Scotts Miracle-Gro Co (SMG) 2002 Q3 法說會逐字稿

Good day, and welcome to The Scotts Company third quarter conference call. Today's call is being recorded. For opening remarks and introductions, I will now turn the call over to Rebecca Bruening, the Vice President and Corporate Treasurer. Please go ahead, Ms. Bruening.

Thank you and good morning. And thank you for joining us to discuss our third quarter results for our 2002 fiscal period ended June 29. Our President and Chief Executive Officer, Jim Hagedorn, and our Executive Vice President and CFO, Pat Norton, will be providing you with some forward-looking information. In accordance with the Safe Harbor regulations, we strongly advise you that actual results could differ materially from our expectations due to a variety of factors. We urge you to read about these factors in today's press release as well as in our SEC filings.

Before we get started this morning, I'd like to inform you that just yesterday we launched a new investor relations website. The site is designed not only to provide more information, but to provide it in a more timely fashion. For the first time you can go to our site and download financial results in an Excel format, which you may find more helpful. There are also direct links on our site to SEC filings and First Call estimates. You can visit the site at www.scotts.com and click on "Investor Relations." Please feel free to share any feedback on the site with either myself or Jim King.

With that, let me introduce our President and CEO, Jim Hagedorn. Jim?

Thanks, Rebecca. Good morning everyone. As I get started this morning, I want to go back for a moment to our year-end conference call last October and remind you of the comments I made regarding our prospects for the year. During that call, I said that our success in fiscal year 2002 would be dependent upon a single issue, execution. And indeed it has. Our team has executed across the board on all the issues within our control. And the result of that execution can be seen in our press release this morning.

The third quarter was great for Scotts. Both sales and net income were a third quarter record. And it was the most profitable quarter in the company's 134-year history. That says a lot given the current retail environment and the overall economic climate. As you can see from our results, we didn't view the third quarter in terms of meeting expectations, but exceeding them. Earnings per share were just above the top end of the range we provided a few weeks ago. On a year-to-date basis, with the exception of sales, which has been impacted by the inventory deload at retail, we were at or above expectations on every key incentive metric we lay out for associates entering the year.

Year-to-date we are well ahead of expectations and debt reduction from effective working capital and cash management. We continue to improve our working capital management while our customer service rates are at the highest levels ever. The savings we are achieving from our supply chain efforts and other cost controls are allowing us to continue tracking favorably on net income even with sales flat on a year-to-date basis. And our ROIC efforts are exactly where we'd hoped they'd be at this time, which is key to reaching the average of our consumer product peer group by 2004.

There is a great story here right now, one that I think is being overlooked by too many on Wall Street where we seem to be lumped in with underperforming companies. But you know what? It's not being overlooked here. The team is pumped about our performance and they should be. After all, they are the ones getting it done. They continue to be excited by seeing the power of our brands at work every day with both consumers and our retail partners. They continue to see their hard work and innovative ideas paying off, and, most importantly, the thing that excites me is that our people continue to believe the best is yet to come.

We set some pretty aggressive targets this year and our people are meeting or exceeding them. It's good to see the alignment of our incentive goals and our company objectives paying off through our strong performance. On that note, it gives us great satisfaction to announce this morning that we now expect adjusted earnings for the full year will be 50 to 60 percent higher than last year. Previously, our range was an already aggressive 45 to 50 percent. This excludes any impairment, restructuring and other one-time gain in charges. As you calculate an EPS number, don't forget that our share count is roughly a million shares higher than last year. Pat will address this in more detail in a few minutes.

Let me jump into a discussion of our performance and how we are seeing the world right now. As I've said, there are a number of great stories here and I want to make sure each of you understand just how strongly we feel about our business now. Let's start by talking about the strength of the business, especially at the consumer level. Point of sale data, or POS, that we get from our largest U.S. retail partners, shows that consumer purchases of Scotts products were up 10 percent in the quarter and are now up 13 percent on a fiscal year-to-date basis. In this economy, maintaining double-digit POS growth throughout the peak of the season is outstanding.

Our season-long growth demonstrates the power of our brand, the effectiveness of our advertising, and the strength of our team. Don't forget, we are seeing this kind of POS even after having a pretty lousy May, our busiest month, and with a key retail partner closing stores and in bankruptcy. I don't keep a daily score card of all the consumer product companies out there, but I can't think of many, if any, who are seeing this kind of ongoing strength with the consumer.

If you want proof of our success, let's start with Growing Media. This story has gone well beyond turning dirt into dollars. This could easily be a case study on how to lever the value of a brand. Hopefully, you saw the press release earlier this month on Miracle-Gro Potting Mix crossing the $100 million sales threshold. That's only the tip of the iceberg. To fully appreciate what this team is doing, you need to look at the year-over-year numbers. Sales of Miracle-Gro Potting Mix are up about 50 percent on a year-to-date basis, including a 70 percent increase with two of our largest four accounts. And profits for the entire Growing Media business are up almost 50 percent. This business has become our second most profitable business behind Lawns, which is pretty impressive given where we were just a few years ago.

One of the best parts of this story is that everyone wins. Consumers are now buying a product that works far better and grows bigger plants than the cheap commodities. And consumer response to the product has not only helped us grow, but has also allowed our retail partners to increase the profitability of their lawn and garden department as well.

Another example of the strength of the brands began playing itself out this quarter in our Lawns business, which introduced Turf Builder with SummerGuard. This product replaced Turf Builder with Insect Control. Our R&D team worked several years to develop an improved formulation to help consumers get a green lawn throughout the summer and control bugs that pose threats to their families, pets and landscapes. The active ingredient in SummerGuard is exclusive to Scotts and replaced [diazinote]. The introduction of this ingredient is consistent with our commitment to use the most benign actives we can and still provide consumers with the most effective product. We also continue to explore ways to improve the labeling of these products and to remind consumers to use these products as directed.

Our sales and marketing teams have done a great job selling this product into the trade. We introduced SummerGuard to the consumer on t.v. using Ashton Ritchey, the long-time voice of Scotts. POS for SummerGuard versus Insect Control is up almost 50 percent from last year, and the product has done so well we actually extended our advertising several weeks longer than planned to continue riding this wave. We just stopped running the ad because we ran out of product. Consumer response to the advertising itself has been so strong that we decided to make Ashton an ongoing part of our t.v. advertising strategy. Roundup is another example of the power of our brand and the benefits of innovation. The active ingredient in Roundup, Glicophate, came off patent two years ago and many people predicted it would spell big problems for Roundup. They were wrong. In fact, we've gained another share point this year and now have 77 percent market share in this category. POS for Roundup was up 14 percent in the quarter and 11 percent on a year-to-date basis.

We've improved Roundup this year and developed a faster acting product that gives consumers results within 24 hours. And once again, we told that story through effective advertising. Whether it was during the Masters or the West Wing, we got our message in front of the right consumers at the right time and they responded by getting out to the store to buy the product.

Consumers of Miracle-Gro plant food are also responding to our enhanced advertising efforts with Peter Strauss. POS for Miracle-Gro was up 14 percent in June as gardeners finally had a chance to get their bedding plants in the ground. On a year-to-date basis, POS for Miracle-Gro is up 6 percent. Gardens is another example of how we are leveraging our brands through product innovation. This year we introduced a dry formulation of Miracle-Gro called "Shake 'n Feed." Excuse me. This product with its innovation--innovative packaging is quick and easy to use. And that really appeals to consumers who want a great garden but don't have a lot of time. Since the introduction of Shake 'n Feed, sales of our dry garden fertilizer products are up 70 percent, another great story.

Following up on a theme of execution, our Ortho team continues to improve its business model. Their focus on customer service has led the fill rates of 98 percent on a year-to-date basis. This time last year they were 86 percent. And their better in-store execution has led to better POS. In the Ortho business, POS was up 4 percent in the quarter and 7 percent on a year-to-date basis, and there are some great stories within the brand. For example, Fire Ant is up 17 percent, Home Defense is up 37 percent.

So you can see the continued success within our core of business. According to Triad, the overall category is up 14 percent in home centers, which is our largest channel. Within that channel we've gained another share point this year and now enjoy 55 percent market share. While most of our sales comes from home centers, we are also taking aggressive steps to strengthen our relationship with the mass and independent trade as well. Last week we announced internally the creation of a new business development group that will have two primary goals. The first is to grow our business with the independent trade by helping them differentiate themselves from the big box retailers. We are forming true partnerships with these independents by offering them unique products of packaging as well as programs that will drive productivity of their businesses even higher.

The second goal is to explore opportunities to leverage our brands even further. An example of this is expanding our presence in the grocery channel. Grocers today are not participating in lawn and garden in any meaningful way and we think the category offers some great potential for them and for Scotts. After all, most of their consumers are women, the very same women who are purchasers of our garden products and our Growing Media products. So having our product at the grocery makes it very convenient for the consumer and also helps us and the grocery channel to continue this growth. So this business development group will make targeting the grocery channel one of its first priorities.

Whether at home centers, mass, independents or grocery, the strength of our brand is not limited to retail. Scotts LawnService continues to gain momentum and remains on pace to achieve its sales and profit growth goals. The SLS team has successfully integrated several acquisitions this year and has made great strides in improving their back office functions. But their ability to retain customers and attract new ones is due largely to the use of the Scotts brand. Homeowners trust the name and they trust the product. Why? Because they look at their yard and it looks better than their neighbor's.

We are continuing to look at additional acquisition opportunities with firms that we think will enhance the SLS business and the overall profitability of Scotts. I'll let Pat elaborate on LawnService in a few minutes. But let me say that these folks, like so many of our associates at Scotts, are doing a great job executing their plan.

Another team doing a great job is our supply chain. The results here are off the charts. I think the value of a world class supply chain is often overlooked and is almost always undervalued. But you only have to look at the dramatic shift in our business this year to see just how vital this function has become. As I said earlier, this is one of the biggest profit quarters in Scotts' history. And it was the first time ever that the third quarter sales exceeded the second quarter in a given year. Without a hiccup, our supply chain team quickly reacted as our largest retail partners moved much closer to just-in-time deliveries. On-time and in-full deliveries or customer fill rates are 98 percent on a year-to-date basis, a tremendous improvement from 91 percent a year ago. Why? Because these guys have fully leveraged our investment in technology. They've also done a great job hiring world class teams that have made both the manufacturing and distribution systems far more efficient.

They've also done a great job developing a clear set of aggressive goals for this year and then made sure they were clearly communicated and understood. The results of these efforts paid off. We still expect to accomplish the anticipated savings we outlined for 2002 in November. Half of the savings was from workforce reduction, the rest from supply chain. So clearly, this is an area where investments are paying off big time for Scotts and our shareholders.

Let me switch gears now and discuss International. This is a story that keeps getting better. We are still not where we wanna be, but we are getting closer. Now that we have the right management team in place, they've developed a plan to significantly improve this business within the next several years. In International, we are starting to see some real progress with both our Consumer and Professional businesses and we're confident we can continue that momentum. On a year-to-date basis, POS at our major retail accounts in the UK is up 7 percent. It's up 6 percent in France and more than 9 percent in Germany.

We are also seeing real progress in product lines where we have significantly increased our advertising. We cut expenses significantly in International last year and then reinvested that money in advertising, and it's paying off. In the UK, we put our advertising behind four brands: Evergreen, Miracle-Gro, Weedol, and Roundup. POS for these brands is up 23 percent, 11 percent, 20 percent, and 51 percent respectively. In France, our advertising is focused on two products in our KB range. Both had POS increases of 14 percent this year. And the Fertiligene lawn care products, supported by advertising, have seen a 28 percent increase in POS.

We also continue putting advertising behind Roundup, which is built on its already market leadership role in France again this year. And in Germany, where we continue to advertise behind the Substral brand, we saw an 8 percent gain in POS. So the momentum in Europe is there, but more has to be done. This week our Board approved a plan to significantly improve the profitability of our International operations. I can't share a lot of the details this morning either in this portion of the call or during the Q-and-A, but we will share more with you at our year-end conference call in October. For now, I can tell you this. We plan to implement SAP platform throughout Europe. We also plan to work to optimize operations in the UK, France, and Germany, and to create a global supply chain.

As I've told you all before, we are nowhere being satisfied with our current returns from Europe. In the end, successful implementation of this plan will lead to ROIC for International that is competitive with the rest of the company.

I've mentioned return on capital several times this morning and it's not by accident. Those of you on the call who know us know that we have a laser beam focus on this goal. Another recurring theme this morning has been our people. As investors, you interface almost exclusively with me, Pat, Rebecca, or Jim King. I think it's important you understand the depth and breadth of our human capital. Our people are getting it done day in and day out. And their creative approach to growing this business is becoming increasingly evident to the outside world every day. The strength of our people is part of the reason we feel good about 2003. While we're keeping an eye on the ball for the rest of 2002, we're already starting to look out into next year, and we think the outlook is really good.

Given the strong POS growth this year, we would expect to see top line growth in the core business to return back to at least normal levels in the mid-single digits. Since retailers are buying based on historical POS, our shipments should grow even if consumer sales are flat next year. But given the strong consumer demand we've been seeing for all of our products, we have every reason to believe that the consumer will continue to increase their support of our brands.

In addition, we would expect Scotts LawnService to continue on its aggressive strategy to grow at both sales and profits. And given the high margins associated with this business, continued growth of SLS should continue to enhance the overall profitability of The Scotts Company. Our focus in ROIC will continue to result in significant cost savings from our supply chain in 2003 that is incremental to the savings we've achieved in 2002.

So you can see why so many of us are psyched up around here. The combination of our brands, our advertising, and our people are making the future look very bright. One more item before I close. Hopefully, you all saw the press release yesterday regarding our decision to expense stock options. We obviously think this is the appropriate thing to do and we're proud to be one of the first companies to make this change. Like many you--like many of you on the line, I am a shareholder of this company. In fact, I'm the single largest shareholder. And from that perspective, I think treating options as an expense is the right thing to do. Along with our Board, management here recognizes that options are a form of compensation and we believe our accounting should reflect that. As you saw in the press release, this is unlikely to have a big impact on our anticipated results. However, I think that--I think it makes us more transparent to the street and that's good. It will give all of you a better understanding of our performance and our corporate culture as well as you make your investment decisions.

With that, I'll turn things over to Pat.

Thanks, Jim, and good morning everyone. As Jim said, we had a great quarter all the way around. The shift in shipments from Q2 to Q3 occurred about as we expected and our forecasted cost savings continue to materialize according to our plan. The result was a record third quarter. Company-wide sales in the third quarter were $692 million, up nearly 16 percent from $599 million last year. Excluding the impact of foreign exchange, sales in the quarter increased 15 percent. For the first time in a while, sales actually increased from foreign exchange as a result of the strengthening of the Euro.

On a year-to-date basis, we've reported net sales of about $1.5 billion, roughly flat with last year. As Jim outlined earlier, the change in the quarter and the flatness for the year is due almost exclusively to changing retail purchasing patterns and the lowering of retail inventory levels primarily in North America, but also worldwide. In the past, we told you that 53 percent of North American consumer purchases in Lawn and Garden occurred last year in the third quarter while only about 38 percent of our shipments occurred during that same period. We estimate that our third quarter shipments are more than 40 percent of the full year. So you can see those two numbers are moving closer together.

Going forward we would expect the third quarter to remain our largest sales and profit quarter, while in the past the second quarter had that distinction. Net shift was apparent in looking at North American consumer sales which were $532 million in the quarter, up 15 percent from last year's total of $461 million. The breakdown on a business by business basis is detailed in the press release and on our website, so I won't go through all of that detail right now. Through the first nine months, we've reported North American consumer sales of $1.1 billion, essentially flat with the same period last year. In the third quarter, Scotts LawnService showed a nearly 90 percent gain in sales to $29 million, up from $15 million from the same period last year. On a year-to-date basis, SLS had sales of $45 million, up 83 percent from $24 million last year.

Scotts LawnService made a series of early season acquisitions that helped fuel this growth. These transactions, which include the purchase of the Lawn Company in Boston and JC Ehrlich in Eastern Pennsylvania, combined with outstanding marketing efforts, industry-leading customer retention rates, and organic growth, had SLS on track to achieve the significant in sales and profits we had anticipated at the beginning of the year.

As Jim also mentioned, International Consumer has also been affected by the effort by their retailers to lower their inventory levels. Sales in the quarter increased 10 percent to $82 million. Excluding the impact of foreign exchanges, sales for the quarter increased 4 percent. And through nine months sales are $210 million or $209 million excluding foreign exchange rates. That's down about 4 percent through the same period last year. While it's clear that International Consumer will not meet the sales goal expectations we had anticipated, they remain on track to meet their increased profit goals.

In our Global Professional business, sales in the quarter increased 4 percent to $50 million compared with $48 million in the comparable period last year. As we mentioned in the previous call, retailers are also lowering their inventories on some live goods and taking shipments later from their growers just so they--just as they have done with our Consumer business. Since our Professional business supplies these growers this change has negatively impacted sales in this business as well. On a year-to-date basis, Global Professional sales are down a little more than 1 percent to $140 million.

In Roundup, we had a net commission in the third quarter of $16.6 million compared with $16.1 million last year. On a year-to-date basis, net commissions are $13 million compared to $23 million for the first nine months of last year. One of the biggest factors at work here is our higher contribution expense, which is $5 million more this fiscal year than last year. However, Roundup sales were also negatively impacted by reduced year-to-date shipments, like most other North American products.

Gross margins in the quarter were higher: 39.1 percent compared to 36.5 percent at the same time last year. On a year-to-date basis, margins were 37.2 percent for the first nine months of 2002 compared with 37.1 percent for the first nine months of 2001. The improvement in the quarter was almost all attributed to North American Consumer and due mostly to a more favorable product mix. Our Lawns business was shipping more higher margin fertilizer in the quarter due to the success of SummerGuard and our Growing Media business shipped more value-added soil.

Advertising expense in the quarter was $30.6 million compared with $31 million from the same period last year. As a percentage of sales, advertising was 4.4 percent of sales versus 5.2 percent last year. Through nine months, advertising expenses have totaled $69 million or 4.7 percent of sales compared to $77 million or 5.3 percent of sales last year. Both in the quarter and on a year-to-date basis you continue to see the efficiency of our advertising spend this year. We continue to hit target audiences watching premium programming, such as the British Open this past weekend, at lower costs than last year.

In Other Income, you see the impact and the disposition of our peat bogs in the UK, which made up a majority of this line. Moving down the income statement, SG&A was $86 million in the quarter, or 12.4 percent of sales compared with $84 million or 14 percent of sales for the third quarter last year. During the quarter, SG&A includes a $3 million non-recurring environmental charge, high legal costs related to our successful defense of lawsuits, and about $4 million of additional support for our rapidly expanding LawnService business.

On a year-to-date basis, SG&A was $246 million or 16.9 percent of sales. This compares to $253 million or 17 percent of sales last year, reflecting good cost controls and continued realization of last year's restructuring more than offsetting higher legal costs, the environmental charge, and $11 million more for LawnService year-to-date.

Moving on to interest expense, we continue to get a good bump from lower rates and lower indebtedness. Interest expense in the quarter was $19 million, a $3 million improvement from the comparable period last year. On a year-to-date basis, we've incurred interest expenses of $59 million, nearly $11 million lower than last year. At the end of the quarter, we were out of our revolver and total debt was down $61 million from last year to $836 million, and we had cash on hand of $76 million.

Our success at debt reduction for the year is due in part to our effective management of working capital. You'll see that receivables were up more than $75 million in the quarter. However, this is primarily due to much higher June shipments this year versus last year. In fact, in North America, day's sales outstanding decreased from 59.7 to 52.5 at June 30, between--comparing those between years, while the quality of our receivables also improved. Total North American past dues decreased by one-third from the prior year period.

We also lowered inventories in the quarter by about $60 million versus last year, as we indicated we would on the last call, and we expect to drive them even lower by year-end. As we have shared with you previously, debt reduction is an important issue for us and our goal is to regain our investment grade rating by 2004. Part of our incentive compensation this year is based on debt level, and it is an area in which we have performed extremely well. So we think this emphasis has paid off for all of us.

Capital expenditures now look like they'll come in about $53 million, which includes additional recent expenditures for increased security. Factoring in the estimated capital expenditures, Scotts LawnService acquisitions, and including the cash that we received from the sale of the peat bogs, we would anticipate free cash flow to be at least $70 million for the full year, which is double our original estimate of $30 to $40 million. This range is supported by our current year-to-date cash flow from operations, which has increased by $85 million, which is more than double the prior year period.

Moving back to the income statement now, EBITDA, excluding restructuring and other non-recurring gains and charges, was $185 million in the quarter compared with $135 million last year, a $50 million increase. Through the first nine months, EBITDA, excluding restructuring and other non-recurring gains and charges, was $278 million compared with $271 million last year. Depreciation in the quarter was $10 million versus $8.3 last year and stood at $26 million through the first nine months compared to $24 million last year. Amortization was $.9 million compared with $7.7 million the same period last year. Year-to-date amortization was $6.3 million compared with $23.5 million the same period last year.

Capital expenditures in the quarter were $11.8 million compared with $9.5 during the same period last year. Year-to-date capital expenditures are $34 million compared with $36.2 million in the prior period.

As you know, FAS 142 deals with the treatment of goodwill and other intangible assets. No longer amortizing goodwill and other intangibles has increased earnings per share by 13 cents per share in the quarter and 41 cents per share year-to-date. This accounting standard also required us to record an impairment charge of $18.5 million after taxes this year related to our European operation.

Taking everything down to the bottom line, we reported net income in the quarter, excluding restructuring and other non-recurring gains and charges, of $95.6 million or $3.01 per diluted share. This compares with $58.4 million or only $1.91 per diluted share for the same period last year. You should note that EPS this quarter was based on 31.8 million shares outstanding, an increase of 1.2 million shares from last year. This is due to the increased average stock price and higher number of options exercised, which both increase the calculation of the number of fully diluted shares.

During the quarter we recorded restructuring and other non-recurring charges of $3.2 million and a gain on the sale of assets of $3.4 million, all net of tax. Including these items, net income in the quarter was $96 million or $3.02 per diluted share. This compares with $45 million or earnings of $45 million or $1.48 per diluted share last year. On a year-to-date basis, excluding the impairment, restructuring and other non-recurring gains and charges, net income was $115.1 million or $3.64 per diluted share compared with $92 million or $3.04 per diluted share for the same period last year. Including these items, Scotts reported net income for the nine months of $95 million or $3.01 per share.

Before we take your questions, let me follow up on Jim's earlier comments about the outlook for the current year. Due to a strengthening sales outlook, our ROIC savings, reductions in interest expense, and improve company-wide expense controls, we now expect net income growth from last year's adjusted earnings of 50 to 60 percent before restructuring or other non-recurring gains and charges. Remember, that's based on a higher number of fully diluted shares than originally forecast.

With that we'll open the phones to any questions that you might have.

: Operator: Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press the "*" key followed by the digit "1" on your touch-tone telephone. We will proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press "*1" on your touch-tone telephone to ask a question. And we'll pause for just a moment.

And our first question comes from John Baugh of Wachovia Securities.

Thank you and congratulations. I guess my question is to try to hone in on this--the nine months as the quarters don't compare year-over-year. You pointed out North American is $1.1 billion, roughly flat if we take out LawnService. And I think the comment was that POS--at the key accounts you're up 10 percent. So I guess the question is what in terms of all of the accounts, not just your key accounts, would be your guess as to what the year will be in POS? And where will your shipments be? You've got one quarter left, and I'm trying to get at what the gap will be between your ship-in versus sell-through on a total basis.

How you doing, John? Jim Hagedorn here.

Good.

It's not a question that's that easy to answer. I am still using, and I think that I'm right although, you know, we're getting into sort of budget time for next year, so the amount of the deload of the inventory is to some extent, you know, when I talk to the sales force now it's like it's becoming a smaller number. But I think we're dealing with sort of a hundred plus million dollars of deload system-wide in the trade. And I don't think that sort of gets any better. Now that being said, the Merrill Lynch downgrade of Depot basically said they think the inventory is too low. And I'm hearing a little noise, you know, from Atlanta, that they are concerned that they not have too little inventory. So there may be a move to sort of let a little more--and I'm not sure. They are different than other retailers for sure, Depot. I think that they may actually put a little more product on the shelf. And that being said, June was a great month for us and July is looking like a really good month for us too.

Jim, is your ship-in, say in the month of June, matching your POS--or close, closer, or if it's closed the gap?

I don't know, Bob, do you have a--Bob Stohler with me. Bob runs North America.

I would say so. You know, June was a very, very strong month and that followed a weak May and so the trade had--and in a sense for our business the spring came three to four weeks late. So the trade had product in its stores in anticipation of a normal May, some of which didn't thrush out until June. So the POS in June was probably stronger than our ship-in.

But you still had a good sale--sales out of our place in June.

Okay. And--.

--And July--and July is looking really good. So, you know, I 'm not sure that, you know, we're continuing to see more deload. I would--I would expect to say that it is at least on parity. I mean, that's my point of view is it meets parity.

Okay.

And John, also to your comment about what's happening in the non-major accounts, we don't think that it's as--the POS growth is as robust in those non-large accounts.

Yeah. So, not to put words in your mouth, Jim, but if POS were flat fiscal '03, everything else being equal, you'd expect your shipments in North American, or maybe globally, I don't know. You tell me. It would be up $100 million?

Look, I'm not gonna sort of define a number for you guys. But I will tell you that my view is, and, you know, we've said it publicly, which is that if the consumer doesn't buy any more we get a sales increase next year just because we have more normalized. And that is not only good 'cause we get more sales, but it's also good because--Mike [Hoopmeyer], who is also here with, we're driving--and he runs our global supply chain. We are working toward an inventory number for year-end which is significantly below where we were last year. So to make that happens he's been really idling our plants for a lot of this year, and running our plants at a normalized level next year should be really beneficial for sort of the expense sort of per unit of manufacturing. Okay?

Yeah.

But even if the consumer doesn't buy anything more, I think we do better than we did this year for reasons. We'll sell more and the plants will be operating at a more normalized level.

Okay. Pat, a question for you just to clarify on the cash flow. So when we look at the debt position of the company at the end of September, your expectation is the debt will be roughly $70 million below the year prior level?

We estimate that it would be in that range.

Okay. Super. Thanks

Thanks, John.

Moving on, we'll next go to Michael Millman of Salmon Smith Barney.

Thank you. Jim, could--you mentioned a bunch of initiatives in your scripted part. Could you rank--maybe take what you consider the top three, let us know what those are and maybe what you expect from those in the near term and over time?

Good morning, Mike.

Good morning.

Sure. The---let me start by saying why did we develop a separate business within North America to operate these? I gave a project that I'm really interested in--pots, it happens to be, you know, decorative pots for putting plants in. And the people who run our Grow Media business, which is what goes into those pots, were really excited about that they could marry these up and make a business out of both of them. That was about a year and a half ago. A couple of months ago, I asked the guy who runs our Grow Media business, hey how are we doing on that project anyway? And he said, you know, I've had a couple of meetings on it. And it became very clear to me, and this is not new. We may have talked about this before. That unless you have somebody assigned to do it and focus on it 100 percent, it--if it's not--if it's a part-time job of somebody's it sort of gets treated like a part-time job, especially where business is doing really well. And we are a fast running business. I mean, I really like working at Scott. It's a lot of energy, but it also means you're pretty busy.

So we decided let's set up a business where innovation and growth of the business in our core business will continue to stay with our sort of conventional marketers, who I think are really terrific by the way. But that we'll set up a separate group of people and their job is to basically look for either new channels--this grocery thing that I talked about today, or new product categories to enter. Because in large part, what we have developed here is I think the best seasonal distribution company for lawn and garden products in the world. And that gives us the ability to say, what are big categories we're not playing in, especially where there are commodities?

So, the channel--I'm sort of saying we've gotta--we've gotta continue to focus on our independent trade because they are important to us. We talked about that. The idea of saying, you know what? Ladies, and men, but a lot of ladies go in the grocery stores every--you know, a couple of times a week. They are walking right by. These are low margin products for the retailer. We can put lawn and garden products in like, you know, branded soils, small boxes of, you know, fertilizer like Miracle-Gro, and other products that are high margin opportunities for them and there's just all these people walking by the shelves. And it should be a good business for us. And if you look there, they tend to have certain non-branded commodity items, you know, sitting out of the sidewalk. That's the business we ought to have.

I talked about pots. The pot business--listen to this. A billion dollar category. Unbranded. We should be in that business. And we can basically use our distribution infrastructure, our sales force, you know, call it our sales and supply chain business, and the technology we put together, and our relationship with the retailers, I think to make everybody a lot more, and produce a more innovative product for the consumer. So, you know, all I would say to you is, you know, we really made an effort not to sort put a flashlight on every single one of our projects, but pots would be one. You know, we've talked about water looks interesting to us. And, you know, you could go out into a shop, Mike, and look and you'd find big categories that we aren't participating in that you could say why not do it.

Now my wife asked a question--I know the answer is getting too long. My wife asked a question when I was first putting the Scotts deal together with Miracle-Gro. And she said what are you trying to build? And I said the Procter and Gamble of lawn and garden. And that--you know, so if you think in those terms I don't think it's very hard. Now. Timing. We think that we can be in some of these businesses in '03, but I would expect sort of major introductions of products in these new categories starting in '04 and before.

By the way, another product I really want to be in--this group is high on the priority list, is natural lawn and garden products where I think there is a category. It just is really lacking a marketing champion behind it. And so that's an area where--this is not an indictment on our core product line, but I do think that there are people who would like natural products and if there is anything selling I'd like it and I think we can develop the category as well. Okay?

One little follow up. You had mentioned, without giving me any specifics, your--an initiative international. How would you compare the potential for that with the potential for some of this--some of these products that you just talked about?

You know, this is--I've got my European team on the line so I want to be careful that I don't make them feel small. We have an excellent opportunity to build a very core franchise on the continent of Europe. And I am a serious believer and the team has done a terrific job putting a plan together that's coherent and that I think deals with a lot of the issues we are dealing with as far as growth and profitability. That being said, you know, look at the big countries over there are like $100 million, you know, countries or companies. It is not very--I mean, look at our Miracle-Gro potting mix. In just a few years, we've developed a--and this is just Miracle-Gro branded potting soil. We're not talking about our whole dirt business here. That little business is bigger than any of the major sort of fortress countries that we have in Europe.

And so I think that basically we have a very strong franchise here in the U.S. and that it's easier for us to get, sort of, pack on growth, or I think, like this LawnService got called, bulk-on growth. So I think that, you know, we have so much ability to sort of move with our big markets here in the U.S. that I think it's easier to get even new products being bigger than the European business. Okay?

Appreciate it. Thank you, Jim.

You bet.

And next we'll go to Jim Barrett of C. L. King & Associates.

Good morning everyone.

Hi, Jim.

Hi, Jim. Jim, could you talk a little bit about the recent consolidation of the second tier? Is that changing either your marketing strategies, your selling strategies, the amount of money you are going to spend going forward as you look into your 2003 plans?

Yes and no. First, I was coached by my team to not be too aggressive in how I talk about this.

You can feel free to ignore them, Jim.

No, what I don't want is I don't want the government breathing down my neck. Look, it's a great country. We love America and we welcome competition. So that's the sort of "PC" answer. What do I think? I think that, you know, the other side of the business, which is a private label value business, is consolidating, which I think is fairly natural to be honest. I think if you look at like the Purcell business that CBC owned that now United Industries owns, like they couldn't make money. And, you know, I was very aware of that. We looked at that business as an acquisition candidate and I would've liked to have acquired if the FTC had--was willing to let us. So I know about that business and it's a very difficult business to make money in by itself and I think the only way to sort of make money there is to consolidate where you've got some volume, which is kind of what Mike was talking about. You know, as we introduce new products in the U.S., that's a good thing.

I think there--you know, I'm gonna--let me give respect to the guys, whether it's St. Louis or it's in Boston. They are real competitors. They know what to do. And so, yes, it has changed how we think about the business and, you know, we believe consumers go to brands. We are continuing to gain market share. We are not losing market share, but they are pretty good in-store. We--I think we learn from them. I would say to you I think we are better in-store today than they are. I think our systems are better than theirs are and we looked at them as state of the art a couple of years ago. I think they're, you know, they're gonna be a little tougher and--but I like competition. Let me tell you. I am a competitive spirit. I do this in large part because I like competition. And it makes us want to fight harder. And we will fight hard, and you know, you heard it here, we will win.

And does--that suggests sort of a related question. When you look at the pricing your brands will have next year combined with the presence of the large boxes, is your pricing gonna be sideways, down or up?

To the consumer?

To the consumer, ultimately to your customers, right.

I would like to see pricing at the consumer level go up a little bit and not because we're changing our prices next year in any sort of material way. I do think that it's important for the trade to be profitable. And , you know, having sort of all the big retailers saying they will have the lowest price, it's a very difficult dynamic, you know. It's basically all it takes is one criminal and, you know, the--nobody makes any money. And I don't--you've got this really great, I mean, I don't wanna make this a speech because I feel really strongly about this. You've got this really great business. It's the number one outdoor leisure activity. The demographic s are great. The age group that like is that buy our product, which are basically 50 plus, there's more and more and in the fastest growing part. It's a really fun business that people are enthusiastic about. Why should the retailers not make any money on it? And so I would like to see some more profitability at the retail level, but that's not up to me, it's up to them. So, I'd like to see them give themselves a chance to make money. And I think that based on a lot of their retail stock prices, they might be interested in basically a little more profitability as well. So I don't think that's a bad dynamic because I don't think to a consumer an extra call it 20 cents on a box of 5-pound Miracle-Gro matters for a once a year purchase. Okay?

I hear you. Then finally, your ROIC objective. Your net assets at this point hasn't been reduced over the past year. Can you give us some sense as to where you see the progression being made on ROIC in 2003/2003? How you'll get there?

I'll let Pat take that one.

Thanks a lot.

It's--we're just trying to, and we think we've done that, slow down the pace of growth of the denominator, the capital part of the equation, by obviously increasing our earnings significantly. You know, another significant component of that is working capital. We've made progress on that. We think we will continue to make progress on that. So its really those three big components, you know, continue to work to minimize the rate of increase of capital, increase profitability and manage working--continue to manage working capital like we think we did this year. We still think that we can get to a significantly higher, and we've talked about it--you know, the 12.5 percent ROIC, by 2004. And we're still working towards that goal.

Thank you, Pat.

Once again, if you would like to ask a question, please press *1. And David Cumberland of Robert Baird has our next question.

Good morning and congratulations. Jim, you mentioned that July is looking really good. Could you please elaborate on that? Are you referring to sell-in, sell-through or both?

: Jim Hagedorn: Well, remember, sales of our products are in large part in today's world based on retail POS. Okay? So there's a very, very high correlation between what we sell and what the retailer sells. Bob, you wanna--feel equipped to talk about what you are willing to talk about as far as how July is looking?

Well, our POS data tends to lag a week to 10 days behind what's actually going through the till, so we don't have all of July, obviously, on POS. But based on our shipments and our projection to the end of the month, and the end of our month ends Saturday, fiscal month. We are seeing, you know, like 30 percent increase in shipments this month, which you know, we don't think the trade is like building inventory. So we're seeing a surprisingly strong response from consumers despite pretty hot weather across the northeast and the Midwestern part of the United States. So we are very pleased with that.

And one other question. Jim, you talked bout next year's sales could increase even if POS were flat. Are you referring to POS being flat on a same store basis and so selling could increase due to uni-growth among your top retailers, or how would that work?

No, I'm just saying if--even if consumer takeaway didn't. So that would imply because I haven't heard neither [Delly] or [Tilman] sort of come off their growth as far as their footprints for the chain and all of our retailers. That would imply a [indiscernible] decline, which I think is unlikely. But all it does is make up feel better that even if consumer doesn't buy a box or bag more of our product, we get a--because of this inventory reduction, we believe we'll get a sales increase.

Okay. Thank you.

You bet.

Moving on, we'll go to James Halloran of National City Bank.

Good morning gentlemen.

Good morning.

Great quarter. Following up on the discussion in July, is there anything you see in the way of--one of the things that benefit you obviously in the third quarter was the mix and the gross margins that resulted from that. Anything different perhaps looking into the fourth quarter in terms of the mix being not quite so good, or how do you see that coming out, Jim?

I'm sort of looking to Bob Stohler to, you know, there's not much of a fourth quarter business in Europe. It's mostly North America.

Yeah.

And LawnService. So maybe both of you guys could sort of answer on the quality of the earnings in the fourth quarter.

In terms of the North American Consumer business in the fourth quarter, it tends to be a Lawns business, an Ortho business, and a Roundup business. Those tend to be the strongest parts of the business in that quarter. And the control part tends to be that July I'll say half of August business and the Lawns business tends to be September. That's kind of the way consumers take care of that part of the business. And we don't see anything radically different in the mix versus say a year ago for those businesses.

And from the LawnService side, you know, obviously, the quarter that just ended and the fourth quarter are the high profit quarters for LawnService, so we think it will be a good contribution in the fourth quarter.

One other thing, I guess last question, sort of combining two items. With Ortho and with Gardens, not to dwell on they're saying the problem children, but can you sort of elucidate a little more where you think you can get these things back on track? I know that Ortho is coming off a bad year, but it's still 29 percent below where it was two years ago.

I can answer that pretty easily.

Okay.

Unless you want to add more. I'm sorry.

Well, just the Gardens is about flat with where it's been in the past too.

But I think that one of the things that we're doing differently next year within our core business is we're combining the marketing efforts of our Growing Media business and our Gardens business. And there's a reason for it and I think that it sort underlies what I is this sort of optics problems that the Miracle-Gro business has that it shouldn't have. Okay? And that is that you guys will remember, and it was one of the most disappointing experiences of my life, although it was a really good on in retrospect, was I wanted to sell our dirt business really bad. And the Board said, if you can make it better, make it better and then sell it if you want to. Okay? And I was really disappointed. I said this was a runaway Board. You know, I was so mad I couldn't--but we have an independent Board, I'll tell you that.

Anyway, that business has turned out to be an incredible moneymaker for us and I'll tell you how they did it. But there's only one--I mean good people and all that stuff--one--or maybe it's two syllables--Miracle-Gro. That business today is a Miracle-Gro business and it is hugely profitable and so we spike all that Gardens--all that soil. They are all spike with Miracle-Gro. To some extent we think that's affecting the business, plus we've come out with all these new products. So we talk about Miracle-Gro, we're really talking about water solubles. When we talk about like the 70 percent increase in the business for our dry products? That's because we keep competing with ourselves and we keep putting out like Osmocote and the Shake 'n Feed Miracle-Gro product, and all these dirt products that contain Miracle-Gro.

And so, to some extent I think Miracle-Gro is getting a bum rap. Plus, May, which for any of you from the Northeast and I'll bet most of the people on the call--May was pretty wet, I mean, like every weekend it was cool. We had a great season up to there and we had a great season after there, but May, sort of as a month, was not so terrific, which is by far the biggest month Miracle-Gro has. So I think that effect will--and the thinking at Miracle-Gro. [Alena Cursio], I want to give her some credit, the lady who runs the Miracle-Gro business for us, has--is doing some really great thinking. And she is a very important executive for this company. I think the Miracle-Gro is getting a little bit of a bum rap.

Now let me turn to Ortho because I think maybe you're a little more right there. Ortho is not out of the woods as far as being a problem child. They have made some very important improvements in the business and the idea of execution. Remember last year how bad customer service was? Now one of the things we did last--at the end of last year, and this came from me if that's a guide. We in the last two years spent $30 million advertising Ortho brand and I haven't seen the needle move at all. What's going on here? We significantly reduced the amount of advertising for Ortho last year because I--my view, and I'm 99 percent certain Bob totally agrees with me on this, and maybe he feels more strongly than I do, is that until we get the right message why waste money on the air, especially when we have other brands that could use that money? And we did that. But that also affected the business a little bit. Okay? You know, advertising works.

The guys have a chart in front of me that shows Scotts Turf Builder with Insect Control, which was not advertised, compared to the new Scotts SummerGuard, Turf Builder with SummerGuard, and the chart is like off the wall different. And the difference is when we put it on t.v., the product went bananas. Remember, this is a pesticide product with Turf Builder. Okay? There is no reason why we can't sell, you know, pest control products, use advertising and make money. We just didn't have the right message in my opinion. And that will be rectified and we will be running advertisements and I think that will really help this business.

Now, in addition, we had a significant issue with our listings this year at Lowes, which is a very important part of our business. We are--we actually have concluded a negotiation that is very important to that business. I don't want to talk about it but it will lead to significant increase in the amount of shelf space allocated to Ortho at Lowes. If you look at the other businesses and remember K-Mart's business is down POS, but actually, it's a comp store increase when you look at the number of stores that closed, which is a lot better than we thought they would be. This issue, if you exclude K-Mart and look at the remaining top three, was really a Lowes issue, really drove a lot of those numbers and solving our issues at Lowes I think was and is very important to next year. So, advertising, better shelf set, increased focus on execution I think is the answer for these guys.

Okay, thank you gentlemen.

And moving on, we'll go to Charlie [Locastro] from Paxton and Associates.

Hi. This is actually Dan Wiscano. What I was calling was I just wanted to see what you thought the balance sheet would look like, really accounts receivable and accounts payable at the end of the year versus last year? And also, could you go over what's in the other income line?

Well, first of all, we're not gonna forecast the balance sheet. And the second question, the biggest number in there we talked about was from the sale of the peat bogs in the UK.

And then the restructuring charges under the restructuring and other?

Its just relocation expenses related to last year--last year's restructuring. The accounting for that is that you have to take the charge when the actual relocation occurs.

Okay. And would that--would you expect your accounts receivable to be up significantly as they are now versus last year or would you expect them to be more in line?

No, I thought I explained that this quarter was impacted by the big increase in June sales this year versus last year, the day sales outstanding actually decreased and by a natural basis they should decrease between now and year end.

Okay. Thank you.

You're welcome.

And as a final reminder, please press *1 now if you would to ask a question. And next we'll go to Todd [Grishbah] with Wagner Asset Management.

Yes. Jim, you made a comment earlier that you did wanna do additional acquisitions. Are these outside of the LawnService business?

Oh, no. That's--I was understood if I--if I said that, or I didn't mean to anyway. No. Our--the--our most important growth opportunities outside of our core business are our LawnService business, Branded Plants business, which is doing very well, by the way, and last is the business development, which I think it's very important we look at how we enter new businesses--new categories with a clean sheet of paper which is more on the lines of the Miracle-Gro model. You know, outsourcing and especially looking at global sourcing opportunities, to really, I think, be unusual in that we can start with a clean sheet, and I think a lot of these new businesses we looked at we can source all over the world and not be sort of stuck with, you know, high cost plants and materials.

I think that makes a lot more sense in terms of you being able to use outside suppliers and use your brand name but have them produce the actual product. Could you also bring us up to speed a little bit on your ability to kind of develop the network of LawnService outlets out there? I would think it's very important to cluster the number of service centers you have. And then, kind of, how is that margin match ratio process coming along?

Well, let me give this to Pat. And Pat is a terrific CFO for us, but he has a pact that we like to talk about. And Pat was the Chief Executive of the second largest lawn care company in the country. It was bought by ChemLawn. And then he joined our Board and then finally became our CFO. So Pat is a very skillful person and made a lot of money himself personally on the sale of his business, which was also a public company. So that's the reason that we have an operating business reporting to our CFO is that Pat knows a heck of a lot more about that business than I do. So, Pat, would you take that?

: Pat Norton: Well, we've done a good job of expanding. And we do expansion through a number of ways. You know, we have, start-ups, "greenfield" we call them, where we go in and just use the power of the Scotts brand primarily through direct mail to acquire new customers and grow the business as within those cities. We also do, as Jim talked about, either platform acquisitions where we'll go to a new city for the first time, and in addition to the direct mail advertising, do it in conjunction with a platform acquisition. And we do build-ons in cities where we've been in operations and we already have an existing customer base and infrastructure and those actually can be very lucrative from day one.

We're in, I think, 35 of the top 100 cities already and we would expect to continue to grow that next year. Obviously, the larger the individual market the more profitable the market is. We've only been in this, this is our fifth year of operating, and some of our most mature markets are already achieving, you know, 25 to 30 percent EBITDA margins. So we are very pleased with our continued progress in this area.

And what type of pricing premium does the Scotts LawnService get over a typical competitor out there?

We charge a premium. We--I don't know that specific number, but it's a premium to the industry.

Is it over 10 or more than 10?

I would say in the 10 percent range.

Thank you.

You're welcome.

And our final question comes from John Evans of [Coker] and [Palmer].

Can you just talk a little bit about the deloading of inventory in Europe? Are you starting to see that like the U.S. and does that have any affect on the '03 results that you think?

Well, let me start and then I'll hand it over to Michel Farkough. I'll get him on the one question. I think the answer is yes. The Europeans were over for a Board meeting we had this week and sounded almost apologetic that sales were flat and POS was up until I told them guys it's the same thing we're seeing in North America. So, sort of, with that foundation, Michel, what would you add?

Thanks, Jim. Good morning, everybody. John, [indiscernible], I mean, we believe, to date, we went back in by 10 million deload from our retailers so we can track, and so that explains, you know, the flatness of our sales. But like Jim said before, we see U.S. being up in every single [indiscernible]. And for the remaining of the year we forecast to sell more [indiscernible] than last year, so we feel good with that number.

But do you think this will help you, Michel, next year, or do you think there'll be continued deload in the--.

--Well, we believe it more specifically in France and the UK. We believe most of the deal that's been done. It may continue a bit and it may continue some in Germany, but definitely we should have a benefit from the deloading [indiscernible] specifically with distributors.

And if you look at your POS, sir, I guess, how much has your POS data kind of been up for the year?

Well, I think we right now it is difficult to predict. It depends I know. First of all, most of this year now is behind us. July and like in U.S., I mean the weather was pretty wet. But we don't believe we are going--we are not going to see any [indiscernible] as in current U.S. we are. I mean, you know, UK is up 7 percent, France is up 6 percent, Germany is up 9 percent. What is left now is a bit of pesticide business and as Jim said before, we have a very small autumn season unlike the U.S.

Okay. Thank you so much.

You're welcome.

Thank you. Thanks, Michel.

And it appears there are no further questions. At this time, I'll turn the conference back over to you, Ms. Bruening.

Thank you. And again, thanks to everyone joining us this morning and we look forward to speaking to you at our year-end conference call which will be towards the late--probably late end of October. Thank you and have a great day.

See you guys.