Scotts Miracle-Gro Co (SMG) 2006 Q4 法說會逐字稿

Good morning, and welcome to the Scotts Miracle-Gro Company fourth-quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Now, I will turn the meeting over to Mr. Jim King, Vice President, Investor Relations and Corporate Communications.

Thank you, operator. Good morning, everyone, and welcome to the Scotts Miracle-Gro fiscal 2006 year-end conference call. With me this morning is Jim Hagedorn, our Chairman and CEO; Chris Nagel, Executive Vice President of North America; and Dave Evans, our Chief Financial Officer.

Before we get started, I want to remind you that our annual analyst day meeting will be held on Tuesday, December 12th, at the Grand Hyatt hotel in New York City. A series of business overviews and presentations will begin at 9AM that day. After lunch with management, we will share a more detailed look at our financial guidance for 2007. We would expect the meeting to conclude at about 2PM. You should have received an invitation via e-mail from us earlier this week. If you have not received the information yet, please contact [Heather Scott] at 937-578-5645.

Moving on to the business at hand, I want to remind everyone that our comments this morning will contain forward-looking statements. As such, actual results may differ materially. Due to that risk, Scotts Miracle-Gro encourages investors to review the risk factors outlined in our Form 10-K, which is filed with the Securities and Exchange Commission. If you did not receive a copy of this morning's press release, you can find it 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As a reminder, this call is being recorded, and an archived version of the call will be available on our website.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 will provide those items on the website as well.

With that, let me turn the call over to Jim Hagedorn to discuss our performance.

Thanks, Jim, and good morning, everyone. As we were preparing for this call, I realized that our year-end messages have become a bit redundant in recent history. But you know what? That's a good thing when you're generating record results year after year.

So, let's get started. As we should, all of us at Scotts Miracle-Gro feel good about what we have accomplished in fiscal 2006 -- record sales, record earnings, our most successful new product launch ever and a strong finish to the year that gives us continued momentum entering 2007.

Our core business had an outstanding year, its best ever. Scotts LawnService also had its best year, surpassing its sales goals, increasing its customer counts to record levels and continuing to take market share. We made meaningful progress in our European business, especially in growing media, as Smith & Hawken had a great launch with its program for Target and made a number of important improvements.

All of us have reason to be proud of 14% sales growth and 20% earnings growth. Our investors should be pleased as well. But for all of our successes in 2006, I believe looking at the year in a vacuum would be a mistake. Investors should look at last year in the context of our long-term track record, which I believe speaks for itself.

Over the past five years, adjusted net income had grown at a compounded annual growth rate of 23%. Sales during that period have grown at a compounded rate of nearly 10%, and along the way we have generated more than $700 million of free cash flow, delevered our balance sheet, improved ROIC by almost 250 basis points and returned cash to shareholders.

As we put the finishing touches on our plans for 2007, all of us, including myself, are doing so with a renewed sense of energy and purpose. We will continue our dialogue with our Board of Directors next week, in an ongoing review of opportunities to exploit our financial flexibility and seeking continued growth, while also contemplating programs to send even more cash back to our shareholders.

When we meet with you in December, you will hear each member of the management team talk about their key learnings from 2006. You will also hear them discuss their business plans for 2007 and beyond in the context of gross margin improvement, free cash flow and returned on invested capital. These important metrics must be the cornerstone of our future planning as we manage our existing portfolio and pursue other opportunities, all with the goal of enhancing long-term shareholder value.

With that, let me begin a review of the results we announced today, which I believe demonstrate the continued power of our brand as well as the passion, energy and commitment of our team. Nowhere was the results of this commitment more evident than in the North American consumer business. Over the next few minutes, I will review what occurred with the consumer in 2006. Later, Dave will share the detailed sales information across the business.

According to the point-of-sale data or POS that we get from our largest retailers, consumer purchases were up 10% for the year. Despite $3 gasoline in the peak of our seasons and concerns about the health of the consumer, lawn and garden activity remained strong. We believe the entire category grew by roughly 4% to 5%.

I hope the strength of the category this season helps investors understand why we believe comparing us to housing-related stocks or consumer durables is improper. While it may be difficult to consider lawn and garden products a true consumer staple, the POS data suggests that consumers are unlikely to forego purchasing our products, even in the face of macroeconomic pressures. Our historical data supports our belief that consumers tend to stick with lawn and garden, even if the economy falters and they are forced to make other financial sacrifices. That certainly was the case this year, as consumers continued to support every category of lawn and garden.

We were especially pleased with consumer acceptance of Miracle-Gro LiquaFeed. Halfway through the season, it had already become our most successful new product launch ever. By year end, it had generated sales of nearly $40 million and led to an 11% increase in plant food purchases.

We believe LiquaFeed has just scratched the surface. Our estimates suggest that household penetration is still in the single digits. We believe LiquaFeed has the potential for continued momentum through 2007. We also continue to succeed with our value-added growing media business, primarily utilizing the Miracle-Gro brand. This is a category we essentially created in the late 1990s.

Consumer purchases of growing media increased 18% in 2006, continuing to demonstrate the dynamic nature of this category. Purchases of Miracle-Gro Moisture Control Potting Mix were up 31%. Miracle-Gro Garden Soil increased by 24%, and Scotts Lawn Soil improved by 32%.

Growing media is a category that continues to benefit from innovation. Whether it's the moisture control feature of our potting mix or the season-long color of our mulches, we continue to find ways to improve these products.

Innovation will also be key to the continued growth in the lawns business. In December, we will share plans with you for a focused range of new products that will more effectively meet consumer needs, while helping both Scotts Miracle-Gro and our retail partners achieve better long-term results.

Even without these new offerings, the lawns business had another strong year in 2006. Overall consumer purchases were up 14% on the year. Within that number, purchases of straight Turf Builder fertilizer were up 24%. Remember, straight Turf Builder is one of our oldest products, first introduced in 1928. Our combination products -- especially Turf Builder Plus 2, which kills dandelions, and Summer Guard, which helps control insects -- also had a solid year. Consumer purchases of these two products were up 6% and 18%, respectively.

Our grass seed business had its best season in years. Consumer purchases improved 17%. Staying on the theme of innovation for a moment, grass seed is a category that often gets overlooked. Our acquisition earlier this year of Landmark and Turf-Seed greatly enhanced our R&D efforts. Simply put, the greatest innovators in turf seed in the world are now members of our team, and we believe our long-term prospects in both the consumer and professional seed businesses will be even stronger as a result of these acquisitions.

The results in the control business were mixed, depending on whether you were looking at the insect control or weed control businesses. On the weed side of the business, it was a disappointing year. A dry and warm spring made the weed season unusually brief, which especially affected our lawns business as well as Ortho and Roundup.

There were still several bright spots in the weed category. First of all, purchases of extended control products, which not only kill weeds but provide a season-long barrier for new ones, were strong throughout the season. Ortho Season-Long Grass & Weed Killer was up 9% from last year, and Roundup Extended Control, which we introduced last year, reported a 46% POS growth.

Secondly, by the end of the year, the category had begun to regain its momentum. In the fourth quarter, for example, consumer purchases of Roundup and Ortho weed control products had rebounded.

On the insect control side of the business, POS of Ortho Home Defense Max, a perimeter control product, grew by 12%. Our fire ant products improved by 22%. We are underrepresented in these categories, and this is an area in which we have significant potential and momentum.

We have had great results in the insect category over the last several years, as we continue to improve our relationship with the consumer by developing better products and driving home messages that build trust for the Ortho brand. Not only have we improved our business by strengthening our relationship with the consumer, we have also continued to build our relationship with our retail partners.

Fiscal 2006 was another year of improved customer service levels, as our fill rates exceeded 99% for the full year, an all-time high. Additionally, our supply chain team not only managed the volatile commodity market, but they did an excellent job working with our retail partners to better manage the distribution of our products, which allowed us to navigate the fuel markets during the season.

Our sales force not only demonstrated why it's such a major competitive advantage, they also received the endorsement of our largest retail partner. Whether it's managing the sell-in or driving the sell-out to the consumer, our sales force continues to outperform our competitors when it comes to helping to improve the productivity of our retail partners.

Last week, Home Depot recognized us for the second time since 2003 as its top vendor in lawn and garden. It's an honor we're proud to have, and one that we believe is justified. We want to think Home Depot for the recognition, as well as thank all of our retail partners for their continued support of Scotts Miracle-Gro, as well as the entire lawn and garden category. They should know that our team is committed to continue building excitement for the category and in helping them improve their returns.

I want to move on to the rest of the businesses, starting with Smith & Hawken, which made significant and important strides in advancing our strategic plan. The first year in our relationship with Target exceeded our goals and set the stage for further improvement next year. We also opened two new flagship stores, both of which are showing strong results and demonstrating the potential for a larger and more disciplined merchandising strategy.

Of course, our new management team, led by Gordy Erickson and Felix Carbullido, also has been a major improvement for us. They are taking Smith & Hawken back to its roots with a greater focus on the gardening experience, and they have developed a strong merchandising program that will start to take shape next year. While we have made important strides, we recognize that investors judge progress by looking at the bottom line. I'm not trying to minimize the fact that 2006 was a financial disappointment for this business. Clearly, we at Scotts started the year with unrealistic expectations for this business, which magnified the impact of every challenge we faced, no matter how small.

But let me reiterate the importance of this fast-growing category. We see the patio as the merge of the house and the garden, and no one is playing there in a meaningful way right now. It's obvious from the number of players jumping on this bandwagon that others see the long-term potential of this category. But in Smith & Hawken, we possess the most important brand in the space, as well as an increasingly stronger understanding about the outdoor living consumer.

Is this going to be quick one for us? No, and we said that at the outset. But in taking a long-term approach to running the business, we must strike a balance between near-term wins and long-term opportunities. We're convinced about the potential for outdoor living, and we look forward to continue making progress against our vision in 2007 and beyond. We also remain optimistic about what we're seeing from our international business. While the overall European consumer lawn and garden market had a tough year, we made progress and continue to take share in the marketplace.

Our European growing media business, which we told you would be a major area of focus, was up 16% on the year. We have also told you previously that we intend to take a more global approach to marketing the Miracle-Gro brand in Europe. Miracle-Gro branded soils in the UK were up nearly 50% on the year, and we are optimistic that we can continue to drive growth in the value-added growing media business, just as we have in the US.

I can spend time talking about issues beyond our control in Europe -- the late break to the season, for example, followed by watering bans in the UK. However, our job is to overcome those sorts of challenges and to deliver improved results in the business. We believe we can.

In addition to growing sales and continuing to outperform the competition, we must find further synergies between this business and North America and continue to drive costs out of the international organization. That process has begun, and we expect continued progress through 2007. In the absence of an opportunity to participate in a consolidation of the European market, which we believe is needed, it's unlikely you'll see a significant change in the lawn and garden category there anytime soon.

As it relates to our expectations, let me reiterate what I said on our last call. Our goal going forward is that international keeps pace with the overall business. While I don't literally mean they need to be in lockstep with every business unit, I do mean that this business cannot continually be a drag on our corporate performance. One goal for her December meeting is to provide you with a more detailed explanation of our plans for this business and a clearer understanding of why we believe we can achieve a higher level of performance there.

Let me move on to discuss Scotts LawnService. Dave will provide a more detailed look at the numbers in a few minutes, but I am extremely pleased with our performance here this year. For the full year, our customer count grew by 12% to nearly 450,000, and our trailing 52-week retention rate at fiscal year end was at an even 70%. We continue to see strong improvement in the customer service, as cancellations related to the service quality actually declined on a year-over-year basis, even as the business grew.

However, cancellations due to economic issues increased noticeably on the year. It was also clear from our sales mix that the value-oriented consumer was less engaged in the category, and we suspect that many of them decided to save money by managing their lawncare needs with DIY products.

On the other end of the spectrum, however, we had a greater level of success with our higher-end program offerings. This favorable sales mix helped us offset higher-than-expected product, labor and sales costs, and we believe we have a continued opportunity to build the high end of the market going forward. Further, unlike others, we do not believe that weather was a big factor in this category during 2006.

While some markets, particularly Dallas and up through the Central Midwest, suffered because of more extreme heat and drought conditions than in 2005, the rest of the country was largely unaffected. In fact, in key southeastern markets, including Florida, the weather was significantly better in 2006. You might recall that last year, six major hurricane struck the US, causing a significant disruption to the lawn service business.

Let me switch gears for the remainder of my time this morning and share my thoughts about the recent management changes we announced and give you a better sense of what I expect for 2007. I want to start by saying I'm excited to be back, more engaged in the operations of the business. In fact, our organization structure now is more similar to what it was in 2001 through 2004. As a result of these changes, I think you'll see a higher level of energy and a greater focus on the long-term growth of our core business. While Smith & Hawken and Scotts LawnService remain important aspects of our enduring franchise strategy, there should be no doubt that we believe the focus should be on the North American core business.

Secondly, I want to take the opportunity to publicly congratulate both Chris and Dave on their new roles. But I also want to reinforce why the Board and I agreed they were the right choices for the Company. Both are extremely knowledgeable about the business, disciplined in their management style and focused on getting results. Both are also respected throughout the organization, not only for the reasons I just shared but because of their willingness and ability to challenge the status quo.

I believe Chris was the perfect choice to run North America, especially since we're going to put more focus on improving gross margins, driving free cash flow and improving ROIC. He is fully engaged already, and brings a level of enthusiasm and commitment to the job that is very much needed.

Dave was the obvious choice to be our next CFO. His knowledge of the overall organization is extensive, and his management style, like Chris's, is a good complement to mine. As I have said many times, I believe every business leader should be handcuffed to a financial partner. Dave is my new financial partner, and I look forward to the contributions he'll bring to the Company.

As it relates to next year, we are optimistic that we will maintain our momentum. Right now, the organization is still absorbing the management changes we made last month. We're not only revisiting and finalizing all of our initial budget assumptions, we are also taking a hard look at our longer-term strategic plan. Before we share any further details about next year with you, we want to do some longer-term modeling on cash flow, return on invested capital and capital structure.

These topics will all be discussed with our Board of Directors next week, and we will be ready to share them with you no later than our December meeting. For now, we are reiterating our guidance of 10% to 12% net income growth and look forward to sharing more details with you in December.

With that, I want to turn the call over to Chris, who will share some thoughts about his initial impressions of the North American business, and then Dave will review the financials.

Thanks, Jim, and good morning, everyone. My comments today will be extremely brief, but I wanted to share with you some of my initial impressions of the North American business.

Let me start by saying that I have inherited a world-class team. It has taken just a few weeks to reinforce my believe that the talent and commitment of this group are the overwhelming reasons why we continue to grow our categories and take market share, while working ever more closely with our retail partners.

Jim already outlined the strong POS growth that the business reported for 2006. As we prepare for the next lawn and garden season, we are optimistic that our momentum will continue. New products in our lawns business, the second full year of LiquaFeed and strong, focused marketing support in both our growing media and controls businesses bode well for the upcoming season.

Obviously, I have been spending the last few weeks getting immersed in the details of the business, meeting with our retail customers and understanding our plans for 2007. My first impression confirms the beliefs that I held as CFO.

Our North American business is stronger than ever, and we have outstanding opportunities for growth. We can drive consumer purchases even further by focusing and selectively increasing our marketing spending. We have barely scratched the surface of cross-merchandising our products, both in-store and within our marketing efforts. We can refresh our advertising to more proactively reach out to both light users and non-users to continue to drive our categories.

Longer-term, our success will depend on a number of factors, but three have become apparent to me -- coupling consumer marketing with consumer-driven innovation; leveraging our innovation to improve both our margins but also the margin opportunities for our retail partners; and, as I said, growing our categories by focusing on light and non-users. I want our focus on the consumer to be apparent in everything we do, and I want innovation to be part of our DNA. We have been successful in growing the business in the past, but now it's time to take the business to the next level.

My team and I are re-examining our strategic plan with these priorities in mind, and I look forward to sharing our strategies and tactics to achieve these goals. When we meet with you in December, I hope to give you further insight on our efforts.

Thanks for your time this morning. Now, I am happy to hand over the financials to Dave.

Thanks, Chris, and good morning, everyone. I would like to echo the comments Jim made earlier. 2006 was an outstanding year for Scotts Miracle-Gro. We are extremely pleased with the results reported this morning.

Before I review those results, though, I went to share a few introductory thoughts. It may be obvious, but I think it's important to say that I am energized about my new role as CFO. Clearly, Chris has left a strong legacy, and I look forward to picking up where he left off. Over the months ahead, I also look forward to sharing with you my views on our business and our financial strategy.

Many CFOs walk into the roles and are immediately tasked with fixing things. I'm fortunate to enter this role with the task of maintaining the momentum and taking advantage of an already strong financial position. I'm also fortunate to be surrounded by a strong finance team ready to help us achieve our goals.

To continue on the theme you have already heard, you will see a renewed focus on cash flow and ROIC as we move forward. As Jim suggested, we will continue to review our current capital structure, recognizing that we have the flexibility to continue seeking growth opportunities, while also contemplating a more aggressive approach to returning cash to shareholders.

With that introduction, let me move on to our financial results. In the fourth quarter and full year, we delivered strong top and bottom-line results, thanks mainly to the continued strength in our North American business and growth of Scotts LawnService. We also had another year of good free cash flow, especially considering the deferred contribution payment made to Monsanto and our decision to pull forward some of our manufacturing needs into 2006.

I will start by giving you a broad overview of Company-wide results, and then provide a more detailed review of the specific reporting units. Company-wide net sales for the fourth quarter were up 21% versus year ago. Organic growth was 9%. Growth from acquisitions was 11%. Foreign exchange contributed the remaining 1%.

For the full year, sales increased 14%. Organic growth was 7%, consistent with the guidance provided last December. Growth from acquisitions was 5%, and the impact of the deferred Roundup purchase obligation charge in 2005 contributed the remaining 2% increase. Foreign exchange was not material to the full-year results.

Now, let me move down the P&L to gross margin. As you can see in the press release, gross margin rates declined 330 basis points for the quarter and 90 basis points for the full year. Excluding the impact of the deferred Roundup purchase obligation recognized in 2005, gross margin rates declined 210 basis points for the full year. There are a lot of factors affecting margins; let me focus on the three principal causes for the decline.

First, the combined impact of pricing, net of trade programs and increased commodity costs, cost us about 70 basis points in the quarter and 90 basis points for the year. You will recall that we raised our prices this year in an effort to cover absolute dollar cost increases, but in the process diluted margin rates.

Second, the acquisitions of Morning Song, Rod McLellan and Turf-Seed diluted gross margins by 110 and 70 basis points in the quarter and year, respectively.

Third, product mix cost us about 20 basis points in the quarter and 80 basis points for the year. Grass seed and garden soils are two examples where our expanding sales led to unfavorable margin mix.

For the quarter, various other issues drove the remaining 130 basis point decline, many of which represented differences in timing of trade program costs and vendor rebates between quarters. On an annual basis, though, these same items were 30 basis points accretive to gross margin rate.

While gross margin pressures were present in every business unit, we made up ground with a disciplined focus on SG&A and the benefits of Project Excellence. Excluding advertising expense, SG&A was up 5% for the quarter and down 2% for the year. The quarter includes severance costs associated with leadership changes announced last September. While these actions include the elimination of two key leadership positions, we have not treated these costs as restructuring expense, consistent with our stated intent of being more disciplined in the use of this accounting treatment.

We will continue to use restructuring charges as appropriate. We're just going to be more conservative in doing so going forward.

As an illustration, major events such as facility closures, non-cash charges, similar discrete nonrecurring events will likely be called out as such. However, costs associated with continuous improvement efforts, such as management changes or consolidating activities to drive efficiencies, will be viewed as a normal cost of doing business and will be treated accordingly.

Moving on, advertising expense included in SG&A increased 29% and 12% for the quarter and full year, respectively. You will recall that we had forecast a higher level of advertising spending. However, some of these dollars were shifted away from traditional media and into consumer-directed promotions funded via programs with our retail partners. These programs are accounted for as a reduction to net sales. The combination of higher advertising spending and consumer promotions led to an 18% increase in spending year over year for the North America consumer business. That is consistent with what we suggested last December.

We also have recorded an impairment charge of a little more than $60 million, primarily related to trademarks, goodwill and our international consumer business. This charge was the result of a recent re-evaluation of this business following the 2006 results and our recently revised future expectations for this business, which Jim has articulated. Because of the recent nature of these changes, we have not fully completed our own internal review process, so while the $60 million charge reflects our best estimate, the exact amount will be finalized over the next several weeks, prior to filing our 10-K.

You'll also see that our tax rate came in lower than we had forecast, due to favorable resolution of prior-year audits and the closure of the statute of limitations. This lowered our effective tax rate to 37% from 38%, which we had expected, and improved earnings per share by about $0.04. We currently expect the tax rate to be 37.5% or higher in 2007.

When you bring it all down to the bottom line, we reported a net loss in the quarter of $39.4 million or $0.59 per share, compared with a loss of $8.4 million, $0.13, last year. On a full-year basis, net income improved 35% to $135.9 million, or $1.96 per share. Excluding restructuring, impairment and other charges, we achieved our earnings guidance of 20% growth with adjusted net income of $181.9 million or $2.62 per share. For the quarter, we reported adjusted net income of $1.6 million or $0.02 per share, compared with a loss of $700,000 or $0.01 per share a year earlier.

Let's move on to discuss the individual operating units now. Our increased investment in advertising and trade programs had clear benefits for the North American business. Sales in North America increased 22% in the quarter and 15% for the full year. When you exclude the impact of acquisitions, sales improved 5% for the quarter and 8% for the full year.

Each of the core businesses performed well. Sales in our largest business, lawn fertilizers, increased 8%. Growing media also grew 11% excluding the Rod McLellan acquisition. Plant food, behind the launch of Miracle-Gro LiquaFeed, grew an impressive 12%, and grass seed grew 24%. Ortho sales, which were flat to last year, were our only disappointment, as it proved to be a poor weed season.

Operating earnings in North America were down slightly for the quarter. For the full year, however, profits improved 11%. While we don't break out the profitability of Smith & Hawken, this business reported a loss for the year. A slow start to the season, supplier issue and unplanned costs all contributed to the performance of the business. However, on the sales line, Smith & Hawken finished the year strong. Sales in the quarter improved 18%, helping us to achieve a 6% improvement for the full year.

Furniture, the largest segment for Smith & Hawken, improved 5% on the year, and home decor improved 20%. However, we saw a 13% full-year decline in tools that was largely related to the supplier issue that I mentioned a moment ago.

In international, sales improved 3% in the quarter but declined 5% for the full year. Excluding the impact of foreign exchange, sales declined 2% for both the quarter and full year.

In the quarter, operating profit for the international business declined 9% from last year. Profits declined 17% to $28.5 million for the full year.

While we saw a meaningful improvement in our competitive position, we also saw category declines in both France and the UK. It's too early to know whether these declines were an anomaly or more systemic. Even in this tough environment, though, we were encouraged by the major strides of our growing media business, and our market-share increases in other categories as well.

As an aside, I had been spending a significant amount of time with our international business in my previous role. I agree with Jim's perspective that we can continue to drive out more costs to improve the profitability of this business. But admittedly, we need to couple these improvements with re-energized growth in the category to get headed in the right direction.

Let me move on to the Scotts LawnService. Sales in this business improved 34% for the quarter, 29% for the full year, ahead of our original guidance. As Jim mentioned, we continued to increase our customer count and market share, and also had success marketing more value-added packages. Labor, fuel, selling and product costs were all higher than expected, however.

So, while overall operating profit improved more than 20%, operating margin declined by 60 basis points. Nonetheless, we remain very pleased with what we're seeing in LawnService, and continue to believe that operating margins in this business can reach the low teens within the next several years.

Let me now shift gears and cover some highlights from the balance sheet. As you can see, accounts receivable are up 18% from last year, which is only slightly above our expectations. About $32 million of the growth is attributable to acquisitions and $4 million to foreign exchange. The majority of the balance is related to growth in the sales.

Inventories are up 26% or $84 million from last year. About three quarters of the increase in inventory is attributable to our North American business. As previously stated, we made a conscious decision this year to pull some of our manufacturing forward in order to provide more cost certainty to the business in 2007. The majority of the remaining increase in North America relates to acquisitions, which added about $17 million in inventories.

The balance of the increase in inventories is primarily related to Smith & Hawken, which finished the year with higher inventory, primarily due to lower-than-planned sales. We expect this balance to be drawn back down over the next several quarters.

Let me quickly touch on a few other items of interest. Capital expenditures for the year were $56 million, depreciation was $51 million, and amortization was $16 million. Free cash flow was approximately $115 million. That includes the $43 million paid to Monsanto in the first quarter.

Also, we repurchased $90 million in shares during 2006. While we had planned to repurchase at least $100 million, we were locked out of the market near the end of the year when we closed our trading window. As soon as the window reopens, we will be back in the market and expect to repurchase the full $100 million in 2007.

Before I turn the call over to the operator, let me briefly address next year. Jim already has reiterated our guidance of 10% to 12% earnings growth for next year. Many of you have been assuming that the recent commodity market movements give us upside to those numbers. It is way too early for that type of assumption. While we remain optimistic, we enter 2007 with some pretty significant comps. Also, SG&A will be up probably higher than sales for 2007, and will include an immediate $10 million hurdle from the legal recovery we captured in early 2006.

Finally, the forward curve on some commodity prices suggests we still may face some headwinds for next year, even though the markets have been trending in a favorable direction lately. We are in the midst of making the final revisions to our budget for next year, including our assumptions for raw materials and other items in costs of goods. When we meet in December, we will give you a more detailed understanding of these issues driving our cost of goods and gross margins, so you can better understand our outlook for 2007.

With that, let me turn the call back over to the operator to take your questions.

(OPERATOR INSTRUCTIONS). Eric Bosshard, Cleveland Research.

This is actually Mark Herbek, stepping in for Eric. First question -- could you just talk a little bit about what you expect the competitive environment to be in LawnService -- obviously, you guys are growing significantly on an organic basis -- and what you would expect your competitors to do in 2007 to combat that?

I'll speak for myself and probably cause political ripples, as usual. I would just say that, as we look at our -- because I think everybody, including our competitors, are having difficulty with customer count. As you look at that -- and by the way, I just want to say I'm so glad our core business is sort of everything sells for $10, roughly, or less, because we have just seen sort of super growth on the sort of retail side of the business.

On the service side, we definitely have seen a lot of more positiveness on the upper end of the market. I think this is where, from a competitive point of view, we are really in a good place. Our average program for an average customer is about $400 a year; our competitors, about $300 a year. We're seeing more difficulty in the low end. We want to work in -- we even more want to be in the high end.

So what do I suspect? I suspect that everybody is going to try to move up the food chain. That's what I would suspect, anyway. That's what I would do. I just think we've got a better name to do it, and I think we have a better mindset for service quality than the competition.

So, I don't know if that really answers the question, except I think it's a tougher time out there than it is in our do-it-yourself business. If you're going to be in that business in a tougher time, I think it's better to be at the high end of the market, like we are.

On Smith & Hawken, the improvements made in the quarter -- do you view those as sustainable? Also, can you talk about the new store progress, what you're seeing from the two new stores relative to what you were seeing from your older stores?

Gordy, do you want to answer that?

Well, I think we made tremendous progress in the last probably three months, three and a half to four months. Most of our progress has been made towards getting our structure right and getting our merchandise mix right. I feel good about the new stores, especially the one in Northern California here, in our backyard. We get a chance to watch that every day. I still think is a lot more we can do to concentrate more on the patio business and more on the garden business, and kind of go back to some of the heritage things we did in the past.

But it's all about the patio, it's all about the garden, and we've just got to make sure that we live there. The new stores show that. Our older stores don't quite show that as well, but our new stores show that very, very well. So we feel good about that. We still think we have a lot more we can do, though.

Let me just mention that I'm not sure that 18% growth, or whatever the number was for the fourth quarter, is what we're expecting. I would say, in fact, we are trying to not build unrealistic numbers into our own budget, so that we can have an opportunity to exceed them. Because it puts everybody not only in a bad mindset, but it puts North America in a bad place when we build a budget around numbers that don't get achieved because then we try to make our numbers, which we spent a lot of time this year doing.

While some of that is not bad, and it's a fair amount of tension, which is positive, to do that, on the other hand, you're not doing things you know you could you to add value if you didn't have a bad budget built in. So we are not -- while Gordy may feel super-positive, and I think he does, we're not using super-positive numbers in our budget assumptions for next year.

Finally, on the cost savings front, any color on what you expect for 2007, and if you expect to continue to drop 50% of that to the bottom line on the Project Excellence?

Let's just say that the answer to that is yes. As we look to cut expenses, we want to take about half of that and invest it in the business and half of that to go to the bottom line. There's no change there. Trying to dimensionalize that, I think we're working on that really hard right to figure what that is. But I think generally, the concept of half to the shareholders and half to the business is fair.

Alice Longley, Buckingham Research.

My question stems from a couple things you said on the call regarding next year. I think Dave said SG&A will probably grow more than sales next year, and you previously said that gross margins we should assume to be flattish next year, and you're kind of guiding us not to change that, all of which means that operating margins are down next year. That doesn't fit at all with what your strategy has been. So, am I missing something?

No, I think you're -- I'm not saying you are right, by the way. What I'm saying, though, is I think that it's a good question and it's a fair one. I would say that some of the stuff we did in this year -- because, while 20% is good, it is not what we had built into our budgets, our internal budgets for 2006.

20% what?

So, what that means is that we're not paying out fully on incentives, and when we budget, we budget at target. So that's one.

Two, the work that recovered vermiculite-related legal expenses that had been expensed in the past that we sort of concentrated and dropped into the P&L in 2006. It probably doesn't get repeated, although Dave is working hard on some new opportunities to be helpful to the P&L. But we're not assuming that's going to happen at the moment.

I think Bob actually, in the last call, was pretty clear that he thought there would actually be some accretion in gross margins in this year. So I think that give us a little time -- I think that was all the issues you mentioned, I think?

So, you are willing -- it seems to make sense that gross margins should expand next year, and you're not arguing with that?

No, I'm not arguing with that. But what I'm not doing is committing to it, either, just because we're still working on it. We will definitely spend as much time as you want in December on that. But I don't view that it's going to be a bad story. I did a lot of work with Bob after the last call, and I think that he was more or less correct that there should be some accretion to the margins.

And then, within SG&A (multiple speakers).

One more than just on that is that the weed business uniformly -- while Turf Builder Plus 2 is one of our -- besides Roundup, Turf Builder Plus 2 is one of our highest gross margin products we have. Okay? If you look and you say, well, it's not that bad. It was up, I think, 6% or something like that, actual consumer takeaway, straight ferts was up like -- I don't know, plus 25%, more than 25%. So that if you look across the entire spectrum of products we sell, weed-oriented products -- both in Ortho, Roundup and Scotts -- all suffered. Those are our highest-margin products in the entire business. So, if we have a normal year, that should be accretive to gross margins as well.

So, I'm not really -- I agree with you that it's counterintuitive to assume that we would be happy or tolerate that. I don't think we're happy, and I don't think we will tolerate it, but I just don't know what the numbers are yet.

On the SG&A, which has been a topic of discussion for a long time with you guys, you seem to admit that you kind of have periodically let it spiral out of control a little bit, which was one of the reasons behind Project Excellence. I know you got that legal gain thing to compare against, but you also won't have the $4 million to Bob Bernstock, and you would think that all the cost-cutting would cut that SG&A ratio, despite whatever the comparison is. So, it's a little discouraging to see you say that the SG&A ratio might not go down next year.

I would say just give us some time to work on that and run the numbers through. It was sort of positiveness as we closed the year that allowed us to say, you know what, run Bernstock and Song through the P&L, even though both of those positions have been eliminated and would have qualified is restructuring. So, I'm not even going to argue with you, because it's not that -- I want the same thing you want. I think the biggest thing is going to be what is legal going to be next year, and when you put target incentives back into the business, what does that do? I'll have more math on that by the December meeting, and I'll share it with you.

But, listen, you and I are on the same side on this one. I've got to tell you, I enjoy our time together. We should spend more time together, because you have given us a lot of good ideas on how to manage our business.

Well, thank you. Can I ask one more question?

Sure.

That's on sales. Your sales were terrific at the consumer level for North American consumer. I hate to bring this up, but it sets a very tough comparison for next year, particularly with that LiquaFeed, which is relatively expensive and you have all those people buying the whole contraption. Is there a danger that you're going to start having trouble with sales next year because of a tough comparison? Or do you have a lot of great new products that are value-added and you're just going to convince us that you can build on that base sales growth in North America north of 5% again?

I'm in the latter category. Okay? I don't know what the North American folks are doing. They may be shivering in their boots right now, but Chris is right when he says we're just scratching the surface. A lot of stuff that we have -- let me tell you the really encouraging thing about having watched Chris the last month or so, is that they are really talking about a lot of good ideas that my old man and I talked about, that Chuck Berger and I talked about, and that we just have never really gotten around to, which is innovation, cross-promoting our products, running our business like our worst enemy owned our business and was attacking us. We can be much more aggressive in how we tie our products together. I'm telling you, the line reviews with our retailers have never been better. So, I'm not afraid of the sales numbers for next year.

Bill Chappell, SunTrust Robinson Humphrey.

You might have covered this, but was there -- obviously, you had, in mid-September, said you might not make your fourth-quarter numbers and put a more cautious tone. But it seems like everything came through. Was there something that happened in the last two weeks of the quarter, strong sales? Were you being extra conservative?

I've got to tell you, one of the issues I had with previous management, maybe I'll put it that way, was -- I'm sure you all know this from your side. But from the management side of a public company, when it's really tight, when you are running really tight, it's a pretty hair-raising time at the end of the year. I was interviewed by Flying Magazine once, who said, what's the scariest thing that ever happened to you? And I said, the end of every quarter. It's not flying.

The fourth-quarter sales, call it our fall sales, were absolutely unbelievably good. I'm talking like things were up -- all of our big products up like 20%. The big businesses would be our lawn business and our potting soil business -- just were super, super good. There were a lot of dandelions, which was good, too.

But all of the businesses did well, and the weed business had a really nice second half of the year, which was good, because it said there's not something funky going on with the consumer in weed killers. It was just the fact that there weren't a lot of weeds and it was just a very compressed season. It was just a really -- and as we counted the numbers, which is typical with Scotts, the numbers tend to get better, not worse, because we tend to scare ourselves so bad at the end of sort of the last month of the year.

So, you're just being very cautious early on?

You can call me and say it's not right. I've been very clear about this with the management team. If we think we're going to have a problem with the year, I do not want people buying shares without having that knowledge. So, I am very much spring-loaded to talk to the Street if I believe that we're going to run up short.

Just moving also to -- I imagine you're done with --

You think that's a good idea, don't you?

I'd rather you be conservative. Maybe a little bit of a head-fake in September scared some people. But hopefully, I mean --

But there's the thing. Every year I was with Bob, he got scared crazy at the end of every year, and then we turned out to do better. So, I agree with you that I would rather not got to the Street and say we're going to be short of the consensus and then it turns out we're not. I don't know, Chris --

The only thing I would add -- as we're coming toward the end of the year, I don't think we were intentionally being overly conservative. But there were things that are difficult to predict with certainty, as you can imagine. As Jim said, the strength of our fall POS. We have seen good POS all year, but the strength of the fall POS was even stronger than our trend, so the business was very strong as we ended the season.

Then, we working very closely with our retailers to help them exit the year in the right place. Knowing exactly where that was going to settle out was also very difficult to predict as well. So you had those two factors, and they came together positively for us. But a month earlier, it was really hard to predict exactly where it would settle out.

No, I'm happy with the final results. It was just a question.

Also, turning to just the cash and your returning it to shareholders, is there any way to quantify, in terms of what's your flexibility, what you would like to have on hand for acquisitions, what debt level you're comfortable with as you go forward?

The answer is yes to all of the above. What I don't want to do is queer my discussion with my Board next week. But I would say that we don't believe we should be in an ultra-high leverage ratio. We do believe -- and I have said this, I think, publicly -- that I am actually pretty happy when senior management come to me and tell me they have a big mortgage, because I know one thing -- they are focused on the business. I'm talking when a manager tells me they have a personal mortgage on a new house they bought.

I think there's an element of we are too underlevered, and it's not only -- we don't believe it's our sweet spot from just an economic point of view. But I've got to say, I don't believe it's good for our heads to have too much money in our pockets. I think that we believe we can, if we focus on our core North American business, we have enough acquisition money under any scenario we have looked at to do just about anything we want in the core North American business, assuming we don't pay too much, and make a very sizable distribution to our shareholders by one or more means. That's effectively what we'll be presenting to our Board.

But I wouldn't really want to become a more than five times leveraged, put it that way. I just think that then I've got to worry at night. So, I would say four times or less leverage, and we are about 1.7 today, is -- I would say it's fair.

Great, I'll stay tuned on that. Any idea what your listings look like for next year, whether you will gain share, maintain share?

I think that if we lose share next year, there will be people looking for jobs. So, I'm very positive that -- look, it's all working. Listen, a lot of people on this call have told us that. Why can't you guys focus on North American business? It's core, it's the keys to the castle. Let me tell you, it's all working there. The thing is, we can do a lot better. So, we've just got to start saying that's what we're going to be focusing on. Smith & Hawken's good, but Gordy has got to prove he can sell stuff. That's what he is going to be proving, and he's not going to get a lot of money until he shows us and you he can sell stuff.

International -- they've just got to keep up with us. So, this whole impairment thing is about saying, you know what, no more hockey sticks, guys. We're taking hockey sticks out of the strategic plan. That caused the impairment; that's it. There's nothing more complicated than that. But no more hockey sticks; just keep up. Forget about 30% next year and the next year, just 10% a year and we're happy. Everything, as far as our focus and our intellectual efforts, are going to go toward our core North American business.

Sam Darkatsh, Raymond James.

I'm a little confused, Dave. Maybe this is specific for me. But you're talking about commodity prices and input costs versus 2007, and how we should hesitate to think that commodity prices may be a tailwind, or at least a help to earnings versus expectations. If commodity prices remain at present levels, would there be upside to 2007? I'm confused.

Let me take that, because I was expecting -- I don't know if anybody saw the interview on CNBC, which was so light I can hardly believe it. I think they wanted to talk about my birthday more than anything else. I was expecting that question, so I'll put mine out there and then see what Dave counters with. But the answer is it's all good, and if prices stay where they are, it should be positive. So, I think that the problem is people are looking at the forward views, which are not quite as good as the market today. But I think, generally speaking, the answer has got to be yes, because the higher prices were built into our budget.

So, you're budgeting higher than $60 oil and higher than $7.50 a Btu gas, that kind of thing?

Yes, sir.

Let me just add a little bit to that, too. I think in the past couple years, we have been really challenged trying to cover cost increases with pricing. In fact, we haven't entirely been successful doing that. So, this year, I think we have taken a slightly different approach and tried to add more certainty to the business. So, what you've seen is we have locked in more costs earlier than prior years. At this point, a lot of our uncertainty, if you think about fuel, a lot of uncertainty really is in that category, which, while rates are down today, we're really not incurring a lot of freight costs.

So, prices are volatile. Next spring is a long time away, and we will see what happens next spring.

Yes. If the prices stayed where they are today, would it be positive? The answer is, it has to be so.

Back on LawnService, I think you guys are doing a fabulous job in SLS. What should we look at, Jim, as a realistic, sustainable, internal growth rate in that business over the next few years? Then I have a follow-up question on LawnService as well.

Tim, do you want to answer that one?

Sure. Mid teens.

That was easy.

Then, your primary competitor is talking about having difficulties in upselling, and it would seem as though you folks are having maybe an alternative reality to what they are looking at. What exactly is happening? Are they simply being more price-aggressive, and therefore having a different type of customer focus, or what seems to be the dynamic that's occurring there that it seems to be the two major players are seeing completely different dynamics?

Let me just jump in, just for a second, to say I believe our biggest risk in our LawnService business is trying to sell downmarket. We can't give people the result they want if we are not giving them the service. What we have learned through consumers just time after time after time -- when you piss them off is one thing. They want a relationship with the service provider, and they want to be part of having a great yard. If we're trying to be cheap, we just don't have the time to hang around and talk. All we have got the time to do is -- I forget what they call it, blow and go or something like that. So, Tim, how would you answer that?

I would agree with what Jim said, and I would add a little bit more color to at least our experience. You should talk to our competition about their experience. But this spring, as we were selling, we offer and we're trying to offer consumers more and more segmented choices around programs that work for them. We know what results we can deliver if we execute those programs. We know what our costs are to do that. So, we had a real strong focus on selling the full programs, and if people had cost issues, we are not going to cut those back and be able to deliver. So, what we saw this spring, when we had $3 a gallon gas and the housing market was slumping, we struggled to sell our more basic program. Our close rate there was down.

The flip side of that was our mix was actually really good. So, the folks that were financially stressed tended to opt away from us. The folks for whom $3 a gallon gas was a pain, but it really didn't change their buying habits or their lifestyles, they bought the programs that fit for them. We were very disciplined in our selling. Our sales team did a great job, and that paid dividends for us not only in our revenues this year but in our service levels.

Do you expect to earn your cost of capital in 2007, or at which point do you begin to be EVA-positive in LawnService?

I think we are actually -- I'll get the final invested capital numbers here shortly. We are either breakeven or positive now on an all-in basis over the history of LawnService. We will definitely be EVA-positive, if we're not already, next year.

The near-term acquisition pipeline -- should we expect or not be surprised with some acquisitions? If so, small bolt-ons, larger strategic moves? What's the thinking? You said $10 million in additional share repurchases, but your free cash flow is considerably higher than that, and I would have suspected that you would be on the prowl.

I'll take that one. We built in, I think, $15 million for Tim for next year. Call it at least $10 million, less than $15 million. So, I think what that means is small bolt-ons. I think we have looked at larger opportunities in LawnService, and frankly, I think that it's inconsistent with our model at this point. We can do better on our own. So, I think, between organic growth and acquired growth in the sort of $10 million to $15 million per year range. I think you're roughly talking onetime sales. You can probably get a picture of, then, what's happening.

My question was more Company-wide versus SLS, with respect to the acquisition appetite.

Sorry about that. I thought you are talking LawnService. I think we have shared with you our enduring franchise strategy. I don't think there's a lot of big stuff out there, to be honest. I don't know the definition of big stuff. We definitely have acquisitions built into our North American consumer business model as necessary, and that's -- but we aren't talking $10 million. We are looking at sort of a major look at our capital structure and see where that takes us. Again, once I got my Board where I -- once the Board is in a good place and agrees that this is the right way forward -- and this is not new conversation for them -- we will be ready to talk to our shareholders.

Doug Lane, Avondale Partners.

Can you give us an update on what the amount of cost savings is you're expecting from the Phase II of Project Excellence in 2007?

Secondly, can you give us an update, now that you have had Morning Song for a year, what you learned about the US birdseed market, and what we should look for from Scotts in wild birdseed in 2007?

Well, let me kind of go in reverse and do Morning Song first. What did we realize? We continue to believe that there's a branded opportunity, and I think our retailers believe that as well. So, start with a value-added branded opportunity to continue to operate with the business we bought in the commodity area and move up the value chain, similar to what we have done with potting soil.

We recognize that we need a national footprint, which we don't currently have. So, what that means is you can expect to see some small acquisitions, probably in 2007 and beyond, as we build out our footprint. [Mike Lukemeyer], who is sitting with us here -- if we don't find the right acquisitions, Mike will build plants, so that we have a distribution presence. Because a lot of the discussions we're having with major retailers is, if I gave you a national program, could you service it? The answer is, not today. So, I think you will see us grow our footprint out.

Another thing we have learned is that young businesses that we acquire need senior sponsorship in the business. We can't just buy a business and a product manager runs it when it's new and it's unique and we don't understand that well. So, today, that business is being run back like we used to run it as sort of a strategic business unit, with a VP leader who owns the P&L and has the entire staff necessary to run that business within his or her control. Happens to be a him, this guy.

So, I think those are the big things that we have learned in the business. I would say, it's all good, so that -- maybe the last thing, which was kind of in the first part, is the commodity side of the business, just like commodity dirt, is a very tough place to play. Since we believe and have experience now in sort of our second year of value-added in Canada, that there is an opportunity to brand us, we're seeing the same thing in the UK. We continue to think it's a good business for us.

That's very helpful. And Project Excellence?

I would just say, and maybe Dave wants -- I doubt he's going to be more aggressive than this -- is to say, give us some time. We still expect savings. I'm not sure if we can give you (technical difficulty) number is. So, I would say, just give us some time to have a number, and we will have it for you in December.

Is that somewhat incorporated in your 10% to 12% growth in net income outlook, or could there be upside to that number in December, once you have worked out the cost savings opportunities?

I think what we said on the last call is that that should be viewed as including it, largely to offset headwinds resulting from incentives and this legal recovery that are sort of not repeatable in the 2007 year-on-year numbers, although Dave is looking at me saying he can repeat it. Well, don't count on that, guys.

[Reid Kim], Merrill Lynch.

Sorry if the question has been asked, but you went over it a little bit in terms of your market-share gains, but I was just wondering within the North American business, Jim, which product areas you felt you picked up the most share this year, and which ones may have been more of a status quo share environment.

I think that, for sure, straight ferts being up in the mid-20's, we picked up share there. For sure, in growing media, we picked up share there. I think, even in the Turf Builder Plus 2 side, we picked up share.

I'm not aware where we lost share. But the big share gains had to have been in the garden fertilizer business with the LiquaFeed. So, I think we picked up share everywhere, and I'm just not really sure of the numbers yet, because we have these like dopey -- since basically no retailers, at least in our space, sell data back for share, so competitive data to anybody, anymore. Unlike food, where Nielsen and others get that data and can put numbers together, we don't have that in lawn and garden. So, ours is diary data, and it's a little bit late coming. I don't think we lost any share on the weed killer side, but I'm not -- I think it was just a very stagnant market. I'm not sure we got much out of that.

That helps. Within the home centers specifically and maybe Wal-Mart, do you think there's sort of a similar story or a little bit different?

That's --

That's it?

Home centers and Wal-Mart is probably 70% of the business. So, we're doing super good in there. This is areas where we have these like huge business development teams. We have people really cranking numbers, working very closely with the merchants that are trying to tie together the sales, marketing and supply chain side with the retailer. This is a very powerful relationship, and it makes it so much easier for them to make money and for us to predict our business.

So, it's a very complimentary circle of life there. So, I would suspect those are the areas where we tend to grow our share faster. So, we're doing really well in those areas of very concentrated business, where we can really, in a big way, partner up with these retailers.

Your comments on consumer behavior, as you looked at some of the POS data as the season went along -- in the product areas where you may not have had as much of a new product intro, how did the progression between, say, a private label and your brands go? Was the consumer still just willing to trade up and go for the stronger brand? Or did you see anything of note there?

No, I would say it's -- this is actually, probably is an area where it's counterintuitive. We, I think, tend to -- we have been taking share every year over the last few years. We're just getting stronger and stronger, and our marketing efforts are getting better. It's a real complement to Rich Sorota and his team on the marketing side, is that as we get better -- this tends to create more stress with our retailers than it does with anybody else, because the retailers -- when we talk about mix issues ourselves, they have got mix issues themselves, and if we're taking a lot of share on the branded side, and they tend to make more money on the opening price point side, they tend to get pretty aggravated at us when we're taking share. That's an area we have got to be careful on, is -- I had to say, maybe we will take too much share. But the retailers would not like that.

I got on a little bit late. I was interrupted. You said something about a sizable distribution to shareholders as something that you might investigate. From the comments on acquisitions, it doesn't sound like there's necessarily something in the pipeline that would take you up to that four times leverage. But if you could just review those comments one more time, I would appreciate it.

You'll have to go back and listen to the tape. Anyway -- no, I won't be mean. I don't think that we are capital-restrained in any regard or under any conditions or scenario that we're looking at, as far as returning cash to shareholders. It is subject to Board approval. I don't want to get too far ahead of the board, but I do think that we are underlevered. It would be good for us intellectually to have a little more debt as well. So, I do think that you can put it all together pretty easily.

I think that's the last call. So, I appreciate everybody's time this morning, and want to remind everybody that our analyst day meeting will be held here in New York on December 12th, and we hope to see you there. Thanks, everybody. Have a good day.

Thank you for your participation. This does conclude today's conference call.