Scotts Miracle-Gro Co (SMG) 2007 Q1 法說會逐字稿

Good morning and welcome to the Scotts first quarter 2007 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 of Investor Relations and Corporate Communications.

Thank you, operator. Good morning, everyone, and welcome to the Scotts Miracle-Gro first-quarter conference call. With me this morning is Jim Hagedorn, our Chairman and CEO, and Dave Evans, our Chief Financial Officer, both of whom will share some prepared remarks in just a few moments. After their comments, both Jim and Dave, as well as several other members of our management team, will be available to take your questions. But before we get started, I would like to take care of two quick pieces of housekeeping.

First, I went to remind everyone that our annual shareholders meeting will be held this Thursday at 10:00 Eastern Time here in Marysville, Ohio. If you can't make it here in person, the meeting also will be Webcast live from our Web site, at investor.scotts.com. There will not be a call-in number for this event.

Secondly, I would like to alert you that our investor relations department has retained Rivel Research to help us in completing a perception study. We have worked with Rivel twice in the past five years, and the insight that we have gained from these studies has helped us improve our IR efforts and strengthen our outreach to the investment community as a whole. Beginning next month, many of you are likely to get a phone call from the Rivel team asking for 15 to 20 minutes of your time. We would be grateful for your cooperation in this effort, and remind you that we are sincerely interested in your feedback.

Moving on to the business at hand, I want to remind everyone that our comments this morning will contain forward-looking statements, and 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 one on the investor relations portion of our Web site. And as a further reminder, this call is being recorded and archived, and will be available on the Web site as well. 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 Web site.

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

Thanks, Jim, and good morning, everyone. While the first quarter usually represents less than 10% of our total-year sales, it is one of the most critical times for our business. In our consumer businesses, both in the U.S. and international, our sales teams spent the last several months working closely with all of our retailers to further refine our 2007 programs and prepare for the major shipments that will begin next month.

Our marketing teams have been working with our advertising agencies and media planners to ensure we have the most effective messaging to the consumers at the break of the season. And our supply chain team has been working through the peak of our manufacturing cycle to effectively manage our inventory levels, our distribution, as well as the volatile commodity markets.

In Scotts LawnService, we are making final adjustments to our program improvements for spring and getting ready for our new season marketing campaign. We also continue to reinforce our message of customer service as we begin to increase our staffing levels to meet our upcoming surge in demand. And at Smith & Hawken, we have begun to reset our stores after the holiday in preparation for the peak of our outdoor living season. I will elaborate on all of these initiatives in a moment. For now let me say we're pleased with the numbers we announced this morning.

We said during our analyst meeting that we expected a loss in the quarter between $60 million and $64 million, and actually we did slightly better than that. Our sales throughout the quarter were mostly in line with what we expected, and consumer purchases, while low during the off season, continue to show that we're winning in the marketplace. While the first quarter was small in terms of customer demand, it's critical, and we feel like we started the year on the right foot.

Now let me spend just a few minutes this morning talking about each of our business units.

In our North American business we had a strong December, leading to a 10% increase in sales for the quarter. Consumer activity during the quarter remained encouraging. I will share a few examples with you from the quarter, but I want to remind you that these are largely anecdotal, and it is too early to see any material trends.

First of all, we saw increases in consumer purchases of our products in nearly every product category, including an 8% increase in Ortho, a 12% improvement in growing media and an 8% improvement in plant food. In Ortho we continue to have success with Ortho Fire Ant MAX, which is used by southern consumers, as well as Ortho Home Defense, a product that consumers can use around the perimeter of their home as well as the inside in order to keep insects out of the house.

Our off-season success with these two products in particular gives me continued confidence in the direction of our Ortho business. These two segments of the insect control category are particularly competitive. The fact that we continue to see POS improvement and, presumably, market share gains is an encouraging sign.

We expect 2007 to be another strong year for Ortho. We're introducing Ortho Home Defense MAX, a new product that provides 12-month insect control, and are committing significant advertising dollars behind it. We're also working with our retail partners on a number of in-store programs to help ensure the success of this product.

On the weed side of the controls business, we're also optimistic. We will be introducing Ortho Weed-B-Gon MAX Plus Crab Grass Control, a new all-in-one product that makes lawn care easier and requires fewer applications. Like Home Defense, a combination of advertising and in-store programs are being finalized that will be critical to this effort.

I'm also encouraged that the momentum in our growing media business has not slowed, even in the off season. During the quarter, consumer purchases of Miracle-Gro Moisture Control Potting Mix increased by 64%. Meanwhile, purchases of Miracle-Gro Garden Soil improved by 15%.

While the numbers in the quarter might be small, I will remind you all that our growing media business has been posting double-digit POS gains for several years in a row, and we're confident that will continue that track record in 2007. LiquaFeed also maintained its momentum in the quarter, resulting in an 8% increase in consumer purchases of plant food. You will recall that in 2006 it became our most successful new product launch ever, and we remain confident that as LiquaFeed enters its second season, it will continue to be popular with consumers. Even though sales doubled our projections for 2006, LiquaFeed has a household penetration rate of less than 5%, so we will continue to put significant advertising effort behind this product this season and will work closely with our retail partners as well. We'll be introducing new formulations of refills for LiquaFeed and drive messages that encourage repeat usage of the product throughout the growing season.

As you know, repeat usage also is key to the growth of our lawns business. Consumer purchases of lawn fertilizer and combination products increased 1% in the quarter. Since so few consumers fertilize during the winter months, we don't believe the quarter really gives us much insight. However, as we prepare for the spring season, we're encouraged by the retailer support we're getting for Bonus S MAX, a new and innovative three-in-one product that fertilizes, kills weeds and prevents fire ants. Bonus S is a product uniquely formulated for lawns in Florida, parts of Texas and other places where St. Augustine grass is prevalent. Bonus S is by far one of our most successful products, and we're hopeful we will expand our share even further with Bonus S MAX.

During our analyst meeting last month, Chris Nagel shared his view that our lawns business in particular needs to reexamine some of our previous marketing efforts and design advertising programs that attract new customers to the category. I agree. That effort is well underway, and we're hopeful that we'll see the impact of this in 2007 and beyond.

Before I move on to discuss the rest of the business, I will tell you that we remain encouraged with the discussions we've been having with all of our retail partners, regardless of the channel. We believe retail inventory levels entering the season are appropriate, and we continue to work closely with our retail partners in order to drive our business as well as theirs.

Now let me spend a few minutes talking about international, which reported 9% sales growth. We saw particularly strong results in the UK, as we continue to see nice momentum in our value-added growing media business there. Our professional segment also got off to a solid start.

As we get ready for the season, we continue to see positive signs. Retailer support in Europe for LiquaFeed remains extremely strong, and we expect to see about $8 million in incremental sales from this product. The launch of LiquaFeed in Europe marks our first real effort to take a global approach to marketing one of our products, and we're encouraged so far.

We're also encouraged by the progress we're making to improve our bottom-line performance in this business. We continue to benefit from our cost-savings initiatives in Europe, as Claude and his team are successfully executing their own Project Excellence initiative. These efforts, coupled with the expected sales growth of 2% to 4%, gives us confidence that we can get international on the right track this year to achieve a 7% to 9% increase in profitability.

We also remain optimistic Smith & Hawken can improve its financial performance in 2007. Sales in the quarter were up 6%, slightly behind what we had expected. However, we saw a better-than-expected reduction in inventory levels, which I will leave for Dave to discuss.

Let me focus on what we're seeing with our new store format. Our new California prototype continues to show strong results, with higher-than-expected sales per square foot and the annualized sales trend. Our Florida prototype is trailing what we're seeing in California, but the surrounding retail area is still developing. And in Cleveland, we opened a third concept store right before the holidays, and it has also showed encouraging signs. As part of our test-and-learn efforts, we will continue to monitor the results of these concept stores to gain important learnings we can apply to the rest of the business in the future. As we have said before, our merchandising efforts in all of the stores will be critical in 2007 as we shift our focus away from decor and back to our gardening heritage.

Finally, I went to spend a few minutes this morning talking about Scotts LawnService, which had sales growth of 9%, slightly higher than what we expected for the quarter. Like our core business, this is a small quarter for LawnService. So, the focus this time of year is really getting on plans in place for the height of the season.

We're entering the season in our best shape ever. Our retention rate of just above 69% was our highest ever for this time of year, and we came to January with a 15% increase in customer count compared to last year. In past years we've started the season with significant unmet staffing needs, which put a strain on the business in the early part of the year. This year, however, nearly every key management role has been filled across the entire business, even as we implement our aggressive no-hire policy for tobacco users in states where the law allows.

In addition, just a few days ago we began our direct-mail effort, which will ultimately result in more than 20 million pieces being sent to consumers across the country. This year we'll have a more clearly defined good, better, best product and pricing strategy, which we hope will allow us to continue moving homeowners up the value chain.

Also, we made a major improvement to customer service when we installed a new Web site just last week. The site now allows customers to easily access their account online and greatly improves our ability to communicate with them. Given the link between communications and customer retention, we see this as a major improvement for 2007.

Across the board, I'm extremely confident in our business as we enter another growing season. Whether in LawnService, Smith & Hawken, international or the core North American business, we continue to leverage our competitive advantages to win with homeowners and our retail partners.

Before I turn the call over to Dave, let me take a few minutes to update you on our recapitalization efforts, our tender offer and plans for a special onetime dividend. I want to start with a brief reminder of the thinking behind the effort.

As many of you know, over recent years we have methodically explored several major growth opportunities in adjacent categories and channels, including lawnservice and pest control. After taking a disciplined approach at looking at our options, we have pushed ourselves away from the table in each of those instances because we could not convince ourselves that we could generate significant shareholder value. In fact, in exploring these opportunities, it only reinforced our strongly-held belief that there are few consumer products categories that have the opportunity for continued growth like lawn and garden. It also reinforced our belief that there are few companies better positioned than Scotts Miracle-Gro to take advantage of the market opportunities that lie before us, and that's exactly what we plan to do.

So, we have opted to stay within our current boundaries and maintain a disciplined focus to our existing portfolio. By doing so, we are confident that we will see improvement in key metrics that drive continued shareholder value. On a company-wide basis, we expect sales growth of 5% to 7% between now and 2007, leading to an 8% to 10% growth each year in operating income. Those assumptions also lead us to believe that the business will continue to generate strong free cash flow.

Given our decisions and financial assumptions, we have determined, after extensive consultation with our board of directors and financial advisers, that our best strategy is to return significant levels of cash -- $750 million to be precise -- to our shareholders. Our strong balance sheet and the noncyclical nature of our cash flow have also prompted us to pursue a more efficient capital structure. So we're in the midst of increasing our leverage, which I will let Dave discuss in more detail in a few minutes, in order to immediately return cash to our shareholders in the form of a share repurchase and a special onetime dividend.

On January 10th we launched a tender to repurchase up to $250 million of our stock in a modified Dutch auction. We simultaneously launched a tender offer to repurchase our public debt. Both of those processes are currently scheduled to conclude on February 8. Shortly after the conclusion of those tenders, we expect our board to declare a special onetime dividend of no less than $500 million. We would expect the dividend to be paid in early March.

Since I have been the CEO of this company, there probably hasn't been a single one of these quarterly calls in which I have not talked about the importance of innovation. Usually it's in the context of new products, marketing programs or supply chain initiatives. But in this case, I think our corporate team has both been innovative and collaborative in determining how to best use our financial strength and flexibility to drive value for our shareholders. I want to take a moment to recognize Dave and his entire team, internally and externally, for their efforts in getting this done. And I'd be remiss if I don't also recognize Chris Nagel, who began a dialogue about our capital structure when he was still the CFO. Their collective efforts have helped drive an important internal assessment of the business that created a focusing event for the entire management team. I'm extremely confident that our decisions represent the best way for Scotts Miracle-Gro to enhance near and long-term shareholder value.

Whether it's our financial strategy or our marketing plans, our goal for 2007 and beyond is to take advantage and improve the enviable position that we enjoy in the marketplace. And we'll do so not just with an eye toward growth, but with an eye toward the type of growth that drives shareholder value.

With that, let me turn the call over to Dave.

Thanks, Jim, and good morning, everyone. As Jim said, we are pleased with our planning and preparation for the coming season, and confident we are on course for another positive year. I will quickly run through our financial results and provide whatever additional color I can along the way. As you know, though, from a shipment and consumer demand perspective, this is a small quarter for every business except Smith & Hawken.

That being said, I am pleased to share that results are generally consistent with the guidance shared at our investor conference. As a result, the financial discussion should be fairly uneventful. As always, I will call out those areas in which foreign exchange rates had a significant impact on results.

Starting with sales, global sales increased by 9% to $271 million for the first quarter, up from $250 million a year ago. Foreign exchange contributed 3% to this growth and acquisitions contributed an additional 6%. So organically -- that is, excluding acquisitions and foreign exchange -- sales were relatively flat to the prior year. This is not a concern to us or materially different from our expectations. I will articulate more as I review each group's results.

North America reported a 10% increase in sales for the quarter on a prior-year base of $126 million. Excluding acquisitions, sales were down about 2%. This was slightly behind what we expected due to a minor shift in timing of some initial store sets. Because we are comfortable with retailer inventory levels as we enter the season, this is purely a function of timing between December and January. It is also a function of small dollars. In any other quarter, the shift would have been rounding, so I'm confident in saying the North American business is right where it needs to be as we prepare for the season.

International sales increased 9% for the quarter. Excluding foreign exchange, sales were down 2%. This is behind our full-year guidance of 2% to 4% growth, but not materially off plan for the quarter, as we are anticipating some delay of shipments in our plan relative to last year as European retailers push inventory closer to consumer demand. And we have not yet begun shipments of our largest new product launch, LiquaFeed.

Sales for Scotts LawnService were up 9% for the quarter. While this is less than our full-year guidance of 14% to 16%, it was slightly above our expectations. In 2005, Florida, Texas and our Southern markets experienced several major hurricanes, resulting in the equivalent of about $1.5 million of treatments being pushed out of September into October. While this is not material to LawnService's annual revenues, it is a big percentage in what is by far the smallest quarter, and is reflected in both our plans and year-over-year quarterly comparison.

Scotts LawnService enters the 2007 season in great shape. Staffing is on plan, and 12-month trailing retention has improved to record levels for this time of the season. As a result, customer count, which was up 12% in September, was up 15% exiting December. We remain confident in our full-year guidance for LawnService.

Smith & Hawken reported sales growth in the quarter of 6%, to just under $45 million. Retail store sales grew 4%, and the B2B business continues to grow. But our catalog and Internet channel fell short of expectations, resulting in overall sales less than planned for the quarter. Given our strong merchandise and catalog plans for the spring, we remain optimistic of achieving our full-year outlook of 12% to 16% sales growth for Smith & Hawken.

Moving on, gross margin rate in the quarter was 20.4%, a 100 basis point decline from last year. This result was consistent with our expectations. As we said during our analyst meeting last month, we expect full-year gross margins to be in line with last year. However, we also indicated that there would be continued downward pressure on margins in the first half of fiscal 2007, balanced by improving trends in the second half of fiscal 2007. The first half/second half dynamic is primarily a function of two items. First, the timing of strategic acquisitions of margin rate dilutive businesses in 2006 that put downward pressure on early-period 2007 comps. And second, commodity cost increases, which will not be offset until 2007 pricing to our retailers takes effect in our second fiscal quarter.

Speaking of pricing in commodities, I know that some of you have recently been asking questions about fuel prices. The assumption is that lower costs at the pump today should give us upside on gross margins. While in isolation that is true, let me give you a more comprehensive perspective. Yes, fuel prices are now lower than we expected. And even though our major distribution months are in front of us, it seems unlikely that fuel will be a headwind for us in 2007. However, what may be less visible is that urea prices are currently 20% to 25% higher than our average cost in 2006, and pressure on bird food inputs like corn, sunflower and millet have not abated. These increases are likely to offset the positive impact from fuel.

In the past we have talked to you about the link between natural gas prices and urea. Well, that was the past. Hardly a week goes by that the Wall Street Journal doesn't have another story about the increasing demand for ethanol. As you know, ethanol is derived from corn, and corn needs fertilizer to grow. And of course, the major component of fertilizer is nitrogen, which is derived from urea. So the law of supply and demand is pushing the forward curve on urea prices up sharply, and we're still in the spot market to purchase the remaining 30% of our annual urea needs that we don't yet have committed either through prior purchases or forward hedging. As a result, we are not forecasting any material upside to gross margin rates from commodities. We continue to believe margin rates for the year will be in line with 2006.

With that, let me move on to discuss SG&A. Overall, SG&A increased 13% in the quarter. As we said last month, we're expecting a full-year increase in SG&A of 10% to 12%, with growth in the first quarter driven by full-year planned increases in technology innovation, Scotts LawnService suspending in advance of growth, overhead additions from prior-year acquisitions, and approximately $2 million of Project Excellence expense in our international segment.

The Project Excellence expense in international relates to costs incurred for the ongoing streamlining of the management structure in Europe. In prior years these costs would have been reflected as restructuring and called out as an adjustment to reported earnings. However, because the costs we incurred in Q1 were not caused by any individual, discrete and large event, we did not adjust our earnings for these charges. This is consistent with what we told you last year and demonstrates our commitment to be more disciplined in our use of adjustments to reported earnings.

On an operating basis we reported a company-wide loss of $92.7 million, compared with $83.7 million a year earlier. North America had an operating loss in the quarter of $29.8 million, compared with $27.2 million. Scotts LawnService had an operating loss of $16.4 million, compared with $11.3 million. And International had an operating loss of $7.9 million, compared to $5.3 million.

Interest expense was $8.2 million for the quarter, up from $7.1 million last year, due mostly to higher borrowings. I know many of you have questions on interest expense for the year as a result of our recently announced recapitalization. I will come back to this topic before I close and give you some updated guidance.

For the quarter depreciation was $12.7 million, amortization was $3.7 million and capital expenditures were $16 million. The net loss in the quarter was $59.4 million, or $0.88 per share. As we are not calling out any restructuring or other onetime charges in the quarter, our adjusted income was the same. Last year we reported a net loss in the quarter of $52.7 million, or $0.78 per share, and an adjusted net loss of $49.1 million, or $0.72 per share.

Moving to the balance sheet, accounts receivable were $265 million, up about 6% from last year. Foreign exchange accounted for the majority of the increase, with the balance coming from increased B2B business at Smith & Hawken.

Inventories totaled $629 million, a $70 million increase from last year. About half of this increase related to our North America segment, and was significantly driven by a decision late in fiscal 2006 to accelerate production to take advantage of seasonally-low commodity costs. The balance of the increase in inventory relates to our grass seed business acquisitions late in 2006, foreign exchange rates and Smith & Hawken, where, as we stated last October, we ended fiscal 2006 with heavier inventory than planned. There is an aggressive plan to manage Smith & Hawken's inventory down over the course of 2007, and measurable progress was made in this quarter.

Overall I am pleased with the results we're seeing across the businesses. At this point we remain comfortable with our full-year guidance and we're optimistic as we enter February, when the season really begins to take shape in warm weather markets in the South.

Before we turn the call over for questions, I will share an update on our recapitalization program and clarify a point that seemed to cause some confusion after our last meeting in December.

First on the recap, as Jim mentioned, we continue to make positive progress and remain on schedule. We expect to conclude both our equity and debt tender offers on February 8. Assuming that occurs, we then expect the Board to declare a special onetime dividend a week or so later, which means we would likely have a payable date in early March.

We are also making positive progress on our new credit facility. We met earlier this month with our bank group, as we seek to essentially double our existing credit facility with the new facility of $2.1 billion to $2.3 billion. That process is going well, and I'm confident we'll have all our financing arranged well before closing on the two tender processes. We expect the new facility to be priced at LIBOR, which is currently at 5.36%, plus, based on leverage levels expected immediately after closing, an additional 125 basis points. Based on that, we'll have a current floating rate just below 6.6%. As you know, we have tendered for our current senior subordinated notes, which are priced at a rate of 6 5/8. We are also replacing our current revolving credit facility, which, at current leverage ratios, is priced at LIBOR plus 55 basis points. As we have done in the past, we will use interest rate swaps to lock in fixed rates on a portion of our borrowings. Based on those assumptions, we expect actual interest expense reflecting our midyear change in capital structure of around $75 million to $80 million.

For calculating full year 2007 EPS, we are currently using an estimate of 66 million fully diluted shares, though this is, obviously, dependent on the outcome of the Dutch auction.

After considering the impact of the recapitalization transaction, we still think adjusted EPS on a year-over-year basis is likely to be flat or up low single digits. This is consistent with what I shared in December. We will have some non-cash charges related to the retirement of our existing debt in Q2, and we do plan to adjust 2007 earnings for these costs.

Now let me share some thoughts about next year, fiscal 2008, in the context of the recapitalization. I will start by saying we are not providing any new guidance on 2008. Obviously, we will incur higher interest expense next year because it will be the first full year after the recap. Remember, the recap only affects about 7.5 months in 2007. However, we still expect the operating income of the business to improve 8% to 10% in 2008, consistent with the full-year guidance provided in December. Based on that assumption, as well as a marginal increase in fully-diluted share count from options, our EPS growth is likely to be in the mid to high single digits. And if the business continues to grow as planned, we would expect our EPS growth to accelerate beginning in 2009 as we begin benefiting from the leverage of paying down debt.

What that, I will conclude my remarks this morning and turn the call back to the operator for your questions.

(OPERATOR INSTRUCTIONS). Sam Darkatsh, Raymond James.

First off, Dave, your last point there on '08, when you're saying EPS growth of mid to high single digits, I'm guessing that includes the additional incremental interest expense over '07 because of the full-year impacts. Is that correct?

Yes. That really reflects the recapitalization, and both the increased interest expense and just our initial estimates on share count following the Dutch tender.

Do you still expect -- going back to '07, do you still expect sales growth to accelerate as the year progresses? You were at 9% in the quarter. I think you had an 8% to 10% sales growth expectation for the year back-end weighted. How should we look at your expectations for sales growth as the year progresses?

I will start and then just hand it back to either one of these two guys, which is Chris or Dave. Our business right now is doing really well. January so far is good. December was awesome. So, we've had, like, two really good months. I think this is some POS where it's still warm, but a lot of sort of getting the stores ready and prepared for the season. So, I think we're starting out really well, part of which you are not seeing in the first quarter. So, the second quarter started well for us. Do you want to take the rest?

I don't want to try and imply a level of precision in calling sales between Q2 and Q3. But, having said that, our internal plan suggests that growth in Q2 is going to be to the lower end or, perhaps, even 100 basis points below our full-year guidance. But then we would expect Q3 to really exceed our full-year guidance, so volume back-loaded in the back half of the year.

That's helpful. Thank you. The other couple questions I have are a little more granular in nature. The Smith & Hawken, with respect to the catalog and Internet sales being a little softer than expectations, is that a new phenomenon or a different dynamic than some of the other things you are dealing with in that business? And what do you think the genesis of that issue is?

Why don't I start, and then Gordy is on the call, and maybe he can finish it. I would say -- I'm not going to get into the historic part of it, only because I just don't know what the answer is. The catalog and Internet is important to us. Part of this acquisition for us is not just outdoor living; it is direct to the consumer; it's a very female audience; there's a lot of feel to the business. And part of what we're trying to learn here at Scotts is more -- and this is -- there's no message to the retailers here -- but better communication with our consumers on a very -- you used the word granular level. So, part of the skills we want to develop at Smith & Hawken, for Smith & Hawken's sake and for Scotts' sake, is how to communicate better directly with the consumer. So, this is a really important part of our business and it's something that we want to improve.

Now, Gordy, do you want to take over here?

Our business has consistently shifted from catalog to Internet over the past six to eight months, and we continue to see that. I think what the disappointment -- if I could use that word -- was is that we didn't have enough of that business shift. And we didn't see real negative things on the Internet side; we just continue to see the catalog not being as strong as we had forecasted.

So it's just a forecasting issue for me, is that -- how much is going to shift from catalog to Internet? We're using the catalog more today to encourage customers to shop the Internet. Because in most cases you do look at the catalog, and then you go online to place your order. So, the catalog is becoming an important marketing tool, not an important ordering tool. So, we continue to understand both businesses. At the same time, where does the store fit in all that? Our stores had a very strong -- stronger than we had expected in December, a little softer than we expected in October and November.

Bill Chappell, SunTrust.

Just a couple quick questions on kind of the cost environment. Maybe on a broad-brush side, can you talk about -- as we look over the next be it 12 months or 24 months, you mentioned kind of the ethanol pressure that puts on urea prices and fertilizer costs. Is this going to be a headwind for the next few years, that you need to constantly be raising prices, or is it manageable? Is there any way to ballpark that?

First, the answer is I think it's manageable. I think it's lame, just so I don't stay safe here. I guess a dollar a gallon of subsidy in ethanol, whatever it is -- and supposedly the President is going to announce increasing from 10% to 20% in gasoline the amount of ethanol. I think, generally, it may be good for corn farmers, but it can't be good for food and it can be good for people who use urea unless they're passing the cost on. So, I think that, clearly, urea and components that go into sort of ethanol are probably, on a supply-and-demand basis, going to be a headwind.

On the other hand, with the price of oil the way it is, I would say -- Dave wouldn't say it; I would say it -- it's a tailwind. So overall, let's just start with '07. I think we feel very comfortable that the balance is okay and, I would say, from my point of view, maybe slightly favorable, even though the guys here view it as -- at least they want to keep telling me it's neutral. But let's just say it's in balance, okay, for right now.

In the future, I think, it depends on what happens with energy costs. So, that's going to sort of be what happens to a barrel of oil. And, I think, if we continue to see a push on sort of the -- start with the subsidies in ethanol and, therefore, the shift of planting into corn, which is a heavy eater, it might mean pricing going forward. And I think that that's -- I'm not sure I can say much else than that.

Chris, you got a point of view on this?

I don't really have much to add other than, Jim, I think we're going to have to take a good look at it, Bill, as we get through the season. I don't -- I think it would be hard to imagine that there's going to be any near-term relief in the cost of urea. So I think Jim is right; it's going to depend on really the net of some of the other inputs.

Just turning quickly to wild birdseed, do you expect price increases to offset the cost this year, or are you baking in no price increases?

This is angry Jim coming out now. The big dog in this space is Central, okay? They have kept a lid on pricing by not allowing us to take pricing. And in the absence of them taking pricing, it's basically impossible for us to get pricing. This didn't have to happen, and it was predictable. Okay? Chris's biggest issue in his business is this one thing -- birdseed. As he stressed out in the budgeting process, it was due to birdseed. This did not have to happen. As far as I know, even though I thought our deal in the past with retailers was if we could show a cost increase, we could get pricing, we are not the big dog in this space, and we have not been able to get pricing on bird food. So, I personally don't suspect or have any hope that pricing is going to relieve Chris's angst on margins for this particular category.

But I do think -- and I met with the guy who runs our birdseed program as I came into this room, and I said we just have to move hard toward brands. Because where we operate now is more or less the commodity side of the business, and it's not value added. We have big plans to go value added, and I think that we can get pricing as we innovate. And I think that that's the key to innovation across our entire line.

Nagel, any hope you have for pricing?

No, I think it's unlikely that in '07 we'll have enough pricing to offset the inputs. So, we're going to try to manage through that the best we can. Jim is right about having to bring a value added component to the category. And obviously, we are hard at work on doing that. We're going to have to continue to find substitutes where appropriate, again, because I don't see really any real near-term relief on the corn side, which is a major input. Also, sunflower -- cost of sunflower seeds are up considerably. So, we're going to have to continue to work the mix and probably talk to our retailers about, you know, the end of the '07 birdseed pricing cycle is a little bit different. So we'll be talking to our retail partners about pricing toward the end of the season, and see what we can do.

Doug Lane, Avondale Partners.

While we're on that topic, Jim, can you just update us on the pricing environment elsewhere, whether you are satisfied with the success you have had taking pricing this year?

The answer is yes. Pricing is done.

Okay. Dave, I noticed the tax rate was 36% in the quarter. Is that a good number for the full year?

It is a good number for the full year.

Can you remind us -- when do we anniversary the acquisitions this year?

There were, I'll call it, three different types of acquisitions. We had Gutwein, which was bird food, and that was in late November last year. So, that is now in our comps as we anniversary to Q2. We had a small growing media acquisition, Rod McLellan, that was also partially through our first quarter last year. And then the third was two smaller acquisitions in our grass seed business that occurred late third quarter, early fourth quarter last fiscal year.

Are they big enough to move the needle in your North American business by a couple of points?

In what respect, Doug? Margin rate, or sales, or --?

Sales growth.

Sales growth? In the first quarter you saw a relatively large impact, but that was because our biggest acquisition was bird food. Going forward, two things happen; the size of the deals is much smaller, and the base business in North America is significantly larger. So, the impact to sales in future periods is fairly insignificant.

Jim Barrett, CL King & Associates.

Jim, I just wanted to follow up on Doug's pricing question. I understand the situation in bird food, where you're not a dominant player. In the categories where you are a dominant player, have you given thought to taking pricing in excess of your increase in cost of goods? What would happen if you went to your retailer and did that?

A beating. I don't know.

You could handle that.

Listen, we have taken pricing -- this is three years in a row. We had the hardest time, I'd say, this year on pricing, largely because in the middle the oil prices started to shift. So, this was a hard one. I think the ability for us to take incremental pricing this year is zero. I continue to believe -- and let's go back to bird food -- that we should be able to get pricing, the industry should be able to get pricing; not just us. Because the cost of these, the inputs, has gone up so dramatically. But unfortunately, that hasn't happened, and I do think that we need to -- Chris, you and I need to go visit some of the retailers ourselves, because I can't tell what the truth is on this at all.

So, I don't think we can get any pricing in '07, and I think we had the discussion regarding what does the future look like for 2008. And I start with saying things look in balance, and it really depends on the price of oil.

This may be a naive question, but it seems to me that the retailers essentially wouldn't have a choice if you enacted pricing that would improve your gross margins. Or am I incorrect on that?

We've got share and we have a relationship, and we are a major player in the space. So, let's start with that. Could we take pricing? This is a question that's come up all the time, which is, based on our sort of importance to the market, couldn't we take -- shouldn't we be more profitable? And I believe that we should be more profitable. I think that that happens through margin shift as a result of innovation and uniqueness.

I think for us to -- I'm really happy with where we are. I think part of where we got to is being fairly responsible in pricing. You may view it as irresponsible, because this has been a discussion we've had for the last decade, really, at Scotts, which is how much market share are we willing to trade for pricing? And we like to compete here at Scotts. So, maybe we could have been more aggressive over time, but I like where we have been. I was looking this morning at -- going through mail. I have a board meeting this week, so I'm clearing my desk. And there was some Forbes, like, 400 platinum list, and they showed our earnings growth at, I don't know, north of 25% over the last five years. It's like I can't really complain about that. So, I'm not sure what the answer is. It's a strategic question. And we have chosen to try to work with our retailers to work to gain shelf and not be so selective, because the result would be they would push their private label harder, and competitors would take advantage of it. That's all.

Then, last and least, do you foresee any change in your relationship at Home Depot, given the change in leadership there?

I got a call from Frank Blake a couple weeks ago at home, at my home in New York, and told me that we were the first vendor he called, that he wanted to get together. We have a meeting set up in, I don't know, a week or two, to visit with him. And I'm really happy that he reached out to us. I'm really happy that he's reaching out to the vendor community, because I know that Scotts Miracle-Gro, and I know that the other key vendors can help them in their business. So he's reaching out, and that's a very positive sign.

Joe Altobello, CIBC World Markets.

First question is on the shift in retailer buying patterns. Obviously, this has been going on for a few years now. And it looks like with North America, organic sales down 2% this quarter and sort of soft last quarter. Is that process accelerating?

Accelerating? No. I would say no. I think it's rational. I'm not sure where all this is going -- and I'll probably scare the bejesus out of my buds here. If you look at the return on capital for retailers, they still sit on a lot of product. And I think that we can all be more efficient, both manufacturers, marketers and retailers, in watching the sort of level of capital that's invested. I don't like product that spends the winter there, largely because it looks terrible. You cannot store something outside at a Lowe's or a Home Depot in a shed and have it look great, and that's the first product they see.

So, I think -- and we have demonstrated 99-plus% ability to ship, and that's one of our strategic advantages. This week with our board is strategic discussion as well as our annual meeting, but it's three days with our board. And I think that one of the things we're looking at is where is it that we're innovating? Where is it that we add value? What are our strategic strengths? How do we not let them disappear and how do we make them even stronger? And what do we not do well that we need to do well?

Well, logistics is one of the things we do really well. And Mike Kelty and Mike [Lukemeyer] and their teams, that sort of built and run that today, are very important for this company, as is the technology that we use to sort of do it. This is a strength of ours. So, I don't think it's accelerating. I think it was painful at first. But I think it's going to continue to evolve, and this is one of our strengths.

And I was thinking, as Dave was talking, that you have kind of got to love the seasonality of our business. I tell my kids all the time -- if you don't love yourself, nobody is going to love you. And we are a seasonal business. And I think that part of what Dave was talking about is sort of it's all in Q2 and Q3, baby -- a little bit in Q4. This is kind of a non-event quarter. But I don't see that changing. And I see that working right into our strengths, because we are really powerful in our ability to execute in a very violent space.

Secondly, a question for Dave. You mentioned that you're going to have some charges in 2Q for the debt retirement. How big are they? I assume that's included in your guidance, I think -- right?

What I would say is that my expectation is those charges will be in the, call it, $18 million to $20 million range.

$18 million to $20 million?

I'm sorry; $18 million to $20 million. So, around half of that is coming from the tender of our sub debt early, and call it the remaining balance is really debt financing costs that were capitalized in prior periods. So, when I spoke of guidance, I would expect that we will adjust our earnings to exclude that. So, that was not contemplated in that guidance.

Alice Longley, Buckingham.

I have another question about the shift in shipments. Can you tell us how much consumer spending on your product was at retail overall? You gave us a couple of -- a few categories, but not the overall number.

Maybe you understood what she said.

You're looking for overall POS in the quarter?

Right, for your products at retail.

It was up 2%.

So, basically, shipments down 2 and POS up 2? Just so you sort of get the order of magnitude. Is that correct?

Yes. But again, the first quarter is one of those ones that's really difficult to try to align. Because there's a lot of POS in the quarter that occurs early in the quarter, in the fall season, where you shipped in before September 30. And a lot of your shipments are setups for all the POS that is going to have to happen after Q1. So, the alignment of sell-in and takeaway in Q1 is one of those things that -- it just doesn't match up very well.

But is that the kind of order of magnitude of difference it would make sense to expect in the second quarter as well?

No, not necessarily at all. I don't think you can predict anything about the relationship between sell-in and POS in Q2 from Q1.

Do you think that the 2Q is going to shift into the 3Q a little bit, so shipments might be up a little less than POS?

I think when Dave was giving you the quarterly guidance, our expectation is just, again, as to what Jim was referring to about our ability to continue to work with the retailers to minimize leadtimes and minimize inventory levels. We continue to see, probably, a little bit more of the sell-in shift back every year more closely aligned to POS. So, we should see a little more sales growth in Q3 this year than you probably see in Q2.

On Smith & Hawken, can you update us as to whether the division loses less money in '07 versus '06?

That's easy. The answer is yes.

But it doesn't make money, right?

No.

But a lesser loss?

Yes ma'am.

Could you break out the various components of your gross margin? In other words, what was the impact of raw material costs versus acquisitions versus any other factors (multiple speakers)

I'm sure there are smart people like that [in our businesses]; not me. Dave, you're a smart guy.

You don't have that?

(indiscernible) so it was down 100 basis points. The two biggest components are going to be the acquisitions, and then the commodity costs. Are they equal, equally shared? Not quite equally. Acquisitions probably had a slightly greater impact than the impact of the costs in our first quarter.

And the last thing is, could you elaborate a little bit about how you're going to go after this new demographic? Are we going to see it this year, and can we see it on any place on the Internet? Or is there any place where we can see what you're doing?

On what?

Will we be able to see what you're doing, and where and how?

Are you talking about when Jim was referring to some of our comments about trying to grow the category and go after new consumers, particularly like with the example of lawn fertilizer?

Right, and not go after exclusively white males over 50. (multiple speakers). That comment came right out of -- came out of the presentation in December.

Yes it did; you were fair. You will begin to see it in '07. You'll probably see it in even more earnest in '08. We are filming some of our advertising spots as we speak, and I think you're going to see us begin to -- the look and feel of our advertising is going to change a little bit, again, to get away from the 50-year-old white male emphasis a little bit.

We are going to begin to -- we're putting in a new platform for our Web site that would give us some good functionality, particularly in '08 (indiscernible) to be more interactive with consumers. Although we are going to look to accelerate what we can do this year still, without necessarily needing to rely on that functionality that we are going to get toward the end of the year. So, keep an eye on our commercials this year. I think you are going to find that they're going to feel a little bit different. Obviously, we're not abandoning what we're doing (multiple speakers)

But it's going to come back to, number one, in our sort of marketing outreach, it's going to be tonal. This is going to be a tone toward new, younger people who are confused by the category. They're going to be more diverse and they're going to be more -- I don't want to use the word sort of spiritual casually, but I do think they're going to be more about what having a really nice -- how it feels to people. You're going to be able to see that starting this year.

By the way, when our commercials are done, we'll post them on our Web site, so you guys can all pull them down and see that. You'll also see, I think, as we have been, a shift toward more RTU products. We believe, from a sort of environmental and from a usage point of view, that this is better for new sort of non sort of "professional" sort of consumers of our products. So, we like that. And I think this also shifts us more toward new users and toward a female base.

Tim's business, for sure, is a very female -- LawnService is a very female business compared to our existing lawn business, and our outdoor living business is very female. So, this is where the sort of battlegrounds are as we talk about new users, especially non-50-year-old white males. And, like, just in Tim's business and Chris's business, we're doing a lot of work now with naturals and hybrids of naturally-based product with a little bit of boost in them, and trying to see where the consumer goes to. And I think, again, this is a battleground for new users. This is clearly not, I think, top of mind for our existing user base; it is for people who are the do-nothings. And remember, I think, it's about a third of homeowners don't do squat. You know?

I've got one last question. When you said adjusted EPS in '07 flat to up low single digits, that is the number you would expect to actually get reported, not fully pro forma for the whole year? Is that correct?

That's correct. That would be as reported.

Eric Bossard, Cleveland Research.

The LawnService business lost $5 million more in the quarter. Is that part of the deal as this business grows and the seasonality of it, at least in the first quarter?

Yes. Every year our --

That's Tim Portland, by the way. He runs it.

Every year our loss in this quarter expands as we invest more in facilities and the management to run them, the fleet, etcetera, to get ready for the coming season.

So, listen -- one of the things that happened last year was, I think, in my script, is that we went into last year really in a sort of pretty bad place. We were whipping the heck out of, like, the HR people, trying to get help to get all Tim's positions filled. This year we're in a much better place, and there's a cost to that. I would gladly pay to be in the situation we are today than where we were last year, where there was just a lot of anxiety over how we started the year and who we were employing, because we are being more selective, both from a background point of view, which includes smoking. So, I think, we're in a much better place than we are, and there's some cost to that. But this is partly we grow the business and partly we're ready to go earlier. Is that fair to say, Tim?

Yes.

Tim, how does pricing feel as you go into this season in your business?

We're happy with where we are. Again, we have taken price increases two of the last three years on our existing base. We have not done that this year, so we won't see the same increases that we saw. We're hoping for and planning for a mix improvement from a lot of the other actions that were taken in terms of our programs. It won't be as significant as it was last year. We are, obviously, monitoring the urea situation as well. But, as Jim noted, we also -- last year in the spring, fuel was at $3 a gallon. And while diesel hasn't come down as much as gas, it's still come down, so that's a nice balance to offset.

Any reason other than -- well, I guess -- any reason why not take price this year?

Listen, I'll take that. Retention is the key metric, I guess, maybe, and how much we can get per customer per year, combine that with retention; that's kind of the business. And maybe [the mark to cost will] get it down. We saw -- and again, maybe there's a lot of whippings that take place around here at Scotts. But where I have been working closely with Tim has been on the level of service and what a consumer expects when we say it's a Scotts lawn. And we have made good progress, maybe better than good, but we have got a long way to go.

That being said, we are freakish when people cancel. And we spend a lot of time either trying to convince them to say or saying help us understand why you are leaving. We saw, really for the first time last year, the big reason people left is they said I can't afford it. Okay? And so, I think there was a lot of sensitivity to that issue; not quality. The reason I can't is I just can't afford it.

Now, the good news is, we have got a $10 bag of fertilizer for them at our brick and mortar retailers. So, we're not losing the customer. But I do think there was a lot of sensitivity to the cost. So, Tim is doing fine, you know?

Secondly, on Smith & Hawken, you talk about the catalog and Internet, which appear to be, perhaps, structural competitive issues that are influencing that. You have grown B2B. But (technical difficulty) you get from here to making a reasonable return in that business, what is the -- is there a silver bullet from this point?

Yes. I'll give you my point of view, and Gordon can say he agrees or disagrees. And he's, clearly, liberated and can disagree, but I don't think he will. And that is this -- I think the Internet and catalog to some extent are structural, but I think it's our structure, okay, which you'll start to see this spring a new approach to how we run the catalog, which are basically these monthly touches -- I think Gordy has talked about this before -- with kind of a source book that comes out in the next few weeks, which is kind of a main book, and everything else is kind of an addendum to that. This starts with the fact that anybody who as ever gotten Gordy's business-to-business catalog, which is the big catalog with everything in it, the non-consumer catalog, always says this is so much better than the consumer catalog. So, his source book is effectively his kind of old-school, all-the-stuff-we-have catalog, and then you get these monthly touches. And I think that will help with the structure. And the Web site, I think, still needs some work, although it's new. But I think we've found out some things that we could do better. So, I do think there's structure. I don't think it's a competitive structural issue; I think it's our structure.

Success -- the silver bullet, and let's be clear on this for a couple of reasons. So, maybe this will be the longest thing, and I hope we're done, which is that -- so, my competition coach is Mike Porter, who is a close friend of mine and works well with us. We were up at Harvard a couple weeks ago, and we were talking about Smith & Hawken. And he basically said, you guys have got to stop talking like they're retarded. They're learning. They're making progress, and you are forgetting the reason you did it. It was a direct-to-the-consumer approach to your business that is not just important for Smith & Hawken; it's important to the rest of your business. This direct marketing, this relationship with ladies is really important, and you guys have to learn how to do it. You've got to reinforce those guys. You've got to help them do it better. This does not mean they're walking on water, but it means that it's an important part of our business, an important skill set we need to learn.

So, the value of that business goes beyond just Smith & Hawken; it goes to how we market and what we learn from them. Now, at the end of the day, it comes to having the right stuff that people want to buy in a store, and having enough stores to more than offset your overheads. And I think that's the silver bullet. So ultimately, profitability of that business will be having stuff people want to buy, both on the Web, catalog/, and with the stores being productive and having enough stores that it offsets the overheads sufficiently.

Gordy, would you add anything to that?

No. I just think the silver bullet is you have to be able to have those three businesses working side by side in conjunction with each other. And that's the catalog, the Web and the stores. And the stores, to me, are still incredibly -- probably the most important, and then the catalog and the Web drive you to the stores and drive you to each other. So, I think it kind of all works out (indiscernible) all of them have to work well.

But Jim hit the most important point that everybody has a tendency to forget once in a while, is that people shop customers -- customers shop stores because they like the merchandise. And we've concentrated the last seven, eight months on getting good merchandise to the stores. And that really starts to show this spring as we get back to the garden.

Connie Maneaty, Prudential.

I don't know if you've already talked about this, but what impact on your business do you think there will be in terms of the timing of shipments with the shift to an earlier Daylight Savings Time?

Chris, you get that one.

I can't imagine much impact on our business from that.

Don't you think retailers will be resetting store shelves earlier in the season?

You know, listen, I wish. I was talking to Dan Paradiso, who runs our sales group, and setting the stores is not a small issue. It involves a huge amount of effort with not only Scotts, but the other vendors that are in the department, and all the store personnel, and headquarters by flowing the product into the stores. And it all has to happen kind of at one time. I think we're making good progress. I don't think it has to do with sort of the Daylight Savings Time; I think it has to do with the fact that retailers want to have a good spring. But I think there's still some level of frustration that we could be setting earlier, especially in the Southern markets. But overall, I think it's just a matter of -- and remember, the retailers, their year-end generally is, I think, at the end of February. (multiple speakers) January. So, they're like freaky about their reported year-end inventories. That puts pressure on, too.

So, I think they want to have a good season. They're allowing more product in the stores earlier to get them set. But it's so complicated that we've got to get other vendors, we've got to get the store people to help. There's just so much stuff that goes into it, I think, it's not as efficient as it could be yet.

I think actually what would be better is a few blizzards would be good for us, so that we could get some of the snow and winter equipment to (multiple speakers)

You want snowblowers and shovels out?

(multiple speakers) the Daylight Savings Time.

Olivia Tong, Merrill Lynch.

I'm just wondering if you could talk a little bit about the profit outlook by segment. You reiterated your outlook on Europe, but that was the only one. Just wondering, relative to the estimate you gave at the analyst meeting, what you're thinking about the other segments.

At this point, this early in the year, I would say that our guidance would be consistent with what we shared with you in December from a segment prospective. It's so early in the season at this stage.

Just maybe a little bit of color. In a sort of very general, I think that we continue to believe that the North American business and Tim's business are businesses that we understand, they have a relatively-high level of profit, and they have got, as I think the original -- I think it was the original George Bush said they've got big mo; they've got momentum. Our expectations for Claude in Europe is that he become a good corporate citizen, and that he grow, I'm going to call it, 8% to 10% per year, which I'm sending a message to my team a little bit.

The Smith & Hawken business has got to improve their absolute level of profitability; i.e., reduce the level of loss and get into profitability as quickly as possible. And I think this is a matter of sort of extreme attention to detail, a sense of urgency, support from us here in Marysville, as well as from the management out in California, so that probably, from a percentage point of view, it will look like a positive, a significant percent positive.

But, I think, generally, that's the flow of the world, which is our big businesses do well, and our rambunctious adolescents, we continue to get them to study and work, and hope we see changes in their grades.

Just one other question, on pricing. Are you expecting pricing this year to offset your raw material needs, or the inflation in raw material costs?

Yes.

Operator, I think that's it for today. If anybody else was in the queue that we didn't get to, if you want to call us back later on, we'll do our best to get to you. Thanks, everybody, for joining us, and have a good day.