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The Scotts Miracle-Gro Company (NYSE:SMG)

F2Q08 Earnings Call

May 5, 2008 5:00 pm ET

Executives

Jim King – Vice President of Investor Relations & Corporate Affairs

James Hagedorn – Chairman of the Board, President & Chief Executive Officer

David C. Evans – Chief Financial Officer & Executive Vice President

Barry W. Sanders – Executive Vice President North America

Peter Korda – Senior Vice President Scotts Lawn Service

Analysts

William Chappell – SunTrust Robinson Humphrey

Olivia Tong – Merrill Lynch

Alice Longley – Buckingham Research Group, Inc.

Joseph Altobello – Oppenheimer

Doug Lane – Jefferies & Company, Inc.

Eric Bossard – Cleveland Research Company

Jim Barrett – CL King & Associates

Connie Maneaty – Bank of Montreal

Operator

Good afternoon and welcome to The Scotts Miracle-Gro Company second quarter 2008 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.

Jim King

Good afternoon everyone and welcome to The Scotts Miracle-Gro second quarter conference call. With me today are Jim Hagedorn, CEO and Dave Evans, our Chief Financial Officer. Before we get started I want to remind everyone that our comments 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 10K which is filed with the Securities & Exchange Commission or our most recent 10Q which will be filed later this week. If you did not receive a copy of today’s press release you can find it on the investor relations portion of our website, www.Scotts.com. This call is being recorded and an archived version of the call will also be available on the website. If we make any comments 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.

James Hagedorn

Hello everyone. We’ve got a lot to cover this afternoon so let me jump right in to our discussion. I know there are a lot of questions about our recent recalls, the state of the business and the current economic environment and the continued movement of commodity costs. I want to start however by stressing that despite the recalls and the fact that we lowered our guidance today, the fundamentals of the business are solid. In fact, when you look at our business in the context of the macro environment I think we’re doing a pretty decent job. Clearly, we’ve seen better days and I’m never happy about calling down our numbers. I’m especially unhappy about our revised guidance when just three weeks ago we felt comfortable reaffirming the year but a lots transpired over that period as I’ll explain shortly.

First though, let me provide some context. Our core consumer remains engaged in the category. In the face of gloomy economic news and gasoline at nearly $4 a gallon people continue to garden. Consumer purchases of our products were at an all time high in most parts of the country in the month of April and the parts of the country where the season broke early and the weather has been good especially in the northeast our year-to-date performance has been very strong. I also note that our retailers continue to be highly supportive. Lawn and garden remains one of the best performing categories in their stores and they continue to support us with strong promotions and better displays. In fact, one of our largest retailers just had its best single week in lawn and garden ever. I also know that our operators are doing a good job managing the difficult commodity market. Even as costs continue to rise they’ve been very effective at managing other expenses while continue to make investments that will benefit the business over the long term.

The guidance we provided this afternoon reflects the reality of four simple issues, three of which shifted unfavorably since mid April. The first is a slow start to the season. While we made up a lot of ground in April, especially the first two weeks of the month, we didn’t get it all back. Our POS growth in the second half of April was up nearly double digits but behind the nearly 50% increase we saw in the first half of the month. So, coming out of April consumer purchases are up 2% on a year-to-date basis. We had budgeted POS to be up 6% to 8% in dollars for the full year so it’s probably unrealistic to expect we can fully close the gap based on where we stand right now. Secondly, the recalls we announced were also part of a tipping point that we reached since April 15th.

In addition to the cost of administrating the cost of recalls we much also deal with the loss sales for the balance of the year as well as several million dollars of unplanned legal and other consulting fees. Since we announced the recalls last week these issues have come in to clearly focus. I’ll let Dave elaborate when he covers the numbers. Before I continue though let me discuss these recalls. The facts around our Wild Bird Food recall are pretty simple. We had been using an unapproved pest control product on our seed, a fact that had been true for years prior to us buying the business. Although the control was approved for human food use and we don’t believe wild birds were ever harmed we recognized that we had an off label use of an active ingredient. Once our senior management learned of the issue we reached out to both the EPA and FDA with a voluntary recall plan and got the product off the retail shelf. This effort is nearly complete.

The facts around the more recent recalls are quite different. On April 10th we were served with a subpoena and a search warrant was executed on our offices here in Marysville. We subsequently learned that the US EPA had questions about the validity of some of our registrations. At first we believed their concerns to be unfounded. As the facts unfolded however, we came to realize that we did in fact have a problem. At this point we know that a terminated employee deliberately and secretly circumvented our policies. Those actions caused invalid regulatory forms to be used for certain products that were later marketed to the consumer. None of the products in question contain any new active ingredients. In fact, some of the product contain actives that have been on the market for decades. Nonetheless, the fact that we have unregistered or mislabeled products in the market is prompting the recalls.

Because this is an ongoing investigation I can’t elaborate much further than that. However, we recognize this series of recalls raises valid questions about our processes. To that end we’re in the midst of hiring a third party to conduct a thorough review of all our processes and help us determine what we can do to help prevent a recurrence in the future. What’s more important now is that we deal with this issue and get it behind us. We’ll continue to work cooperatively with both EPA and Department of Justice. We’ll be as transparent as we can in sharing developments with all of you and we’ll try not to allow this issue to distract us from running the business.

Let me get back to our full year outlook. In addition to the slow start to the season and a product recall we’re also seeing a bit more stress than we expected at both Scott’s Lawn Service and Smith & Hawken as a result of the economy. While both businesses continue to make progress their performance in April made it unlikely that either will hit its full year target. Finally, commodity costs, even though we locked in the majority of our costs by February we still had incremental exposure. We’re working to cover as much as we can but we’re unlikely to cover it all. Of the four issues that led to the call down commodities really weren’t an April event although we continue to see costs rise.

I want to be clear in telling you that we’re not giving up on our original budget and the team remains highly incentivized to hit those original targets. But, I also want to be transparent, the guidance we provided this afternoon is based on everything we know today and represents what we currently believe is a likely outcome. It’s also important to remember that we are not pulling back in making long term investments in our business. Our R&D pipeline looks extremely strong and we’re making project on project catalyst which we expect to result in significant cost savings over the next several years. We will not sacrifice these opportunities to close the gap on near term challenges. In terms of near term investments, the money we spent on our sales force this year has gone a long way in strengthening our relationship with our retail partners. We have better displays this season for example with more excusive end caps than ever before. I also believe we’re getting a good return out of our marketing spending.

Other than the recalls each of the four issues I just outlined a moment ago reflects mainly the impact of a challenging macroeconomic environment. Actually, as I look at things through a broader lens I think we’re doing a fairly decent job navigating right now. If I saw fundamental weakness in the category I’d be more concerned but let me give you some examples of why I actually feel pretty good about how things are going. March was a dreary month and we got off to a slow start to the season. In fact, by the end of the month year-to-date POS was down 10%. At the end of April though POS was up 2% on a year-to-date basis and within that number we had some great trends.

In the Northeast consumer purchases on a year-to-date basis are up nearly 30% through April. In fact, I can’t remember the last time I saw this sales force as fired up as they are. While we can’t break market share down by region, we don’t believe our competitors are performing nearly as well. If you look at the mid Atlantic we’re up 5% year-to-date which is pretty much in line with what we planned so we have no complaints there. If you want to see the impact of a slow start to the season look at the Midwest. Through the end of Q2 POS was down 24% on a year-to-date basis. By the end of April we were flat and we entered May with a lot of momentum. We’re hopeful to finish the year in positive numbers though I think we’ll fall short of our original goals. Only in the southeast are we seeing continued slowness. POS through April was down 5% while moderating the drought remains a challenge in both Georgia and Alabama and we believe the economy is probably a bigger factor in Florida than any other place right now.

Let’s shift away from geography and look at the business by category. In our lawns category consumer purchases of our fertilizers were up 32% in April though we remain slightly down on a year-to-date basis. I already explained that we loss some early season sales in March but this business has a lot of momentum as we enter the next phase of the season. We’re hopeful that the momentum coming out of April will carry forward based on the strong level of acceptance of our Water Smart product both from consumers and retailers. Remember that our $30 million marketing effort behind Water Smart is the largest and most integrated program we’ve ever conducted. In addition to a great TV spot we have utilized radio more effectively this year as well as print including our first ever free standing newspaper insert that included a discount coupon. The early redemption rates look encouraging.

As always we continue to see strong growth our of our growing media business. Year-to-date consumer purchase of Miracle-Gro Moisture Control Potting Mix are up 11% and we’ve also seen a 26% improvement in Nature Scapes Mulch over that period. Both of these businesses are just getting ready to enter their peak season. In our home protection business, that is Ortho and Roundup combined are essentially flat from last year. However, remember that the vast majority of this business occurs in the second half of the year.

When you translate all this in to market share our lawns business where the price points are higher and the gap between us and private label is the highest, we believe our market share is down slightly. In our home protection business our market share is flat from last year and in our gardens business we have maintained our momentum and continue to take market share. What we’re seeing in our lawns business does begin to raise some questions about the impact of pricing. We’ve taken pricing in this category four consecutive years and have gained market share during that time. But, as Urea prices continue to escalate and the consumer continues to show some weakness we need to reevaluate that position.

As you know, Urea is our largest raw material and a key element to fertilizer. Today, Urea is selling at $600 a ton, as week ago that number was $490 a ton and a month ago it was $370 a ton, roughly in line with a year ago. So, while pricing will clearly be necessary, it’s hard to imagine that we can pass along the entire increase. We need to do some carefully analysis to better understand how much further prices can move before our core consumers decide to opt for opening price points. Conducting this analysis will clearly be a priority in the months to come.

Overall, when I look at the core US business I still feel pretty good about our core lawn and garden consumer. Do I feel great? No. But, I do sense that both Scotts Miracle-Gro and the overall category are faring better with the consumer than a lot of other areas of discretionary spending. I’m also feeling okay about retail inventory in the US again, not great but okay. Through April inventory levels have generally been slightly lower than last year, a trend we now expect to continue. Entering the year we expected inventory levels for all of our retailers to be up about 5% overall in dollars at the end of the season. We assumed slight unit declines in retail inventory with the entire increase being explained by pricing and new store growth. That now appears unlikely. In fact, we now expect retail inventory dollars to be flat to slightly down by the end of our year.

Let’s move on to the international side of our global consumer business. Before I do, let me be clear, the information I’ve provided about the US business was update through April. The results from international will be through March. On the top line consumer sales in Europe both in the quarter and on a year-to-date basis are up about 10%, flat excluding foreign exchange which is in line with what we guided last December. Remember, this is a business that had strong growth last year so we knew going in to the year that it would be challenging to grow off that base. However, we’re seeing some good stories develop in this business. The strongest growth continues to come out of France which is nearly 35% of our consumer business in Europe. We’re seeing strong growth across that entire business building upon last year’s momentum. In the UK we had a late break to the season but we’ve been quickly making up ground. We gained major new listings this spring in one of the country’s largest garden centers and we increased our SKUs at many major accounts. We also believe we gained market share since this time last year.

Across the entire international business we continue to see solid growth in our pest and disease control categories as well as growing media. In fact, we’ve begun to see our branded growing media business outpace private label which is a positive development for the long term. In pest and disease products we continue to see strong consumer acceptance of our new organic and natural line of products which we believe will result in about $16 million of sales for the year. While I’m speaking of international issues, let me turn my attention to our global professional business which remains particularly strong in Europe. Our sales in this business are up 29% in the quarter and 21% on a year-to-date basis. In the largest segment of that business which is Europe, sales are up nearly 20% so far this year which is also what we’re seeing in Asia Pac. In Latin America sales have increased 23% and we’ve seen a 9% improvement in North America.

We’ve seen strong demand for our proprietary Osmocote technology throughout the world and we’ve done a good job managing commodity pressures in this business. Unlike the consumer business where pricing has historically been an annual event, we can make real time changes to our pricing structure in the professional business. So while we’ve seen strong organic sales growth we’ve also seen several points of growth from pricing. The trends we are seeing in this business are well above our internal expectations so we’ll probably see some upside in Pro for the full year.

Changing gears again, let me elaborate on Smith & Hawken which as I said earlier seems to have been impacted by the broader economy. Like the core business the outdoor living season broke late so Smith & Hawken sales were down 21% in the quarter. Most of that decline was related to our catalog, business-to-business and wholesale. You might remember that we expected our wholesale business to be down this year when compared against the strong growth we saw last year with Starbucks. Retails sales were flat in the quarter but picked up in April when consumer sales were up 8% and comp store sales were up 5%. We continue to see solid improvement in furniture including our new low and middle price point products that were introduced this season. While the peak of the season is not yet to unfold for Smith & Hawken, our results in the first half are likely to be too challenging to overcome. The expected loss in this business is likely to be in line with last year or slightly greater.

Finally, let me spend a few moments talking about Scotts Lawn Service. Remember, compared to the DIY business, this is a high ticket purchase for homeowners. The average lawn service customer spends several hundred dollars a year with us on what is clearly a discretionary purchase so we’re seeing more cancellations related to economic conditions that we have in previous years and clearly, more cancels related to the economy than any other reason. That’s not really that surprising. Remember we said back in December that we had modest growth targets for this business in 2008 compared to prior years.

More than growth, our goal for 2008 was to better understand the best way to enhance the long term value of this business. To that end, we’ve been extensively analyzing and contrasting our best and worst performing markets in an effort that’s already paying dividends. We believe we’ll come out of this year with a much better understand of the best ways to improve market density which is the key to profitability across the business. We’ve begun to better understand the best ways to refine our pricing model in each market and we’re reexamining our market strategy as well. And, our staffing model has stabilized with a 25% improvement with field labor turnover versus a year ago. The improvements that we’re seeing and the lessons that we’re learning will help us continue to drive growth in SOS going forward.

In all of our businesses, I think we’re doing a good job executing against the plan we’ve shared with you in the past. If we had to start the year from scratch, I don’t think we’d do much differently. We’re simply getting caught up a bit in broader issues. Along that line, I want to make one final an important point as I wrap up. Whether it’s with our consumers, our retail partners or our investors, I believe that our reputation and credibility is our greatest asset and over the past several weeks I recognize that our reputation has been compromised. I’m not happy that we’re calling down the year and I’m truly troubled we find ourselves in the midst of several recalls and a government investigation. But, you have my commitment speaking for all 6,000 of our associates that we will resolve these issues and get them behind us.

I also want to stress that these recent challenges should not in my view affect the way that you see the company and the category. This continues to be a great business and all things considered we remain satisfied with what we’re seeing out there in the core lawn and garden market. Sure, some consumers may be scaling back a bit and spending less but they remain engaged in the activity of gardening and that’s critical. Our job then is to continue to strengthen our relationship with those consumers and not only keep them engaged in the category but continue to give them reasons to choice our products. Based on our long track record I’m confident we’ll succeed.

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

David C. Evans

I’ll start my comments with some housekeeping on the product recalls. I’ll then provide some additional color on the second quarter adjusted results and updated full year guidance. As you saw in our release we are treating the direct cost of the product recalls as a non-recurring item and are excluding them from adjusted earnings. When we speak to annual earnings guidance we’re referring to adjusted earnings.

The direct cost of the product recalls included in our second quarter reported results but excluded from adjusted results primarily consists of gross margin dollars associated with sales reserves for expected retailer returns, labor and freight costs required to remove and return recalled products, and inventory dollars to be written down and written off and related disposal costs. When we original announced the recalls we disclosed cost ranges for these direct costs of $15 to $20 million for the Wild Bird Food recall and $5 to $10 million each for the subsequent two recalls. In aggregate the estimate of the direct costs was $25 to $40 million. As you saw in our release the cumulative impact on the second quarter operating income was about $31 million. At this stage we anticipate the total direct cost for these recalls including charges which will be incurred in the third and fourth quarters to fall close to the high end of the $40 million range. This cost estimate excludes the impact of potential regulatory fines or penalties which would also be treated as non-recurring items.

At this stage we remain focused with working with regulators and fully investigating the matter including confirming all product registrations and executing the previously announced recalls. As a result it will likely take some time before we can access whether we’ll be subject to regulatory fines or penalties and if so, to establish a reasonable range for potential fines. I would also point out that these costs exclude the expected impact of loss sales for the remainder of the year, products we can no longer ship. And, finally the $40 million estimate also excludes any additional unplanned G&A spend to complete the comprehensive review of the product registration process in a broader regulatory compliance risk assessment. The combined impact of the potential loss sales and additional G&A spend is estimated to be about $10 million will be reflected in adjusted earnings and is contemplated in our updated guidance.

I’ll now focus my remaining comments on adjusted operating results for the second quarter and our updated full year outlook starting with the second quarter. Global consumer sales represented nearly 85% of total sales. For global consumer excluding return reserves for recalls net sales declined 4% in total, 6% excluding the impact of foreign exchange rates. Sales within the North America geography of global consumer declined 6% as compared to the 10% decline in US consumer purchases at point of sale. This difference primarily reflects changes in retail inventory levels between the start and end of the second fiscal quarter. Retail inventory at March and month end was up mid single digits. We believe that this increase was primarily attributable to disappointing March weather and resulting softness in consumer purchases. As Jim stated, inventory at the end of April showed a slight decline and our updated forecast now assumes retail inventory levels settle to flat to slight down in absolute dollars relative to prior year by the end of the season. Excluding pricing, this infers a decline in retail inventory units in the low to mid single digits.

Gross margin rate for the quarter was 33.7% as compared to 37.1% for 2007, 340 basis point decline. Excluding the impact of product recalls, the decline in rate was 100 basis points. While there are a variety of moving parts, the largest individual factor contributing to this decline was an increase in promotional costs which is one of our major initiatives for 2008. Promotional costs are generally expenses when the related products are shipped which is often in advance of when consumer promotions occur. Because this is primarily a timing issue I do not expect the impact of promotions on gross margin rate to be as pronounced in subsequent quarters.

Commodity cost increases did not have a significant impact on year-to-date March margin rate relative to the prior year due to pricing but unplanned increases will become more of a drag in the back half of the year. SG&A costs increased 3% for the quarter and excluding the impact of foreign exchange are nearly flat to prior year. I’m very pleased with our control of SG&A to date however, we expect more pressure on SG&A in the second half due to the combined impact of timing of our strategic investments, in direct costs associated with the product recalls and challenging year-over-year comps. If you recall last year we saw the release of nearly $17 million in variable compensation expense in the second half of the year.

Second quarter interest expense of $23.5 million was in line with our full year expectation of $80 to $85 million and represents a $3.7 million decline from 2007 pro forma interest expense. The decline is primarily a function of a $200 million reduction in average debt from prior year pro forma and about a 30 basis point reduction in average year-over-year rates. Second quarter reported earnings per share were $0.88 versus $1.23 in the prior year. Adjusted earnings per share were $1.19 slightly above the range of $1.14 to $1.18 per share earlier in April and compared to the $1.40 per share in the prior year.

Moving on to the balance sheet, accounts receivable increased about $34 million or about 3%. This increase is primarily driven by foreign exchange rates on our international consumer and Pro accounts receivable balances. The increase driven by fx was partially offset by reductions in North America consumer receivables resulting from lower sales volume. Our days sale outstanding remains in line with our expectations and the quality of our receivables remains high. Inventories increased by about $53 million or about 9%. This growth is driven almost equally by foreign exchange rates, increased commodity costs at a lower amount of sales. While the amount of the increase relative to prior year will significantly decline by year end as our production plans are adjusted fx rates and unplanned commodity cost increases represent challenges that will be more difficult to offset in their entirety.

Our current debt balanced increased $258 million primarily a function of our accounts receivable purchase facility which was not put in place until April, 2007. Beginning in the third quarter of 2007 the receivables facility is being presented as a current liability with a direct offset in long term debt.

Now, moving on to our revised guidance for the full year we now expect full year adjusted earnings to range from $2 to $2.20 per share. We previously expected to be flat to last year which was $2.37 per share. The reduced expectations are primarily driven by three factors. First, lower than forecast consumer purchases updated expectations around reduced yearend retail inventory,\ and potential loss sales in the second half related to the product recalls, collectively will reduce our full year’s sales growth outlook by about 300 basis points to 3% to 5%. This equates to a $25 to $30 million decline in operating income.

Second, continued increases in commodity cost net of pricing and other actions will result in additional operating income pressure of about $10 to $15 million. While we spoke of $10 to $15 million in commodity cost pressure last January we have seen that estimate of cost increases grow to $30 to $35 million in a very volatile market. We have been able to offset about $20 million primarily through pricing but we can no longer reasonable expect to cover the remaining amount. As a result, we expect to see full year margin rates decline up to 50 basis points. Just one final update on commodities, we now have 85% of our costs locked for the year.

The third and final reason for the earnings guidance change is offsetting reductions in G&A spend where we expect to see up to $10 million in savings net of process reviews and other improvement programs initiated in response to the recalls. This represents an improvement of another 100 basis points relative to our previous guidance of 8% year-over-year growth in SG&A. Any one of these items could be slightly better or slightly worse for a variety of reasons, the biggest of which is that 50% of consumer purchases for the year are still in front of us. Also, the situation relative to the product recalls has clearly been a fluid issue and those numbers could move.

Free cash flow for the year is now expected to range from about $130 million to $150 million which is about $50 million less than our previous guidance. This is primarily a result in the reduction of adjusted earnings, non-recurring costs associated with product recalls and incremental inventory pressure resulting from increased commodity costs and fx. We’re clearly not alone in adjusting to the fast moving changes in the economy both with consumer and the commodity market. While we probably have a bit more uncertainty than usual at this time of the year, we’ve outlined for you what I consider to be the likely outcome for 2008 based on what we know today. As it relates to 2009, there’s not much we can say with any certainty that this point but we’ll work to provide you with a stronger view of next year when we discuss our third quarter results in July.

With that, I’ll turn the call back over the operator to take your questions.

Question-and-Answer Session

Operator

Your first question comes from the line of William Chappell – SunTrust Robinson Humphrey.

William Chappell – SunTrust Robinson Humphrey

I guess on the EPA part it sounds like you’re uncertain in the fines. Is there any chance of other recalls or have you kind of gone through all the product lines by this point?

James Hagedorn

No, I think we’ve done sort of a high view of all of our active registrations so I don’t think we see the sort of significant issues that we saw on the four that are sort of in the news. We are right now, we’ve brought a third party in to take a look at all of the detail in our active registrations and see if there’s anything else there. But, that process is underway, in fact, that really very fine sort of view just started today and this is something we’ve been talking about with the EPA and they’ve encouraged us to do and we want to do.

William Chappell – SunTrust Robinson Humphrey

Then in terms of just what you talked about on strong April sales, is there any way to kind of shed the easy comps and the catch up from a weak March and figure out what the consumer is doing on the global consumer part of the business? I mean, are you seeing some sensitivity there, or is it fairly normal?

William Chappell – SunTrust Robinson Humphrey

Bill, it’s the big question, I think. It’s a righteous one that you’re asking. If you ask Barry, Barry would say that he believes that there’s less consumer foot traffic and that’s driving about half the issues and I think he’d say half of it is weather. I’m trying to make sense of for instance the northeast where they’ve had pretty darn good weather so when I come back on Monday’s and they’re saying, “Oh the weather was terrible.” We’ve actually had great weekends on the east. And, by the way, last week’s numbers are also looking good so far based on the POS we’re seeing. But, just for example, and this just makes it confusing for me, I don’t know what the answer is other than I think Barry’s probably more right than he is wrong. But, if you look at the northeast they had like almost 100% increase in the month of April, no admittedly against easy comps because that same sales region last year would have been near despair. But, year-to-date they’re up like almost a third. Year-to-date POS which I think is really good and so you say, “Okay what the heck does that say about the consumer?” And, when you ask them, as far as our sales folks, “What do you see about sort of competitive activity?” They say, “We’re doing really well and there doesn’t seem to be a lot of competitive pressure out there.”

Mid Atlantic I think looked okay and the weather’s been okay. Midwest the weather has been terrible, I think POS not as terrible, actually the weather has been or felt like here. So, I don’t really know what the answer is except you can’t say that the consumer is totally there. But, it does appear that when the weather is good a sort of tepid consumer is more active and this is the part that I don’t understand yet. We’re going to work hard to try and figure it out but I’m not sure that I can really tell you except for other than what Barry said which is, his guess is as good as any, that he believes it’s 50/50. Barry do you want to add anything to that?

Barry W. Sanders

I think when you look geography based around the country you see definitely the impacts of weather so the northeast is better than the southeast where there’s still drought, Midwest is kind of lagging, the west coast is kind of lagging. So, I think weather definitely has an impact but also when you look at footsteps in the store and comps of other categories that are down much more significantly than ours the sensitivity on pricing relative to the consumer discretionary income is definitely having an impact.

James Hagedorn

We’ve got a board meeting this week so in the deck that is being prepared which we give Wednesday and Thursday of this week to the board, they showed sort of color coded maps of POS of the entire country and through the end of February, things looked pretty darn good. Then, March hit and basically the entire country goes red. Then, the season starts hitting and the country looks a lot less red and the northeast looks pretty green. So, definitely a very significant weather impact and again, we’re call it half way through the POS year and so we’re watching all the POS really carefully and we’re seeing from the retailers that we get data from, we’re seeing just last week double digit POS gains again. And, the weather in the Midwest was really Sunday was great and I think in New York, I haven’t been there, Sunday was good, Saturday was pretty cold and dreary and I think the same here in the Midwest. So, I don’t know what the answer is Bill, I wish I could tell you.

William Chappell – SunTrust Robinson Humphrey

Just as a follow up there, as you look at your updated full year guidance are you assuming weather is just kind of normal May, June and the consumer remains somewhat tepid?

James Hagedorn

Look, Dave is nodding his head yes. My view is that depression has sunk in and that’s reflected in people’s numbers that they input to the system. I do think that if there’s a year where like everything could go wrong for us we seem to be in it and so I’m sort of accepting of it. But, I think this is kind of our best look at, and I have to say we went back like a little over a week ago and went over sort of the Dave’s wet blanket we call it forecast and we basically pushed back on it. But, given the recall and everything else and we basically said, “You know what, he’s probably…” I’m not saying he’s a savant but I’m not fighting too hard on it. I don’t know, it could be better, it could be worse, it depends on the weather and a lot of other factors.

Operator

Your next question comes from the line of Olivia Tong – Merrill Lynch.

Olivia Tong – Merrill Lynch

I wanted to ask a little bit first about gross margin, I think you had said, if I heard correctly that you’re expecting for the full year for it to be down 50 basis points now. Is that correct?

David C. Evans

Yes, Olivia that’s correct, up to 50 basis points.

Olivia Tong – Merrill Lynch

What sort of crude end diesel prices are you factoring in to come to that assumption?

David C. Evans

Well, the assumption is that really drives you there fairly quick is that commodity cost in aggregate are up call it $30 to $35 million. Of that assume that we got pricing to cover about $20 in aggregate so what’s left of the $20 falls right to the bottom line. The $20 million in pricing we did get is $20 million of volume at zero margin and then you take the rest of the base point decline in sales volume and assume that at average rates and you quickly can do the math and get to a decline of close to 50 basis points.

Olivia Tong – Merrill Lynch

But, I mean as far as assumptions on diesel and the cost of crude going forward are you factoring in like $120 or is it more a blended rate below that or higher?

David C. Evans

As you probably know these costs are just jumping all over the place right now so we do have at this stage about 85% of our total year costs locked in. So, we’ve made estimates, the estimates are reasonably reflected of prices in the month of April for where our risk is for the balance of the year and we’ve incorporated that in to our forecast. Having said that, just this week we’ve seen a lot of volatility in some of our core items so these things are going up and they’re going down. I think we’ve made some assumptions of the cost continuing to increase and we have 85% locked so the remaining risks continue to narrow.

Olivia Tong – Merrill Lynch

That pricing of $20 million that’s assuming a 4% price increase in North America consumer for the full year, right?

David C. Evans

The $20 million is pricing that was taken globally across all of our business segments since we last met in December.

Olivia Tong – Merrill Lynch

So that’s the incremental pricing is the $20?

David C. Evans

Exactly. So, in January we saw exposure of $10 to $15 million in commodity. That $10 to $15 over the course in to January to end of April grew to $30 to $35. Over that same period we were able to collectively develop pricing that was presented of $20 million.

Olivia Tong – Merrill Lynch

The other question I had if you could sort of rank of the three things that you mentioned that are hitting the top line, if you could sort of give order of severity for those?

David C. Evans

Well, I think the three things we talked about was a more tepid consumer either due to some combination of weather and economy. I’d say that’s the largest. The second largest would be revised expectations about yearend retail inventory. Then, the third item which would be the least impactful would be the potential inability to ship for the balance of this season some of the products that have been recalled. That’s the order of magnitude.

Operator

Your next question comes from the line of Alice Longley – Buckingham Research Group, Inc.

Alice Longley – Buckingham Research Group, Inc.

So what is the pricing running now? Year-to-date you said your sales are up 2% I guess that’s at retail or your level, clarify that. And, what’s the pricing in there? That’s US consumer.

David C. Evans

With consumer, back in December when we spoke to you as I recall we talked about pricing of 4% in the consumer business and that translated to about 3% in aggregate for the full business. So, what we’re talking about now is an additional $20 million of pricing for the total company so it’s now running close to 4% in total, 3.5% to 4% in total.

Alice Longley – Buckingham Research Group, Inc.

So it’s 5% for the US consumer?

David C. Evans

Well, the incremental pricing we’ve taken hasn’t been exclusively in the consumer business. It’s been taken, that’s an international, a global number across both our professional and consumer business units.

Alice Longley – Buckingham Research Group, Inc.

Well, just to keep with the US consumer business, if I’m getting things mixed up here, year-to-date your sales are up 2%?

David C. Evans

In the US, correct.

Alice Longley – Buckingham Research Group, Inc.

Okay. Is that your sales or POS?

David C. Evans

That’s POS.

Alice Longley – Buckingham Research Group, Inc.

So your units are down?

David C. Evans

Yes, so the units are down a couple percent on a year-to-date basis consumer POS within the US.

Alice Longley – Buckingham Research Group, Inc.

Now with these additional costs that are being included in your guidance for legal and consultants, etc., what is that totaling? What’s the cost of those incremental costs that you’re incurring to try and deal with regulatory issues better?

David C. Evans

I would say that you have to look at this two different ways, there’s the direct cost of the recall and those are cost like legal, I’ll call it crisis management costs, things of that nature that are being occurred directly in support of executing this recall on the investigation so that’s one piece. Those are included in I’ll call it the $40 million estimate we have for costs that will be excluded from adjusted earnings. Then, there’s a second piece Alice that’s really more the forward-looking costs which are now how do we asses where we are going forward? Asses our controls? Do a more comprehensive review over all our compliance areas? Those are costs, and any costs we incur to implement those changes, those are costs we’re including in our adjusted earnings that we’re providing guidance for. The magnitude of that I’d say is around $5 million.

Alice Longley – Buckingham Research Group, Inc.

On an annual basis?

David C. Evans

Well, for the balance of this year. So when I speak to about $10 million in G&A improvements relative to what we spoke about in January, it’s really closer to $15 net of about $5 for those activities I just described. I couldn’t tell you at this point, its way, way too early to say what implications there might be moving forward.

James Hagedorn

And Alice I want to just sort of deal with this doing better. We clearly had some lapses and we have a employee how committed criminal acts, I don’t think there’s any doubt about that. We’re going to look at the entire business to see if there’s any areas where we could do things better. But, I’ve got to say I probably know as much about this issue as anybody and this would be a really hard issue to have found unless you were some sort of forensic criminal person. I’ve got to tell you that while I’m sure we’ll find ways to do things better I believe sort of now more than ever that the more I’ve learned about this issue and this behavior is that this would have been a very difficult thing to find. And, I would say I’m not really asking you to trust me on that but I sort of feel like saying I know more about it than anyone and I think I know what I’m talking about.

Alice Longley – Buckingham Research Group, Inc.

On the $15 million essentially cuts in G&A could you tell us what you cut out? That’s a lot. And, as part of that you’ve referred to the $17 million in variable compensation you cut out last year. Are you still restoring that this year with this performance? Or did you cut away at that? And, I also want to know if you cut away at your advertising or sales support plans?

James Hagedorn

All good questions and probably likely to make everyone nervous in this room. I’ll start sort of with the incentive, I doubt anyone is figuring they’re going to get full incentive payout, okay. I do have to say and this is a subject for discussion with our entire board is it is really important that we understand these sort of retention issues that we’re dealing with and we are preparing to speak to our board about these issues like while I don’t think anyone expects a full payout and we will not be recommending anything other than a full payout only happens when you hit budget. I do think we have to take a look at these sort of retention elements of our compensation given the world we’re living in which is not I think unique to us. So, I do think that is something that we have to talk about but, the answer is no we’re not anticipating a sort of significant payout of the incentive plan.

The other question was are we cutting advertising and sales? I would say that I think we’re taking a look at everything but I think of our sort of key promotions and the work we’re doing we fought hard for the budget that says we’re investing in various parts of our business which included sort of our sales force, our ability for them to make decisions in the field and having some funds available to do that and hours available for in store merchandising. I do think that we’re going to look at regions and accounts and categories to look and make sure that for instance in the south where drought seems to be happening, in Florida and the same if we don’t see POS happening sort of no matter what we’re doing we either reinvest that money other places or just don’t spend it. I think that’s just being smart, I don’t think that we’re sort of trading back. And, our issue of advertising I think we look exactly the same way where we’re seeing payouts and these are important investments that we fought hard for not only with ourselves but with our board and with you guys, I think we’re not looking to back track on those issues. Dave, do you want to add anything to that?

David C. Evans

Well, I think Jim just stated it very correctly. Those are the things that we aren’t cutting, the strategic investments, items of that nature. So, some portion of this undoubtedly will be variable based pay because as Jim stated I don’t think many people today in this environment are expecting 100% payout. But, other areas Alice are open headcount we’re not filling right now in non-critical areas, discretionary areas, travel could be an example. So, remember we have a base of $700 million in SG&A so in a base that large you can generally find a few million dollars that haven’t been committed at this point, that isn’t consider to be mission critical to fulfilling the full year’s expectations.

Alice Longley – Buckingham Research Group, Inc.

My next question is I think you said that there’s one area where you’re losing market share. Are you losing market share anywhere? And, is pricing getting in your way of gaining share?

James Hagedorn

I would say there’s some work to be done on this Alice but the question is in our lawn’s business have we hit kind of the elasticity limit of our consumer? I think we’re seeing slight market share degradation with our lawns business.

Alice Longley – Buckingham Research Group, Inc.

This is fertilizer, right?

James Hagedorn

Correct. Now, I don’t have the data yet but I’m going to get it soon, I’m sort of looking at folks on what we’re seeing in markets where it’s been really decent weather. And, do we see different consumer behavior and the problem gets to be is the northeast different than the Midwest for instance in regard to share and is the northeast less sensitive to economic issues because sort of higher pay levels than let’s say the [Russ Belt] and I think you could look at sort of housing as an example of that. But, I do think that I don’t really know what the data says yet except on this sort of nationwide basis we’re losing a bit of share and I think the private label, and we make a lot of that so we can see that. So, I do think that we’re hitting sort of a limit, more or less again, because I don’t have perfect data yet.

Let me just sort of throw forward an example for you and I gave you guys some numbers on Urea over the last 12 months and its way, way higher. To cover that, I don’t know call it roughly, to keep us margin neutral would cost the consumer about 20% more in a one year price increase just to hold our margins on our fertilizer products. I don’t know Alice, I’ll ask you a question, what do you think dangerous or not?

Alice Longley – Buckingham Research Group, Inc.

So it sound like your gross margins are going to be down next year too?

James Hagedorn

Look, don’t go forward too far. What I would say is that on lawn fertilizers you’re probably going to see margins decline because I think we’re probably going to say that the consumer has about had it and is incapable of absorbing a 20% plus increase in retail. And, I don’t think the retailers would say anything different. I don’t think we’re seeing that kind of pressure across the board and so depending on how we price I’m not sure it will be margin dilutive. But, I don’t think we know and it is a concern. We brought it up to you guys for a reason and that is to say that we’re in a really strange time especially on fertilizer. You can read it in the New York Times, like every other day it seems to be an article in the Times or the Journal about sort of fertilizer pricing around the world and availability of food products around the world and ethanol versus food and we are in the vortex of that, at least our cost of basic raw material for lawn fertilizer is.

I’m not sure what it means yet and I think when Dave said we’ll talk to you guys more about 09 at our next call it’s because we need some time to digest this and take a look at rapidly moving prices. And, we’ll become more sort of coherent on this but that’s what we’ve got to say.

Operator

Your next question comes from the line of Joseph Altobello – Oppenheimer.

Joseph Altobello – Oppenheimer

I just wanted to follow up on Alice’s question about pricing. Jim, in March when we were down in Orlando with you guys you were pretty adamant that you would be taking pricing next year. It sounds like you’re sort of [inaudible] a bit.

James Hagedorn

I could answer that one. We will be taking pricing and it will probably be moderately significant if that makes any sense. But, I think it’s not going to be like 1% or 2%. The question is on certain products where does it hit a limit and where do we start damaging ourselves? And, this work is already occurring in the North American business where they’re looking at we can take pricing of X,Y, Z but we’re going to hit elasticity limits and therefore it’s going to affect our volume and it nets out to X, Y, Z and I think this is our big issue right now of saying, “What’s the right thing to do as long term stewards of a business given a view that says it is unprecedented to see this kind of pricing of our raw building blocks for lawn fertilizer.” I think we’re not the only ones in the fertilizer industry dealing with this issue. But I do think anyway, that we are going to take pricing and I am adamant about that, it’s just how much and how do we apply that across the board.

Joseph Altobello – Oppenheimer

That then sort of begs the question, if you’re seeing some market share degradation because of possibly price gaps for example this year, wouldn’t that exacerbate that problem next year?

James Hagedorn

It depends on what the private label does and remember they’re dealing with the same issues we are except a higher percent of their selling price so it’s more in their margin than it is because the Urea represents a smaller percent of our selling price than it does on them. So, it depends on what happens with our colleagues in the space and what they do and, in part, how we price our opening price point and there’s still a lot of discussions that have to happen with the retailers on where we all want to be. And, if we’re long term in this business do we not do anything that’s sort of affects the industry. That’s that.

Joseph Altobello – Oppenheimer

Then in terms of staying on the pricing situation, you guys have a tough business because you have to price often times months in advance of the season so as you enter the season how does the negotiation with the retailer go? How do you try to forecast your Urea costs or diesel costs eight, 10 months out? Are you pricing today’s price plus 20%? Plus 10%?

James Hagedorn

Listen, I think as most of you know, I think we have a really superb team at Scotts. Our purchasing group is led by a guy named Pete Supron, he’s awesome and I think that he and a lot of people work with the fertilizer industry, the basic materials people, there’s a lot of long term views of where these prices are headed and I think they deal with the best tools that are sort of available as they try to set pricing. But, you’re right, unlike certain companies that can sort or price weekly, we can’t do that. So, it does make it a little harder and everybody is resistant. Now, in the discussion about the retailers, I personally made visits recently to our biggest retailers and one of the things I’ve said is people are asking for pricing, give it to them because they ain’t asking for enough and they hate being there so I would just say yes. I think that part of the dynamic that is out there is that everybody’s capitulated to pricing. Where, a couple of years ago Joe we’d go back just getting half a percent was like a blood bath. Today, this is the really strange part about it, is nobody knows where prices are headed and therefore everyone is kind of accepting it and the problem is exactly where we got to in this conversation which is at the end of the day, it goes to the consumer and can the consumer afford it and what choices do they make when they say, “I want to fertilize but…” So, everybody is kind of capitulated and I think maybe even the consumer a little bit and this is where we have to be really careful where we tread and it just means that we have to be a little bit more thoughtful and I think long term. We’re mentioning to you guys for a reason and that is to bring you in to the discussion so that these issues are sort of transparent and you understand why we’re talking about them.

Joseph Altobello – Oppenheimer

Lastly, on the recall if I could, it sounds like in your comments, the issues or the registration issues would have been tough to find for anybody let alone the EPA so I’m curious how did the EPA find this needle in a haystack.

James Hagedorn

Well, the lawyer is going to get mad at me so just stand back because I have more lawyers around me at the moment then I’m use too. It happened for a very simple reason, we believed based on all of our record that we had good registration and I’m not going to go much farther than that except to say you and I would have looked them over and you wouldn’t have see anything either would I have. Part of that is an ongoing process of registration maintenance that requires you to keep in constant contact over certain issues with the regulators. As we were doing our normal thing of reporting we got questions starting about a year ago saying, “We don’t have that registration number.” And we said, “Well, we do.” So the guy says, “Well, how about you send me a copy of your stuff.” And I think that’s how this whole thing started. We’re reporting on registrations that the EPA didn’t see in their files. At first we thought everybody had lost the files and then it became more clear that the problem was bigger than that.

Joseph Altobello – Oppenheimer

So it wasn’t a whistle blower or anything like that?

James Hagedorn

No sir. It was something as simple as we’re reporting and the other side is not seeing what we’re seeing.

Operator

Your next question comes from the line of Doug Lane – Jefferies & Company, Inc.

Doug Lane – Jefferies & Company, Inc.

You talked a lot about the fertilizer and the cost issue but help me understand how private label competitors aren’t in a worse position than Scotts? And shouldn’t that and isn’t that price gap closing between the Scotts brand and private label in fertilizer?

James Hagedorn

I would say in sort of you could look at it one way and say, “Yes, they’re issue is bigger.” As I said, the cost of their raw materials to percent of their selling price is higher. So, they’re issue as a margin would be higher although again, having looked at pieces of that business when parts of it had been for sale I would say that these are very low margin businesses, the bag fertilizer business on private label side. So, I think the answer is yes, you’re right there. I think the price gap has to some extent narrowed. But, in absolute terms, we’re starting to see products that are kind of a little bit of our niche products but the prices are sort of approaching astronomic levels. I would have said, and you guys have heard it over the years, we’re more or less resistant to recession because people are buying products for $10 that make a big difference in their lawn. A bag of 5M Turf Builder use to be less than $10, I mean a lot less than $10. $12, $13 for a 5M bag of Plus 2. That ain’t the prices anymore, they are really getting steep and the retailers, remember the retailers are not giving the stuff away anymore so that the heighten competition you saw, call it five years ago at retail is over. You have more financial bosses running these retailers so their margins are higher than they use to be. They’re passing prices along and to the consumer, you’re seeing prices way more than double what they use to be.

I think that while it may be true that the gap has narrowed, I think in absolute terms when you have somebody running out of money, they’re making choices. We’re not crying the blues here by the way just so we’re clear. This is one category that’s seen huge increases and we’re seeing major pressures to increase. But, you know you could go to places in Florida where you have a lot of people on fixed incomes and you’d see in regions, parts of the country where there’s a lot of people living on a tight budget where there’s more of a sort of bias toward opening pricing point products. The question is are we pushing the whole American consumer towards those kind of choices, especially those kind of people who are running on empty. Personally, I think the answer is pretty obvious, okay. I just think we need to be careful there, that’s all. But, I think what you said is right but in absolute terms it’s still getting to be a pretty pricy marketplace.

Doug Lane – Jefferies & Company, Inc.

Is the category down in volumes year-to-date?

James Hagedorn

I think the category is down in units. So, you’re seeing positive in dollars, Barry do you want to talk about it at all?

Barry W. Sanders

For us the category is flat in dollars, up 2% for the retailers which means, that includes the pricing which means units are down 4% to 5%.

Doug Lane – Jefferies & Company, Inc.

But that bares out your point Jim, they’re just leaving the category.

James Hagedorn

But you see, I don’t know that enough yet because the problem is I’ve got to spend a little time and the folks here have to spend a little time analyzing the data because when we were on the phone with what we call our warlord, the guy who runs the northeast and I mean owns that hardcore. This is a person who is not only a great long term employee but I know the guy well and when I call him I get the facts. He’s an emotional person so he tells me usually the way it is. I don’t sense based on what he was telling me that we have market share issues in the northeast like we’re talking about here. But, I haven’t seen that data carefully enough yet. So the question is when it’s gloomy and dreary does that have an effect on people’s willingness to spend? I don’t know. The way it felt last Saturday in New York compared to Sunday personally I felt down and I felt a lot better on Sunday. Or, is regional economic conditions dealing with that? Because, I think you have a level of foreclosures here in central Ohio probably as high as anywhere in the country, if not higher, and is that part of it?

I just don’t know enough to say what I told you is right or I think it is right. But, I know one thing, the economy has got to be part of this and you cannot have basic raw materials for a category going up call it 20% plus year-on-year and not say, “Should I price it all in or am I going to blow my consumer up?”

Doug Lane – Jefferies & Company, Inc.

So it sounds like if Urea stays where it is and I’ll pick on Urea because it’s the biggest and most egregious at this point, then your outlook for accelerating EPS growth to the mid teens looks like it’s pushed out at least a year at this point?

James Hagedorn

Sir, I do not know yet. And, the reason I’m saying I do not know yet is because we are thinking here that our plan for 09 needs to be different and responsive to what we think is happening out there. And, I don’t know what changes we’re talking about yet as a result of that, that’s work that is in process. So, I would just really ask you guys to give us some time to sort of contemplate how our plans for 09 are different today as a result of what we now know then they were call it a year ago or eight months ago. And until we’re ready to talk about that I just think it would be too early to sort of try to say what exactly it means.

Operator

Your next question comes from the line of Eric Bossard – Cleveland Research Company.

Eric Bossard – Cleveland Research Company

Two questions, first of all the $2.00 to $2.20 guidance for 08, what is the sort of real operating number that we should think about as we think about earnings growing or contracting in 2009 when you add back all the stuff that’s just 08 specific ex the weather?

David C. Evans

Well, I think Eric this is a question that when we get back to you in July, I think we can be a lot sharper on because recall there’s the three drivers for calling the numbers down or volume and there are three elements of that. It’s the consumer, so what’s our expectation next year on the consumer. The retail inventories, do we see a continuation of this year’s apparent trend to reduce the inventory or not. And then the third, which clearly wouldn’t be recurring as we expect to be back in business on these small handful SKUs today would be loss sales for the balance of the year. So, at this point the one element of those three that I have the most clarity on would be the loss sales, we would not experience presumably next year under the assumption we’ll have appropriate registrations at that point.

When I look at the margin rate degradation, I think what Jim’s being alluding to some of the pressure that we see today and some of the decisions we have to make as we start developing and finalizing our pricing for next year. So, it’s going to be difficult and premature at this point to try and start speaking to that level. I think the SG&A, you know, it’s maybe getting a bit of a fine point. We know that we had some investments this year, some of those investments are going to recur again next year but they’ll be in the current year base so we wouldn’t expect to see that growth continue. We know, I think Alice was asking me earlier about what are some of the kind of non-recurring costs that we’re experiencing in SG&A as we look forward to deal with this concern or compliance, some of those will be non-recurring. But, we need to go through piece by piece each of those before we’re really prepared to have a more detailed discussion about next year.

Eric Bossard – Cleveland Research Company

Within just that third bucket, the recall and all the noise around that, I know the first two are impossible to handicap but the third one at least you have some, are we talking within the $2.20…

David C. Evans

I’d say the impact for the balance this year is up to $10 million or about $0.10. So, that was really driven by two pieces, it was loss sales for the balance of the year and then secondarily the incremental SG&A we will incur. Now, what I don’t know is if the SG&A we’re going to incur this year is really more for evaluation. I don’t know what the conclusions of that will be at this point so some portion of that $5 might be more permanent in nature if we need to put additional fixes in place that cost money. Does that answer your question Eric? Of the $10 it’s about a half and half roughly sales and G&A that are exclusively related to the recall.

Eric Bossard – Cleveland Research Company

Then secondly Jim, as you look strategically at the business and obviously there are some unique events that are transpiring right now but do you think any differently strategically about the exposure with Smith & Hawken or the lawn service business or even the exposure with Urea that makes you think strategically about how the company ought to be optimally positioned?

James Hagedorn

Yes.

Eric Bossard – Cleveland Research Company

How so?

James Hagedorn

I personally, I think this is going to be a tough time for the American consumer. I think we’ve got a lot of good things going on in this company particularly 09, 10 and beyond. We are going to focus on those things. Things that get in the way we’re going to focus a lot less on and so I think this is hard poker time for parts of our business that aren’t pulling their weight. I don’t have much credibility I’m sure with you guys because I admittedly am the worse guy at selling anything but I’d tell you there are a lot of impatient people here. So, I think we should be focusing in tough times in things we believe will be driving long term value. If there’s parts of our business that we don’t believe are driving long term value they’re less important to us. Period. And, less optional I might add.

Jim King

Operator, I think we’re going to have time to take two more questions.

Operator

Your next question comes from the line of Jim Barrett – CL King & Associates.

Jim Barrett – CL King & Associates

Jim, given your technological edge and the brand equity you’ve built over decades of advertising in the lawn fertilizer business, and considering what’s happening with Urea, would you consider backing off on your advertising in that business until the economy recovers in order to achieve acceptable margins in that business on an operating basis?

James Hagedorn

First of all I’m going to say probably not this year, the year we’re in. And largely because I don’t have enough data to say it’s working or it’s not working yet. I think we’ll have a lot more visibility of that after the year is over. I do think that our view of 09 will include a review of incremental spend over and above what we’re spending today and how do we feel about the spend we did make this year. So, I think for sure that will be on the table and that’s not a prediction of how it will come out but it is that will be on the table as sort of everything will be in sort of light of pressure particularly on that business. But, there is a lot of really cool stuff on that. Our lawn business has a lot of cool stuff going on. What’s not so cool is how pricy this product is becoming so I think the answer is yes.

Jim Barrett – CL King & Associates

And in somewhat a related question especially given the new developments, what premium at retail do you think that brand deserves versus the store brands, broadly speaking, different lawn fertilizer?

James Hagedorn

It’s kind of a version of a question I’m not sure if it was Joe but it’s this question of what’s the difference and how big is it and is it declining? I think the answer is that we kind of know where the business comfortably fits based on many decades performing vis-à-vis private label and that’s sort of in the 30% to 40% premium range. I think the issue is actually not that, I think it’s an issue of sort of absolute price to the consumer relative to the money in their wallet and I think that’s where we’ve got to really be careful. But, I think 30% to 40% is typically where we are able to operate in a really fine way there and the consumer makes the right choices which is go with a product that performs better, is better, does more, controls better. But, we’ve got to take a look at again, it goes back to dollars in the wallet and how much are they willing to spend for a product given the fact that, we have a sort of list of stuff that’s showing sort of price pressure that we’re going to share with our board, I don’t think we’re seeing anything with this sort of level of pressure on pricing as fertilizers. And, I doubt even with fuel that you’ll see this kind of inflationary numbers in any product other than basic fertilizer materials and bird seed. But again, this goes back to the sort of ethanol economy and what people are choosing to plant and therefore demand pressures are created within the seed industry.

Operator

Your next question comes from the line of Connie Maneaty – Bank of Montreal.

Connie Maneaty – Bank of Montreal

Just a housekeeping question for Dave, could we have the segment operating profit for the different businesses?

David C. Evans

Yes, we’ll be filing our 10Q this Thursday, we’ll be disclosing that in the 10Q.

Connie Maneaty – Bank of Montreal

Back to Urea, is it safe to assume that as of this week or a couple of weeks ago you hadn’t hedged at all for fiscal 09?

David C. Evans

On the Urea, that is in large part correct. At this point I’d say we’re trying to sort through as this changes and then we’re going to try to match up at the time we taking pricing, try to lock in as much as we can at that point to remove the uncertainty. But, given the volatility in the market right now, we’re not out as far as we’ve been in prior years at this point.

Connie Maneaty – Bank of Montreal

Well, wouldn’t you be buying now for production in six months or so? And, if the price of Urea is up 50% over the last six or eight weeks or whatever the time frame is and you weren’t hedged before, is it safe to assume that what you would be buying would cost you right now 50% more? Or, is that too simplistic?

David C. Evans

What we have hedged at this point, we’re hedged, remember the market exists to hedge for purchases up to six months out. So, the production we have going through six months out is for the most part still this year and in the summer there’s typically a shut down and this year because of volume changes we’ve seen in fertilizer we’ll probably be producing less this summer than even in prior years. So, we really haven’t at this stage advanced to the point of buying significant Urea for product that will be produced for next year’s sales.

Connie Maneaty – Bank of Montreal

What is the cancellation rate been for Scotts Lawn Service? How much higher is it than what you thought it might be?

Peter Korda

Our cancellation through the first quarter were about 60 basis points higher than prior year. Our cancellation rate on new sales is actually better than last year and it’s essentially what Jim said which is economic pressures on customers from prior years.

Connie Maneaty – Bank of Montreal

So with the cost of diesel, what’s happening to the contracts? All the costs that you’re incurring are higher, do you have to raise your prices to your customers or are you keeping prices the same? And, have you had to pass along a surcharge for diesel?

James Hagedorn

Are you asking that question about the broad business in general or lawn service in particular?

Connie Maneaty – Bank of Montreal

Lawn service in particular.

David C. Evans

In lawn services we actually hedged almost all of our fuel purchases from March through September as of last fall. So, we’re pretty well protected on the cost side in terms of the cost of materials and our people are paid what they’re paid so we’re pretty good on the cost side through the year.

Connie Maneaty – Bank of Montreal

Just one final question, given the unusual difficulty that you’re looking at, do these conditions change the qualifications for the COO that you are looking to hire?

James Hagedorn

No, I don’t think so. It probably just says, it’d be nice to have someone to cry on their shoulder. No, I don’t think so. I think it just makes people say, “We could use a little help.” But, I think the team has, I do want to take this opportunity to sort of compliment the team. You know a lot about people with how they respond on stress and how seriously they take their life’s employment and that they stick with you and they come to work every day sort of knowing that there’s pressure on their incentive which affects their paycheck and there’s pressure on the stock which affects their net worth. So, for people to come to work and sort of fight the fight and work this issue in sort of good faith and with a smile on their face is pretty hard. So, I do want to compliment the entire team because you can tell a lot about people under stress and the team has performed pretty well.

Jim King

Operator, that’s it for us. We’re about 90 minutes in, I know there may be a few more questions, you can feel free to give me a call. I’ll stick around for probably another hour or later tonight, 937-578-5622. Thanks everybody for joining us and we will talk to you again formally in July when we issue our Q3 results.

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Source: The Scotts Miracle-Gro Company F2Q08 (Quarter End 3/31/2008) Earnings Call Transcript
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