Scotts Miracle-Gro Co (SMG) 2006 Q1 法說會逐字稿

Good morning. Welcome to the Scotts Company first quarter 2006 earnings conference call. And welcome to the Scotts Company first quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode. After the presentation we will conduct a question and answer session. [OPERATOR INSTRUCTIONS]. This conference is being recorded. If you have any objections you may disconnect at this time. I would like to turn the call over to Mr. Jim King. You may begin.

Thank you, Operator. Good morning everyone and welcome to our first quarter conference call. With us this morning is Jim Hagedorn, our Chairman and CEO, and Chris Nagel our CFO.

I want to remind everyone that our comments this morning will likely 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 outlined in our form 10-K which was filed with the Securities and Exchange Commission. If you did not receive a copy of this morning's press release, you can find one on the Investor Relations portion of our website, Scotts.com. As a reminder, this call is being recorded and an archived version of the call will be available on our website. If we make any comments this morning related to non-GAAP financial measures not covered in the press release, we also will provide those items on the website.

Before I get started, I want to remind everyone that our annual shareholder meeting will be held this Thursday at 10:00 a.m. eastern time. If you're interested, you can listen to a live webcast of the call on our website. With that, let me now turn the call over to Jim Hagedorn to discuss our performance. Jim?

Thanks, Jim, and good morning everyone. Before jumping into a discussion about the quarter, I believe I owe you an explanation regarding the results released today versus those we anticipated in our press release on December 29th, when we said the seasonal loss this quarter would be 15-20% greater than last year. Let me start by saying when it comes to our communications with Wall Street we try to err on the side of being more open than less; more transparent than not. In the days after our December 14th analyst meeting in New York, we came to believe the first quarter outlook we shared during the meeting was too optimistic. Since first call estimates were based on our guidance, we attempted to correct the record as soon as we believed we had guided the numbers too high. However, as we closed the books on the quarter it became apparent that two things had happened.

First, sales in some areas of the business came in higher than our forecast at the time of the press release. Also, several pieces of positive news related to SG&A materialized throughout the rest of the business. Individually, these were modest changes but on a collective basis the impact of these items in a small quarter added up to an adjusted earnings number that not only was higher than outlined in our December press release but also was above our own budget projections.

So let me move on. As you know, the first quarter accounts for less than 10% of our year, so we seldom get overly excited or overly concerned about what's happening in our business through the December quarter. But even though the quarter is small it's always better to start the year ahead of plan than behind it. And as we prepare for the break of the season, everyone here has been working on all cylinders.

Our sales team has been working with our retail partners on programs to drive sales in the peak of the season. Our marketing group has been busy developing new commercials, reviewing its media buying strategy and working on other initiatives designed to get the attention of consumers. Also, our supply chain team has been continuing to balance our manufacturing needs in a volatile raw material environment. And our executive team has been preparing for a major strategic planning session later this week with our board of directors.

This morning I'd like to share top level results from the quarter at well as describe how the efforts I just outlined will help drive our business throughout the year. Even with the delay in shipments to some accounts, our retail partners had a strong finish to the previous season, and most of them began preparing as we expected for the new season in the warm weather markets. Based on our start to the year, the programs we have in place, and the current level of retail inventories, which we believe are appropriate, we remain confident with our full-year outlook that sales will increase 10-11% and that adjusted net income improve 20-22%. We remain confident because our consumers remain engaged in the category, even during the slow time of the season.

In the first quarter we enjoyed a 13% increase in consumer purchases of our products with an improvement in nearly all areas of the business. At the end of last season we saw strong POS growth across the country. As we move to the break of the new season we're encouraged by the POS growth we've seen in warm weather markets such as Florida, Texas and California, where we've seen average POS growth of 5% over the last six weeks.

During the quarter our lawns business, which was supported by strong winterizer advertising, had the strongest growth with a 21% increase in consumer takeaway. As we look to the rest of the year, we remain confident that the lawns business will continue to show steady growth. We intend to increase advertising for our most important product, Turf Builder plus 2, by nearly a third this year, and will also support the product with new and more competitive TV commercials. 2006 also marked the second season for our southern Turf Builder product line, which had a great start last year. This program was widely supported by our retailers and we believe the momentum will continue again this year.

We also continue to remain optimistic about our growing media business. In the quarter we saw a 19% increase in consumer purchases building upon the 14% increase we saw in 2005.

This spring will have an even stronger message behind our Miracle-Gro potting mix with moisture control, a message reminding consumers that the product not only takes the guess work out of watering, but also feeds the plants for three full months. We believe even more consumers will see this as a fool proof solution to helping them grow the best plants ever.

We'll also increase our marketing support of Miracle-Gro Organic Choice, a product line we rolled out nationally last year. The entire natural and organic segment of gardening continues to increase in popularity, and it's our intent to be THE choice for consumers in this area of the market. Even though it's fully organic, the product claims for Organic Choice are the same as the traditional product line: they grow plants twice as big. While Organic Choice won't make the growing media category twice as big, we do believe it will contribute to the continued growth of the business. This is a small but growing segment of the category, but one we think has real potential.

As Bob Bernstock mentioned to you in December, our plans to increase advertising support will go well beyond just the lawns and growing media businesses. Overall, we plan to increase our advertising by 20% from last year's levels, as we remain focused on our goal of achieving an advertising to sales ratio of 7%. On a percentage basis, our plant food business, which posted a 6% POS growth in the quarter, will see the sharpest increase in advertising due to the introduction of LiquaFeed, a new product from Miracle-Gro.

This product is our most exciting product launch in years, and is one of the most innovative tools ever developed to help gardeners feed and water their plants simultaneously. Retailer response has been encouraging, and we're confident it will be a compelling story for us throughout the 2006 growing season. We believe LiquaFeed will be successful for three simple reasons. First, the product's easy to use. Second, our communications with consumers will clearly articulate the benefits of the product. And third, the product works better than anything on the market today.

That same combination was key to our success in our Ortho business, which we expect to have another strong year in 2006. Consumer purchases up were up nearly 4% in the quarter, and we are confident the strategy we employed throughout the Ortho line over the past two seasons will continue to work again this year. We are optimistic that we can build upon the success last year in Ortho Home Defense with a new granular product. The new formulation makes outdoor pest control around the perimeter of the home even easier than in the past. Throughout the line, our retail partners remain strong supporters of the Ortho brand, and we're coordinating with them on several new programs for 2006 that will continue to drive our growth in this business.

On the other side of our control business we're also stepping up efforts with Roundup. Our new formulation, which provides results within 6 hours and is rain-proof in 10 minutes, will be supported by new TV commercials that highlights the competitive advantage of the product and builds upon the equity of the Roundup brand. We'll also continue to support Roundup extended control which we launched last year and became our most successful new product launch ever.

As you'd expect, our primary focus during the upcoming season will be in our core brand, but we are already seeing strong opportunities with our new Morning Song bird food brand as well. Our short-term focus remains on getting Morning Song fully integrated into the company. However, we're getting positive feedback regarding our entrance into this category and believe there is significant growth potential for us going forward. Already we've had a good experience in Canada using the Scotts name on the line of premium bird seed there. Regardless of the branding in the U.S., our goal is to extend the reach of bird food by providing value-added products for consumers and a value-added service, such as improved merchandising, for our retail partners.

Let me move on to Smith & Hawken. While the first quarter is insignificant for the core business, it's an important part of Smith & Hawken's year. Like many direct-to-consumer businesses, there were ups and downs in the holiday season this year. By the end of the quarter, our results fell just a bit shy of our expectations, but not enough to affect our full year outlook. We continue--

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--for retail media and said it will provide significant marketing and advertising support as we move closer to spring. If terms of our own operations, we continue to make good progress with our new prototype store, which will be unveiled later this year in Mill Valley California. And we continue to make technical and design updates to our internet site that will make shopping an easier and more enjoyable experience for consumer who visit Smith-Hawken.com this year. We also continue to get good consumer feedback from the design time to be made to our catalog. Between now and the end of the third quarter we expect to send more than 9 million mailings to consumers as we continue to use our catalogs as primary advertising tool for Smith & Hawken.

As you know, direct mail is also key to our marketing efforts with Scott LawnService. Our first mailing hit warm southern markets last week, and by the end of the season, we expect to send more than 17 million direct mail pieces throughout our operation. As an aside, between SLS, Smith & Hawken and our core business, we expect to mail nearly 45 million pieces of direct mail this year as this becomes an even more critical component of our overall advertising efforts. During the first quarter, SLS reported a 13% increase in sales, which is ahead of what we expected. Again, it's a seasonally small quarter, so it's too early to assess the impact of the strong start on the full year.

What is encouraging, however, is that our current customer count is in line with our expectations, despite our second price increase in two years. In our communication with our customers we clearly explained the impact of both fertilizer costs and fuel on our business, and we renewed our commitment to view our relationship with them as a partnership. The fact that both customer count and retention is tracking almost exactly as we expected is telling us that our customers view the relationship the same way. As we prepare for the season, our presence in Massachusetts and New Jersey, both of them important markets for SLS, has been bolstered by an acquisition in each of those markets. In both cases we acquired an existing franchise, which we hope will allow us to quickly leverage the positive equity the Scotts brand already enjoys in those markets.

Let me move on to International. As we shared with you last month, we remain encouraged by the progress we're making in Europe, including the strengthened relationships we now enjoy with several major retailers. Now that we are rededicating ourselves to win in the European market, our plan here is worth restating. In a fragmented and extremely competitive marketplace, we are determined to intensify our efforts to emerge as the clear leader in this category. Our aggressive stance already is getting a positive reception from retailers, resulting in improved listings, stronger retail relationships, improved market share and ultimately improved profitability. As we enter the season, we believe we have our strongest programs ever in this business. We are confident in Claude Lopez and his team and remain optimistic that our improvements there will continue.

As you can see in the release, sales in the quarter were down from last year, but much of that was expected. We are working with several key accounts as they move the timing of the shipments to better coincide with consumer purchases. Based on our conversations with those accounts, we expect to begin aggressively shipping in the second quarter and remain confident in our plans for the year. As shipments begin to accelerate, we're also optimistic about our market share outlook. We expect to make significant strides, especially in growing media, which, as we've explained in the past, is key to our long-term success in Europe. Even with lower international sales in the quarter, our seasonal loss improved from last year and was in line with our internal budget. As a result, we continue to feel confident about our expectations for this business. In all area of the business, we are pleased with what we are seeing right now. We have strong sales programs in place supported by bold and aggressive marketing efforts. And even though there's been little relief in the commodity markets, our ability to pull some manufacturing forward, as well as capture pricing, gives us confidence in our ability to manage recent cross pressures on our business.

As I mentioned at the outset, we have a two day strategic planning meeting with our board of directors this week, and I'm looking forward to the dialog. I will share with them, as I have with you, my optimism for this business this year, but I'll also share my increased confidence in the long-term outlook for our company. In preparing for the future, it remains clear to me we are making the right investments to leverage core competitive advantages: Our brands, our people and our financial strength. All of us look forward to sharing our updated strategic plan with the board as we continue moving closer to our ultimate goal of creating an enduring franchise. Thanks for your time this morning, and let me now turn the call over to Chris to review the financials.

Thanks, Jim, and good morning, everyone. Let me give you some additional insight into our results for the quarter. And, as usual, I'll highlight areas where foreign exchange rates have significantly impacted our financial statement.

Global sales for the quarter 250 million, up about 1% from last year. Excluding the impact of foreign exchange rates, sales increased about 4% this quarter, primarily driven by sales from Morning Song, the bird food business we acquired on November 18, 2005. It's also important to remember that our sales figure includes the reclassification of two amounts related to the Roundup agreement into sales.

The first adjustment is the first quarter net expense associated with the Roundup commission of 5 million. Net expense associated with the commission for the first quarter of last year was 7 million. So the reduction in the expense this year contributed a little less than 100 basis points to our first quarter sales growth. With the payment of the deferred contribution amount in early October, the annual contribution payment will remain constant at 20 million going forward. Scotts does not recognize commission in a fiscal year until minimum profit levels required by the Roundup agreement are reached, which is typically in the second fiscal quarter.

The second adjustment is to include in net sales certain amounts we incurred in the first quarter in support of the Roundup business. These costs were about 8 million this year compared to 9 million last year. I know that's a very confusing summary of our first quarter sales performance, but it's clear that between the change in Roundup accounting, acquisitions and foreign exchange the year-over-year comparison isn't straightforward. Down to the core business performance, sales in the first quarter of fiscal 2006 were about even with last year.

In North America sales increased 9% to 126 million, with the growth coming from the addition of the Morning Song business. Growth in the core North American business was hampered by retailer initiatives to reduce inventory levels and further push their purchases closer to consumer take away. Listings, programs and pricing are all well positioned as we enter the lawn and garden season, and early season POS is strong in the south and west, so we remain confident about the performance of the North American business for this year.

Scotts LawnService sales were up 13% in the quarter to $24 million. Acquisitions made in Florida in fiscal 2005 contributed about 200 basis points of the quarter's sales growth. However, the business clearly continues to generate impressive organic growth, with the increase in sales driven primarily by increased customer counts from successful market and sales campaigns and improved customer retention.

International sales were down 16% in the quarter on a reported basis, but were down 7% excluding foreign exchange. The decrease in sales occurred primarily in the UK and France as retailers delayed purchases further toward the lawn and garden season. Also, changes in distributor arrangements leading to more direct sales to the retail customer have delayed shipments into the second quarter. Gross margin dipped in the quarter to 21% from 25% last year, primarily due to the decline in margin for the North American business. While we have taken pricing in fiscal 2006 to recover anticipated cost increases, our price increases didn't take effect until January 1st of 2006. While we have some carryover from price increases we took last January 1st, they were not sufficient to cover increased raw material and fuel costs in the first quarter of 2006. The decline in gross margin rate was anticipated for the first quarter, and we remain confident about our full year margin outlook.

Total SG&A expense for the quarter was 126 million compared with 130 million a year ago. A little over one half of the decrease in SG&A this quarter was due to the impact of foreign exchange rates. The remaining decrease in SG&A reflects the impact of our SG&A reduction initiative partially offset by an increase in SG&A for our LawnService business of about $3 million as the business continues its rapid expansion. Impairment, restructuring and other charges were about 6 million in the first quarter, down from 22 million last year. This year's charges consist primarily of severance and consulting costs associated with our profit improvement initiatives, and a small impairment charge for a trade name we have transitioned out of in the UK. The charge last year reflected an impairment charge associated with the carrying value of our UK business.

Interest expense was 7 million this quarter compared to 10 million last year. We've also reduced our average net debt balance by 136 million, which includes the favorable impact of foreign exchange rates of about 37 million. Our leverage ratio was 2.0 and our coverage ratio was 7.7 as of the end of the quarter, compared to 2.3 and 6.2 respectively for the same period last year. For the quarter, depreciation was 12 million and amortization 3.5 million. Capital expenditures were 14 million. The comparable numbers for last year were 12.5, 3 million and 5 million. Adjusted net loss for the quarter, excluding impairment, restructuring and other charges, was 49 million which is flat with last year's adjusted net loss. The adjusted loss per share was $0.72 compared to $0.74 last year after adjusting for our two-for-one stock split declared on November 9th, 2005. The reported net loss for the quarter was 53 million or $0.78 per share compared to 63 million or $0.95 per share last year.

On the balance sheet, accounts receivable of 251 million were flat with last year, with the impact of foreign exchange rates roughly offsetting additional receivables from acquisitions. Inventories were 559 million at the end of quarter, a $58 million increase over last year. Acquisitions contributed about 12 million to the increase. Changes in foreign exchange rates decreased inventory balance by a similar amount. The operating increase in inventory was driven by increased raw material costs and inventory build for some new product launches. But the most significant factor behind the increase is our planned decision to prebuild inventory, particularly for our lawn fertilizer and Ortho lines in the face of potentially escalating costs and input shortages.

Hurricanes last year significantly disrupted the supply and cost of some commodities, including natural gas, urea and resins. And we are aware of circumstances where supplies of these inputs are being restricted under force majeure consideration. Prebuilding inventory was prudent insurance to ensure we don't encounter supply disruptions as we enter our season.

Overall, we are pleased with our start to fiscal 2006. The early signs point to strong potions with our retail customers, aggressive advertising plans and good cost control. And with that, I'll turn the call over to the operator so we can answer your questions.

We will not begin the question and answer session. [OPERATOR INSTRUCTIONS] Our first question comes from Joe Altobello.

Hey, guys, good morning.

Hi, Joe.

A quick question, first of all, in terms of the delayed shipments that went into the March quarter, could you quantify how much of that should hit in the March quarter?

That is a really bizarre question, Joe. [ LAUGHTER ]

Bad choice of words, I guess?

Also, I'm sorry about the electronics. I don't know, that was not us those noises and muting that was going on, so we'll have to deal with Verizon when we get off the call. Chris.

About 10 million. That was probably about 10 million, Joe.

About 10 million.

Should move over into the second quarter.

Okay. And in terms of the cost saves that you guys realized to do better than we had projected, does that mean that project excellence is ahead of plan or you're finding more costs than you had originally budgeted?

Well, Joe, I think that we're -- I think it's very -- we're very cost conscious right now in the organization. I think it's too early for us to tell what this means for the full year, but I would say this does mean that we're very pleased with the start to our initiatives. And like Jim said, it's good to start out ahead. So, I just think that we're really watching our costs and hopefully by the end of the second quarter we'll have better insight in terms of what it could mean for the full year.

I think it is fair to say it does mean we're not running behind. And if the organization is a little paranoid about over delivery, I think that that probably, Chris is right, we'll -- as we go through the year I think people are not filling positions where they have openings, and I think we were aggressive in getting going on excellence. So, Bob's done a good job leading the effort, and so I think we're pleased where we are right now.

Okay. Great. Thanks.

Our next question is from Sam Darkatsh.

Good morning, Jim. Good morning, Chris.

Hi, Sam.

Good morning.

A couple of questions. First off, your sales were better than at least internally you were expecting, and yet you're not raising guidance for the year. Am I do read that, Chris, perhaps it's because you built a little extra inventory ahead of the season that your fixed cost absorption may -- may become a little bit impaired going forward, so that kind of offsets the additional sales boost that you got in the quarter? Is that how to read that?

I don't think so. I think that, in regard -- So, I'll take the first part of the question and I'll hand the second part over to Chris. But the first part is that I think that the sales force would say that movement -- retailers, in the U.S. in particular, their fiscal years tend to be end of January, and so movement around their year ends as they try to balance their inventories for their year ends, I don't think really affects what the sales force at this point of the year is willing to say about sales for the year, IE, not willing to change their forecast. So, I don't think it means anything other than sort of an answer I hate around here which is timing. Chris, you want to take the second part?

Yes. Sam, I just -- I think it'd be helpful for you and anybody else listening to make sure we're being real clear on the communication. Sales for the quarter did not come in better than our expectations in general. They came in a little better than when we made our earnings release the last week of December, sales did come in a little stronger than that, but in general overall for the quarter, certainly relative to where we were in early December when we all got together, sales were short of our initial expectations for the quarter, again for the reasons that Jim and I have articulated coming from the retailers really managing the purchases. So, what you really had happen on the quarter is sales got moved a little bit from Q1 into Q2. And gross margins were down pretty much as expected, and SG&A came in better than expected. What it means for the full year at this point I think, our position is it's a little premature to judge. You've got to let us get a quarter into the season and see how that unfolds before we start declaring anything about the year right now.

Okay. I think I understand it that; I'll catch you offline if I don't. Two other questions, if I could. Smith & Hawken looks like it was flat on the year-over-year basis. At what point do you begin to see some of the benefits of the new -- of the new customer inflow. And then my final question would be, you mentioned that your POS was up about 13% and your overall sales, I guess excluding the Morning Song, were about flat in North America. Is that difference, that 13% difference between POS and your organic sales, is that what was -- what was the -- the inventory drawdown or is there some definitional issues with how you define the POS data that maybe obscures that, that information flow?

Smith & Hawken first, up about 2%, and I think if you look at what we're see so it's up slightly. I think the store business, our sort of customer count was pretty good. I think what we saw was sort of not the size of the purchases that we would have liked to have seen, but I'm not sure we are different than a lot of retailers. It was kind of a mixed season I would say at retail. The internet business and the catalog business was really good. And I -- I'd say that Christmas is a -- a season that is important to Smith & Hawken, but I'd say we haven't quite figured it out yet.

And I know that they're really optimistic about the spring and feel that they're well prepared for that business. And so, that's kind of where we are with Smith & Hawken, but I think continuing to work moderately satisfied with the Christmas season, particularly on the internet and catalog, less so in the stores, but not, it wasn't a disaster, and looking forward to the spring and some important new store openings in both location and design. Can you take the second part, Chris?

Yes. Sam, the first quarter of our fiscal year is a tricky year -- tricky period to try to correlate selling and consumer takeaway. If you think about in August and September of last year we're selling in a lot of the fall product and the consumer is buying it in September, October, early November. So, some of the POS that you're seeing the results there are really from products that we sold in in fiscal 2005. So it's a tricky period to try to correlate POS and first quarter sell-in. It just means, from our point of view, that we're pleased the consumer takeaway of our products was strong in the quarter, but it's a very difficult quarter to try to correlate sell-in and takeaway and you can't read anything into the --

I think what you can read is that consumer takeaway was fairly robust, and retailers continue to manage inventories down, and I think that's positive for us.

Okay. Thank you. I have other questions, but I'll ask them offline. Thank you, gentlemen.

Thanks.

Thank you.

Our next question comes from Eric Bosshard.

Good morning, Eric.

A couple things. First of all, can you talk a little bit about -- you made the comment, I think Chris, of pulling manufacturing forward in the quarter to build some inventory related to some concerns with either price or availability of materials. Can you give us a little more color on what's changing relative to what you might have expected and how you managed through this.

I mean, I'll start with that and then maybe ask [Mike Lufarner] if he wants to throw something into that. I just read a lot of stuff in the papers about force majeure and a lot of our sort of colleague companies in sort of the marketing world. I know that a lot of people were having tough times getting product where natural gas was involved and where plastics were involved. And basically, running out of product is not something -- I mean, I would rather pay a little more actually than get force majeured out so we didn't have packaging materials especially. So, in discussions with Bob and his team, what we elected to do was just accelerate the manufacturing process, pull as much manufacturing as we could forward, buy as much raw materials as we could, in order to be sure that if -- which was my fear and I wasn't the only one -- that natural gas would be divested to consumers in it time, if it was really tight supplies, that we had the products, and that would be urea and basically plastic packaging, to satisfy the consumer. So, Mike, you want to add anything?

No, I think, Jim, you covered it. We had some, we saw some companies that were cut off and allocated on resins for plastic packaging, so we wanted to get ahead of the curve, control our costs.

Okay. And then, within that, now that you've done what you've done, how do you feel about your ability to get material and then how do you feel about the cost that you're going to have to deal with this year relative to what you had planned and what you discussed back in December?

Well, I'd say that we're, as far as, we're on our financial plan for manufacturing. We're over-inventoried, slightly, at this point but that -- that's not hard for us to solve. So, we feel good about it, and I think that as we look at the availability, just because we were talking before the call began, I think we had started to become more comfortable with the environment until all the talk of Iran and we're back to sort of close to $70 oil again, and that -- we'll just have to take a look at what that puts us to as far as we deliver product now. So now, the part will be diesel fuel to move finished goods from our warehouses to our retailers, and I know Mike's watching that hard to see -- But, right now we're comfortable where -- between pricing and all the work we've done to sort of keep our costs under control, I think we're comfortable with our cost of goods compared to budget right now.

Yes, cost of goods are fine. Availability won't be a problem. As Jim said, the $70 oil could be a problem on shipments.

But that's just -- that's a cost issue, not so we couldn't deliver.

Right. It's a manageable issue. And the second question is, based on what we've seen so far in the south, where the season is beginning to break, can you give us any insight into either the success of new products or product categories or share of sales that you're seeing as a precursor of what the season will show us as it further develops, what's going really good, what's not going so good?

Well, I mean, I think what we've seen so far is our lawn business continues to perform well in our warm season markets. And our dirt business, our growing media business, also performs -- is performing really well. It's a little early for Miracle-Gro yet, but bottom line is, I think, we're seeing -- in those markets where it's warm, we're seeing really good numbers across the board and so -- across all of our categories. And, as far as the introduction of new products, the biggest being the LiquaFeed product, I think we are surprised in a really positive way on the sort of listings we've gotten for that product. And, not like we can't believe it, but the retailers have endorsed product well. And, again, I think it's a market that is really starving for innovation, and any time anybody innovates, I think the retailers say, Attaboy, that's what you should be doing.

Okay. And then, lastly, if I could, international margins. Can you just talk about progress and how you feel coming out of the first quarter with that opportunity.

Yes, like I mentioned, Eric, the margins are, for all of our businesses, are down a bit in the first quarter, but it was really anticipated, so I don't think that there's anything in the first quarter for the international business that gives us any cause for alarm right now, relative to our full year outlook.

Okay. Very good. Thank you.

Our next question comes from Bill Chappell.

Good morning. Just following up on the international, can you -- I think your 10 to 11% sales growth number is excluding foreign currency impact. Can you kind of update us, maybe with where the dollar and the euro stand, where you think that will fall out this year?

Bill, the 10 to 11% sales guidance was using a budgeted FX rate for the euro and the pound. We have to estimate what we think that's going to be for the year. For right now, FX is tracking reasonably close to that. So, right now I don't have any reason, really, to change that guidance.

Okay. And the second, I think, did the analysts say there was commentary about a few acquisitions in the LawnService business that might happen before year end. Did those happen and did that change kind of the outlook of that business?

Yes, we made a couple of acquisitions. If Tim Portland's on the line, he might be able to speak to what-- We bought back a franchise in New Jersey. So we have secured a couple of those. I don't --

And New Hampshire.

So we, we bought a small franchise in northern New Jersey and one in north Boston. They're pretty small. They were more strategic to get those territories back, and we believe we can grow them aggressively. But they're not going to be very material to this fiscal year.

Okay. And then, on the restructuring, just -- can you give us an idea what further restructuring you have in future quarters, or are we pretty much done in terms of the cost savings program?

No, we're not done yet. Jim has laid out some targets for us as an organization to work to to continue the program into 2007. Both in the U.S. and Europe. So, like coming out of our strategic planning meeting this year, we're going to reinitiate on our plans, and Bob Bernstock is really leading that on a global basis. We'll hope in the second quarter to really complete our plans for our further cost reduction initiatives in 2007, and maybe by then we can be in a position to give you a little more insight in terms of where those are going to be and to what extent and what are the costs associated with them. So, say, give us the quarter to really work through that, and maybe, hopefully by the next call we'll be in a position to talk about it.

Well, let's be clear on what -- the targets I set. The targets I set were earnings targets, and that probably means some -- I know you're going to use -- want to use the word restructuring, but changing how we do business, which will involve some one-time expenses, probably.

Okay.

I just want to get to a point that Chris and I are sort of circling around, at least from a corporate side. We sort of hate being criticized as serial restructurers, and I think that we are at least intellectually, the two of us, thinking really hard about basically saying there is a point and that we don't care what we change, it's just -- we're just going to run it through the P&L and we'll tell you guys so you know about it, and you guys can do whatever you want with your models. But I think this -- I just don't like being called a serial restructurist, because people say it's just part of running your business. And that, directionally, is where we're headed. I don't know when that'll be, but I would hope that we'd be sort of seriously in that mindset by '07 or '08, where we just -- we don't talk about restructuring any more, and we don't use the word as some excuse.

Got it. One last follow-up. I missed that first question. Did -- for the fourth, I mean, for the fiscal first quarter, did that one customer that postponed sales just not postpone as much or not postpone as all the purchases?

I'm looking down at the sales end and they're just nodding their head no. I'm not sure what that means.

I'm not sure about the one customer. Well, sales same in a little bit stronger in the quarter, North American business, plus sales came in a little stronger in some of the ancillary businesses, so, what Jim was alluding to, in a small quarter you can have a series of relatively insignificant changes that can add up to a significant impact on the quarter and that's really what we saw. And, I think it's also fair to say that one customer was pretty serious about getting their inventory levels down, and they worked hard at it. Yes. The -- it was really more a series of other customers buying a little bit more and that one customer pretty much doing what we expected.

Okay, great. Thanks.

Our next question comes from Joe Norton.

Yes, thanks, good morning.

Good morning.

Just going a little bit more on this retailer inventory issue. Does that -- how is that playing out as you go through -- as you get closer to the peak season? I mean, it sounds like that could create some risk that --inventories may be managed more tightly through the season. I guess I'm just thinking of as we get into March and we do that really big sell-in, doesn't that create some risk? Really, just the timing -- the usual timing risks, but wouldn't that imply we want to be real conservative on that March quarter sales estimate?

Listen, I'm not talking to you, Joe, so let me just talk to sort of across the table at my colleagues, but this is a conversation we've had before, which is that if we weren't communicating and partnering with our retail partners, it would create risk. Because, and if we have a transparent relationship, which is the way it has to be when people are acting financially reasonable, that is the issue of selling a whole lot of stuff in 5 months, and then sitting on a bunch of inventory for 7 months, doesn't make a lot of sense economically and from a sort of GMROI and return on vested capital. So, everybody is going continue to draw down their inventory to the extent they can, and then expect us to perform in this sort of pristine fashion as we reinventory them sort of after the fiscal year and just before the customers need -- the consumer walks into their stores. And that sounds good, okay, but there are limits on our ability to perform, even though our performance, compared to call it 5 years ago, is significantly better in all kinds of ways than it was from a supply chain point of view.

So, the way to reduce the risk is to sit down and plan out with the retailer in a honest, transparent way, saying here is our limits to ship and our limits to execute and get the stuff put out in the stores so it looks good to the consumer. And I think that -- so, I think you will continue to see pressure to keep me out of inventory until I need it, and I think we have to avoid that risk, just keep telling consumers, or the retail customer, here's what we can do and here's what we can't do. And I think if we do that honestly, the retailer will appreciate our honesty, we'll get out of the gaming game that I think a lot of vendors and retailers have, where they don't believe anything anybody says, but that's the way it has to work. And I think if you don't do that, there will be risk. But I don't believe we are in a situation where they misunderstand what we're capable of. Our capacity to ship just in time I think continues to improve, and therefore retailers will try to take advantage of it.

So does that -- so then, we shouldn't worry that as we get to the last half of March somebody's going to try to take another week out of that sell-in? That's kind of what I'm driving at.

I wouldn't worry.

Joe, I mean, just, I'd say the same thing as Jim and kind of build on it a little bit. For sure, customers are going to be drawing down inventory over time, and we're constantly getting better at delivering just in time and improving our customer service. And so the skill in putting together a plan, a quarterly plan, is to understand and work with each individual customer and build those changes into the plan that we have, and we think we've done a pretty good job. We don't anticipate any surprises at this moment.

Okay. And then, just going back to the oil prices. And it sounds like it's still a bit of a question mark on the core business, but more specifically on the LawnService. Where -- can you just give us any sense of the sensitivity of that business to $70 oil, kind of where you plan is and at what point you feel you have a problem?

I'll hand this over to Tim Portland but, let me just say that that business is pretty sensitive to oil. Now, on the other hand, I would say Tim and his team have done a really good job managing the business in so that they have been able to deal with a few body blows, but to those guys, kind of laborer and fuel are major factors, more so than in the sort of conventional brick and mortar business that we run. Tim, you want to add anything to that.

No, I think you summarized it pretty accurately. We budgeted for approximately $70 a barrel oil, so if it stays in that range we're in line with our budget. If if goes beyond that, we'll have unfavorability and we'll have to deal with it. That happened to us last year, particularly at the end of the season with Katrina when fuel spiked way up, and diesel spiked disproportionately. So, we have to manage the business and look and scrape and find other expenses.

Do you think you would be able to take another price increase in that business if it was -- if it went to 80.

Don't answer that. I'll take that one. I don't want to get into the pricing game with consumers. I think that we've taken pricing -- we're, I think, really lucky that our cancels have been either lower than we thought or within sort of what we thought was going to happen, but I do think that innovation, to me, in our LawnService business, is one of the things, is that we just can not assume we can take pricing every year. And we've got to find ways to change the products that are being put down, the active ingredients we're putting down, to sort of reduce the volatility of call it delivery, which is people and fuel. And I think this is really important challenge for the LawnService team to really be innovative. I think this business has been growing so fast and has been doing what I think is such a good job, that they're kind of just running their meat and potatoes business. And I think we got to start thinking about innovation, and this has happened in the pest control side, where there's a lot less home visits today, and they still get a good, great result. And so I think that one of the things we have to do is not put too much pressure on the consumer, and I would really put a lot of pressure on Tim and his team to not take pricing, unless it was absolutely critical, and I can't kind of see that happening.

Okay. Thank you.

Tim, you copy?

Amen.

Okay.

And --

Go ahead.

I take it, Tim, you make the final decision on pricing in that group or?

Yeah, except I got a finance guy handcuffed to me and he's my partner.

Got it. Thank you.

Operator, we have time for two more questioners at this point.

Thank you. Our next question comes from Alice Longley.

Hi, good morning.

Hi, Alice.

I'm looking for an update on your annual sales guidance. You said 10 to 11%, and if you take out Morning Song I think it's 7%, and assuming that Europe continues to be sort of lack luster at best organically and then you have currency to deal with, can you back out what you're expecting North American consumer shipments to be? I know we also have LawnService. Could you back those two increases out?

Alice, we can probably help you do whatever you need off line. I would say the headline right now is that we're really comfortable, still comfortable with the topline guidance. Are comfortable with our FX assumption. What's going on with international, we view as very similar to what is going on in the U.S. and in talking to the management team, we anticipate making most of that up in second quarter. We don't view that as anything other than retailers managing the timing of purchases in Europe as well. So, I think the headline right now is that we're not -- nothing that's occurred in the first quarter has caused us to want to change our full year guidance on the top line.

Okay, but I think the mix of sales growth is LawnService, as a newbie, continues to be a high growth business for us. Our North American consumer business tends to grow faster than the European consumer business, and our pro business, I think, has performed well. And that's kind of where we're at. And I think, within that, I'm happy for everybody to talk and try to figure out, if they can, what that all means.

Are you assuming that North American consumer continues to gain share?

Yes.

And how fast do you think lawn and garden as a category will grow, something like 5%?

I would be a bit more conservative and say 3% percent like last year, Alice.

Okay, and I've got a question put a little different way than some of the earlier questions. Would you expect third quarter shipments in North American consumer to be up more than second quarter shipments, because of a continued shifting, some of the inventory issue but also a shifting out into when the shipments will be the strongest?

Dave, do you want to--

Well, I'm looking at North American finance chaps and they're nodding their heads so--

Meaning, yes?

Marginally.

Okay. So we should work that in. And then could you update us on the -- you gross margin guidance for the year, and then what we'll see in the second quarter for gross margin year-over-year?

I can take that second one. You know, Alice, we're not talking by quarters in terms of margin. And we've not certainly given any guidance to that effect. For the full year, though, again we're still comfortable with our full year. We said that with Morning Song, Morning Song is going to be a little dilutive to gross margin, but not really dilutive to operating margin. That continues to be our belief. But given that, we saw being down 30 or 40 basis points on gross margin for the full year. If you exclude Morning Song, we thought margins would be flat to up 10 basis points. So, I think given the cost environment and pricing, we're looking for those basically to offset. And if, so if you take out the acquisition we call it sort of flat performance on margin rate this year.

And would -- would we see that evenly, taking up Morning Song, would we see flattish gross margins year-over-year in the second and third quarter, or is it going to be better in the third quarter than the second, do you think?

I think we will have to maybe we can talk to you afterward. Again, we haven't really talked about it. Given specific P&L guidance by quarter, and we're reluctant to really want to get into that. So, why don't we see if we can talk to Alice and somehow get you comfortable. But I -- we really don't want to get into trying to give detailed P&L guidance by quarter.

Okay, and then, I have one final question about your innovative smoking program. Are you getting any disruptive employee morale issues around that?

No, in fact, I'd say that, considering the manufacturing associates here sort of, as a demographic group, tend to be higher smokers, I think that they feel it'd be challenged by it. I think they feel better that when we tell people that we are not looking to smoke people -- smoke people? -- fire people, and start with the fact that people who should consider themselves at risk in states where we have a choice to hire or to employ smokers or not, people who say I know the risks and I don't care have good reason to be fearful of the policy, but I think that what we have said, and this seems to have been positively received, is the fact that anybody who is making an effort to quit legitimately is not -- there is no line in the sand on timing. If they're working at quitting, we'll work with them. And the other side of that, which I think is really important in this debate, is the fact that this is not a smoking policy at Scotts. It's a wellness policy, and in part of our wellness, we have thrown a lot of stuff in as far as our health facilities, our medical facilities, really made the -- all kinds of the medical programs free to people and their families, and so we're hearing a lot more about that. Go ahead, Bob, you're looking to throw something out, and I'm not sure what percent usage means.

In visiting the wellness center on a regular basis and including the manufacturing site and the folks in the headquarters, we've got about 60% usage of the wellness center, which is really greatly appreciated by the employee.

You know, I give maple syrup to every associate, and here on this campus, where we got about, I don't know, call it a quarter of our people, I do that myself, with my eyes and my hands, and when I went over to the manufacturing facility, I was a little worried, to be honest, about what the -- what I'd hear. And, while there were a few angry people, I think generally people were sort of Midwest nice, one. And two, much more concerned about why the fitness facility closed before the second shift got off and it was not very hard for us to say, we're going keep it open for the second shift, IE, until kind of 1:00 in the morning, so that people who want-- And I heard more about that than I heard about smoking, in the manufacturing plant, and I think that's a positive and says something about how our people are feeling.

Okay. And I guess I do have one more question. You've quantified the cost cutting benefits in fiscal '06. Can you quantify the benefits that might be incremental to the P&L for fiscal '07, carrying over?

Well, Nagel was--

Anything new--

No, no. But, I will say this, that it's going to be a significant amount, and we are working really hard on it and Bob, who led the effort for the first wave, is leading on the second wave. It is much less, if not at all, a non people issue and much more sort of a process and how we run our business issue. So, but we're on it. It's a significant amount of money. We're just not prepared to say how much it is.

And one reason I was shaking my head is, we simply just don't know the answer yet. So, like I said before, we'll try to be as transparent and communicate as much as we can as soon as we know the number. It's going to be our highest priority here in the second quarter, I'm sure, as a management team, and I think we should be pretty prepared by the end of Q2 to talk about it.

Excellent. Okay, thank you.

Yes.

Our final question comes from Doug Lane.

Hi, good morning, everybody.

Hi, Doug.

Question, can you, Chris, give us what the dollar contribution was from the Morning Song and [Rod McClelland] acquisitions in the quarter?

You talking about bottom line?

No, sales.

Sales. Yes, sales -- sales from Morning Song were about $10 million. And Rod McClelland was $3 or $4 million.

Okay. Thank you.

But, you know, again, we didn't own them for the entire quarter, so, but that's how you can sort of think about the year-over-year.

No, that's all. Yes. You only had Morning Song for about half the quarter, right? Or even -- if that.

Right.

Jim, judging by your comments a few minutes ago, I assume then that the outlook for pricing that you talked about in our December meeting hasn't changed, that your success rate is at or better than where you thought it would be then?

Yes. I think that we weren't the only one out there taking pricing. I think that other people had different techniques of, ie, going after 12% and accepting 4 or whatever. But, I think given the pricing environment, we took a what I consider to be a very moderate view of pricing. It was not negotiable. You can look in as we talk about gross margin, we are not making money on pricing. We are just trying to stay even with our changes of raw materials and no, we -- I -- this is not to say everybody's happy with 2 price increases in 2 years, but I do think that people are understanding, and I don't think, unless something really amazing happens, that we should expect to get pricing next year. I think that might break the camel's back.

Okay. David, I was in and out of the call I apologize, but did you talk about the specific materials that you're experiencing, or think you might potentially experience, shortages in?

Yes, I mean we did. I think it's anything that's naturally natural gas based, and so I think we're -- resins were something we're really concerned about because a lot of those resin plants are on the gulf coast, and coming out of the hurricane season, a lot of people in our business that buy packaging were put on force majeure. Now, we tend to buy slightly different kinds of plastics on the films we use in our packaging, so we didn't see that force majeure but we were concerned about it, and we tended to accelerate our purchases on those products, and urea is another area where we just had no idea where sort of pricing was going on gas, which is a major ingredient in urea, and we tended to buy as much as we could early, and we converted quite a bit of that to finished goods. And, so, we just accelerated the process of, I think, given what we knew after Katrina, or at the time of Katrina, our view was, sitting on a little extra inventory to make sure we can deliver, given the retailer mood that they'd like to sit on lower quantities of inventory, we viewed as being conservative and kind of righteous, and we did that. I think the world hasn't gone as ugly as we thought it would. Although, right now again, with the oil prices being up high, it's at the different challenge and it'll be a delivery-price issue. But, we're on budget, but it was, I think, plastics and urea that we really were pushing and worried about.

Right, and so, obviously, energy costs are continue to be high and that will be a price to pay going forward, but on the shortage front, do you you view yourself as pretty much out of the woods and then that should have a favorable impact in inventories going into March?

Yes.

Okay. And then, lastly, can you talk a little bit about Smith & Hawken and the move into target and where we are there? Did that contribute to sales in this quarter, or what is the timing of that? And a little rundown on the economics on how it is going to impact the P&L.

Well, why don't I hand you over to Barry Sanders, who's in the room with me here, and he runs that business and is doing a super job, so--

Okay.

This quarter it was positive about a million dollars. We just started the program that's rolling out to the target garden centers which is in the state of Florida, Arizona and California. They rolled out their -- began rolling out their outdoor set. Inside the store, that will roll out around end of March, beginning of April this year, so for our fiscal year we'll only get about a half a year impact. Positive to the P&L will be about $5 or $6 million this year.

Now, does that go right to the bottom line?

There is some cost associated with it, but about half of it.

Okay. And so that will be in the Smith & Hawken or the corporate or whatever that segment is.

Correct, it'll be in Smith & Hawken.

Okay, I got it. Thank you.

You bet. Operator, we're are going to wrap things up this morning. If there's anybody who didn't get their questions answered just give Investor Relations a call later today and we'll take care of you separately. You should know that management is going to be participating in a series of equity conferences between now and our second quarter results, and those will be posted on our website if you want to listen in to those. Otherwise we will talk to you all again in April when we release our second quarter numbers. Thanks. Have a good day.