Scotts Miracle-Gro Co (SMG) 2003 Q3 法說會逐字稿

Good morning. Welcome to Scott third quarter Earnings Conference Call. All participants will be able to listen until the Q&A answer session. This conference has been recorded if you have any objections you may disconnect at this time.

I would like to introduce Rebecca Bruening, VP and corporate treasurer. You may begin.

Thanks, Kathy. Good morning, everyone and welcome to the third quarter conference call. With us this morning is Jim Hagedorn, our CEO, and Chris Nagel, our CFO, and Bob Bernstock who joined us recently as President of our North American consumer business. Before we get started, I want to take care of several housekeeping items.

First, please mark your calendars for the first week of December for Scotts annual analyst and investor meeting. This year, we are changing meeting locations from Marysville, Ohio to New York city. We will be following up with more details at a later date. Stay tuned. Second, it is likely our comments will include forward-looking statements. As such, actual results may differ materially from what is discussed this morning. Because of that risk, we strongly urge you to review the risk factors outlined in our form 10-Q, which is filed with the SEC. Third, I hope that all of you have seen our earnings announcement, which was issued earlier this morning. The release which has been filed with the SEC may be found on Scotts err portion of the Web site at www.scotts.com

As a reminder this call is being recorded and an archived version will be available on the Ir portion of our Web site. If you make any comments morning related to non GAAP financial measures not covered in the press release we will provide those items on the Web site. The press release reconciliation statements will remain on our site for this year. On sign upon before we start the call well, we open the line for you question and press is concluded .we ask issues related to today's press release. We make this request to keep the Q&A session as brief as possible as well as out of fairness to the vast majority of listeners to today's call w that

Let me now turn the call over to Jim Hagedorn to discuss our third quarter performance. Jim?

Thanks, Rebecca, good morning, everybody. I want to start this morning by reminding you of a theme we've been using this year in our annual report, our investor presentations and in our corporate advertising. We also use it internally with our associates. In all of those communications, we used the following challenge. If there's a better business to be in, please let us know. I would like to issue that challenge again this morning because if ever there was a year in which we demonstrated this to be true, it's 2003. Let me quickly mention five areas in which we proven this point so far this year and then I'll elaborate on each of them later.

First of all, in a season beset by heavy rainfall and below-average temperatures, consumer purchases of our products are up 7% at major retailers in the U.S. for the year and are up in nearly every major market in the country. Secondly, our effort to expand in the independent channels of retail have led to 10% sales growth through the first nine months of the year. Third, our long service business continues to show the impact it can have on the company is on track for sales growth at 50% for the year. Fourth, Global Pro, a business that has under-delivered in the past has delivered and is ahead of expectations so far this year, and finally, our international consumer business not only continues to make significant bottom-line improvements but is gaining market share in key markets and demonstrating its ability to be a meaningful contributor to our results.

Although our stock was behaving earlier this summer as if our growth will be pretty meager, we remain confident that earnings will grow by double digits again this year. And I would be remiss if I didn't remind you that we're achieving that growth not only in the face of a challenging season, but in the year which we made planned investments worth about 50 cents a share. Also, we've left another 8 cents on the table with our decision to expense stock options this year. Double-digit earnings growth in 2003 speaks volumes about the strength of the business and our continued focus on shareholder value. It also tells you how good our team is here at Scotts. You want hear us making apologies or excuses for the fact that weather impacted our business. That's because we don't simply roll over and play dead when factors outside of our control affect the season.

Throughout the organization, our team rallied together this spring to overcome adversity and stay focus on our goals. Without doing anything that hindered the integrity of our long-term strategy, we asked our associates to be as flexible as possible and make difficult sacrifices in their spending decisions. I want to thank them for their commitment and hard work and let them know that it has not gone unnoticed. With that, let me elaborate a bit on the five areas I outlined earlier. Let's start by talking about the consumer. As many of you know, we received point of sales data, or POS, from our largest retail accounts of the as I mentioned earlier that data shows consumer purchases of Scotts products is up 7% on a fiscal year-to-date basis. It was up 4% for the third quarter.

This is one of the few areas where I want to discuss the impact of weather. POS in April, which historically has been the biggest month of the year for consumer purchases, was down 8% from last year. That's a big deal. You recall the POS was up 13% through the first six months of our year. After the seventh month, April, consumer purchases on a year-to-date basis were up only 3%. Obviously, we had a strong rebound in May where POS was up 17% and June up another 5% to get us back to where we are today, and we've seen continued strength in July as well, up 19% so far. So, the consumer has stuck with the category, and as I said earlier, that's true across the country even in areas hard hit by weather. What's also encouraging is that our retailers tell us that sales of Scotts products continue to outperform the category. In other words, we continue to improve upon already-leading industry market shares.

This simply reinforces the mantra we've been preaching since 1996, grow the category and take the lion's share of the growth. Let me anticipate a couple of your questions based on your phone calls in recent weeks. First, I know many of you are wondering about retail inventory levels and whether they will present challenges for us in the quarter ahead. Based on our data as well as conversations with retailers, we think inventory levels are appropriate and don't see this as a concern.

Secondly, many of you are also asked how we managed to drive strong POS with less than ideal season. There's a lot of reasons. He will me start by looking at our increased investment in advertising. As early in May, we began taking an extremely critical look at all expenses, about you we never retreated from our long-term investments in the business, including our commitment to increase advertising by 20% this year. Regardless of the weather, we knew that building brand equity was in the best interest of Scotts over the long term.

As planned, advertising for every brand, Scotts, Miracle-Gro, Ortho and Roundup, focused on product superiority. Our consumer impressions are up this year by more than 25%. We think the frequency of our message helped to keep the consumer engaged and allowed us to take share in the category. The big gains we saw in POS came in categories where we focused our advertising dollars. Through the first nine months, Roundup was up 8%, Miracle-Gro potting mix up 12, Turf Builder with summer guard up 13. Ortho home defense up 16, Ortho Weed-B-Gon up 23%.

Consumer purchases of Miracle-Gro Shake-N-Feed which were advertised for the first time this year are up more than 110%. So is there any doubt in our mind about the power of the brand or any question that advertising drives the category? No. That's why we're increasing ad spending by 20% this year, and while we plan to increase --increasing our ad spend faster than sales in 2004 and beyond. POS growth has been aided by our decision to double the number of in-store counselors as well as the development of creative trade programs that encourage larger dollar purchases by our consumers. We also need to give credit to the retailers who remain focused on lawn and garden and who continue to use their own advertising and merchandising strategies to propel the category.

Finally, we had another major change in our North American business during the quarter. Bob Bernstock joined us as president of that group and replaced Bob Stohler who retired. We're lucky to have someone of Bob Bernstock's caliber on our team. He's a seasoned consumer products executive who has a proven track record. He joined us most recently from the Dial Corporation and had a successful career at Campbell's Soup and Kraft general foods. His track record as a brand builder and insight on how to interact with consume percent retailers will be a tremendous benefit at Scotts. He's a proven leader and team builder that will serve us well as we grow our North American business. There's nothing more fun than There's nothing more fun than putting the new guy on the spot.

So I would like to introduce Bob to you this morning and ask him to spend a minute or two sharing his initial impressions of Scotts.

Thanks, Jim, and good morning, everyone. As you just heard, I spent the vast majority of my career in consumer products, working in dynamic categories with some of the best brands in America. Scotts has a lot in common because lawn and guard isn't a dynamic business, and Scotts, Miracle-Gro, Ortho and Roundup clearly are the best brands in lawn and garden. Expect us to focus harder on product innovation to meet the needs of consumers. We'll also work to make the consumers smarter about the category, whether that's through advertising, in-store execution, traditional PR, or other communication. And, of course, we'll do so with an eye toward improving earnings and an eye toward improving return on invested capital.

Another immediate observation is Scotts is a company with a lot more than good brands. I'm impressed with the sophisticated systems that we have in place, our R&D capabilities and the ways in which we use supply chain as a competitive advantage in the marketplace. Most of all, I've been impressed by the quality of the people here. From R&D to marketing, to sales, supply chain, as well as HR, finance, legal, and everything in between. This is a dedicated group of men and women who are passionate about our company. In terms of my focus, I'll tell you that I'm mostly interested in building upon all the strengths that I just mentioned. The goal is to take our brands to a whole new level. I'm very excited to be here. As a new guy, I think I bring fresh perspective, and I look forward to helping us build upon our successes and continue to grow the business. I know we have an annual meeting with investors later this year. I hope to see all of us -- I hope to see all of you then, if not sooner, and I will be glad to share my thoughts and insights in terms of what we plan to do in fiscal 2004.

Thanks, Bob. Welcome aboard. Now, let me get back to elaborating on why we think our results so far demonstrate why this is such a great business to be in. Our increased presence with the independent trade this year is a secondary that proves our point. Going into the year, Tom Foise and his team built specific programs for retailer ins this channel that recognized their unique challenges. We also increased our focus on this area so we can deal with those issues more effectively. Those investments are paying off big time. Sales in the independent channel, which had been falling in previous years are up 10% through the first nine months of the year. And by no means do we think we're done.

It's clear that these retailers especially in the hardware channel are becoming more important in the lawn and garden category. With each passing day, more of these retailers are understanding that Scotts is squarely behind them and committed to helping them succeed. We recognize these retailers need a strategy that allows them to compete more effectively with the nation's largest retailers and a product line that helps them differentiate themselves in the mind of the consumer. This year, we've been mostly focused on the first half of that equation, and it's paid off handsomely. But we think the best is around the corner. In 2004, we'll be offering the independent trade a new product line called nursery select, which is designed to meet the demands of the retailers who shop in this retail channel.

We'll tell you more about our efforts in this area later in the year, but we're confident that our efforts to combine programs with unique product offerings will help Scotts achieve the same market share in the independent trade that we see at dry or mass retail. The third story I want to share with you is Scotts Lawn Service. With a lot of challenges caused by weather, Tony's organization has done an outstanding job this year growing the business and servicing our customers. These guys were doubly challenged this year. First, they had to deal with the late winter and early spring snowfall that delayed sales and compressed the spring sales campaign in many markets. Then like the rest of the U.S. business, they had to deal with a cool, wet spring.

As a result, they'll probably see sales growth of about 50% this year instead of our previous estimates of about 60%. Regardless of whether it's 50 or 60, it's still impressive, and from a bottom-line perspective, lawn service continues to demonstrate the earnings potential for the business model. For those of you who don't know the story as well, we have said that we believe a mature branch operation with Scotts Lawn Service is able to generate EBITDA margins of 25% or better, and that's what we're seeing. But to achieve that performance throughout the business, we have to remain focused on our vision to create a world-class service organization that delivers the type of personalized service and expertise that customers want and expect. It's not just about giving the consumer a good result. That's a given. We know the consumers of lawn care services strive to have the best lawn possible, but don't have the time or expertise to do it themselves.

We also know many consumers who hire a lawn care professional are not satisfied, which leads them to get a new provider from season to season. We want them to see Scotts Lawn Service as indispensable. We want them to see not as a service provider, but as a partner in their success. If we can do that, homeowners will see us as an investment in their home. By accomplishing this, we will have a truly differentiated our service which will translate to even better retention rates for us and improved profitability.

Our growth of focusing on achieving this vision, which is why we remain so excited about the potential for this business and why we think it can grow profitably and enhance the Scotts brand. Let's move on to take a look at the fourth issue I mentioned earlier, our global professional business. This is the business we didn't talk about much in the past, but we really think it's worth drawing attention to. Tim Portland and Michelle and their teams have done an outstanding job restoring discipline to this business, which is showing up on the p.m.

You have to look beyond the top line. What you don't see is walking away from a lot of low margin business that we would have chased in the past. Instead of simply discounting products, Pro is putting stronger programs in place that promote our competitive advantage. This team is also working more closely with supply chains to streamline their product lines, improve forecasting throughout the distribution Channel and reduce operating costs. And we've moved away from extending terms simply because a competitor might. We no longer provide incentives to the sales team simply to go out and make a deal. Instead, we're rewarding the sales team based on margins which has everyone focused on profitable growth versus pure volume. Pro is making great progress on several other fronts, as well.

Our branded plants program had a great start in its first year as a national business and show even more potential going forward. In the types of plants mostly annual flowers where Miracle-Gro select plants were part of the offering this year, we took significant market share and it was clear that the consumer was willing to move up the value chain to a premium product. We, and our retail partners learned a lot about the marketing and execution of selling premium live goods this year, and we're applying that learning to our plans going forward.

Going forward, our plans call to extend the product offerings into perennials as well as other types of plants. While we're still in the learning stages with this business, we continue to believe it holds great promise. The overall result in the Global Pro business is that profits are far above last year and they're exceeding their internal goals and commitments for the year. This reinforces our confidence that this business can, once again, be a meaningful contributor to profitability as well as our ROIC. Finally, the fifth story I want to share with you is the progress we're making with international consumer. Michelle's team continues to do an outstanding job driving profitability.

As is true with Global Pro, all you see in the press release are the top-line results from this group, but the real story is how they managed the overall business. They continue to execute on their plan and meet their numbers in spite of an ongoing and significant restructuring effort. In 2002, this group doubled its profitability and met its bottom-line goals for the first time since we began acquiring businesses in Europe in 1998. This year, profits are up by another 30% and they are meeting expectations. We're also gaining share in key markets. We gained share in the UK, thanks mostly to increased advertising, new products and improved trade relationships. We have seen a 12% improvement in Miracle-Gro plant in the UK after they began using a TV campaign called I believe in Miracles which was developed for use in the U.S. We also see ourselves gaining share in France. We see major gains in the food channel from last year and have reversed the trend that had us losing share in that channel over the past several years.

In Germany, we increased our market share this year with indoor pest control products strengthening our number one position in that category. We're making progress throughout international consumer and continue to see improvements when we commit advertising and marketing resources behind specific products, but we still need to achieve top-line growth across that business and doing so is a major goal in the years ahead. As most of you know, international, both consumer and professional, is an area which we openly expressed disappointment in the past, but quarter by quarter, our confidence is increasing and these businesses can be a meaningful contributor to corporate earnings as well as help our improve our return on invested capital. Michelle manages both pieces of international and his team is making great progress. I mentioned earlier in the --that the consumer business is up 30% this year.

However, his combined international p/l is up more than 30% on a year-over-year basis and Michelle had and his team deserve a lot of credit for his work. Whether it's international or North America, we have good reason to be proud of our results this year, strong consumer demand, a growth in diversity strategy that is taking hold, double-digit growth in a difficult environment and in the interest of time, I didn't elaborate the problem we're making on the international growth and integration plan or continued refinements to our North American supply chain. I also didn't elaborate on the progress we're making in our pottery business, where we made two acquisitions this quarter or the programs being put in place by hr to maximize our investment in our associates. If we can achieve all of this in a year like 2003, we think the future years can be even stronger. That's why we continue to have confident that you will be hard-pressed to find a better business to be than ours. With that, I will turn the call over to Chris.

Thanks, Jim, and Good morning, everyone. As Jim mentioned, we had serious challenges beyond our control in the quarter and we feel pretty good about today's announcement given the results we saw in April. I'll run through the numbers with you this morning and provide a little more insight along the way about what we anticipate for the balance of the year. Where appropriate, I will discuss the results that exclude the results of foreign exchange rates. You can see from the press release that foreign exchange rates continue to have a significant impact on our international business as the U.S. dollar has weakened substantially from last year.

With those comments, let's move on. Global sales were $710 million in the quarter, up 3% of $689 million last year. Excluding foreign exchange rates, sales were flat the prior year. On a year-to-date basis, sales were $1.57 billion, up 8% from $1.45 billion for the same period last year. Excluding the impact of foreign exchange rates, year-to-date sales were up 5% from last year. Our North American consumer business was down 1% in the quarter to $524 million.

A poor start to the quarter in April was really the issue in every line of business in the U.S. Our lawn business was slightly up in the quarter. However, both gardening products and Ortho were both down about 4% in the quarter. Sales for these two businesses are more heavily weighted in this period with nearly one half of the annual sales volume occurring in the third quarter compared to our lawn business, for which the third quarter accounts for only a third of the annual sales volume. Canada, which is having a strong year, was up 46% to nearly $16 million.

For the first nine months, North American sales are up nearly 5%. Led by lawns, which is up 10% for the year. Gardening products and Ortho are both down about 1% on a year-to-date basis. Canada is up nearly 34% year to date. As Jim mentioned earlier, retail inventory levels remain at reasonable levels, but we don't have any major overhang in the stores that will be working against us in the fourth quarter and entering 2004. Scotts Lawn Service was up 41% in the quarter to $41 million and is up 50% for the year to $67 million. As you heard, these guys did a great job serving existing customers, even with the difficult weather conditions in the quarter. The cool and wet conditions made it more difficult to attract new customers this spring. Those hurdles, coupled with the slower pace of acquisitions this year, is what leads to the lower growth Jim talked about a few minutes ago.

International consumer continues to show improvement. If you exclude the impact of foreign exchange rates and nonrecurring revenue items in fiscal 2002, sales increased in the quarter and on a year-to-date basis by 2%. And we continue to see strong improvement on the bottom line as they continue to refine their expense structure and execute their restructuring plan. In global professional, sales were up 1% in the quarter and year-to-date excluding foreign exchange. Obviously, the weather impacted the U.S. component of this business, but we are restoring more discipline to this business. That means we have walked away from sales this year that didn't carry a reasonable margin for us and we are better managing our operating expenses in connection with top-line results.

As a result, earnings are significantly improved over last year and ahead of plan this year. Moving on to gross margins, we have seen a 20 basis point improvement over the prior year to 39.5% in the third quarter. As we indicated in our press release, about half of the improvement resulted from the growth of Scotts Lawn Service, which has a higher gross margin than our other business segments. The other half of the gross margin improvement resulted from improved sales mix toward higher margin products particularly in the gardening products and Ortho businesses. Year-to-date margins were 36.8%, down from 37.4% last year. You'll recall that we originally projected a 200 basis point improvement in gross margins for the year, driven by continued supply chain improvements in both North America and international consumer and the growth of the Scotts Lawn Service business.

Due to a variety of issues that I will touch on, we will fall short of our gross margin improvement goal, but we believe we will see margins improve by at least 50 basis points on a full-year basis. Obviously, this suggests significantly higher margins in the fourth quarter than we saw last year. The anticipated improvement in the fourth quarter gross margin is due in part to the impact of lawn service. The fourth quarter is their largest and most profitable period of the year. We should also see significant improvements in fourth quarter gross margins in our North American consume Global Pro businesses as well primarily driven by supply chain improvements and to a lesser extent improved sales toward products.

As I said, year-to-date gross margin is down compared to the prior year and short of our improvement goal. The sales volume shortfall versus plan, plus the increase in our inventory levels earlier in the quarter have contributed to this gap. We also had to revise our logistic improvement strategy during the course of the year. We upgraded our warehousing facilities this year at a higher operating cost in anticipation of cost savings we would achieve later in the year from outsourcing much of our North American logistics function.

However, it became clear as we entered the height of our season that we could not execute the outsourcing to the logistics provider without seriously jeopardizing customer service so we reverted to our previous logistics model in-season at a higher cost than planned. This taught us a great deal about the unique challenges of our business. However, we believe we can learn from fiscal 2003 to secure logistics savings in future years. Listening to our Roundup commission, Roundup is having another terrific year. Year-to-date, global sales are improved over the prior year, leading to an increase in our growth commission in bow the quarter and the year.

Our net commission of $16.5 million for the quarter and $13.5 million for the year to date are flat to the prior year periods due to the increase in the contribution payment due back to Monsano in fiscal 2003. Advertising was $38 million in the quarter, or 5.4% of sales, up from $31 million or 4.4% of sales last year. Year-to-date, advertising represents 5.2% of sales and continues to track with our planned 20% increase in spending year over year. As we expected, SG&A spending has increased this year. Operating expenses for Scotts Lawn Service has increased for the quarter and year reflecting the rapid expansion of the business. You'll also see on the face of our press release p/l that we highlighted the impact of expensing stock options this year, which is $1.6 million for the quarter and $3.1 million for the year to date.

Restructuring and other nonrecurring charges increased to $1.2 million in the quarter and $5.5 million for the year to date, reflecting costs associated with the change in the north American logistics model and the execution of the international restructuring plan. The remaining increase in SG&A is due to planned investment in new business development and in-store execution as well as increases in pension and health care costs. In addition, the impact of the change in foreign exchange rates represents at least 1/3 of the increase in SG&A for the quarter and year-to-date period. While SG&A has increased from last year, it's important to recognize that this was planned.

In fact, we've done a great job controlling other discretionary SG&A spending this year in response to the difficulties this season, so SG&A is actually running considerably favorable as planned. We continue to see improvements in interest expense with interest expense in the quarter down half a million to $18.2 million. Year-to-date, interest expense is down more than $5 million compared to the prior year as we continue to benefit from both lower debt levels and interest rates. Over the past four quarters, we reduced our average net debt by $53 million to $879 million. That translated into a leverage ratio of 3.31 and an interest coverage ratio to 3.75, both well within the terms of our existing covenance and improved over the prior year. For the quarter, depreciation was $10 million and amortization was $3 million. Through nine months, those totals are approximately $29 million and $9 million respectively. Capital expenditures were $9 million for the quarter and $41 million through nine months.

Let me address the income tax line for the quarter. You saw our effective tax rate with 36.1% in the quarter compared to 38.5% last year. The reduction in the rate reflects an unplanned benefit we recorded in the third quarter associated with deferred tax adjustment. Bringing everything to the bottom line, net income in the quarter excluding restructuring and other charges, was $92.3 million, or $2.85 per share, compared with $95.6 million, or $3.01 per share last year. Including restructuring and other charges, net income in the quarter was $91.2 million, or $2.81 per share, compared with $95.8 million, or $3.02 per share last year. On a year-to-date basis, adjusted net income was $114 million, or $3.55 per share, compared with $115.1 million, or $3.64 per share last year.

As we summarized, the issues surrounding gross margin and the incremental investments we made this year have prevented us from reporting year-over-year earnings improvement through our first nine months. However, most of our anticipated improvements for the full year was planned to occur in the fourth quarter. We are confident that we will at least break even in our fourth quarter compared to a loss of nearly $10 million, or 31 cents per share, last year, and report full-year earnings improvement on at least 10%. We anticipate fourth quarter sales to be strong in North America, so are likely to come in at the low end of our original guidance of 6 to 8% growth for the year. Fourth quarter sales for our lawn service business will continue to track at least 50% over last year, leading to full-year sales growth of at least 50%.

Let me move on to the balance sheet for a moment. Accounts receivable has increased over the prior year reflecting an increase and end of quarter sales, the impact of foreign exchange rates and a shift in sales mix toward customers with longer payment terms. Despite the increase, we consider the management of receivables to be very good. Our days sales outstanding remain in line with our exceptions and our past dues continue to decline. Finally, inventory stood at $323 million at the end of the quarter compared with $302 million a year earlier.

Obviously the weakness we saw in April contributed to the year over year increase. However, we have reduced production throughout the summer in response, and we expect year-end inventory to levels to be comparable to last year. Speaking of next year, I want to make one final point before we open the call to questions. I know many of you are looking to 2004 for and probably have questions about what we expect. I'd appreciate it if you held off for now. We obviously are focused on finishing 2003 as strongly as possible and are still in the budgeting and (inaudible) for next year. As always, we'll provide you with appropriate guidance when we have it. I will reiterate our previous comment that we believe we can continue to grow the top line in the mid single digits and the bottom line by double digits with that I turn the call over to the operate so we can answer your questions.

Thank you. We are ready to begin the question and answer session. If you would like to ask a question, please press star one. You will be announced prior to asking your question. If you would lake to withdraw your question, press star two. Once again, to ask a question, please press star one.

Our first question comes from Alice Longley of Credit Suisse First Boston.

Hi.

How are you?

Fine, thanks. How are you? First question your guidance of earnings are up double digit for the year. What's the base you're using for that? I'm assuming you're meaning net income, right? And is it up double digits from some number a year ago without one-time items?

Alice this is Chris. The number that we're talking about is at least 10% net income, adjusted net income growth.

so the basis, 104.3?

Correct.

Thank you. And then another question is on sales. Year to date, you said consumption of your products of 7% and in the third quarter up 4% at major retailers, your shipments were at what level for those retailers, flat? Wondering what's the difference between the shipments and ( inaudible ) Is it inventory between the retailers?

If you look at it as the top retailers or proxy because call it 80% within those retailers, what you are seeing is actually I have a dollar bet going with Chris on this right now. Inventory levels out there right now are at most of the retailers are down and one of the top four retailers up very slightly, but actually look at that on a per store basis, but DIY especially are growing their outlets by call it double-digit numbers so absolute inventory is at most of the retailers flat to down and then you're seeing a pretty significant decline in inventory on a per store basis at the retailers, so I think that the answer then is continue decline in retail inventories at -- especially on a per store basis.

I think particularly at Kmart, so I think generally, Alice, we think that roughly sell-in and sell-out are roughly in line, but I think that, you know, Kmart is continuing to aggressively effectively d-load.

I guess my question is it looks like your shipments were less than sell-throughs, which is encouraging in a way because it indicates that retailers are working down inventory that might have been too high going into the quarter.

I would say that's generally true, and I would say very declined inventory at Kmart.

My last question is receivables. Could you comment more about that? They were up a lot. One could be suspicious that you gave favorable terms to encourage sales.

Yeah, I tried to briefly summarize the -- what was going on there. I think it's a combination of end of quarter sales increase, fx, and like I said, the shift in customers. To my knowledge, there was certainly no deals made in the quarter on terms to promote sales so this is simply

Or for the year.

Or for the year, so this is simply a shift. You know, terms are a function to lots of things to customers, pricing and programs.

Alice, no change in terms this year at any of our retailers.

so your shipments are strong at the end of the quarter, not because you offered some deal at the end of the quarter but because the weather got better?

Correct.

Thank you.

Ron Philis of bank of America.

Ron Philis I was wondering if we could go over inventories. They looked significantly above the prior third quarter. The other question I had is pertaining to the in-store folks that you guys are ramping up or according to the press release, doubling. I was wondering if that is throughout all of your retailers, or just certain of them?

Why don't I deal with the last part first, and I will let somebody else, I guess, Chris, deal with the inventory issue.

appreciate it, Jim. Is that really showing up one retailer that you can do a better job with or across the board?

I would say that the use of in-store counselors, which is a lot of the money, is presumably DIY issue, OK. Not an issue, but it's the opportunity there in a big way with DIY. What I would say to you that as going forward and this is part of the budget for this year is increased use of merchandisers in other classes of trade besides DIY, as well so this is a very significant increase in the number of hours and folks who do this, and we will see broadening it out to beyond DIY as well this year. I mean, listen, we believe it's highly effective, or we wouldn't be doing it.

I just wondered if it was a Depot or Lowe's thing or both?

Both. It will be moving outside of that in the fourth quarter. Now, inventory. Nagel has his calculator out.

If you look June over June, you will see probably a $20 million or so increase in inventory. About half of that is fx. So if you say and the other half is about 3% increase on the base. We indicated in script that comment. That there were inventory challenges earlier in the quarter coming out of April. Mike and the team are addressing that pro-actively and have a plan to get that in line to get it in by the end of the year, so it's even to prior year. Right now, I don't think we're overly concerned about the plan.

Part of that is building inventory for basically a slowdown of our manufacturing to keep us balanced through the fourth quarter, so we are we're closed down pretty tight on manufacturing at this point to get inventory levels down, but it did require some building to balance. Is that fair?

That's fair. Thanks, guys.

Bill Chappell of SunTrust Robinson Humphrey, you may ask your question.

yeah just a couple quick questions. First, on your guidance for the full year, I want to understand with the 10% net income growth is that with the assumption of the lower tax rate so really it's kind of high single digits, but the pre-tax growth and then the lower tax rate?

Our guidance is earnings growth and at least 10%. We said we're living to do better than that -- we said we're striving to do better than that, and Bill, that's as much as we can say at this point.

the tax rate is an unplanned thing that you are seeing and it's not going to carry over next quarter, right?

Well, it will tax the full year effective rate, but there won't be another adjustment that we perceive in the fourth quarter.

switching gears to the lawn service business. Can you help me on a couple of things. You throw up the metric of kind of your retention rate, and also what that business is running. You said the mature business is up 25% EBITDA. What the total business is doing kind of year to date, and then also with the money you made, give a little more color as why you didn't have as many acquisitions as planned? Will that money that you set aside for this year be rolled over to next year?

Well, I'm going to ask Tony to answer most of those questions, but let's start with sort of even margins in mature branches, and let's go then to acquisition schedules, you know, sort of -- earnings this year, revenue this year was definitely impacted from doing less than budgeted acquisitions.

Part of that is sort of our ability to chase, and what we're willing to pay for businesses and what we turned away from ourselves, and I think a little bit that the opportunities weren't there, that we sort of had hoped that it would be, but in part because in a lousy season, it might be a business you might decide if you owned the lawn service business, I'll wait to next year before, you know, I chase it down, and I would say somewhat more activity by true green, as well, where there are points where we walk away and say we're not willing to pay those kinds of multiple. I don't know. Tony, I guess, last, I would say probably not when it comes to -- I mean, if we saw a good acquisition that was opportunistic, would we increase the sort of annual call it 30 to 35 million that we have sort of running with our board, probably, but I would say in absence of sort of some compelling reason or some compelling opportunity to do so would we say, and I'm making this number up, and if Tony was 15 short from this year, would we, you know, give him 45 next year, I think the answer to that is no. Unless we saw an opportunity at the right value.

Let me comment first on the acquisitions. You know, clearly what most businesses are typically for sale in the fall time period, and then there's another period where businesses become available after the initial spring surge, which is really after the weed control is put down because that's when consumer needs are the great he and the hiring challenge is the greatest. What we are seeing now is a pickup in acquisition activity so I would expect that it would have more opportunities going forward, but being that we're nine months into the year, obviously from a pacing point of view, the revenue opportunity in the current year is far less than what was originally anticipated, and Jim is correct. Early in the year, there were a few acquisitions. I believe we commented on this before, that we looked at and felt were overpriced and therefore past.

I'm encouraged that we will be able to report increased acquisition activity in the fourth quarter, and I do agree with Jim's comment that we're standing steadfast to looking at about $30 million a year, and we'll difference deviate from that when and if a good opportunity comes up and not otherwise.

EBITDA margins.

EBITDA margins in our mature branches are in the mid-20s, but again, mature is in the 4 to 5-year range, and we said that before as well. I think there was a question asked about where are you year to date. Year to date, the business is, you know, actually slightly at a loss on a year-to-date basis and that's because of the importance of the fourth quarter to the entirety of the business. About 40% of the revenue occurs in the fourth quarter and vast majority of the profit, that is no different than would have been the case last year or will be the case in the year ahead.

One last follow-up. I know you're not commenting on those '04 numbers, but can you just help me understand with rising natural gas prices how that might impact your cost of goods sold going forward?

Sure. I will look over at my splicing guy and say, how do you feel about your cost of goods going into next year?

I think we are in pretty good shape because of some forward buying, but we are concerned and watching the natural gas price so we have some basic concerns where we think we're in a good position at least going into next year.

What I would say is what I've said every year that I've been talking to you guys, which is that if our cost go up, remember our competition is store controlled brands. The costs of raw materials is a much higher percentage of their selling price than ours. So they came -- retailer margins are higher than the private label brands than they are on ours. They keenly feel cost of good increases, but remember, our price at the consumer level are pretty much tied together as kind of a ratio, so they feel the pain. They know if costs of goods are going up, and we have an understanding with all of our major retailers that if we can demonstrate our cost of goods are going up, we can take pricing, and those people who followed us through the urea spikes have known that we have gotten pricing in those situations, and if we see that as an issue, we will be talking with them. The programs are, I would say close to being locked down, but not in regard to pricing if we thought there was a pricing problem. Barry Sanders, and that was Michael Meyer from the supply chain before. Barry runs the sales force.

Right, if there's an issue with any of the natural material pricing, we would address that with the retailers, and I think they would be understanding of that.

Jim Barrett from C.L. King, you may ask your question.

Good morning, everyone. Actually, I had a question for Tony. Tony, are the number of applications in the business this year, are you likely to catch up by the end of your fiscal year?

I think the essence of your question is because of the late start of the year in our programming of round late revenue, what we have in fact the (inaudible) much of our complete --the full year's completed work by the end of September? We hope to be close to back on schedule. We may be a week behind going into the first fiscal quarter of next year versus the way we programmed our budget (inaudible) our revenue on a normal year.

OK thanks and Jim, could you talk a bit about your current outlook in terms of return on investment capital for this year 04 and then beyond.

I will talk through the generalities of it then I will hand it over to Chris to give details of that. As you guys know when we first started looking at this back on call three years ago we are below our costs of capital. I think actually at a dinner with you, you and I had this conversation about the same time that we started getting interested in return on invested capital as a metric that the company should be following and that on review, one, that the company was very poor in the bottom --of the bottom quartile of our peer group. If you look at the sort of mean or median of our peer group as of last year, that number was running, I don't know call it high 10s or 11%. So our goal and our focus of this business, and remember 20% of our executive incentive is based on return of invested capital. We're looking for a number of around 9.5% this year, and so I look to Chris and say how do you think we're doing on that?

I think we reported something around 9 or 9.1 last year. We are striving to 9.5 this year. I think we will get sort of somewhere in between last year in our goal given the challenges we have this year. So I think we are keen to make some improvement but that would be a little off of our goal but still from the macro sense, nothing to deviate from the way Jim has described it in terms of still pursuing and getting to the median of our peer group.

No but I would say one thing --improvement for our goal, we will continue to-- it will stay as a important metric in our executive compensation but I also say that our weighted average cost per capital are whack has declined and so that we are well above our cost per capital now and would be EBA positive, and we continue to plan on getting better. But it's (inaudible), thank you.

So after 2005, maybe 2006 sort of timeframe?

Are you referring to the median, Jim?

Yeah.

Yeah, I guess in probably somewhere in that timeframe yeah maybe 2006. I don't know. I think we're pretty confident with our improvements in the international and so forth that we can continue to make good strides forward.

I don't want to carry this question on too much longer because I get criticized sometimes as taking too much time on the call talking about like this. I will tell you that, you know, this year is a year and when I say this year, 2003 was a year that we basically said we have to make some investments. We can't save our way to success. That the street will not value us if we basically give up growth with the result of being ROIC is better and our growth rate is less than we like it to be. We made investments this years that have cost us profitability, and not -- and not an insubstantial amount of profitability, but our view is that long term, the value of this business is not only based on financial discipline which includes ROIC, but it's based on growth, and so we have made some sacrifices in that regard in order to ensure the long-term top-line growth of the business.

I understand, OK. Thank you very much.

Thanks, Jim.

James Halloran of National City Bank, you may ask your question.

Good morning, gentlemen.

Good morning.

I just want to get back to very quickly to something maybe you covered it but on the Scotts Lawn Service. Granted you don't give income numbers, but in the second quarter, what kind of impact did it have in terms of the impact on lawn service and what would be sort of nonrecurring or whether normalized in terms of sales or activity in Scoot Lawn Service if you haven't had the bad quarter.

You mentioned seconds quarter.

Third quarter, excuse me..

I am not--we are going to be careful about you know we prefer to not talk about detail.

Well, in generality.

I mean-we are clear that lawn service was a little bit off of their target of top line in the third quarter so given the weather, and how from an earnings basis, like Tony described, the lion's share of the earnings is going to occur in Q4 for that business anyway, so the big mover in the metrics in terms of its contribution to the company's financial is really in Q4, not Q3.

Analyst: OK.

I just want to throw in there, Jim, that you know, the difference we talked about because we said, you know, 50%, 60%, so you got -- there's kind of a differential in sort of the expectations, one, so that I think probably enough for you all to figure that out if you get into your models. The second thing is that of that delta, about half of that is acquisition pacing related and about half of that is sort of what we'd call performance around here, which is just, you know, weather related, et cetera.

That is a good point.

OK?

Yeah. One other question if I could. You mentioned that there are higher commissions on the Roundup in 2003. Isn't that far off for 2004 fallback?

No, no that's--.

Distribution payment, the contribution payment.

That's done. That's flat. It's as high as it gets, thank God.

OK. It will still be the same next year?

Yes, sir.

OK.

But the contribution payment back to months (inaudible) is now fixed in perpetuity.

OK. So we can model basically the same general levels for the future?

Yes, sir, with hopefully sales growth, so it's a little bit like we've been working and working and working, and thank god, the, you know, because now increased sales means increased commission, and that feels a lot better to the people who are running the business.

Thanks very much.

You bet.

Michael Millman from Millman Research.

Millman Research, I say, welcome back, Mike.

Thank you, Jim. How about that? Can you compare for us the return on increased advertising versus in-store counselors? And then just a break, explain, this is Chris, why the current deferred tax asset increased about 25% of what that means or how you got there.

All right s that it? For you, that's like a short list.

we listened to Rebecca.

Return on advertising versus sales, to be honest, you know, I'm sort of looking at my or Bob's head sales guy and head marketing guy and saying, can you guys figure that out? I would say that, and this is a philosophical part of the discussion, and if they have better, you know, answers, which probably we could get for you because, you know, we know what we spent. We know the brands we spent on. We know the POS improvements on those brands because of the spend, so probably we could put some better math to what you're asking, but, and this is, again, a longer answer probably than everybody would like, but remember the old days at Miracle-Gro where we viewed advertising as a sort of carpet bombing approach, which I think basically is what it is. Now, do we get a more local today with radio and local TV and sort of, you know, this weekend style advertising? Yes, but generally, it's a sort of carpet bombing air force approach.

As we sort of did the Scotts deal and looked at the business, especially competition to Ortho, before we even owned Ortho, what we saw was United Industries did a really good job of in-store execution, and not against us, but against Ortho, and we actually were really impressed with the amount of share an unadvertised brand could get with proper in-store execution. What you've seen at Scotts as we've integrated North America is sort of understanding, and we would say or at least I think Berger would have said, and I agree with him that the in-store bit is the infantry, Army, feet on the ground approach, and you don't win a war with just air force or just Army guys. That what you're seeing in Scotts as we go forward is a sort of combination and recognition that both are necessary and then the whole issue, which is kind of gets to the point of your question which is what's the right mix? I'm not sure we know the right mix. I'm not sure we're that scientific, but I don't know.

I will turn it to Bernstock, and say, you can have this one. Good luck.

I will take a crack. At least on the advertising piece, and Barry Sanders can talk a bit on the sales piece. I think as a range on revenue, these investment targeted correctly are in the 3X to 6X on sales so 1.03 can lead six times in terms of revenue. What we're seeing in advertising is once you get behind an overlay of Scotts or Miracle-Gro, if you focus on the right products like we have onion Miracle-Gro, Shake-N-Feed, potting soil, home defense, Scotts Summer Guard, you can see tremendous growth. The most growth is Shake-N-Feed where we doubled the size of the business through advertising. The trick is to have an overlay of brand advertising with product-specific focus on really most attractive products we have. In terms of sales, Barry?

You know, I view them in combination together. We're certainly trying to test the right mix, but the advertising brings the people in the stores and we're really testing the concept that says we can cross-merchandise and sell more products for the consumers when the consumers are in the store and actually having someone to assist them on projects and tell them what type of products they need to buy and so forth, so we're seeing kind of the same type of return on our investment for counseling than we're seeing in advertising, and you know, we're doing lots of testing now to determine what the right mix. Lieu like Jim said, we don't have exact answer, but we're seeing positive results from both investments.

And I would say that I was in sort of toward the sort of the spring whenever that was in the northeast season, and traveling with a bunch of Barry's folks in the northeast and jersey looking at stores, and they feel that we are probably -- remember, this is many could from salespeople at 50% of when we really need to spend, and they believe that the return on the foot, the Army guys, and you know, you would expect this, and their view is the return on the Army guys will be higher than the advertising once you reach a certain level of sort of saturation. What was the other part? ( Laughter )

I think you're looking at taxes compared to last June. If you compare to last September, you will see it's up modestly. There was a reclassification between current and long term. You'll see that during that same period from June of last year to September of last year, the long term other assets went down by similar amount, so mostly just reclassification on the balance sheet.

That reclassification had nothing to do then with the change in the tax rate, and if so, what was the change in the tax rate?

The change in the tax rate has more to do with the small increase you saw from September 30 to June 30 of this year. Not the big number that I think you probably were looking at, June over June.

What I suggest is, Mike, give our folks a call and you know, they'll continue to help you with understanding that for your model, OK.

Great. Thank you.

Harley Gonzalez,(ph) J. P. Morgan, you may ask your question.

This will be the last question, operator OK. One more after this, OK, sorry. Second to last question.

It's housekeeping and I apologize if you answered this and I missed it, but the CAPEX number for the quarter, the acquisitions for the quarter and the availability in your bank facility?

We have people yanking paper out, so stand by a second.

OK.

CAPEX for the quarter, we didn't d say it in the script, but for some reason I have the see in the area of my head. CAPEX was $9 million, $41 million for the nine months. By this point, the availability on the revolver is we're only slightly borrowed against that. I think out of it in the U.S.

Almost fully available?

Yeah. By the end of June, it was --almost completely available and by now, we're almost completely out of it.

Carla, end of June availability was $527 million. As of today, we're completely out of the revolver.

OK, and acquisitions?

On a year-to-date basis this year, at least the cash from acquisitions is about $10 million. How much do you think you spent total on acquisitions, Tony?

Through the third quarter?

Yeah.

Someone in the neighborhood of $13 to $14 million.

OK, thank you.

Our final question comes from Alice Longley of Credit Suisse First Boston.

Hi, I have two follow-up questions. One is, I don't think you ever gave us industry growth for the third quarter in year-to-date. Could you give us that? At retail.

I can't. And let me -- this is actually something that I know Bob Bernstock is working pretty hard on. As I think you probably know, but I'll tell you, Wal-Mart was the first last year to announce that they were declining to sell to anyone sales data. Now, you might remember that --.

You usually put together your own numbers.

Yes, we do.

for the industry.

But let me continue. Soon thereafter, both Lowe's and Home Depot also declined to sell data broadly. Now, some accounts, you know, we are the captain and receive all the department data. This data is viewed by the retailers and by us because if we didn't, we would be in deep trouble as proprietary to them. OK? So what we said is and I know this from our own data and from conversations from the retailers is that the Scotts business is growing faster than their departments are, OK. So, if you said to me try to figure out what that means, you know what, with you guys show up in November or next time I see you, we'll put some effort behind trying to sort of come up with a swag at what we are willing to say we think the categories are growing compared to what we think is going on.

Now, Bernstock arrives and says basically, how can you fly an airplane without that data? I never been in a business where they didn't have the data, and this is not a good place to be. Although, it sounds and looks to us when you look at the data that it is positive for us. So, we do this in Europe, and we probably are going to start doing this here is developing panel data with Nielsen that will give us the kind of category and share information that we've had in the past, but not through point of sale, but by people who are in the Nielsen family and so you know, putting lawn and garden into the panel work that they do. Bob, do you want to add anything?

Pretty much Jim captured the key points. We contacted or I contacted the providers from past lives, and her coming in and we're going to find the best way to get the panel and trademark et share.

As you said because your industry captain in a lot of places, you get department data. Is it fair to say in the third quarter when your sales and leading retailers are up 4% that the category, itself, was it flat or down?

What would I say?

yeah.

I would say it's flat.

so that's your best guess?

Don't do it, Jim. Don't it.

All right. If that's your best guess, it's probably as good as anybody else's.

I would think so.

my other question was on your sales guidance for the year and the fourth quarter, I'm trying to back out a couple of things you said. Did you say that North American consumer will be up to 6 to 7% for the year?

I said at the bottom end of your 6 to 8 range.

well, that means in the fourth quarter it's got to be up like 15%. Is that right?

Well, hold on IF you look at North America right now, I think in the release they're up, what, 5%. The fourth quarter will be accretive to that number and I think that's as much as I want to say on that, but you know, we anticipate having a good fourth quarter. Remember, we're a month into the quarter already. Most of the programs for the quarter, I would say, you know, virtually all the programs are put to bed. We understand, like inventory positions, we understand where the retailers are at. Everybody is -- and this is a compliment to our retailers.

Our retailers, in general, are definitely complimenting our view that we want to make the season better than it was if sort of improve -- you know, try and sort of cover and that's not the right word, but trying to sort of get beyond April and the fact that, you know, for those people, especially you who are in the northeast, you guys know what the season was like. It was really a bad weather season, and the numbers look a lot better than the weather was. That being said, people had very high expectations for the year, including the retailers, and they're very enthusiastic about working with us in the fourth quarter to drive business, and that doesn't mean drive inventory, but it means drive consumer into the stores and get them to buy our products and other products, so we both feel, you know, we need to have a good fourth quarter and I think we're comfortable with our expectations based on the fact that we're a month in and we have worked very closely with the retailers to make things happen.

you depart give guidance for the year on international consumer and global professional, but just making my own guesses. It sound like you think sales will be up somewhere around 10% for the year, is that right?

National consumer

Taking out FX, it's basically like 2% up, and Alice, they don't have much of a fourth quarter. Their business -- this is I think maybe the only call Michele hasn't said anything, but ho do you look at your business for the year?

Good morning, everybody. ( Laughter ) The sales growth of 2% to your point, Jim, the first quarter for us is only 15% of the total year. Not very big. You know, we don't have a four season like you have in North America, and July is a big month and July so far, we're in good shape, so we feel comfortable for the quarter.

well, putting the pieces together, it still looks like you expect sales overall, company wide in the fourth quarter, all in, including currents, I guess, would be up somewhere in the teens, is this right?

I don't think -- Alice, I will say it another way. I don't think we need sales growth in the teens to -- in order to hit our earnings guidance. So we can follow up with you.

sounds like your guidance leads one to back that out. I don't know how else your guidance could be right.

I would say please call and talk to them, and you know, there's nothing material and anything else I'll add.

I will do that. Thank you.

All right.

Thanks, everyone, for joining us and we look forward to speaking to you again on October 30th for our fourth quarter and fiscal year-end call. Thanks.