Scotts Miracle-Gro Co (SMG) 2005 Q4 法說會逐字稿

Good morning and thank you for standing by. At this time all participants are in a listen-only mode. After the presentation we will conduct a question and answer session. To ask a question at that time please press "*" then "1". 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, you may begin.

Thank you operator. Good morning every one and welcome to our fourth quarter and year end conference call. With us this morning is Jim Hagedorn, our Chairman and CEO; Chris Nagel, our CFO. I want to remind every one that our comments this morning will contain forward-looking statements as such actual results may differ materially, due to that risks Scotts miracle-Gro encourages investors to review the risk factors outlined in our Form 10-K which is filed with the Securities and Exchange Commission. If you did not receive a copy of this morning's press release you can find it on the investor relations portion of our website scotts.com. As a reminder this call is being recorded and an archive version of the call will also be available on the website. If we make any comments this morning related to non-GAAP financial measures not covered in the press release we will provide those items on the website. Before we get started, I want to make sure you all are aware that our Annual Analyst Day will be held on Wednesday December 14. Once again the meeting will be held at the [inaudible] and States Museum in New York. Our presentations will begin at 9:00 am and will run until about 1:30 pm. A continental breakfast will be available beginning at 8:00 am and lunch will also be served. You will be receiving more information about the event next week from our investor relations department.

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

Thank Paul and good morning everyone there are so many positive things to say about our business that it hard to know where to start, so let be begin by commenting on what you can see in our press release another great year for The Scotts Miracle-Gross. Companywide sales exceeded our guidance and improved nearly 15%, 7% if you exclude Smith & Hawken also adjusted net income of 12% was on the high side of our original guidance which we reduced for a month ago.

While some of you might think we were too quick in pulling out number down in June I disagree. At the time we believe our revised guidance was accurate our results were better than we expected and the results of lot hard work by 100 of people it was the year in which raw material prices were well ahead our budget in fact our price increase to our retailer probably felt short of completely offsetting the increase in our raw materials. Additionally spring was mediocre from a weather perspective and our Sarbanes-Oxley compliance cost and legal expenses were higher than we anticipated to deal with all of this challenges in a single year what in a enormous task I want probably thanks our associate for their hard work and tireless commitment to winning.

You will hear me talk a lot about the importance of our brand and supply chain but behind those competitive advantages lie our greatest asset our people and the value of those people was never more evidence in 2005. I also want to knowledge our retail partners in environment the rising prices nearly always create stress between retailers and their suppliers this was true for us in 2005 and will likely be the case next year but our retailer should remain committed to lawn and garden aggressively working with us on creative approaches to growing the business in the end the collaboration is benefiting both of us as I look at our results as well as the news related to our share purchase and stock split I can say with confident that our business has never being stronger our risk profile is better than it has been years as we have successfully depended ourselves in the quote against baseless claims made by our competitors. And while this defense has not been cheap, investors should take comfort in knowing that the courts have consistently found that although we are tough competitors, we play by the rules. Our flexibility is probably the best it's been in many years due to our strong balance sheet and ability to continue generating high levels of free cash flow.

I want to spend the next several minutes touching briefly on the key headlines from 2005. But more importantly, I want to focus on where the business is headed for 2006. Let me start with a look at our performance and outlook on a companywide basis. Then I'll move to the business units.

We said at the beginning of the year, we would drive value by improving operating profit, return on invested capital, and free cash flow. And we delivered. Companywide operating profit improved 8%, and was higher in every business. Where an interest saving helped drive our net income growth in previous years, and did to an extent in 2005, we said operating income would be the key driver in the business going forward. This has proven true. We also said we’d remain focused on ROIC. In 2005, ROIC improved nearly 40 basis points to 10%. I remind you that our return is only 7% when we first began using ROIC as part of our incentive compensation program in 2002. Free cash flow exceeded $100 million and that's after the $70 million we spent on Smith and Hawken. Not only were we able to fund growth and reduce debt, but we also began returning money to shareholders. In the fourth quarter we paid our first ever common dividend. And as you can see this morning, we are now embarking on a $500 million share repurchase program. Based on the current stock price, this will more than offset the impact of delusion from options. And when combined with our dividend, we will return about $135 million next year to our shareholders. That’s equivalent of our entire adjusted earnings number for 2004.

We believe Wall Street is telling us we are winning. Our stock price improved more than 25% in fiscal 2005 and reached an all time high. Due to our continued confidence, our Board has authorized a two falling stock split. In addition to making the stock price more attracted to retail investors, we believe the optics are having a higher number of shares traded everyday will also appeal to institutional investors.

The dilutive impact of our option plan in our low trading volume, both were concerns that analyst and shareholders consistently shared with us. Obviously, your feedback was critical as we made these decisions. With all of the good news, we are reporting, you shouldn’t be surprised to hear me say that I have never felt more bullish about our business. And as we enter 2006, we are positioned to do even better.

I will reiterate that we currently expect organic growth next year to be in the 10% to 12% range, and feel confident about the performance of the every business unit as we entered the year. In addition to our organic growth, we expect at least $25 million in pre-tax savings from our project excellence initiative to positively impact the bottom line. With Booz Allen's help, we are nearly complete in streamlining our organization, reducing low value work and improving our business practices to eliminate unneeded costs. These steps will raise the baseline profitability of our business. We will give you more details regarding these efforts when we meet in December, but let me say for now we are very pleased with our progress.

In addition to the $25 million that will go toward earnings, we have identified at least another $25 million in savings that will be reinvested in the business. A majority of these savings will be invested in advertising, which I will discuss in a few moments. However, we are also allocating funds for R&D with an eye toward continuing to innovate. Innovation goes beyond our product line. It also relates to employment issues. That’s why we are using these savings to make major investments in [enormous] program that includes an on campus fitness and medical facility. Our goal is to create the most innovative program in the country when dealing with the increasing costs of associated healthcare.

As a member of the Board of the CDC Foundation, I am well aware of the impact of obesity, smoking and other concerns. Not just on the nation's health, but on our economy. By in sourcing some of our healthcare needs, we believe, we can achieve two important goals, first, to help our associates to maintain a healthy lifestyle, and second, drive down our costs. Whether in managing our costs or improving our marketing efforts, we feel confident as we look at our entire company entering 2006. So, now let's drill down a bit more and look at each of the business units starting with North America, which had another strong year.

Our most recent data indicates that we gained another two market share points and now stand at 54%. What's more impressive is that we have gained share in lawn fertilizers, plant food, growing media, grass seed and weed control. Better yet, we gained share while the overall consumption of lawn and garden products continue to grow. Consumer purchases of our products were up 7% for the year and 9% for the fourth quarter. In both periods, we saw an increase in every category. For the year, lawn media increased 14% or so it round up were up 9%, lawns and plant food increased 3%. Once again, there is a correlation between advertising and consumer purchases. For example, after increasing advertising for Miracle-Gro Garden soil, POS increased by 50%. Ortho Home Defense we see TV support for the first time resulting in 28% increase in consumer purchases. And also, we did our maths, which was supported by new and more focused TV commercials improved by 15%.

In 2006, we plan to increase our advertising spent by about 20% as we continue to move toward an advertising-to-sales ratio of 7%. Before I move on, let me quickly address an issue, I know, it will come up during Q&A, the commodity market and our pricing strategy for 2006. With increases in natural gas, urea prices are up 14% from a year ago. Well, I won't speak about our purchasing strategies, I will tell you that we have been optimistic in the early purchasing of both urea and plastic as we prepare for the peak of our production. Well, this has had a modest effects in both free cash flow and inventory, it is clearly the right decision. However, even with these early purchases, our pricing to our retailers is critical to maintaining our margins. Our 2006 plans include an average price increase of 2.5% to offset urea, resin and distribution costs. We will hope for this modest increases well out to cover our costs and hold margin constant. While the commodity markets appear to stabilized a bit, we could face challenges if the market deteriorates further. Any margin improvement next year will be the result of improved product mix and controls and cost of goods, it will not come from pricing.

Let me move on to discuss Smith & Hawken. Our integration continues to go well, and I am encouraged by the direction of the business and the enthusiasm of our team. In addition to delivering results in net expectations, we made important improvements to our stores and supply chain for overhauling our catalogue and continuing to redesign our website. Overall, sale increased 7% from last year, and our most important product line Patio Furniture, we had an 18% increase in sales and it continues the second biggest category sales improved by 5%. As we enter 2006, we are excited about our exclusive arrangement with target. Well, it’s too soon to elaborate on the program we believe targets focused on fashion and brand is a perfect spot for Smith & Hawken. We are working closely with target on an aggressive program to way the visibility of the after looking category and Smith & Hawken brand in particular. We remain very enthusiastic about this business and we are confident our efforts in 2006, will go a long way toward our long-term success

Smith & Hawken was our first step in expanding our reach beyond our traditional product line. Our entrance in to the $700 million birding category, with the acquisition of Morning Song also fits within this strategy. There are several reasons we like to steal. First our consumers are already engaged in this activity. Our retailers are also engaged. Wal-Mart, for example, is the largest customer of Morning Song. In fact, Wal-Mart is the overall leader among retailers when it comes to sales in this category. As the number 2 player in this category, Morning Song has about $85 million in sales, and a compounded growth rate of more than 20% since 2001. We expect the transaction will be immediately accretive in 2006.

Morning Song also leverages our strength. Our research tells us that consumers will accept value-added branded products in this category. While the category had the characteristics of a commodity business today, we believe we can change the rules. I'll remind you that in the late 1990s, our growing media business was 100% commodity. By creating value-added products and supporting them with strong marketing, it has become our second most profitable category. We hope to discuss our plans for this business in more detail in December. But I want you to know we are excited about this transaction and see the categories having strong potential for us.

Let me move on and talk about international which recorded nearly 6% growth for the year, and double-digit improvements in operating profits. Scott Lopez (phonetic) and the team in France have done a great job managing this business through a period of uncertainty, executing a good strategic plan and building momentum for the business going forward. We have told you for the past year that our bias was to extract capital from that business and redeploy it elsewhere. As a result, we have explored everything from selling the business, to creating a JV with a financial partner, to merging with a strategic partner. Now [inaudible] has communicated their opposition to transferring the marketing rights of the international roundup business to another owner.

In that context, the economics of the transaction changed dramatically, meaning a divestiture that does not include roundup is not acceptable to us. So if we’re going to stay in Europe, which now seems as more likely that means we are going to recommit our selves to winning, and our competitor should expect us to compete and perform like a leader. Our more aggressive attitude is already paying rewards. In France we won an exclusive 2 year contract [Carfor] covering both branded and private label business.

In the UK we won a significant grown media deal with Focus, which also would drive both our branded and private label businesses. And our 2006 listings with [inaudible] also look excellent. While we are please d with the trends, we are not fully satisfied with our overall performance. We continue to work toward rationalizing number of SKUs to take more costs out of the operations. We also have made organizational design changes as we move away from a countries-specific approach to managing the business and adopt a category specific approach.

Additional Bob Bernstock’s recent promotion to Chief Operating Officer will give him a more active roll in this business. As COO, Bob will be uniquely positioned to help find additional synergies between the U.S. and international, helping both to operate more efficiently. I asked Bob to take this extended roll because he has proven to me he has a vision in disciple to drive our Company to new heights. He is proven operator and I annual meeting confident he will succeed. In his new job Bob will also oversee Scotts lawn service, a business that continues to exceed expectations.

Our team continues to deliver outstanding results and their focus on customer service continues to drive our growth. We ended 2005 with more that 390,000 customers, and a retention rate of 71%, both all time highs for this business. The business stayed at or above budget the entire season, and finished the year with an 18% increase in sales. If you exclude acquisitions and pricing, sales still increased 14% showing the organic growth opportunities in this business are significant. Additionally, we managed labor costs and SG&A to over come sharply higher fuel prices resulting in a 38% gain in operating profit for the year.

Like the rest of our business we are well-positioned to continue building upon the successes as we enter 2006. While we plan to provide more detail overview of our progress in December I think it's clear that Scotts Lawn service continues to emerge as a strong part of our strategy. It gives the fact that the consumers are in a do-it-for-me category which we believe will grow as [inaudible] continue to age. It is also a meaningful driver to our sales and earnings growth, and longer return to ROIC.

Before I turn things over to Chris, I want to set the stage what you will hear from us in December. At the end of our call with you in July, I said executing our strategy would allow us to meet our ultimate goal to create an enduring franchise. The only company that can make such a claim are those who truly own a relationship with the customer, continue to leverage their core strength, and continue to distance themselves from the competition. When I think enduring franchises I think of Starbucks, Wal-Mart, Procter and Gamble and Microsoft. If you look at what we've created since Scotts and Miracle-Gro merged in 1994, I believe we can be one of those companies, just on the smaller scale.

In December we will talk about the focus on building a stronger relationship with consumers no matter how they interact with us. Clearly our primary focus will be in our core business. Since most will continue to buy their lawn and garden products through traditional channels of retail. But over time we expect many home owners to migrate to the do-it-for-me model. Our focus on customer service will help Scotts Lawn service continue to be the choice of those who want the highest quality results. And finally it's important to understand that Smith and Hawkin gives us more than an expanded product portfolio. Smith and Hawkins provides us a third way and a critically important one to interact with consumers. Our catalog and internet businesses will be an increasingly important part in helping us connect directly with gardeners, and our redesign stores will help set the tone for the category the investment we are making and innovation and our ability to find new channels of growth also support the vision of an enduring franchise.

As we share this vision with you, I am hopeful you will better appreciate the strides that we continue to make. More importantly I hope you will share my view The Scotts Miracle-Gro continuous to emerge as a great company and perhaps one of the few that can be truly called an enduring franchise. With that, I will turn the call over to Chris, who will elaborate further on our results.

Thanks Jim, and good morning everyone. As Jim described, we are very pleased with our performance this year in a challenging environment, net sales are up over 14% this year, and adjusted earnings have increased nearly 12%, we also are pleased to exceed our revised adjusted earnings growth guidance of 6% to 10% as consumer takeaway remained strong throughout the summer, and with highly managed costs in the face of the headwind we encountered this year. Just as importantly, I am delighted to report that our free cash flow was outstanding once again this year, our control of working capital and capital expenditures allowed us to generate free cash flow before acquisitions in dividend of 179 million. After the Smith & Hawken acquisition, free cash flow was more than 105 million which is higher than our expectations coming into the year, in fact free cash flow would have been even better this year, have enough proactively address anticipated cost increases and possible shortages of raw materials, securing larger than normal quantities of certain raw materials such as urea at year end, provided us with some operating insurance for fiscal 2006, but diminish fiscal 2005 free cash flow by nearly 10 million. Smith & Hawken inventories account for 18 million of the year-over-year inventory increase, accounts receivable increased almost 8% from last year, through the timing and customer mix of sales for the North American business in the fourth quarter and smaller impacts from Smith & Hawken and the expansion of the LawnService business in the fourth quarter. The increase in accrued liabilities is driven by the recognition in the third quarter of a charge of almost 46 million for the outstanding balance of the roundup deferred contribution liability.

Our cash generation has allowed us to reduce our trailing four quarter average net debt, by more than 120 million this year. Average debt has declined from 731 million in 2004 to 609 million in 2005. Our reported leverage ratio was around 2.3 at year-end, and would be 1.8 on an adjusted basis.

Over the last few quarters, we have discussed our capital structure and you have heard us articulate our level of comfort with our current position at a strong crossover credit. We believe this position provides for favorable pricing and good access in the debt markets while maintaining flexibility for future growth and puts us in the range of minimizing our weighted average cost of capital. I believe in the strength of the Company, and our financial position allowed us to initiate payment of a dividend this year. This quarter, I am very pleased to reiterate our intention to implement 500 million stock buyback. We believe, that the stock buyback allows us to return cash to shareholders, although helping us to maintain an appropriate debt and equity mix, and preserving flexibility for future growth and acquisitions. Repurchasing stock at this level, also allows us to begin to offset the annual dilution in shares outstanding, and eliminate the gap between adjusted earnings, and diluted earnings per share growth. We anticipate executing the repurchase program over five years at about 100 million per year.

As Jim mentioned, we are also declaring a 2 for 1 stock split to shareholders of the record date of November 2nd. Given the appreciation in our stock over the last several years and its current value, we believe now is an appropriate time to split. As a result, we should have a stock trading in a $40 to $45 range. That range, along with our 50 cent a share annual dividend after the split, makes our stock more attractive to the average retail investor, a group with whom we are under represented. It also should been seen as a strong signal of our belief in the continue depreciation of our stock.

Coming back to the P&L, adjusted loss for the quarter was 700,000 or 2 cents per share. Last year we reported adjusted earnings of 2.6 million or 8 cents per share. Our international and LawnService businesses both showed profit increases over last year. Offsetting those increases were the Smith & Hawken business, which incurs the small loss during the fourth quarter, Sarbanes and Oxley spending, [The Dial] and consulting fees not included in the restructuring line, and IT investment behind the implementation of an ERP system for our LawnService business.

Revenues for the quarter were up 8%, however excluding Smith & Hawken sales were down about 2%. The decline in quarterly sales was driven by the lawn fertilizer business which experienced strong sales in the third quarter of this year and strong sales in the fourth quarter of last year. Our growing media and Ortho businesses shows sales growth for the quarter of 4% and 5% respectively and our LawnService business grew by 14%. Changes in foreign exchange rates did not have a meaningful impact on the quarter-over-quarter sales comparisons. Gross margin as a percentage of sales of 33.1% for the quarter, down 40 basis points from last year, excluding Smith & Hawken margins were about flat for the quarter.

Moving to the full year, adjusted earnings for the year were 151.4 million, or 4.41 per diluted share. Up nearly 12% and 9% respectively from last year. Adjusted EBITDA is up by 8% for the period, demonstrating strong growth in the profitability of the business in spite of our increased commodity Sarbanes and legal costs.

Revenues were up 14.5% over the last year. Excluding the impact of Smith & Hawken sales for the Company were up 7%. Changes and exchange rate accounted for about 1% of the Company's sales growth.

Sales growth in North America was 6% this year. We had some spectacular successes in the core business in 2005, especially on products we have improved and supported with advertising. The Ortho business had another outstanding year, with sales up 11%. The sales of Weed 'B Gon and Home Defense are up 18% and 32% respectively as we re-launched these products with stronger claims more impactful packaging and increased marketing support.

Our growing media business continues on its stair, the top-line growth of 13%. Sales of value added Garden Soil's were up over 44% and premium LawnSoil's were up 27%. Dainichiseika colored lawn sales were up in excess of 40%. Sales for our lawns group were flat year-over-year but there are variety of different stories in that result. Grass seeds sales were down 5% this year due to the wet early spring that negatively impacted POS and kept inventory levels high at retail.

Sales of spreaders were down 8% this year as retailers worked down inventories to prepare for a significant spreader re-launch in fiscal 2006. Deferred SP earlier in the year about the late break to the spring season, which contributed to sales of Turf Builder with Halts being flat with last year. Successes in the lawn fertilizer group this year include Turf Builder plus two and bonuses, which enjoyed sales growth of 8% and 10% respectively. Scott LawnService continued its impressive growth trend, with sales up 18% this year; about 90% of which was organic. Our international business reported sales growth of 6% or 1% excluding the impact of foreign exchange.

Smith & Hawken revenue increased 7% year-over-year, same store sales growth was good and the back half of the year show even more strength. Additionally the internet business continues to demonstrate terrific growth. The gross margin rate for the year was 37.1%, which is down 40 basis points from last year. The decline in margin rate is driven by Smith & Hawken, which is moderately believe to the Company's margin rate. Gross margin rates for North American business did expand by 20 basis points this year. Margins for our LawnService business improved by 210 basis points driven by pricing and labor efficiency more than covering higher field costs. This was offset by 200 basis points decline in margin rate for our international business as favorability from manufacturing and freight was offset by un-favorability in provisions for inventory, warehousing in mix.

As we've been discussing throughout the year, we were looking to expand the Company's overall gross margin rate this year. However, this is proven to be difficult in the phase of rising raw material and fuel costs. While we budgeted for significant costs increases from other and fuel prices in many cases came in above even though expectations. For example we budget for nearly 15% increase in urea this year that urea costs were up by more than 30%. We budgeted for $50 a barrel oil that oil has been over that mark for much of the year. Overall we are pleased with our gross margin performance this year and challenging cost environment.

Around our business continue to perform exceptionally well. Global revenues were up almost 10% behind the success of new extended control product as a result of the business performance the gross Roundup commission is up 9 million or 15% this year. The net Roundup commission was a charge of 5 million this year compared to income of 28 million last year as a result of the charge of almost 46 million for the outstanding balance of the deferred contributions liability I mentioned earlier.

SG&A spending this year has actually been a pretty good story for us. Although total SG&A is up almost 16% for the year, excluding Smith & Hawken, FX, and the increase in stock options; SG&A is up only 8%. Within that 8%, we experienced over 11 million of litigation and Sarbanes compliance costs that accounted for almost 3 full percentage points of the total increase. As part of the profit improvement plan, Jim is outlined. We are confident that we can both reduce SG&A costs, and control their growth going forward.

Amortization includes the catch up adjustment of 4.5 million for the amortization of certain intangibles. Two thirds of this amount relates to corrections of amounts in prior years, but the Company believes it's immaterial to those years. Amortization also includes amortization of Smith & Hawken intangibles of 700,000 this year. Full year interest expenses declined by 7 million excluding refinancing costs as increases in borrowing rates have been more than offset by the decline in our average debt balance and the benefit of our refinancing in August. There's one additional item I want to share with you. As of this call, we have an open accounting issue. It relates to how we account for the reimbursement of certain costs we incur in support of the Roundup business, and it's a question of presentation. Regardless of how it is resolved, there will be no impact on net earnings or cash flows.

In question is whether the gross up our P&L for the reimbursement of these costs, which we estimate are not more than 40 million this year. The Company has consistently reported the reimbursement of costs from Monsanto on a net basis. I mean they are recorded as an offset to the incurred costs. We believe we have a reasonable basis for this treatment based on our interpretation of the accounting guidance, and we’ve bedded this issue with PWC when they were our auditors, and with the SEC through the comment letter process. The Deloitte has reviewed the accounting guidance and comps with includes that differs from the company's assessment. We Deloitte and PWC are currently in discussions on the topic to resolve the issue, unfortunately Deloitte's conclusion may resolve in the company receiving a material weakness under Sarbanes 404. If that should occur clearly we do not believe that a classification issue for reimbursement of costs qualified as a weakness in internal controls that should concern our shareholders.

We embrace the spirit of good governance and fully understand what of uses in the market place Sarbanes set out to correct. As I have indicated this issue may be resolved favorably without any negative implications on our Sarbanes 404 compliance. In the spirit of transparency we wanted to bring this to your attention so they are no surprises when our 10K is filed and to allow you to ask any question you might have.

Regarding the provisions of Sarbanes-Oxley while our complaints will not be definitive until our 10K is filled in December we are not aware of any other potential material weaknesses and I would like to thank the incredible amount of dedication and effort put forth by our entire organization.

I want to remind you that our Analyst Day in New York is scheduled for December 14 it is going to be held at the Aircraft Carrier in [Trafid] museum.

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

Thank you. We will now begin the question and answer session. If you would like to ask a question please press "*" then "1", you will be prompted to record your name. To withdraw your request press "*" then "2". Once again if you do have a question please press "*" then "1". Our first question comes from Dara Mohsenian from J.P Morgan. Your line is open.

Good morning guys.

Good morning.

Jim just to check, you expected incremental 25 million of cost cutting under your restructuring program that you are going to reinvest behind your business and that’s on top of the original 25 million expectation?

Yes, that’s just for ‘06.

Okay

So this project that is going to is we call it is actually it's a two year project and we just there was parts of which we couldn’t get down and the fiscal year we are in now so part of the but the 25 million is in ‘05 and the 25 million additional [inaudible] is also in ‘05. We are going beyond that, I am sorry in ‘06 and we will be will be going more in '07.

Okay so the way we should think about it is there is 50 million in total savings in ‘06 about half of that gets reinvested back behind the business.

Correct.

Okay

And as we go forward that’s basically our approach of the business is that every dollar we save about half goes to the P&L and about half will go into investing in areas we think drives business going forward.

Okay, could you identify incremental savings versus your pervious expectations or with this something that you expected originally and just hadn't fully articulated.

I would say the latter.

Okay and Chris can we get an update on the costs that are going to be associated with this program?

I don’t think we have it finalized quite year, I think our guidance is typically been that for every dollars saved it usually cost you about a dollar. I still don’t think that’s too far from our experience but we will certainly have some more precise guidance and thoughts on that in December.

Okay and Jim with the movement of wild bird food I am wondering if you are content with your category exposure in lawn and garden at this point or is there other categories you are potential interested in entering into.

Well I mean I kind of started by I don't want to get into a long [inaudible] it's not a speed really you know this issue I think that are strategic documents which is really our thoughts on were we go are as good as they were ever been and I think the whole team deserves credit particularly Joe Catid (phonetic) who runs our strategy group. So we basically think and it really can goes back to my wife ask me what you trying to build this is back in 1994 and I said the Proctor and Gamble, lawn and garden which means to me wherever there is value in lawn and garden we want that I think that we have been doing a lot of work as we look at this certain new place we are in the last couple years which is much more cash generation much better debt position and saying how do we invest in our business and so as we look at the and this is primarily an American issue as we look at north America we looked at tools, we looked houses and this are all pretty challenged low sort of brand awareness, low margin highly petroleum base store sort of offshore risk I think with these are our retailer so we like this bird see category I being watching it for while in England its for last two years its being the fastest category in lawn and garden and they actually have created really nice value added sort of branded approach to it which I think we can sort of steal from them and do over here but are we really hungry and looking and thinking there is a lot of other stuff there is probably stuff but I would say I think we’re fairly content with our -- with what we’ve got, and if that's the question.

Why are you doing differently in that?

No. And I think using the model what [Joe Patito] has built for us. We’re kind of going at where we think the best opportunities are on a kind of subcategory by subcategory basis, and I think, virtually grows to the top of the list. And I would say, in this probably I think should make people feel calm is that, you know, we recognized what our limitations are, particularly, while we’re in this project excellence mode. And we’ve got Smith & Hawken, which I think we’ve made a lot of progress on and there's really good thinking there. We’ve got our core business to run, we’ve got the long service business, and now it’s about just this [pottery] business, and I think that I would say pretty much of it. At this point, it will probably add a band with to be able to manage these businesses and so, I think, we’re pretty happy where we are.

Okay. And what are the key dynamics that attracted you to [inaudible]?

Well Mohsenian, it's a -- well, I'll go back to right two years when I was in a Home Depot store and the seasons was terrible, and -- so the season was terrible and I'm standing here with a store manager saying this just blows. And we’re watching all these people walk away with birdseed, and I said, is that a good business? And he said, "You're damn, right". And it's like more 12 months and people keep coming back and they are crazy about their birds, and that's when we started thinking about it and then we started seeing what was happening in Europe and I think that's kind of worked out our interest. But it has some of the stuffs that we like, which is that it's a big business several times the size of the grass seed business. There's no strong brand. It's growing. It's very fragmented. It is not chemical oriented so, it's a sort of unregulated business. It's highly consumable. There is less seasonality than the rest of our business. The demographics are similar to what we have. And I think that there is a minimal threat of people bringing seed in from China. So that’s what we liked about it.

Okay. And how do you think the brand dynamics stack up in this -- in that category versus the rest of your exposure?

Well, I would say nonexistent, and therefore, we think it's a big opportunity and I am not picking on the brand ahead. They have a as good a brand is probably they are in this business. We believe that there are a significant branding opportunities in the category.

Just as part of the due diligence process, we tested the [scotch] name against reversely every name out there and it is one of those great tests we are not even in the category and you have got the best brand name out there on a whole bunch of measures.

Yeah. Lets -- we are going to move on. We got other people in queue and I know other call so, we will catch up with you offline later.

Sam Darkatsh, Raymond James. You may ask your question.

Good morning, Jim. Good morning, Chris.

Hi, Sam.

Hi, Sam.

A couple of broad questions and a couple of real [mid-tricky] things. First start with the -- now though the likelihood that you are going to be staying in Europe at least for a while, Jim, how would you define success over the next few years? Those are -- it would be difficult to begin to earn your cost to capital though you could go in that direction, so how would you look two, three years out if we are still in it and say, we did a good job here. It was a good decision?

I think -- good question. I think return on invested capital to be honest, it’s kind of a tough measure for the Europeans because either we [hubbarded] or we pay too much or some combination of the two, but I think return on sales is a much better probably metric for the Europeans and return on invested capital. If you believe that we have a pretty rigid ROIC calculation, and that we overpaid or I will leave it back, so what do I think? I start and this is what I told the Europeans that we have to have a business that our rational investor would be willing to invest in and I don’t think that’s the case as it stands today. So, I -- the business has to be significantly more profitable that it is. The brand that -- the brand have to mean more vis-à-vis the retailer or we are in a very weak dynamic, which I really can't stand. So, I do think that probably that needs to be consolidation in the European market, and I have always felt that way. And I think that without a Montano's cooperation probably means, we can sell, but I do think that we continue to be wiling to work with other people to consolidate this business.

So, I guess, the obvious question that will be if you are going to stick privet do you commit more capitals in order to try and get the returns on sales to an attractive level?

I don’t know. It -- again, it's a really good question. I guess I really don’t know. I think that the opportunities in the state is so much more significant than in Europe, but on the other hand, there is no value in being there if we are not going to win in Europe. Now, I do think that if you look and say, "Where is our biggest weakness?" It's in growing media. You know this is the most important category in Europe. It is a growing category and as we exited our [inaudible] in -- under environmental pressure in England, we really didn’t rebuild as we probably should have, a supply chain infrastructure to yield that in the U.K., and I think we are suffering as a result of that. We have in Germany zero you know share in grown media, and you know if you look it our business in France probably aggressive fast growing media is sort of infrastructure and it’s an important part of the business and a growing part of the business. So, I do think that growing media is where I would say if you look at the business it will be different in three years we have got some within growing media. I think we have got to act like a leader and that means a little bit like the U.S. and now in the middle they are own like project excellence which is invest more money in the consumer and more money to our shareholders and back here to Maryville, but I think return on sales would be a major that I would say is something to look at as we go forward, the business is got to be lot more profitable and more powerful, that probably means that as we move forward we relocate at least our entity in the Switzerland for tax reasons that will be significantly helpful from our earnings point of view. Grown media is the place we have got to participate more actively -- I think that probably it.

The second question, the distinct inventory draw down some retail in a consumer side did that come at least in part as a response to selling price hikes by both you and the major competitor what was genesis behind that decision about that retail?

No I think that you might have seen some what higher inventories in the Q3 and I think every retailer who operates on [inaudible] metric and you have heard me on this before which is sell a lot of stuff and in five months and sit a bunch of stuff for seven months is a bad ROIC model. So I think everybody is trying to end the year as low as they can, now we like that too so I just think that if you know other than sort of the Gulf Coast, I think the weather was really a nice summer and fall, and retailers are just trying to end up clean and then maybe ended up with slightly more inventories as they’d fall a little bit forward in Q3.

Then. Chris, two quick housekeeping questions. The guidance for next year, I'm guessing includes the, any accretion you're getting from the acquisition you announced this morning?

No actually we’ll give you some more insight on that, but, no, that would be, that guidance we’d given them before was sort of organic growth plus project excellence as Jim described.

Okay. So that's –

Any amount of acquisitions would really be separate from that. we’ll try to give some –

But I do want to sort of throw in because it's a perfect time to sort of say that I know Chris feels strongly about this which is sort of a menu approach to sort of trying to come up with what you guys think we’re going to do next year. You know, we have, we look at our business and feel the business is performing just organically realty well. We’re doing this excellence largely because we do believe the company should be more profitable, and that, that will help the value of our shares and have a lot of good reasons to do that for a lot of reasons. But, the problem is if you take all the stuff we’re doing, and you say what about this, and what about that, and then you know, I'm sort of waiting for Alice’s comments. You know, it's just that if you do that, you're going to come up with a huge number of – part of what we are trying to say is, what’s the righteous number for us to deliver to you guys as well as invest in our business. And so, I really would sort of urge you guys not to sort of add up all the stuff that we talk about and say Wow! They’re going to be $10 a share next year. And I don’t think that that's the way to do it. I do think that, you know, organic growth plus call it 50 cents a share is a pretty righteous number. And you know, in a year where you know I am a little worried about sort of the consumer and costs and I am not alone in that. So you know I just draw that out there as a kind of warning.

And last question is I just want to make sure I understood this correctly in the prepared remarks gross margins next years are expected to be flat excluding mix even with the urea and the packaging and all that type of inflation though the pricing is expected to ff sets it's excluding mix you are looking at flat gross margins, is that how to understand it?

No I don’t think we have given any specific guidance for next year in terms of gross margin rate, I think that you know I think you can take away that we are definitely looking at pricing to help off set anticipated costs, but you can understand the math, even if you have got pricing to off set your costs your margin rate will go down, so that’s just math, so we have not given specific rate guidance for ‘06 quite yet Sam.

Okay, thank you I'll let others ask.

Bill Chapell from SunTrust Robinson Humphrey. Your line is open.

Good morning two questions, first on the bird seed business, will that, I guess based on what you are paying forth in the prior to lower margins will that fit your internal ROIC calculations or criteria?

Yeah we looked at pretty hard as part of you know the process of our own due diligence and then talking to the finance committee and the board, I would say ROIC is important to us, we got comfortable at such price levels that we could get to the point and you know fairly near term that it will be accretive to our ROIC target, probably not in the first year or so, but we felt like the returns, the overall return on -- internal rate of return on this and impact on ROIC will both be accretive as we you know as we really develop the business.

So that’s assuming some synergies have just distribution and just being able to improve the overall business over the next couple of years?

That’s right.

And again Jim, just help me on the reinvestment on the advertising, I mean you've never really helped too much back on the advertising in past years, is there a point of diminishing returns?

I don’t know you know I think this is one of those things that I am still because I have sat down with like to do some comcast you know with Brian Robert, and what's his name from Australia with Rupert Murdoch personally and we have talked about the ability for people to not watch commercials and to use Video OnDemand or certain key goal like boxes to avoid watching commercials and clearly people do that. The thing is every time we spent money on reasonably good advertising we get an excellent return, and we do believe that where this company should be and this is not just TV so this would be internet will be part of that, mail will be part of that, radio will be part of that; is that we should be up around 7% advertising the sales and so while I kind of keep thinking when it comes to TV that we should be seeing a limit we don’t and the returns continue to be good and while they are we are going to continue to spend behind it. But it will be more than just TV and I think we are pretty creative about that and I don’t think we are spending enough in that.

But your increase is not -- you are not assuming any increase in cost on the advertising you just more impressions?

Yeah, I mean we are probably saying that this is going to I don’t think costs are going down, they might but so there is probably some increasing costs in there but right now it's approximately 20% probably a little bit plus on that but roughly 20%.

Okay, thanks.

Alice Longley, Fulcrum you may ask your question.

Hi, Alice how about [in pick] on you?

You got well, I don’t know what that was all about my estimates are well below your guidance so, and my questions aren’t about that right now anyway, so you are getting in divert seat and I think the number one brand is KTO, owned by Central Garden and it serve opens the question is to whether you are interested in Pet more broadly speaking like this?

Answer is no.

Okay, my second one is about this restructuring program and we just all live through and see a lot yesterday that has got religion about heavy duty restructuring and you know and their first effort placing not to be doing it very smoothly and their efforts are actually backfiring some and hurting sales and earnings and how you know can you ensure in someway that that’s not going to happen here, and a part to that question I am wondering you know with here at North American Shipments being down 5% while the self service have so much and what your explanation was that I am wondering if that had anything to do with maybe you are not executing on plan becomes people were being hired left and right?

Definitely not and that you know a lot those actions are going to happen in the future and haven’t happen yet I mean there has been some people going up a door but not huge amount. Can I give you my assurances, listen I don’t think we are doing anything we think is going to backfire and hit us we recognize that the most important things we do around here are make product ship it execute in store advertise and collect our amounts and that’s I mean those are kind of our better be our core competencies. And I think if you look at how we’re looking to save money, Alice, what you'll see is we’re not looking for big benefits in those areas. It's basically if you are in one of those areas, that the problem. And I think that's, we’re really trying to be smart about it. Does that mean we won't have any screw-ups? No. But it means that we’re pretty flexible group. We’re pretty aware what's happening in our business. And, you know, the answer to the later part of that question is did we have any executional mess-ups at the end of this year? The answer is definitely not.

So you expect that your shipments to be down 5% in that business?

We are expecting them to be down.

We’re really happy with the results.

Yeah. They’re in line with our expectations, Alice.

Alright.

But then it's difficult for us. We do have to recall or we have to remind everyone periodically that there are always a variety of sort of reconciling factors between the POS numbers that we quote and the numbers that you see for selling because they are not always apples-to-apples. Both POS numbers are the big three. So, for instance some of that sell in for some of the other than big three customers were down in the quarter. This POS includes roundup, the numbers you see on selling does not. So, there's a variety of things that you have to be careful in terms of trying to align those too much. And then we did see some redemption in inventory – retail inventory as well, so, I just a second what Jim said, I think we simply saw a change, you know, a decline in the lawn fertilizer business that were sort of in line with our expectations given last years fourth quarter and this years third quarter, doesn’t really reflect in anyway, our ability to execute.

Okay. And then from on your first quarter, it seems to be sort of normal, but in your small quarters, your earnings sort of normal within you small quarters or earnings sort of deteriorate every year because you are building costs turned long term growth and you don’t get much incremental sales in that full returns and I understand that, but could you just give us an update will the first quarter again be a greater loss than last year do you think?

Alice I again we haven’t provided certainly anything near quarterly guidance for the next year, but I don’t have any reason to believe that this years first quarter is going to be much different than the trends you have seen in the past.

Okay and the --

There will be some offsetting impact from some of the steps we have taken on our profit improvement plan. We've taken some of those steps this year that will carry over we will be taking some steps here in the first quarter that will have some impact. So you probably have some competing forces there.

So it may it's reasonable to just assume that stable loss?

I don’t know I am trying to give you a sort of macro mind here.

Yeah.

One of the things we know Alice, one of the things we know is that the close this year was really hard work and the fact that we are in excellent is really hard work and I think that so that we really, we got to do some catching up to do and we will be prepared for the December meeting with you guys, but sort of getting to our first 404 year and going through project excellence and just the sort of normal running on the business and we are working our butts off, I'll tell you, this is the hardest work I have ever been involved with.

Good, I mean can you give us any guidance so we could just do something with their model with the things like interest expense for next year or do you not want to do any of that?

I think eventually I would say directionally what you asked is correct.

Okay but now I am asking for all of next year, interest expense can you tell us anything about that.

No Alice, I am sorry the most we can tell you right now is what we told you before.

Okay so I want be speaking further.

We aren’t in a position to give you anything further.

And then my last question is what was on the industry growth rate for the fiscal year do you think?

I would say yes, between 1% and 2% we've, the categories we measured, okay.

Why is it so why was that so weak?

Well, how about the March was the worst like I had been in this business for a long time and I know like we don’t know more Alice and any blame in weather this year, okay we mention it only because we are somewhat weather dependent business and I've never seen a March this bad we had like two good weeks in April which thank God because that kind of made the year, May was okay but I would say the summer and the fall were really superb and that’s kind of what made the year but it was this was a hard work here, the whole year so I don’t think there is much to it other than like you can't blow up March and half of April and have luck a stupendous year.

Okay, so thank you.

Okay, operator we are going to take two more calls and then we are going to move on.

Two more questions.

Two more questions, I am sorry.

Doug Lane, Avondale Partners, your line is open.

Hi, good morning every body.

Hi Doug.

Few questions on the acquisition, the $700 million category that are retail or wholesale numbers?

That’s a wholesale number.

Okay.

More or like 1 billion to billion 2 retail.

Okay and you mentioned you are the number two brand and I am assuming that KB is number one can you at least confirm that and maybe just talk a little bit about the competitive landscape on top brands and market shares?

You are correct that the KT would be number one. It's pretty fragmented I mean you are going to there is really no one who would we invent to have a share over 20 and I think the number one player will have a share in that mid to high teens and it declines from there in terms of brand recognition there were no nationally recognized brands none with more than 5% awareness and so I think it there really is an opportunity to go after with a strong brand name overtime and invest a high and superior product and superior branding.

You plan on be branding with a visible Scotts logo on the package from Morningstar.

Yeah we have a test going in Canada right now with the Scotts brand name the indication are pretty positive and will definitely keep the morning star brand name Morningstar brand name; the Morning song brand name.

And I want to talk about your share business studies you done on consumers?

Yeah, I said it previously none of the brands out there I mean advertising virtually doesn’t exist. And we tested the Scotts brand name against the top 5 or 6 brand names out there and Scotts emerged as a number one in terms of a brand you would trust brand that would delivery high quality brand you would buy. So we feel pretty good that there are some opportunities for the Scotts name.

So I am just obviously not this is done yet but something like morning song by Scotts is the way to look at this?

I would say with we have a straight Scotts test in Canada we have morning song in the states and there is several combinations of using both brandings individually even combination to the few names.

And clearly that what the understanding that we need to further develop would be what are things that consumers want they will be feel knowing the past for the family it owns the company currently has a lot of ideas on this and this would be attracting certain type of birds specifically certain less of a mess when the birds eat these are kind of things and less corrals and rodents, these are the things that I think, we believe consumers wants which we have to develop further, but, I think if we can figure out like what it is the consumers want, offer them that as a value added product. Probably you wouldn’t see a mix in the brands. We probably continue with the current brand as kind of a mid tier line and look to have sort of unique lines on the high end probably.

Okay. Now that makes sense. You could have different brands for different price points within the category. Also, there's, it's a little bit different distribution. I don’t know if you do business now with the pets margins Pet Co's but they have a big wild bird seed business, and is this acquisition of vehicle to further expand your distribution space?

I think that having a broader consumer base is a good thing over time, and also this is a business where we can build strength for future of our current customers.

Does [inaudible] go into the pets margin Pet Co now?

I believe they do on a small scale.

Is that something you're looking to escalate? So could we see a Scott’s brand in a pets market in Pet Co?

I think it's kind of like the branding strategy, really at the beginning of the exploration stage in terms of customer, and product and brand strategies.

Okay. So it's just to be determined I guess at the way we lead that?

I would say someone more than to be determined but no comment now I think is the answer.

Okay. And I am everybody asking this, but can you explain a little bit more about what the accountants are looking at. On a roundup agreement maybe I just don’t understand how it's accounted for and what the difference would be if the Deloitte had they way. Just a little bit more detail and maybe 2 minutes or less.

I don’t think you'll be sorry you asked. I think it's a good question.

Okay.

We do want to make it clear that the issue is not yet resolved. We have been looking at this for Deloitte and TWC for a couple of weeks now in connection with the year-end close. And it may not prove to be any issue at all. We just wanted to give some insight to the investors as to might occur when our case has filed in December. It really has to do with -- the company incurs certain costs in support of the business, and the biggest one to think about our sales force and third, and constitute with Monsanto, we allocate a portion of those costs that we incur for our sales force to round them -- to round the P&L and Monsanto reimburses us for those costs. We have historically shown the reimbursement of those costs that against SG&A, for instance, in this case on the P&L and Deloitte is now questioning whether that is the appropriate treatment. If we change the treatment -- change the presentation or we would simply be doing is showing that if you pick a number whatever the number would in the case of say, $40 million that I am going to mentioned before, could be showing $40 million in our revenue line item instead of offsetting the costs on the P&L. So it doesn't change gross profit dollars, it doesn't change net earnings, it doesn't change cash flows but it is really a question of presentation and our prior auditors TWC were comfortable with our current presentation, in fact, we had gotten a question from the SEC a couple of years ago on this, and we responded to it without thinking and then they didn't take any exception to our presentation. But Deloitte is questioning whether it's really appropriate in terms of their REIT on the guidance. So it is just important that every body knows that if we do make a changes certainly want to change any important metrics in terms of understanding the business and but we ultimately may end up changing the presentation and then there have to be some discussion as to under the new 404 rules and material weaknesses whether this is some way constitute some weakness in our financial reporting tools. Now we certainly don’t believe that, that’s -- that it does and we would certainly think that reason will prevail in terms of not want to suggest in any way that some how we do have a weakness in those controls. But the rules are the rules and though it may end up coming to that conclusion so we just have to stand by for now it's not resolved, we are working on it but it's important to know that it doesn’t change any thing important with respect to the financials of the Company. And we just we didn’t want any body to be surprised when the carriers eventually filed.

So I mean this year you have gross commissions of 67 and then contribution expenses of 24

Yeah, those are separate considerations; the commission is what we earn in terms of the amount that we are paid for the overall agency

Yeah, but the bottom line the thing that will change here is revenue grow by 40 million and then either in cost of sales or in SG&A they would together be 40 with net out to zero, that’s the change.

Got it. Okay.

But nothing would change in the central part of the P&L where you see the round up commissions so

No, but I guess the only thing to be aware of is that obviously net operating income, net income cash flow doesn't change but your margin percentage is mainly around as you move these pockets of money in different line items?

The margin percentages may change a little bit I think you will find it there is certainly no trends would be disturbed.

Alright, okay thanks.

Our last question comes from Dan Purpe (phonetic), KeyBanc Capital Markets. You may ask your question.

Hi, good morning guy's thanks for taking my questions, you indicated that you free brought some of your raw materials in Plastics and Urea any indication of how much in [did you borrow]?

I think Chris mentioned that

Yeah I think it's almost $10 million that said in inventory right now in terms of comparison to inventory last year.

Okay

I think the important point on that is you know today we are buying below this standard that’s been our budget so we are comfortable doing that and based on instead of what happening you know in the gulf and natural gas we just started was the good thing to have a bigger pile and so you know I supported that and some other moves we are making to make sure that we have sort of contingencies covered depending on what happens in natural gas this winter.

Any indication of what percentage of your 2006 means that would be?

I mention that 10 million but if you take the inventory we have plus well what we’ve already manufactured, I would say we are more than half way through. Yeah?

That’s correct

Okay thank you.

Okay.

Okay operator, at this point we are going to end the call, if anybody has any outstanding questions that we didn’t get to, just please give us a call at investor relations today, we will try to get to you as soon as we can and other than that we will see everybody hopefully in on December 14th, in New York City. Thanks have a good day.