flow to be generated this year, any updated thoughts on how you would apply that?

Speaker 1

Really, no updates. It would be consistent with what we've articulated in the past. I would say the guideposts that we've laid out in the past is first from a capital structure. We're going to keep one eye on our debt leverage. Our guidelines are 2, 2.5 times. On the other hand, we're going to focus on kind of a third of our operating cash flow to shareholders and two-thirds for growth, both organic and inorganic. Short of finding value accretive inorganic opportunities, we would choose to return that to shareholders as well. Our first choice would be to dedicate two-thirds of our cash to growth. I would say those are our general guidelines. It's not something that we live and die by, but it certainly directs how we think about this on a quarter-to-quarter basis.

Speaker 6

Got it. Thank you.

Speaker 7

Your next question comes from Jason Geer with RBC Capital Markets.

Speaker 2

Thanks. Good morning.

Speaker 0

Morning.

Speaker 2

Hey, just a couple of questions. I guess one, just thinking about the international outlook with the very weak macro backdrop there. You had some positive comments earlier in the call, but I was just wondering how you're thinking about that market and what you're seeing out there right now.

Speaker 1

What we're seeing right now is the economic backdrop is not affecting lawn and garden sales. That's not to say that something won't happen going forward, but I think culturally in the geographies that we compete in, we're not seeing any impact from our sales at all.

Speaker 2

Okay, great. I guess the second question really is on just the role of promotions. Last year, obviously, there were some inefficient promotions out there. You guys have pledged we don't want to go back that route again. Just in terms of thinking about the rest of the year, and hopefully, God willing, we don't ever see the type of weather we saw last year. How do you think about the balance of promotions in there if, you know, weather doesn't cooperate, is not as normal as what we hope it could be this year, but, you know, just kind of thinking about that role in there. Thanks.

Speaker 0

Barry is going to be like, who's going to take this one? Look, you know, when you say inefficient promotions, I assume that you mean we spent money and got like nothing for it. I guess that qualifies as inefficient. Yeah, but you know, listen, everybody around here is even laughing. I sort of can't believe this, guys. No laughing. To some extent, we were chasing the business. We were trying to basically make the most of the year and invest behind promotions to drive the business. The hope was that the weather would improve and we'd be in a position to have the sort of displays and promotional activity that would drive the business.

That didn't play out, and therefore it qualifies as, you know, around here, we'd say chasing the business and inefficient promotional activity that we do want to work away from and we're not planning to repeat. Now, if you're saying, would the same thing happen if the same thing was to happen again? I think we'd try to be much more careful about it. You know, I'm not sure what else to say except to say we were trying to operate the business real time and did the best we can. It didn't play out. I think we could do and have, I think we could have more effective promotional spend. I'd start with saying with our advertising. Instead of relying completely on sort of on-the-floor display activity, I think we'd go to advertising and we could do it much more real time depending on the weather.

If the weather didn't play, not invest that money. I don't know, Barry. What would you do? It's kind of what would you do differently if the whole thing happened again?

Speaker 1

Going back to where we started on pricing, we didn't take pricing this year, and the promotions that we've done are an indirect form of a pricing action. We didn't take the pricing. We think we have the right pricing. The mix of the spend that we're going to spend, and you're going to hear more of this from Jim Lyski next week, is it's going to be spent more on brand building activities and driving the longer term and getting participation rates up this year, more so than what Jim termed as chasing the business last year. I think we have a much better marketing plan. It's integrated with our customers better. The cadence of it is not only to get it up in advance, but we have a very good marketing plan all the way through our fall business next year.

I would say this year we'll probably be a little more patient with letting the marketing plan play out and focusing more on brand building activities than more so pricing action.

Speaker 0

Okay, thanks.

Speaker 7

Your next question comes from Connie Manatee with BMO Capital.

Speaker 3

Morning. I do have a question on the first quarter. What would you imagine that a normalized gross margin is in the first quarter given all these moving parts? I mean, ICL anniversary, sales keep moving into the second quarter, capacity utilization is going to be always not as high as the rest of the year, and it's going to be plus or minus the impact of commodity. What's normalized now for the first quarter?

Speaker 6

As I think about your question, in many respects, I would say that what we saw this quarter probably is more normalized because if you consider the fact that the sales shift is something that we wouldn't anticipate to return back to Q1 next year, that's permanent. ICL is now embedded in our financials for nearly a full 12 months. From the perspective of the first quarter, that won't go away. The one thing that we will benefit from next year would be the professional grass seed business that we've said we're intending to exhaust the inventories and exit. That would be kind of one adjustment I would say would need to be thought through to call what's normal. I really think the big question then is going to be commodity assumptions in terms of what's normal in the future for commodities.

If you say, was this year the anomaly or was the past the anomaly? In many respects, I'd say this year might reflect more of the new normal given the pacing of the season and the composition of our sales in this quarter.

Speaker 3

Okay, that's helpful. On the accelerated procurement of long lead time inventory, what's that about?

Speaker 6

There is a handful of items that we really source from Asia, I'll say more broadly. The corn, which is a key part of some of our highest growing items, soils and easy seed, is sourced from that region. As well, some of our new innovation that we're launching this year in our Ortho product line has components that are sourced from Asia. From the perspective that it's both related to innovation that we want to make sure we have good service on, I would include in that innovation SNAP as well. Some of the components in SNAP come from Asia. It's coming from innovation in our higher growth product lines. The decision was made this year to more aggressively source those materials ahead of the season to simply de-risk any issue later in the season from a service perspective.

Speaker 3

Should we think that these long lead time items sourced in the first quarter are also part of a new normal?

Speaker 6

I would think that a couple of things. One is the key drivers. The order that I explained them in would be representative of the order of significance in terms of the growth of $88 million. The increase in cost was the largest. The second would be the more rapid build and production plan anticipation of growth from the back part of the year. I would tell you on that, I think we'll progressively get better as we drive for improved inventory returns year in, year out. I guess I'll look to Barry in terms of the supply chain from a sourcing perspective on these components.

Speaker 1

Connie, this year, which is pretty remarkable given this time of year, the conversations that I'm having with our customers are about already when the products start moving, make sure I'm the one that gets the allocation. What we wanted to do this year, given these new innovations, we don't really know how high high is with these. What we didn't want to do was kill the innovation, you know, in a full national launch year. We took a pretty aggressive approach on the inventory. I would say those products next year will have a much better feel, and I think we can do a more regular flow. Any of these new innovations that were coming out that have long lead time items, given the seasonal nature and the flow of how our sales goes at the retailers, we could really damage our sales by missing a week.

I think you won't see this exact same repeat, but as we have new products, we'll evaluate that and make sure that you guys understand how we're going to manage that.

Speaker 3

Okay, thank you very much.

Speaker 1

All right, Amber, listen, in the interest of time, I think we're going to take two more questions, and then we're going to wrap things up.

Speaker 7

Next question comes from Jim Barrett with C.L. King & Associates.

Speaker 4

Good morning, everyone.

Speaker 0

Hey, Jim.

Speaker 4

Jim, could you talk about your lead markets? How are your regional and private label competitors pricing their product relative to a year ago?

Speaker 0

Maybe I'll just... Barry would.

Speaker 4

Yeah, we haven't seen really any change, Jim, so I don't think anybody has really taken pricing, which is consistent with where we're at, and we think it's the right thing to do. Okay. Barry, on a follow-up, any change in the promotional efforts by the mass merch retailers in support of private label or store brand, or is it unchanged from last year?

Speaker 0

I would say on the private label side, unchanged, but I think you're going to see a much more aggressive branded approach.

Speaker 4

By your competitors?

Speaker 0

By us.

Speaker 4

Yes, by Scotts Miracle-Gro.

Speaker 0

By Scotts.

Speaker 4

Wonderful.

Speaker 0

I also think that you're going to see, if we're talking mass, I think the tab support is a very welcome change for the whole category. I think it's, my understanding is it's very focused on branded products.

Speaker 4

Branded products, correct. Thank you both.

Speaker 0

I mean, I just want, you know, Jim, just throw in there, just because I think it's important, that I think us not taking price drove a lot of the fact that even in an increasing commodity period, other people weren't pricing. Just remember, the effect on their margin is much more destructive than it is to us.

Speaker 4

Understood. Thank you very much.

Speaker 7

The last question comes from Jon Robert Andersen with William Blair.

Speaker 6

Morning, guys. Thanks for taking the question.

Speaker 0

Hey.

Speaker 6

Just a question on the cost side. The restructuring benefit for the full year, what you're expecting there, and maybe how much of that impacted the first quarter?

Speaker 1

John, I'm going back to, I'm trying to recall the exact number I provided on the fourth quarter call. I think what I described is close to $20 million full-year benefit. That's a fully loaded cost. What we saw in the first quarter was probably an order of magnitude around, I'll call it a $6 million benefit in our first quarter.

Speaker 6

Is that separate and distinct from the ongoing supply chain savings associated with the multi-year program that you've had going on there?

Speaker 1

Yes, it's absolutely distinct from those savings.

Speaker 6

Okay. Terrific. Thanks, guys. I'll see you next week.

Speaker 0

Thank you.

Speaker 7

I'll now turn the call back over to Jim King for any closing remarks.

Speaker 2

Okay. Thanks, Amber. Thanks for joining us this morning. We look forward to seeing you all next Tuesday in New York. If you want to register and you still haven't, you can call my office directly today at 937-578-5622, or send us an email at [email protected]. We ask that if you haven't registered, you do so by the end of the day on Thursday. Other than that, we look forward to seeing you next week. Thanks, guys. See you guys later.

Speaker 6

Thanks, Amber.

Speaker 1

Thanks.

Speaker 7

Thank you for participating. You may.