Scotts Miracle-Gro Co (SMG) 2004 Q3 法說會逐字稿

Good morning and welcome to the Scotts Company third-quarter 2004 earnings release conference call. At this time all participants are in a listen-only mode. After the presentation we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) Today's conference is being recorded; if you have any objections you may disconnect at this time. Now I will turn the meeting over to Mr. Paul DeSantis, Vice President Corporate Treasurer. Mr. DeSantis, you may begin.

Good morning, everyone, and welcome to our second-quarter conference call. With us this morning is Jim Hagedorn, our Chairman and CEO, and Chris Nagel, our CFO. I want to remind everyone that our comments this morning are likely to contain forward-looking statements. As such actual results may differ materially. Due to that risk Scotts encourages investors to review the risk factors outlined in our Form 10-K which is filed with the Securities and Exchange Commission. If you did not receive a copy of this morning's press release you can find it on the investor relations portion of our website -- www.Scotts.com.

As a reminder, this call is being recorded and an archived version of the call will also be available on the IR portion of the website. If we make any comments this morning related to non-GAAP financial measures not covered in the press release, we will also provide those items on the website. On a housekeeping note, we're tentatively planning our annual analyst day on December 9th in New York City. We will send you more details in the weeks ahead. With that, let me turn the call over to Jim Hagedorn to discuss our performance. Jim?

Thanks and good morning, everyone. By now you've seen our press release which shows we continue to make good progress in executing our strategic plans especially with our North American business and Scotts LawnService. Our third quarter and year-to-date results also demonstrate why we're confident in our recently increased guidance to achieve 13 to 16 percent adjusted net income growth for the full year.

We're having another record year at Scotts both in the top and bottom lines. We're seeing more than a 100 basis point improvement in margins and continued improvement in return on invested capital. We're also seeing another year of high cash flow. By October we will have generated nearly $500 million in free cash flow over the past 3 years.

Our successes this year are occurring even in the face of rising commodity costs, unplanned challenges in Europe and higher than normal SG&A growth. Separately I'll remind you that our decision to expense stock options is costing 20 cents a share this year.

While I believe our success in the face of these head winds is impressive, it is more important to understand why we are succeeding. It's not by accident. The results we've been consistently reporting are based on the outstanding execution of well developed strategies throughout our organization.

The most exciting part of our success in executing these strategies is that we've just started. Scott's is better positioned than ever to continue leveraging our core strengths to become an even stronger player in our core business and perhaps adjacent categories of lawn and garden. We've discussed many of these strategies in the past; they are areas in which we've made significant investment. They are the things that are defining our progress and giving as significant competitive advantage in the marketplace.

For example, we've been more focused on innovation in introducing new products that are moving the consumer up the value chain. We've invested in technology and new people to strengthen our supply chain to become a world-class supplier. We've invested in advertising and made those ads more creative and more effective than ever. We've invested to build a sales force that has become a competitive weapon that is without rival in the industry. By executing against each of these initiatives we have outperformed our competitors in taking share. And we believe there's more to come.

There are other areas of investment that we've not talked about that are equally important; one area would be our people. We have been working to instill a high-performance culture that focuses on attributes like innovation, accountability and collaboration. And in doing so we are creating an environment that encourages our associates to push the envelope every day.

Over the last 2 years our human resources department and business leaders have identified the right competencies for each department within Scotts. They've developed new performance metrics that better enable us to identify and reward our best people. We've also implemented new talent management programs to help us better develop associates at midlevels of management who can grow with Scotts and play a critical role in taking us to the next level. I believe the evolution of our corporate culture is key to our future success. In fact, it's where everything begins.

Our culture is just as important as our brands, supply chain and all the other areas that have allowed us to win. Our focus on executing this collection of programs has been evident in our results, including those we reported today. I'm going to delve into a broader discussion of our year-to-date results in a few minutes. First though, I want to address the current issues in our international business which I know are top of mine. Let me start by bringing you up to speed on international performance.

Despite a late start to the season to cause availability problems related to our SKU simplification efforts, the topline bounced back in the third quarter. This is especially true in the UK where sales went from being down 4 percent entering the third quarter to being up 7 percent by the end of the quarter. That type of growth is not only encouraging, but also represents what we believe the entire international business can accomplish. However, we remain disappointed in the bottom line.

Although France is reporting its strongest profit in several years, every European operation is trailing our expectation. This brings me back to what we said in our press release a few weeks ago and what you've heard me say repeatedly -- our overall performance in international is unacceptable. But when I said in our previous press releases that we are exploring all of our options, that's exactly what we meant. Do I want Scotts to be an international business? Yes. Does that mean we will continue to be an international business? Only if it makes sense for our shareholders.

So maintaining the status quo and hoping for better days is the only option we're not considering. Everything else is on the table. From establishing a new organizational structure to selling the operation, we're also looking at a wide range of exciting options in between, though I'm not at liberty to discuss them.

I know someone is going to ask about a timetable. So let me address that now. We will move as quickly as possible but we will not be rushed. We've been much more disciplined throughout the Company in recent years which has been a benefit to our shareholders. Given the importance of getting this decision right we will ask every question and make no decision until we are confident we have the right answers. But rest assured, the questions are being asked and we are moving aggressively to find the appropriate solution for our international business.

With that, let me move on to discuss the issues that are driving our record performance this year. As I said, these results are reflective of executing on the right priorities and continued development of a high-performance culture. I'm going to let Chris focus on our actual financial results; I'm going to spend my time discussing what we're seeing with the consumer and with our retail partners.

Through 9 months consumer purchases of Scott's products at our largest retailers is up 7 percent. This point of sale data, or POS, also shows gains in every product category, the most robust of which is in our controlled business, especially Ortho. I want to congratulate Bob Bernstock, Eugene Sung and the entire team at Ortho and Roundup for these outstanding results. The Ortho story demonstrates the impact of our focused approach to getting to business right. It also shows that we're winning with the consumer and the retailer because of well developed strategies.

Consumer purchases of Ortho products this year are up 19 percent. You don't have to have a long institutional memory to know that Ortho has bringing up the rear of Scotts for years. But under Eugene's leadership we have introduced new products and improved our advertising with great results. For example, POS of non selective weed control is up more than 50 percent this season; this is due mainly to the introduction of Ortho Season-Long Grass & Weed Killer.

For those new to Scotts, we have taken this once poorly marketed and underperforming product and transferred it with great success. Previously this was a product with a confusing name and nothing to differentiate it on the shelf. We renamed the product to reflect what it actually does and repackaged it to stand out from the clutter. We also put an effective and significant advertising effort behind Season-Long; the results speak for themselves.

We've also seen a 12 percent increase in POS in our outdoor insect business, again due to a new product launch, Ortho Bug 'B Gon Max. The story behind Max is much like that of Season-Long, using the same strategy to turn an underperformer into a product that is gaining respect and driving growth. Advertising was a key component in both Season-Long and Max. It's also a key to why we're seeing double-digit gains in both our (indiscernible) business, an important product for (indiscernible) as well as our Weed 'B Gon business.

Across all major products within Ortho I'm extremely pleased with our results. The business has really turned the corner and I'm confident there are significant opportunities in the future for Ortho.

What's also encouraging is the continued growth in Roundup where POS is up 15 percent on a year-to-date basis. Most of you know that the active ingredient in Roundup came off patent 3 years ago and yet the business continues to grow well. Since the patent expired we've made innovations in product formulations as well as packaging and have also been aggressively advertising the product. All have been key to Roundup's continued growth.

The impact of innovation is obvious in Ortho and Roundup, but it's also apparent in our growing media business. If you exclude the impact of low margin commodity soils, which we continue to deemphasize, and POS and growing media products is up almost 9 percent so far this year. The advertising response to both Scotts’ lawn soil and Miracle-Gro potting mix with moisture control, a super value-added product, has been outstanding with POS gains of 12 percent and 139 percent respectively.

Both of these products have been in the marketplace only a couple of years, but 2004 marked the first time they have been supported by advertising. Given the correlation between advertising and sales growth, you can understand why increasing our advertising to sales ratio is an important long-term goal for us.

Let me move on to lawn which continues to be a strong and steady performer. The business has also benefited from a strategy that is moving consumers up the value chain to higher margin products. Fertilizer purchases by consumers at our largest retailers were up 6 percent through to the first 9 months.

The strongest POS growth, more than 10 percent, came in key and fast-growing markets in the South. Remember, in states like Florida, Texas, North Carolina and Georgia, the market is more fragmented and our marketshares are lower. However, we're making outstanding progress in these states and our strategy to build a more regional focus should help our business continue to grow in these markets not only in lawn but in every other category as well. The benefits we're seeing from the ongoing strength in lawn, as well as the growth in Ortho, demonstrates our success in creating a product portfolio that mitigates some of the risk inherent in the lawn and garden business.

In building our current portfolio of brands, weather, which is a risk in our business, has become less of a concern. For example, weather affects lawn fertilizers differently than growing media which is different from pest and weed control. We've also lengthened our season starting earlier in key markets in the South and stretching later into the fall across the country.

While the breadth of our product portfolio mitigates risk, so does our geographic diversity. We divide our businesses in 6 regions. On average each region represents 17 percent of consumer purchases on a company wide basis with no region having less than 13 percent and no region having more than 20 percent of total POS. It's hard to imagine our business being more equally distributed.

I'm addressing weather because it always comes up during Q&A and it is largely misunderstood. As I said, we recognize the potential of weather on our business, but our diversification strategy has allowed us to successfully manage this risk and outperform our competitors.

Let me address two other issues that I know are of interest to many of you: first, the current retail environment and, second, the issue of pricing for 2005. By now most of you know that recently some of our large retail partners have been reporting slower-than-expected same store sales. However, the vast majority of our consumer purchases for the year are behind us and we feel good about the current level of retail inventory. So we don't expect any softness at retail to prevent us from hitting our guidance.

On the pricing question we have communicated to our major retail partners that we will be taking pricing in 2005. We have not done this in 5 years. During that time we have dealt with higher commodity prices, labor costs, medical costs and so forth. We believe these are all issues that we will face again next year. While we've been able to maintain margins so far, it will be tougher to do so going forward without a price increase.

With that, let me move away from the North American consumer business and give you an update on Scotts LawnService. SLS has performed exceptionally well this year and is tracking ahead of our expectations. Going into the year we established the right strategy for this business; measure our performance against service and customer satisfaction as well as financial performance. We've got a terrific spring and early summer both in terms of new sales and servicing our customer base.

On the sales and marketing front we tested and modified our direct-mail marketing messages, focused on our brands and our commitment to quality. As a result the comp rates have been ahead of expectation. On the service front we have focused on quality and established the right metric to measure success. Service levels are higher than they've ever been and cancellations are significantly lower than we expected. Consumer surveys are helping us better understand where we're succeeding and where we're falling short.

All of this has led to customer retention rates in many of our key markets that are near or above 80 percent. This is not only ahead of expectation, but significantly better than much of our competition. These higher levels have allowed SLS to stay ahead of the guidance we gave you earlier this year. That should remain the case when we report full year results in October.

Looking ahead, we're not going to change the strategy much here. You've heard me say in the past that quality is critical to the success of Scotts LawnService. We want our customers to view us as a partner in helping them create a great lawn, not just a service provider. From all the metrics that we review we're succeeding in this effort. We once again feel comfortable making selective acquisitions in this business.

For example, we just completed an important acquisition in Houston that significantly helped our presence there. But in making these acquisitions we will do so with greater discipline than in the past, focusing more intently in our ability to successfully integrate the businesses. There is no doubt that Scotts LawnService remains a critical component of our future success and I feel very good about how this business is performing right now.

To bring us full circle, I'm extremely pleased with the overall results we reported today. I'm also encouraged that our adjusted net income growth for the full year will exceed our budget and initial projections. Even with several headwinds, not the least of which was Europe, 2004 has been a tremendous success for Scotts. Our North American business continues to execute its strategic plan, proving that lawn and garden is not a mature category. Growth opportunities abound in North America and we will continue to execute on our strategy that is working well.

We continue to work against a clear set of priorities that allows us to leverage our brand and increase our market share. We will also continue to use innovation, advertising and a world-class sales force to drive consumers to value added products that better meet their needs while driving growth for both Scotts and our retail partners.

We remain focused on our strategy to improve ROIC and remain committed to managing the business to generate significant amounts of free cash flow. This will give us continued flexibility in managing our business with an eye towards shareholder value. Thanks for your time this morning. Now I'd like to turn the call over to Chris to discuss the financials.

Thinks, Jim, and good morning, everyone. As Jim said, we are very pleased with the terrific performance we are reporting today. I'm going to highlight both the reasons why our performance was so strong and the effects of foreign exchange where it has significantly impacted our results. Before I close I will spend a few minutes sharing our outlook for the balance of the year to help you reconcile our first 9 months results with our full year expectations. With those comments let's move on.

Global sales increased 9 percent in the quarter to 774 million, up from 710 million last year. All of our businesses experienced solid growth in the quarter. On a year-to-date basis sales were almost 1.7 billion, an 8 percent increase from 1.6 billion last year. Excluding the impact of foreign exchange, sales over the last year increased 8 percent in the quarter and 5 percent on a year-to-date basis.

Sales in North America, which include both our consumer and professional businesses, increased 7 percent to 587 million for the third quarter. Growth in the quarter was led by or Ortho and growing media businesses. For the year-to-date period north American sales increased to 6 percent. Every business in North America showed strong sell in for the year-to-date period. We are especially pleased with the growth of Ortho this year.

Consumers continue to respond to new innovative products like Season-Long Grass & Weed Killer and Bug 'B Gon Max. Shipments of Roundup were up significantly, driving the commission up 42 percent. Lawn sales were up modestly with a decline in seed sales and durables partially matching good growth in fertilizers. We are especially pleased with ongoing growth in the high margin TurfBuilder combo products like TurfBuilder+2 and TurfBuilder with Halts. Growth in the growing media category was driven by value added growing media which was up 24 percent behind strong performance of both lawn soils and our new moisture control potting mix.

Next let me discuss our Scotts LawnService business. Scotts LawnService sales were up 23 percent in the quarter to 50 million, and up 26 percent for the year to almost 85 million. Approximately three-fourths of the sales increase is driven by organic growth, while the remaining one-fourth of the growth reflects the full-year effect of prior-year acquisitions.

Our strategy of improving customer-focused metrics is proving to be a successful strategy. Our customer count is 42,000 greater than the same time in 2003 and considerably ahead of plan. Customer retention rates and response to direct marketing are trending well ahead of last year as well.

International sales increased 12 percent in the quarter to 137 million. On a year-to-date basis sales were 357 million, up 9 percent. Excluding the impact of foreign exchange sales increased 4 percent for the quarter, driven by strong performance in the UK where sales were up 26 percent. On a year-to-date basis, excluding FX, sales are down 3 percent. Within that 3 percent sales decline consumer sales are flat while professional sales are down as expected, as a result of the discontinuance of a line of low-margin growing media. Year-to-date sales in the UK are up 8 percent.

Sales outside of the UK are down year-over-year, driven by category weakness and a late break to the season. We saw some pickup in sales on the continent in the month of June, but it will not be enough to catch up to our original full-year expectations. For example, France sales were up 43 percent in the month of June but are flat on a year-to-date basis.

Moving on to gross margins, our third-quarter gross margin as a percentage of sales excluding restructuring charges improved by 20 basis points to 39.8 percent. For the year, gross margin excluding restructuring charges has increased 130 basis points, from 37.1 percent to 38.4 percent. The year-to-date increase in gross margins is being driven by all of our businesses.

In North America we have seen a 100 basis point margin improvement driven by the strength of our Ortho new product introduction, the continuation of our trade-up strategy on growing media, and the strength of shipments of higher margin combination fertilizer products. Scotts LawnService gross margins are up in excess of 250 basis points as the scale effect of the business growth helps margin improvement. International gross margins are also up significantly as we see the effects of the discontinuance of the low-margin growing media line I discussed earlier.

Roundup is having another great year. Net roundup commission in the quarter was 23 million, up from 16 million last year. Through 9 months the commission was 24 million, up from 14 million last year, driven by outstanding sales volume increases. The annual contribution payment remains unchanged again this year at 25 million. As we mentioned, our guidance for the commission is that it is now expected to increase by 50 percent over last year, up from previous guidance of 16 to 18 percent.

SG&A for the quarter excluding stock-based compensation, Scotts LawnService, and nonrecurring charges increased 9 million or 11 percent to 94 million. Excluding foreign exchange the increase was 9 percent. For the year-to-date period, SG&A excluding stock-based compensation, Scotts LawnService, and nonrecurring charges increased 35 million or 15 percent to 279 million. Excluding the impact of foreign exchange the increase was 26 million or 11 percent. We continue to expect 12 to 14 percent annual growth in SG&A, excluding stock based compensation, Scotts LawnService and non recurring charges, due to merchandising, selling and incentive expenses to be incurred in our North American business in the fourth quarter.

Stock option expense for the year-to-date period reached 8 million, up 5 million for the 9 month period and in line with are annual guidance of expense between 9 million and 10 million. As Jim mentioned, this move to make our financials more transparent dilutes earning per share by 20 percent this year. Scotts LawnService reported SG&A for the 9 month period of 42 million, up 21 percent from the comparable period last year. This increase is in line with our expectations and is driven by the full year affect of last year's acquisition as well as service infrastructure investments required to sustain growth.

Restructuring charges in both gross margin and SG&A totaled 3 million in the quarter and 4 million on a 9 month basis compared to 2 million and 11 million last year respectively. The overall decrease in charges reflects the completion of our North American distribution restructuring in 2003, and lower spending this year on our international growth and integration plan as it enters its final phase.

Interest expense in the quarter, excluding refinancing charges, was 13 million, a 6 million improvement from last year. For the first 9 months interest expense, excluding refinancing charges, is down from 53 million to 38 million. Slightly more than half of the decrease in interest expense compared to last year is due to lower interest rates resulting from market conditions and our successful October 2003 refinancing.

As a result of our significant cash generation, we prepaid 100 million of our term debt in the quarter. We are also refinancing the remaining 400 million of our term loan facility, the benefits of which we will begin to see in the fourth quarter.

I am frequently asked about our intended use of our high levels of free cash flow. As Jim said, we will continue to delever our balance sheet as well as pursue acquisitions to support growth opportunities where appropriate.

Over the past four quarters we have reduced our average net debt by 112 million despite the adverse impact of foreign exchange rates of 15 million. Debt translated into a leverage ratio of 2.42, a sharp improvement from 3.31 a year ago. We also have improved our interest coverage ratio to 5.88 from 3.75 a year ago. Depreciation was 12 million and amortization was 2 million for the quarter. Capital expenditures for the quarter were 6 million. Through 9 months those totals are approximately 34 million, 7 million and 16 million respectively.

Capital expenditures are tracking significantly below prior year. We anticipate that capital expenditures will be approximately 45 million this year. At the bottom line net income in the quarter, excluding restructuring and other charges, was 102 million or 306 per share compared with 92 million or 285 per share last year. That represents an 11 percent increase in earnings over the prior year which is slightly ahead of the revised guidance we issued in June.

International results were stronger than expected for the quarter driving the earnings up (indiscernible). It's important to note that our share count increased by almost 1 million shares compared to the prior year which impacts the year-over-year EPS comparison by 10 cents. Including restructuring and other charges, net income in the quarter was 100 million or 3.01 per share compared with 91 million or 2.81 per share last year. On a year-to-date basis adjusted net income was up 16 percent to 133 million or $4 per share. Reported net income was 103 million or 3.09 per share compared with net income of 107 million or 3.33 per share for the same time last year.

On the balance sheet you'll see that accounts receivable are up 5 percent in line with sales growth. Excluding the impact of foreign exchange, accounts receivable grew a modest 3 percent. Inventory is up approximately 4 percent, about half of which is due to foreign exchange. Overall we are pleased with our results and they speak to the overall strength of the business.

We continue to believe that our full year adjusted net income guidance of 13 to 16 percent is appropriate. As you know, we released updated projections on June 30th; so let me reiterate the full year guidance with a focus on what's changed. Full year companywide sales are projected to increase 78 percent over last year. Sales for our international business are projected to be flat to slightly down for the year. Roundup commission is now expected to increase by about 50 percent for the year.

Interest expense for the year is projected to be 3 to 4 million lower than the previously expected 53 to 54 million. Free cash flow is projected to range from 130 to 150 million for the year. And restructuring charges will be higher than our original guidance by 3 to 4 million related to restructuring of our global information services group and our international management team.

With that, I'll turn the call over to the operator so we can answer your questions.

(OPERATOR INSTRUCTIONS) Dara Mohsenian, JP Morgan.

Your POS our reported sales growth number in Q3 was similar to Q2 growth despite a much easier comparison. And I'm just wondering if you can take us through why we didn't see more of an acceleration in North American top-line in Q3?

I'll start and then maybe move it to Bob Bernstock if he wants to sort of finish the answer. This is Jim. I start by saying -- if you remember last year, the year was pretty good other than April, really. So I think we saw really good sales in the same period last year. So I think it was a pretty tough comparison. And then I would also say that the Midwest weather was pretty tough.

I keep telling Mike Kelty I want to take everybody off to a Caribbean island when we have sort of the perfect season. Since I've been here we haven't had it. But the Midwest, which is our biggest single region, continues, I think, to have pretty crummy weather. That would be my point of view is moderately tough comparisons and pretty dour Midwest weather. Bob, do you want to add anything to that?

Yes, I think it varies by business. We feel pretty good about the POS growth on fertilizers which are up about 6 percent. We feel great about the growth on Ortho and Roundup and -- having some mixed results on the plant food business with the continuous release business doing quite well and a little bit of difficulty with the water-soluble business. But on balance we're pleased with the results, and where we've put effort, have new products, refocusing advertising we've seen very, very strong results.

(indiscernible) answer to your question?

Yes, thanks. Then on the Ortho business, you obviously had a very strong year in what typically has been one of your lower share segments. Do you think that puts you in a position next year to gain some Ortho shelf space at retail, or do you think you already saw a lot of benefits from that this year when retailers saw how strong the business was early in the peak season?

I would say both. So, do I think we picked up shelf space this year? I know the answer to that is yes. The surprising thing is that a lot of that shelf pickup, at especially Depot, while there were good results there, the results were really driven by the sort of new move up the continuum products they've got advertising like Max and Season-Long. So, do I think that success breeds success? Yes. Do to I think that there's a lot of really cool stuff happening in Eugene's group in both Roundup and Ortho? The answer is yes. Do I think that will result in more shelf space pickup all things being equal, sort of excluding any sort of tenseness over pricing? I would say yes. So yes, I think it's a virtuous cycle and good things are happening on the intellectual front which really means innovation within that unit.

Great. And do you guys also have the June POS number?

June POS -- I don't know but I'll tell you what, I don't have it handy and we'll get that to you guys. And if it's material we'll get it out on the website.

(OPERATOR INSTRUCTIONS) Joe Norton, Banc of America.

Good morning. First of all, Chris, I was wondering if you could just give us the operating profit by division.

The operating profit for what period, Joe?

For the third quarter.

As a percentage of sales?

Sure, or just the (indiscernible) number.

I guess this is something we'll be disclosing in the Q. Why don't I do it as a percentage of sales, Joe?

Okay.

North American operating profit in the quarter -- you will see a number that will be about -- you'll see a number that will be about 28 percent. Lawn service you'll see a number that will be in the low 20 percent range -- 20 to 22 percent, something in that range. No, excuse me -- yes, that's right. And then I would say international you'll see something probably in the 15 percent range.

So lawn service is down pretty significantly over the prior year?

On a percentage basis? No, it shouldn't be. No, it's pretty consistent. And you'll see a big pickup in the operating profitability in Q4.

I have 25.7 percent for last year, is that not the right number?

Let me get you an exact number here for this year because I was sort of doing it in my head.

Joe, let me just say that -- I personally believe this is a pretty inefficient way to get that -- those numbers. I've got people working on calculators right now.

All right. Well, then can I just move on to a couple of other things?

Joe, yes, I've got lawn service up near -- approaching 30. I was doing it in my head and I --.

All right. Sorry about that. And then just -- on the international business, you said the gross margins were up. I was just wondering if you could talk a little bit more about where the business is falling short or what your analysis is telling you is wrong over there, what needs to be fixed.

I'll deal with that. I would say wrong this year, I would say a host of executional issues. Now on one hand you might say you put an SAP, you big-time simplify the product offering, we consolidated our manufacturing supply chain by having sort of let's say all the pesticides made in France, all the lawn fertilizers made in the UK. You might say, well, you invited executional issues. But I've got to say that we have been doing a lot of work along those lines both in here and Canada and in our other units and feel really good about that. And I think we're surprised by some of what I would say were some of the mistakes we made.

So I would start saying this year executional, although -- and I don't want to make excuses -- we did a lot of stuff this year and so you might say you survived and a lot of people coming through SAP would be happy to survive. We had a higher standard.

I think the biggest thing that would -- that matters to me is sort of growth. If we cannot be -- if we're investing all this time and effort and blood and sweat into this business and we can't see growth rates that we believe are there -- that they're capable of seeing, I would say there is something wrong with us or there's something wrong with the market and it's probably some combination of the above. But I would say the biggest issue I have is growth rates where in the U.S. you have a good weekend and you'll see the POS immediately.

It seems to me in Europe we'll have good weather -- now, this is not exactly true in that the UK, which in my script came out, is that this is in a period of like 6 weeks they went from -4 to +7 percent on a year to date basis which is really some executional but mostly decent advertising and good weather. This is the kind of results I think we should be seeing all over Europe, to be honest, instead of working our butts off and seeing flat sales.

So that is my biggest issue is that if we just can't see the sales growth and then on top of that is the whole issue of making changes in Europe, the employment laws -- this is just my point of view -- are so painful that some of the stuff that -- efficiencies that we can get in the U.S. are just much harder and more expensive to get to in Europe and I think it's all (indiscernible) does it mute your enthusiasm for being there? And this is I would say an open question.

But I would say muted, yes. We will be presenting a plan to the Board and to you guys in due course. But I would say that the biggest things are execution, ability and is there growth in the market compared to the efforts we put into it and vis-a-vis the U.S. So that's the answer to that.

Okay, thanks. And then can you just talk a little bit more about the price increases? Is that announced or what's the feedback you're getting and is it just going to be fertilizer products or could it extend to a broader range?

Well, I'll start by saying broader, and I'll end it by saying civil. How's that? But I think there's an understanding. So this is something that it's not negotiable, the only issues that we have are what does it mean as far as response rate -- risk response from them. But I would say generally it's been civil and understood, I think people understand the issues. This is a market that hasn't seen pricing in a long time, we are taking it, we need to take it and we'll have to see what happens.

Okay, good. Thank you very much.

Sam Darkatsch, Raymond James.

Jim, you mentioned that growth in Europe is the bugaboo. Could you more broadly define that and say it's volume being the issue more so than growth? For instance, by saying exploring all options would you also include in that perhaps acquiring businesses that would create some critical mass for you or am I reading the situation too broadly with respect to what's on the table for you?

I would say it could, but that is not directionally I think at the top of my list. I don't think it's volume. I think volume does matter. I do think that if you say -- if someone said to me -- well, you're kind of asking -- what are the issues (indiscernible), what's different in the U.S. than it is in Europe? I would say that you're almost by definition vulnerable to the retailers, which gets kind of one of your issues is does volume matter? But the antitrust authorities I think are more difficult over there. We have to be able say we really see a growing market before I'd want to invest more money over there.

But where you have 3 players all -- I'm going to call it roughly even size, it's not quite true, but if it's too easy for a retailer to say, "You know what? I don't like your face. I like you, I'm giving you the business." And it doesn't really matter that you have brands or you're investing and you're trying to do the right thing. It's a more difficult environment.

And so my view is the volume probably matters, but I think it's the ability to see a responsive market to advertising which is kind of what we do. And if we don't see the response to advertising that we think -- if we saw that I could make time. If I can't see that it's a lot harder to make time which really means making time with you to keep the Street off my back while we sort of execute a plan. The question is, if we don't believe we can drive sales what does that mean for us? And then you have much more difficult issues to deal with.

Second question. If I recall, I believe your purchases of Urea come up next month. Any thoughts with respect to how that process should play out?

Yes, price increase is a good thing. How's that?. I think we continue to see pressure on natural gas, and that's going to drive urea. We, I think, had a very good successful year in the supply chain. But it was a little bit of a trade. It was a trading of increased commodities, prices versus efficiencies through the system which basically held it and actually allowed it to increase margins. Large and different by mix, but let's just say that on a cost basis it was roughly a swap where we were able to save approximately the same amount as our cost increase went up. And I think that people around here that are in that part of the business believe that was a highly successful year. So that's the good news for this year. I think that we continue to see -- we don't believe prices will come down on urea, is that fair to say, Mike?

That's fair to say.

And therefore I believe pricing is righteous. I don't know if that answers the question.

In a roundabout way, sure, it does. The final question --.

I usually am roundabout, sorry.

In this forum it's tough to do anything but. The final question, if my math holds, your advertising spend as a percent of sales was roughly flat year over year. And if this was in your part remarks, Chris, I apologize I missed it. At what point do we expect advertising spend to begin to ramp up as a percent of sales as you've indicated over the long-term?

I'm not sure Chris mentioned it, but I'll deal with it. And I'll turn it to Bob because I'm going to put him on the spot here on purpose. There are certain things that I know, okay? Now I have been arguing for a while and there's been a little lot of articles about this about digital video recorders and sort of on demand cable. And I believe over time the penetration of those will increase and that given the choice people will be less inclined, unless they're forced to, to watch commercials. This is a concern of mine.

And I believe there's still already a lot of people, like me, that won't watch commercials. I'll flip versus hangout. So I'll try to watch 2 or 3 shows at one time and hope they don't get together and all advertise at the same time. But I do believe that over time TV is going to be a more difficult media unless people figure out how to sort of either get the advertising into the content or force people somehow to watch TV by making it more difficult to sort of move around.

But, that being said, I think we had great response to advertising this year. So Bob pulled me aside and said in spite of all of your anti TV stuff that you've been saying, the response has been pretty terrific. In fact, it's probably the best thing we can do is spend money on television. And I think if you go through the list of all the things that we said were really good successes product wise this year, what you'll see is almost all them, if not all of them, were actually supported by television.

So are you going to see that continue? Yes. Do I still believe that our media spend or call it promotional marketing spend of like I'm going to call it media is call it 5.5 and we went to get it up to -- we believe world class marketers should be about 7 percent and we're headed that way. Now Bob will defend himself by saying that he's got a new media agency that's doing some really terrific work and it's very analytical and smart and they were telling me all about this just before the call which I guess I more or less believe. So what they would say is the buy was a lot better this year. And so in sort of -- in the efficiency the buy was better.

So I think they would say even though it was, I think, marginally up -- this is in rounding -- the spend as a percent of sales, they would say it was a much better media buy this year than in previous years. And I would say -- now this is Jim talking -- we will be spending more and we're in that sort of period right now where we're in the -- about to start negotiating the budget with the various business units including North America and, let me just tell you, Bob, my expectation is that we will see a higher percent spend on television. Okay, now, do you want to respond publicly?

And with that let me respond to both your question and Jim's statement. First piece is just national television advertising which is roughly flat versus year ago. And it really is 2 things. One, one of which Jim covered, we're using Media Edge which is the second largest of the major New York shops. They've done an enormous amount of modeling so there's a great amount of productivity in terms of when we spent and how we spend. So that's why I've been able to keep television flat.

That means I'm looking at a list of commercials we ran and volume growth. The numbers are fairly -- moisture control potting soil, we advertised, volume is up 127 percent. Bug 'B Gon Max advertised, sales were up 107 percent. Shake 'n Feed advertised, sales up 50 percent. So national television advertising works.

To Jim's other point, where is the extra money going to go as we drive the percent of revenue up? It's going to go into direct marketing, it's going to go into market research, it's going to go into the Web, it's going to go into alternative media. So expect to see national television advertising as a percent of revenue, relatively flat, incremental investments and alternative media.

There you go.

Okay. So to paraphrase, the efficiency has been much better than expected so the ramp up from 5.5 or whatever to 7 might be a little bit more deliberate, but that does not indicate that the effectiveness will diminish accordingly?

And also, if you take the market research and Grow Magazine and some of the other indirect kinds of advertising we're doing, there's a decent chunk, that might get you another 5 or 10 million bucks. So we are investing, it's just not showing up as national media.

Thank you very much, gentlemen.

Ron Phillis, Banc of America.

Good morning, this is Read in for Ron. We were just curious, looking at the good sales growth you reported and with the large retailers, we were just wondering if you could specify a little bit how much of that was kind of a market share take from some of your competitors? Thank you.

That is a tough one. I think that Bob and I would both like to be in back in the day, which was not very long ago, where retailers would share their sales data with external vendors to provide share data. Today we don't have that, although as category captain (ph) in many of these retailers and channels are categories we do have that data which I would be murdered if I share with you. But what I do know is just read the public releases of United in regard to their lawn and garden business and Central. We don't feel that way at all. I would say -- I know from data I have we're taking share, which I can't share with you. And I would say just from the seat of the pants, just look at what other people are saying about their business. Bob, do you want to add anything to do?

Yes. The other thing is we have -- it's absolutely critical that we have market share data over time. I think everything Jim said is correct. Directionally we feel like we're gaining share. We're putting together some fairly large diary (ph) panels right now. If you could just hold that question for one year -- about this time next year we'll --.

Well, what are we going to have next year?

We'll have fairly massive diary data which will allow us to read share at the Ortho and sub brand level. Non selective weed, selective weed fertilizer.

But we're having to but this together ourselves.

We're doing this ourselves. We're making the investment to be able to read share out of diary, not through our customers.

Because, you know -- I've got to say, back in the period when I was running North America and Chuck was my boss, we had -- I'm going to say it was maybe 68 in lag, but we had good share data and it was really useful to us to know what's happening not only in the market but what's happening to us compared to our competitors. This is really frustrating not to have it now, but I think the days of Wal-Mart, Home Depot and Lowe's sharing that data with other people are over. And we have not been able to convince them to do it. So if we've got to spend the money we will, but view it as part of trying to have what I would call market intelligence about what's happening in the world.

And we definitely -- to Jim's point -- we definitely are building those databases so we'll have shared data within about 12 months.

Thanks.

Does that conclude your questions?

Thank you very much.

Jim Barrett, C.L. King.

Good morning. On the pricing front, two questions. When will your negotiations conclude and do you plan to take price or ask for price that will fully cover inflationary raw material cost and other cost?

Let me start -- yes, okay? And when will they conclude? One of the things I'm trying to get this company comfortable with is that when we're in situations like this sometimes it doesn't conclude until you get the order. And that there's an element of hardball and poker involved here that has to be played. And we've been in a really benign pricing environment for so long that I think people have forgotten how to do it and what the response of people might be. And I say "might" because I think they've been cordial up to now.

So when do I think the negotiations will be? Well, first of all, a price increase is not negotiable, okay? But I would say that -- when do we know everything's okay? Probably when the spring orders start coming in in kind of January. So I am giving you the totally honest straight poop just like I would tell the guys here. There's no politics here, no spin as they would say.

If the other side was also non negotiable, would you cut back on either merchandising, advertising in order to maintain your margin?

No.

You would not. Okay. On a second note, outside of Europe, outside of consumer lawn service, could you comment on the acquisition opportunities? I was actually surprised that Ames True Temper went to a strategic buyer. I thought that would have (multiple speakers).

You mean a financial buyer.

A financial buyer -- did I say a -- okay, I meant a financial buyer. I thought obviously Scotts was the obvious strategic buyer of those assets.

Was all that a question?

I think so. It's 2 parts. A, can you talk about acquisitions outside of Europe and lawn service; and B, what was there about Ames True Temper that prompted you to not get them?

I don't really think I can talk about that part except to say I believe that the team here did an excellent job on the diligence effort, and that that was highly productive for us, okay? So let's start there. I'd also say that Bob and his group did an excellent job on the financial plan which is exactly how we want sort of planning to work at this company which is that ownership of a business case belongs to the operators and corporate supports the mission of M&A activity, which includes legal, antitrust, all the other stuff that goes along with those things at Scotts.

What I do think as part -- as we look at the market place, which is a challenge I've gotten from our Board, is to say where do we believe growth is going to come from in the future? I think we've got a great business here with great brands and we believe there's growth opportunities in our core business. We also look outside of what our core business is more into what we in the past have called adjacencies. And what we're seeing is growth rates that are -- I would say on average significantly higher than what we're seeing in our own business and our business is pretty damn good.

So what we're seeing is I think pretty exciting sort of opportunities that we believe can be branded outside of our -- within lawn and garden, but outside of sort of our core, if you don't mind my saying, lawn and garden chemical bandwidth. So -- do we believe that from a financial basis that if we look at the leverage numbers and everything else that Chris talked about, that we believe we have a lot more flexibility today than we did in the past? Yes. Do we have a fire burning in our pocket to spend money? No. Will we look at acquisition opportunities which we believe can benefit from what we do?

Because remember what we are, we're basically a brander or marketer of branded lawn and garden products and I am not looking to leave the lawn and garden business. I have no interest in going into automotive. You can throw a bunch of stuff out there but I believe there is a whole lifetime's worth of work right here in lawn and garden for this company. At least for me.

And so I want to stay where we are. Do I believe our brands can be used outside of that? Yes. And do I believe there are other brands outside that might be useful to us at the right price? Yes. So that's kind of where I'm at on both those questions which is that I think we did a good job. Would I have liked to own Ames True Temper? Yes. Do I think we made exactly the right decision? And by the way, we weren't thrown out. Do I think we made the right decision? Yes. Can I go into the detail of that? No. Anyway.

Thank you.

Operator, I think we've got time for two more calls at this point.

Two more questions?

Two more questions.

I don't want to do 2 more calls. I can't deal with this.

Joe Altobello, CIBC.

Just a quick question on North America. If you could estimate what the decline in grass seed sales year over year cost you in terms of top-line growth?

I might ask Bob to estimate it, but I think that if you look and say how are sales -- let me deal with this from what I know and people can correct me if I'm wrong because I heard this like a week ago. I could be wrong.

On a dollar basis sales are pretty much flat compared to year ago. If you look on a unit basis sales are probably down I'm going to call it on the order of about 15 percent. The difference is this is a highly responsive to commodity pricing of seed and therefore if the seed goes up it is well understood in this business, the seed business, that costs will flow with it both up and down. And so we've probably seen about a 15 percent increase in the cost of seed and therefore dollars flat, units down.

Not absolutely terrible from my point of view considering the other releases people have put out there as to how terrible it is, but I don't view that as particularly terrible. It's just if you're going to have -- what is a perfect season is like an incredibly hot, dry summer where everybody's lawn gets burned to hell. Yes, the year before. And then that following fall and spring will be terrific for grass seed. That was not particularly what happened last year.

So I view this as -- we've talked about this in the past and I'm sorry to go on on this one, but I actually believe this is an important point. One of the things we try to get across on this call was the stuff that maybe you guys take for granted -- and I think maybe even to some extent we do -- didn't happen by accident. I think we have an excellent portfolio of products that really spreads the weather risk out across a large part of the season.

The fall fertilizer season didn't happen by accident either. That was pretty much developed -- and I'm not going to take credit for myself -- but by good people at Scotts. When I first started running the North American business was when the fall business, as you guys might recall, was a much smaller business than it is today. So not only do we have a portfolio in lawn and garden that I think spreads our business across the season, but there is nobody in this business that's more national than we are.

And so I think that while seed might be a big deal for somebody who's like highly concentrated in seed. We ain't (ph) highly concentrated in seed. It's a good business for us, but we've got a lot of good businesses. And therefore I think our business risk is spread out geographically and across product categories and, again, this didn't happen by accident. It is trying to sort of minimize the impact or risk of weather in our business and I think we've done about as good a job as you can do. Sure, we can probably do things better around here, but I think this is one of the things I wouldn't be critical of Scotts on.

Okay. And if I could ask another one on the gross margin number. Just looking at your historical numbers, it seems like over the past 3 or 4 years the gross margin improvement on an annual basis did about 20 basis points a year and then this year you're gapping up to a 110 of 120 basis point improvement. (indiscernible) a lot of that due to your trade up strategy and your supply chain investment? In terms of steady-state gross margin improvement, is the truth somewhere in between those 2 numbers?

Definitely. Listen -- I hate to be like the old historical guy who says not only do I not feel old but I'm not that great at history. But I would start by saying that Berger had a challenge to me when I was running North America, 50 basis points a year. I don't know what the number is but I would say if Bob is not getting 20 basis points a year I would be sort of amazed and I don't know what the challenge would be. I would think 100 basis points as probably not achievable on a per year basis. So I would say, yes, it is somewhere in between and my expectation from North America, and for really all the units, would be margin expansion not only from supply chain improvement -- pricing, but from mix improvement as well. Bob, do you want to add anything to that?

I think between 20 and 150 is a pretty good target.

I'm so glad you work for me, man.

And for roughly 3 reasons. What else is there besides pricing, supply chain savings and mix? So that's what we're going to do.

The answer is somewhere in the middle.

Okay. And one last one if I could, sort of a hypothetical. But you guys have talked about international in the options you're exploring, one of those is obviously a sale. And would you guys consider a transaction where you sold that business and it was modestly dilutive to earnings but accretive to return on capital?

Yes.

You would consider something. Okay, great. Thank you.

Are we done or do we have one more? One more, okay.

Bill Chappell, SunTrust.

Jim, just help me understand. Going way back to Dara's question. I guess I didn't understand that looking at last year, June quarter when we were on the call, certainly weather hit it and reported sales were down half a percent, but you just said recently it was kind of a tough comparison versus June last year. So I'm trying to understand that first of all. Then second, I guess on the year to date POS in North America it's up 6 percent which is kind of in line with the category of 5 to 6 percent growth. But you're saying you're getting market share gains and better mix. Help me reconcile those two issues.

I'll start with the latter part because that's what I remember. I think we've outperformed the market. I think that because I've read what other people have said about their businesses. I understand how we're doing with the retailer. I understand how they're doing with their lawn and garden businesses in general. So I think that we are outperforming the market therefore taking share. I think we're outperforming our competition therefore taking share. Some of this I think, some of it I know.

In regard to last year I would say that while April was just hellaciously poor last year, the weather, it was like the one month that was really, really terrible, other months weren't that bad. In fact, we had a pretty good recovery going and a lot of people shaking in their boots sort of come end of April, but the rest of the year turned out p to be a really nice year for us. And therefore what I would say is that after April the comparables were moderately tough because it turned out to be a pretty good year other than April last year. Which remember, the most important single lawn and garden month there is. So that's kind of my point of view in regard to two of the issues. Bob, I don't know if you want to add to it?

Looking at two ways to kind of answer your question, but one is by April/May/June. And we had a spectacular April, a decent May, and June was slightly up versus year ago. So that combination gives us the results that we have. Comparison versus year ago where April was the easiest (ph) month. The other way to cut it is business by business and I'm looking at the numbers right now. (indiscernible) fertilizers are doing very, very well. I'm showing (indiscernible) that's a cume (ph) number, I'm growing media on the value added piece because we've got still a decent sized commodity business which is down we're showing spectacular numbers. We're showing great numbers on Roundup, great numbers on Ortho and wish we were doing a bit better on plant food. But by and by of the five major businesses we have, four are showing really terrific --.

And I don't want to get into a point where we're looking at this in a sort of bad, evil, depressed way. For those of us who live or, at least during the week I do, live in Columbus -- everybody else normally I think is here more or less full-time -- the Midwest, our single largest region I would say had a pretty poor year. So to me I view this as the silver lining is that our both diversification of products and our geographic diversity work us through this, but the Midwest was a tough -- I don't even know if they had a really great weekend.

I guess just as a follow-up then, two things. One, would you say the category is not growing 5 to 6 percent year to date? And then also, help give me what gives you confidence for the September quarter. I think from your guidance you're kind of talking about a 5 to 10 cent EPS number for the fourth quarter which would be really the second time you've ever had a profitable fourth quarter last year being when you had a late start to the season. What gives you confidence you can be so profitable in the fourth quarter this year?

I would say two things. One is the fourth quarter is largely -- not largely but a major contributor to the fourth quarter is lawn service and they're doing really well and I think are confident in their year. And I would say that if you talk to North American sales, they're also confident in the fall program put together both in major accounts and the independent/distributor business in the programs that are put together for Q4.

So I would say we have a group of people who are -- and we are, for maybe one of the first times, very comfortable with our sales growth and POS growth being roughly equivalent. This is a period we've been waiting a long time to get to where our sales growth and POS growth was about the same and it's within 100 basis points this year. So I think we feel comfortable with inventory, we feel comfortable in the trade programs that are put together to sell product to consumers in Q4, and we are comfortable with our lawn service business. And I would say comfortable with our expenses as well.

And on the category growth? Less than 5 to 6 percent right now or year to date?

Yes, I think that's probably -- I would say probably fair. We think we're taking share and we're up call it 6 to 7 and I would say, looking at category growth, around 5.

Thank you.

Okay, operator, that's all we have time for today. If there are people who didn't get a chance to ask a question, just please call our investor relations department and that contact information is on the press release. And (indiscernible) will be hearing from us shortly regarding our analyst day meeting in December, otherwise we'll talk to you again at our final conference call of the year in October. Thanks and have a great day.