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The Scotts Miracle-Gro Co. (NYSE:SMG)

F4Q08 Earnings Call

October 31, 2008 8:30 am ET

Executives

Jim King – Senior Vice President Investor Relations & Corporate Affairs

James Hagedorn – Chairman, Chief Executive Officer

Mark Baker – President, Chief Operating Officer

David Evans – Chief Financial Officer

Barry Sanders – Executive VP North American Business

Analysts

William Chappell – SunTrust

Eric Bossard – Cleveland Research

Joseph Altobello – Oppenheimer

Olivia Tong – Merrill Lynch

Sam Darkatsh – Raymond James

Connie Maneaty – BMO Capital Markets

Doug Lane – Jefferies & Company

John Anderson – William Blair

Jim Barrett – CL King & Associates

Alice Longley – Buckingham Research

Operator

Welcome to The Scotts Miracle-Gro Company's fourth quarter 2008 earnings conference call. (Operator Instructions) Now I will turn the meeting over to Mr. Jim King, Senior Vice President of Investor Relations and Corporate Affairs.

Jim King

Good morning everyone. Welcome to our fourth quarter and year end conference call. With me this morning in Marysville, Ohio is James Hagedorn, our Chairman and Chief Executive Officer, Mark Baker, President and Chief Operating Officer and Dave Evans, our Chief Financial Officer.

By now I'm sure you've seen a copy of our fourth quarter financial results we issued this morning at 6:30, however if you don't have a copy you can find it on the investor relations section of our website, scotts.com.

Before we get started, I want to attend to a little housekeeping. A few weeks ago, most of you received an email regarding our Analyst Day event scheduled for December 10, in New York. Given the recent addition of Mark Baker to our leadership team, we have decided to postpone this event until late January or early February. We are still working to navigate around the earnings calendar before setting a final date. I'll be communicating with you again with the next week or so once we've done so.

Moving on to the business at hand, we're going to get started this morning with some prepared remarks from Jim who will comment on what we've been seeing with the consumer. He'll also share his thoughts on what we currently expect for next year. Mark will then share his early impressions of the company and Dave will walk you through the financials and expand a bit on our 2009 outlook.

At the conclusion of our prepared remarks, we'll open the call to questions. To be fair to everyone and to keep the Q&A session manageable please refrain from asking more than two follow up question to your initial question. If there are issues left unanswered at the end of the call please feel free to call me directly at 937-578-5622.

I would remind you this morning that our comments will indeed include forward-looking statements. As such, actual results may differ materially from what we discuss here today. We encourage investors to read the risk factors associated with our business which are outlined in today's press release and discussed in more detail in our filings with the SEC.

As the operator stated, today's call is being recorded. In addition to any service you may subscribe to, you'll be able to find an audio archive of this call on our web site. And one final point, if we discuss any non-GAAP measures not covered in the press release, we will elaborate on those on the web site as well. With that, let me turn the call over to Jim Hagedorn.

James Hagedorn

I'll start by saying I'm satisfied with the results we announced today. Sales, net income and free cash flow all came in within the range we outlined two quarters ago even though it feels like two years ago. When you look at the underlying consumer trends that drove those results, I think you'll better understand why we're cautiously optimistic about 2009 as we shift gears and enter the off season.

Before I go further, I want to acknowledge and thank each of our 6,000 associates for their hard work and dedication. There's no doubt that fiscal 2008 was the most challenging year I've ever been involved with. Despite a late start to the season, multiple product recalls, skyrocketing commodity costs and a deteriorating economy, our associates stayed focused.

We kept our consumers engaged and our retailers in the game, and in the end we had on a relative basis, a decent outcome. I'm proud of their efforts and for those associates who are listening, thank you.

Most of my intention this morning will focus on what lies ahead in 2009. I think we're well positioned which gives us optimism that will have solid results next season despite the challenging economic environment. Before I get there, let me spend a few minutes talking about consumer trends we saw in the fourth quarter.

In the interest of time, I'll confine my comments to the performance of the consumer business in the United States. In a nutshell, we had outstanding results during the fourth quarter in our core legacy markets in the mid west and north east. I've said all year this is a resilient business even in a tough economy and we saw evidence of that again in the fourth quarter.

In our home state of Ohio which has one of the highest foreclosure rates in America and in Michigan which has the highest employment in the country, consumer purchases in the quarter improved 14% in each state. These great results were outdone by a 15% improvement in both Indiana and Minnesota, a 17% improvement in Wisconsin, a 20% improvement in Illinois. In the north east consumer purchased in the quarter climbed by 8% in New York and 6% in Pennsylvania.

In North Carolina which has been hammered by two years of drought and has one of the top ten unemployment rates in the U.S., consumer purchases in the quarter rose by 19%. Even in Texas which dodged hurricanes throughout the quarter, consumer purchases increased by 4%. Florida and California, two of our largest markets were down 10% and 1% respectively in the quarter. These are markets that have struggled all year.

The growth we saw in the quarter occurred mostly in July and August, then slowed a bit in September, but given the inability of any of us to escape the dire financial news over the past six weeks, it is hardly surprising as traffic at retail was down sharply during the month.

In terms of the product portfolio, we continue to see strong growth in gardening categories, led by a 12% increase in the quarter in growing media. For the full year consumer purchases of growing media improved by more than 6%. Within the growing media category, we continue to see an encouraging trend as more consumers moved up to higher margin, value added products and stepped away from commodity products.

Scotts Nature Scape mulch, which sells at a significant premium improved 30% in the quarter and our Premium Garden Soil improved by 9%. Let by our new Pump and Go, a $20 product, consumer purchases of Round Up increased 16% in the quarter and 10% for the full year.

As most of you know, the lawn fertilizer category is important to us at year end. Consumer purchases in the fourth quarter were flat on a year over year basis and decreased 1% for the full year. Throughout 2008 we saw a higher year over year consumer purchases of straight fertilizer and declines in combination products, which are fertilizers which also contain weed or insect control.

But within our portfolio of combination products, we saw signs of improvements in the second half of the season. After a slow start, our largest and most important lawn product, Turf Builder Plus Two, reported 20 consecutive weeks of improved POS and finished the year with 2% growth. The fact that consumer purchases of Plus Two continue to increase, even as the economy and consumer sentiment deteriorated, it is encouraging as we plan for next season.

The only two areas of the U.S. consumer businesses that saw declines in the quarter were Ortho and grass seed with consumers' purchases down 4% and 7% respectively. While Ortho had a similar decline on a full year basis, grass seed improved 11% for the full year.

So when you tie it all together, U.S. consumer purchases in the quarter grew by a little bit more than 4%. On a full year basis they increased by 2%.

With 2008 now in the rear view mirror, our focus has turned to what these trends mean as we look ahead and I believe there are three clear and positive messages. First, lawn and garden matters to consumers. This is a category that has historically performed relatively well in economic downturns and this year was no exception.

Entering next season, our programs will be designed to keep consumers engaged. Our marketing messages will be more competitive as will our products. We'll have a new garden soil product from Miracle Gro, enhancements to Nature Scapes Mulch, and two new Scott's branded grass seed products that represent some of the best innovations we've seen in the grass seed category for years.

The second key take away, even though the lawn fertilizer category was challenged, the Turf Builder brand remains important to consumers. In this economy it would have been easy for the consumer to trade down to private label which sells at about a 30% discount to Turf Builder, we gained market share in the second half of the year, when we saw steady growth and straight Turf Builder and as I mentioned, Turf Builder Plus Two.

Looking ahead, we're building consumer programs to hit the ground running and get the lawn fertilizer business off to a good start early in the season in markets like Florida and Texas. We're gong to bring as many resources to bear as possible to get the lawn fertilizer season off to a good start and build early season momentum.

The third take away from 2008, innovation is critical to growth. There's nothing new about this but it has been reinforced again. Round Up Pump and Go is one of our best new products ever with sales eclipsing $40 million. Consumers demonstrated a clear willingness to trade up to a higher price point for packaging improvements that made gardening easier.

Whether it's been Nature Scapes Mulch, Miracle Gro Moisture Control potting mix, Liquifeed or now Pump and Go, we continue to see that innovation drives success, and we've got a lot in the pipeline that gives us confidence as we look ahead.

With that as a transition, let's talk about next year. On our last call, I said that I had challenged our team to create a budget that resulted in earnings of $2.00 for 2009. At the time we said this was an aspirational goal. We weren't sure we could get there. We now believe it's attainable.

Frankly, it's amazing how much has changed since July. At that time we were facing an unprecedented number of challenges that could have put significant pressure on our 2009 outlook. Sitting here today though, I can say the management teams feel better about those collective challenges than we did even a month ago.

With each passing week we feel better about our ongoing EPA compliance review. In the spirit of transparency, we discovered more problems along the way than we would have liked and that's both disappointing and unacceptable. But over the past several months we've maintained an open, honest and productive dialogue with the EPA. We've established an agreed upon process that allows us to resolve the concerns that have been raised and ensure that our products are fully compliant.

The vast majority of our current products subject to EPA regulation have been reviewed at this point. While the process isn't complete, it's proceeding well and we believe the majority of our remaining issues can be resolved prior to the beginning of the next season. We know that our retail partners are counting on us to deliver and we appreciate their continued support and patience as we work through this matter.

A second challenge that had us wringing our hands recently is September. Commodity prices also look better with each passing week. We said during our last call that we took a 30% price increase on lawn fertilizer for 2009. After we took those price increases, raw material costs particularly Urea continued to climb. By late summer we had begun to wonder if we needed to take even more pricing.

As you've seen, the speed at which the prices went up has been followed by an equally rapid decline. Although we've hedged about half of our Urea to price near $750 per ton, we are now locking in costs at a much lower cost. Also, oil prices are now well below what we had anticipated and our concerns about shipping costs have begun to moderate as well. So as we sit here now, we have substantially more confidence the pricing we took in lawn fertilizer and intend to keep throughout the season gives us the cover we need in 2009.

As it relates to commodity prices, another trend that's emerging right now that could bode well for our fertilizer business. While Urea prices have fallen phosphorus and potassium prices have barely moved from their record high. If this dynamic remains in place, it's good news for us from a competitive position. Let me explain.

Because Turf Builder is specifically formulated for lawns, it contains only small amounts of phosphorus and potassium, usually 2% or 3%. Commodity fertilizers which are sold at retail but now really designed for lawns contain three to five times the amount of both phosphorus and potassium as Turf Builder. As a result, these low value commodity products are likely to cost more than Turf Builder at the launch of next season.

A third challenge, the impact of competition from private label also continues to improve. As the commodity environment became more difficult, we know that our competitors have pulled back their support for the category. Meanwhile, we have found ways to put even more hours into the stores for our retailers and continue to maintain extremely high customer service levels.

We believe the competitive environment continues to move in our favor and we're poised to provide even greater support to our retailers if the opportunity presents itself.

The final issue, the health of the consumer, represents the fourth challenge and like every other consumer products company, it's impossible for us to predict what will happen. Like everyone else, we expect the consumer to be soft. However, we remain confident that we're in a better position than most other categories.

Time has brought back to my earlier comment. The fact that consumers remain engaged in the category throughout the fourth quarter gives us a sense of cautious optimism. If we assume a weak but less panicked economic environment exists when spring arrives, then we feel like we're in a good place and our retail partners agree. In fact, they'd be the first to say they don't expect major home improvement projects and expenditures to be strong next year. And, they say that this means lawn and garden will perhaps remain the most attractive category in the store.

The solid POS growth we saw in the lawn and gardening business throughout 2008 reinforces our long held belief that this category represents a way of life for millions of home owners, and it's an activity that occurs whether the economy is weak or strong. However, as it relates to lawn fertilizer we know that our decision to take aggressive pricing could lead to further volume declines.

So the guidance we're providing is tempered a little bit by some conservative assumptions on the top line. In addition to outlining our assumption for sales, Dave will share with you some directional comments related to broad measures like gross margin and SG&A. However, you're likely going to have to wait until we meet with you in New York to provide a detailed break down by segment of what we expect.

Let me provide some comments about the way we are viewing earnings for next year. I told you on our last call that the leadership team felt we needed to take a stand. Earnings have retreated in two consecutive years and we're not signing up for a third. So for roughly the top 25 people in the company, including me, our incentive compensation next year will be handcuffed to net income, free cash flow and ROI targets that are the equivalent of earning $2.00 per share on an adjusted basis. If we don't make $2.00, there's no incentive payouts, period.

Speaking of the team, as you know, Mark Baker joined us earlier this month as both President and Chief Operator, and I'll tell you that we're lucky to have him. I'll turn the call over to Mark in a moment, but let me share some of my thoughts about him before I do.

As many of you know, he's been a member of our Board for several years and was formerly the Chief Merchant and Chief Operating Officer at the Home Depot which happens to be the largest seller of lawn and garden products in the world. Most recently, he was CEO of Gander Mountain, so Mark knows our business, knows our channels of trade and knows how to drive sales.

Most importantly, he's a proven leader who has a clear focus and leadership style that will serve us well. In just a matter of weeks, he's begun to provide a production dialogue in all areas of business that I expect will help us build more efficient processes and to help us drive profitable growth. Mark and I have known each other for years and will work together as true partners. He and I have complimentary styles and skills to the business and I look forward to working with him as we continue to grow.

As Jim King mentioned at the outset, we've decided to delay our analyst meeting for a few weeks. There are no hidden messages here. This decision is solely based on my desire to give Mark a bit more time to get established and lay the foundation for initiatives that he want to pursue. With that, I'm pleased to introduce you to Mark Baker, who will then turn the call over to Dave.

Mark Baker

There's one thing I know for sure entering Scott's. This is a great company and a great category with substantial opportunities in front of us. As a member of the Board, I've built strong relationships with the management team for the past several years. I feel fortunate to have such a talented group around me.

From an investor relations perspective, I look forward to getting to know all of you in the months ahead as an experienced COO and CEO of two public companies. I understand and respect all relationships in the investment community.

Some of you know me from my previous jobs and I think you'll find more of the same rule here at Scott's. As Jim mentioned, when I was at Home Depot, I was overseeing the largest lawn and garden retailer in the world. I also oversaw substantial marketing budget, so I think it's pretty natural to transition for me to move to a consumer focused lawn and garden company, especially one that I know and respect very well.

My job description is pretty straightforward; to lead the operating groups and delivering results against our broader long term strategy and there's nothing complicated about how to do that. We'll structure our efforts with one goal in mind; to drive profitable growth that enhances shareholder value.

I'll share specific initiatives with you in the months ahead. Here's one thing you can count on. Look for us to step up our efforts to drive sales on a more local and regional level beginning in 2009. If I learned one thing about the lawn and garden category from my previous life, it's that local solutions drive growth and that we, not the retailers alone are the ones most capable of driving that growth.

Lawn care and pest problems facing consumers in the south east are completely different than in the mid west and the challenges in the mid west are different than in the north west. We have products that address those local needs and we've had them for years. But I don't believe we have fully maximized our sales force or marketing strategies on this front.

That will begin to change with the upcoming lawn and garden seasons. We'll make more of a targeted effort region by region to get the season off to a strong start and maximize our results. And that effort will start soon in both Florida and Texas.

Beginning in those states, we'll once again increase the number of hours we spend providing merchandizing support to our retail partners and counseling assistance to our consumers. We'll be using more variable cost seasonal labor and reducing the full time mangers. This important change in structure of our sales force will give us improved flexibility to invest more time and energy in the regions of the country that are doing particularly well in any given season while scaling back our spending in regions that may be seeing less robust results.

In terms of my management style, let me tell you a little of what you can expect. As I look ahead, my near term focus will be to drive alignment around priorities, establish the plans and metrics that will plan our success. In fact, I'm holding a global leadership meeting in early December for this purpose.

Afterward, we'll make sure we've aligned our resources property to drive the business going forward. We plan to share that progress with our Board of Directors in January and we'll share it with you shortly afterward during our Analyst day event.

Once we set plans in place, for me it's all about accountability. One entire wall of my office from floor to ceiling is compromised to a white board. I'll use that wall to remind me and my team of the goals and performance measures that we established. The rules of the wall are simple. Items that go up on the wall don't get erased until they're complete.

As Jim has already articulated, we have a lot of reasons to be optimistic as we look ahead. We have the best brands, the best competitive position, the best sales force, and the best supply chain in our industry. Even more importantly, we have the team to leverage those strengths.

I'm convinced our significant growth opportunities ahead of us. My goal is a simple one; to take advantage of those opportunities and clearly establish this company as a global authority in lawn and garden. That's a mantle that we much claim with our consumers, our retailers, our associates and all of our stake holders. That includes our investors.

I look forward to sharing some of those additional plans and insights with you when we meet in person early next year. With that, I'll let Dave things to discuss the financials.

David Evans

I'll take the next several minutes to provide some additional context for 2008 financial performance as well as share some thoughts on 2009. I'd like to begin by echoing what Jim said at the outset. While we started 2008 with plans to significantly exceed the results reported today, I'm pleased that in a very difficult year, we quickly recognized changes in our environment and early in the season, built a new plan, revised our guidance and then proceeded to deliver to those expectations in the face of tremendous adversity.

Let me hit the head lines. The top line growth of 4% for the year was straight down the middle of our revised guidance. And by the way, the 7% growth we saw in the fourth quarter was in the middle of the original outlook we provided last December.

SG&A growth grew for the year just 2%, demonstrates the diligence with which we managed the business throughout the year. It still incorporates some targeted investments in selling, research and development. Free cash flow of $141 million accomplished through an outstanding job of focusing on working capital exceeded our revised guidance. Adjusted net income of $2.05 per share was well within the range we outlined last spring.

Before I walk through the P&L balance sheet, let me jump first to the bottom line. For the first time I can remember, we posted a net lost on a GAAP or reported basis. Our reported net loss for the year was $10.9 million or $0.17 per share. These reported results included two significant charges.

$51 million for costs associated with product registration and recall issues, and $137 million for impairment charges. These two charges reduced reported net income by $145 million on an after tax basis.

Because both of these items are unusual in nature, non recurring, in the case of impairment non cash, we believe that adjusted earnings which exclude these two charges are a more appropriate basis for understanding the recurring operating performance of the business. Accordingly, all of my comments which follow are based on adjusted results.

On that basis, our adjusted net income was $134 million or $2.05 earnings per share. One last word on adjustments; as we have disclosed on prior calls, we'll continue to incur costs in 2009 related to recall and registration matters until the review process is completed and the EPA matter closed.

Our current estimate of 2009 costs is about $15 million. However, this estimate is subject to change when and if additional product registration concerns are identified. The estimate does not include any potential fines or penalties which we are not in a position to estimate at this time. And as we have done in 2008, we'll continue to exclude these costs from adjusted earnings in 2009.

Before I walk through the P&L balance sheet, with that, let me move on to the operating results. Jim has already discussed the strong POS data we saw in the quarter which is the primary driver in the 7% top line growth we reported. Our global consumer segment sales were up 8% in Q4, about 3% of which was organic growth. On a full year basis, global consumer sales were up 2%.

As we've said throughout the year, the fertilizer business in the U.S. which makes up about $500 million of the business was seriously challenged so excluding pricing and FX, sales declined by about 4% for this segment.

The global professional segment remains strong with sales up 20% in the quarter and 24% for the full year. Pearl was a great story for us all year. Strong demand for products as well as a great effort by our sales group led to a 9% organic growth in this business for the full year. The balance came from a combination of pricing and FX.

Scott's Lawn Service delivered better results than we thought possible earlier in the year with 4% growth in the quarter and 7% on the year. About three points of the full year growth came from acquisitions. The balance of growth, 4% came despite reduce customer accounts partially due to increased penetration on tree, shrub and insect services, a reduction in new customer cancel rates and reduced cancels due to issues with service results.

Regardless of the segment, the real story in 2008 wasn't the top line. It was cost of goods. When we originally provided guidance for the year, we thought we could improve the gross margin rate by up to 50 basis points. When you exclude all the noise from the product recalls, gross margin rates actually declined 510 basis points in the quarter and 190 basis points for the full year.

What was most frustrating about this trend is, it was a moving target all year long. Even after our third quarter call we thought we'd have a better performance than we reported today. But we are seeing record high commodity costs nearly every day we walk into the office. On a full year basis, 2008 costs were more than $150 million higher than a year ago.

Pricing left us about $40 million short of covering these costs. The combination of pricing and costs explain more than 190 basis points of the decline in margin rates for the full year. That's a point I'll come back to in discussing our 2009 outlook.

On the flip side, our control of SG&A was solid throughout the year. SG&A in the quarter increased just 1% and it increased 2% for the full year. This modest SG&A growth was achieved even as we invested more heavily in our sales force and research and development efforts. On a combined basis, these costs within our global consumer and global professional segments increased $24 million from 2007.

All other SG&A in aggregate declined $7 million principally the result of shifting media to other trade and consumer promotions, the cost of which are netted against sales rather than classified as SG&A. As a result, it's fair to say all other SG&A was flat year over year.

Throughout the year we were focused on minimizing less productive overhead and spending money when and where it drove the business. Clearly, we'll need to maintain this kind of focus as we continue to navigate through a challenging environment in 2009.

In terms of segment profitability, the global consumer segment had operating profit of $344 million compared with $377 million last year. In global pro, profits were essentially flat at $34 million. Scott's Lawn Service was flat with earnings of $11 million in both years. Smith & Hawkin, whose results are reported in our corporate segment, fell short of our goals for the year and sales fell 14% and the business showed a higher operating loss.

The corporate segment in aggregate reported a net cost of $87 million in 2008 versus a net cost of $91 million in 2007. As a reminder, the corporate segment includes our direct headquarters costs and various unallocated costs such as information systems.

While I'm on the subject, let me give you a brief update on Smith & Hawkin. As we've said in the past, we are currently exploring strategic options for this business and our preference remains to divest. If we decide to keep the business though, we're poised to make substantial changes to the cost structure to smooth Smith & Hawkin closer to profitability.

Right now, we're in the midst of a process and hope to have a final decision on the directional take by our Analyst day event and likely sooner.

Let's move on to the balance sheet where we have a couple of good stories to share. Even in a challenging economy we saw a nice improvement in the quality of our accounts receivable. This is especially true in our consumer business. Past due balances in the U.S. were reduced by nearly $21 million from last year.

The story on inventory is even better. Despite the $150 million increase in commodity costs, year over year inventory increased on $10 million. Our supply chain did a great job managing inventories while maintaining service contributing to the $140 million of free cash flow I mentioned earlier.

One final point in wrapping up our 2008 performance relates to our leverage ratio and debt covenants. Our debt to EBITDA covenant which is based on a rolling fourth quarter average stepped down to a ratio of 4.25 on September 30. We are projecting to finish the year at 3.97 closer than we would have like, but well within compliance.

Our current guidance of $2.00 per share should continue to keep us in compliance for 2009. Keep in mind that EBITDA for purposes of measuring the covenant includes non recurring recall and registration costs. The covenant is measured quarterly and it steps down an additional 50 basis points next September.

With that let me move on to 2009, but before I do, let me start by addressing an issue that is emerging for many global companies, the impact of the suddenly strengthened U.S. dollar. We have obviously seen dramatic changes in currency rates over the last several weeks. In fact, approximately 25% of our sales are non U.S. denominated currencies, primarily the Euro, Pound and Canadian dollar.

What I can tell you is that these rate changes will only have a nominal impact on our earnings. Why? The reason is that operating income generated in these currencies is partially offset by interest expense and debt denominated in the same currencies. And, we have a net outflow of raw materials from those countries to the U.S., primarily sphagnum peat from Canada that offsets a substantial portion of the remaining risk. So while changes to currency rates will impact the optics of our financial statements, they represent a relatively small head wind to our earnings.

As Jim mentioned, we're not prepared this morning to give you detailed 2009 guidance by line item or segment, but I can give you a general sense of the path we're on. Jim told you earlier that we believe we could earn $2.00 per share next year. He also said that if we fall below $2.00 the executive team will not receive any incentive compensation.

Let me take that a step further. If we fall below $1.90 next year, the entire management incentive program for 2009 which affects about 500 associates who are not in field positions like sales or lawn service will also be zeroed out. So how do we get there?

I'll start with sales which begin with pricing. As we described in our third quarter call, we did take significant price increases for 2009 in both our global consumer and professional segments. For our consumer segment in which we historically have only an annual opportunity to take pricing, those increases were developed several weeks prior to the peak in commodity markets.

All told, we'll net price increases of around 8% across the enterprise for 2009. This pricing will be partially offset by changes in currency rates. If today's rates remain for the full fiscal year, we would expect approximately a 5% negative impact on sales due to the strengthened dollar. Right now, our plan assumes low single digit declines in unit volume.

The net of these three factors could result in nearly flat sales growth. While we hope these assumptions are overly conservative, they are consistent with our recent history. Gross margin meanwhile, is a bit like grabbing the tiger by the tail. Obviously we've seen some of our major inputs decline in recent weeks. Urea peaked at just over $800. It is now in the low $300's. And remember, we are buying forward throughout the summer period.

Diesel has seen similar dramatic climes but we also have some input which we have yet to see substantial downward movement including other fertilizer inputs like phosphorus and potash, the P&K in fertilizer. While costs have declined, we have been locking in costs throughout the summer. We have now locked about 40% of our materials principally Urea and other fertilizer inputs, grass seed and wild bird feed.

Additionally, a portion of the inventory we'll sell in fiscal 2009 was produced in 2008 at the higher costs. All told, based on today's input costs we still anticipate seeing year over year costs increased of approximately $200 million.

When considering other productivity and cost saving projects of about $40 million, we currently believe gross margin rates will be approximately flat to 2008 on an adjusted basis. That is excluding the negative impact of the recall and registration issues.

But as we saw this year, the commodity environment right now is just too fluid to predict with a high level of certainty. As it was in 2008, SG&A will continue to be a focus for us with the goal of keeping increases to a minimum and interest expense should be slightly lower, $75 million to $80 million, but the results here are largely dependant on what happens with LIBOR and exchange rates.

Roughly half our debt is floating and is priced at three month LIBOR. About a third of our average debt is denominated in foreign currencies. We expect free cash flow to be approximately flat to 2008 or about $140 million.

It's quickly becoming clear that the outlook for the entire consumer products universe is more unpredictable entering 2009 than it's been for years. But I can tell you that all of us here are feeling better than we have in awhile. We're cautiously optimistic that the trends may be working in our favor for next year and we're poised to have a solid lawn and garden season.

From the quality of our new products, our more aggressive promotional programs and advertising campaigns, to the increased listing and shelf space we're expecting, we feel good about our prospects for next year. Additionally, with compliance issues, commodity prices and the competitive environment all showing signs of improvement, I'm hopeful we will be able to come back to you when we meet in January with a prospect of even stronger performance than we discussed here this morning.

With that, let me turn the call back to the operator to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from William Chappell – SunTrust.

William Chappell – SunTrust

Talk a little bit more about your commodity hedging on a go forward basis. With the drop off you've seen are you accelerating the hedging for 2009? Are you waiting to see how far it drops? How does this change your outlook?

James Hagedorn

In regard to Urea we're buying pretty hard and the prices are excellent, way better than budget so while we probably hedged out about half, call it roughly 750, we're buying in the $300 range. So that's pretty sweet.

The other big variable that's very good compared to budget is diesel.

David Evans

I'm looking at diesel every day and expect that we'll be making some decisions shortly on diesel. The key variable on diesel that makes it different from Urea for us is the type of accounting treatment we get. Urea we get hedge accounting, in diesel we do not. So we're keeping an eye on the volatility of diesel but we're going to be making a decision shortly on the strategy.

William Chappell – SunTrust

I'm having a tough time understanding flat gross margin in 2009. It seems that costs at least will continue to go lower and unless there are plans to pull back on your pricing, I would think it more than offsets what you originally expected.

David Evans

The three key variables that affect the margin rate is pricing, roughly $240 million, so 8% over $3 billion. Cost increases, given how much we've hedged already and given the fact that part of inventory we sell next year was manufactured in 2008 of around $200 million and that $200 million is offset by improved productivity and supply chain initiatives of about $40 million.

So if you net the $40 million and the $200 million, it's about $160 million. With pricing at $240, that drops about $80 million to the bottom line or about a third of the pricing. So what you can see is the pricing, net of cost, net of supply chain, productivity enhancements, it retains about a flat margin rate.

James Hagedorn

What I would add a lot of it depends on volume. So I think the more we can load the plants, the more we can buy at lower costs and the better absorption will be. In large regard, especially in our very high margin fertilizer business, our lawn fertilizer business, the more units we can run through that plant. So a lot of it depends on consumer volume.

We see better consumer volume, and remember what we're taking about is in the lawn fertilizer business, I wouldn't say significant but I would say we talked about in the script, which is a decline in unit volume. If that doesn't happen and we don't want it to happen, and we have Mark and Sanders have put together an excellent plan with the sales force and working with our retailers for hitting the market hard starting right off the get go in those early season markets, if we can show that we can actually be neutral or increase volume, I think you'll see a very significant positive affect from that.

But a lot of it depends on volume. So I think there is upside potential but it's going to be based on volume.

Operator

Your next question comes from Eric Bossard – Cleveland Research.

Eric Bossard – Cleveland Research

As you look at 2009 can you talk a little bit about what you're thinking in terms of the mix trend you're going to see in the business? I think about 90 days ago you had talked about some newer products that may have been a little bit less engineered or a little more straight fertilizer. What are your thoughts about mix and what the mix experience will be in light of how the consumer responds to a 30% price increase on a bag of fertilizer?

Barry Sanders

We've seen it trade down to straight fertilizer so we're going to be focused on driving where the consumer's going to go. So we have pricing and promotions in line to drive it to that straight fertilizer volume. But also, from a trend standpoint, Turf Builder Plus Two showed really strong in the later half of the year which means that we believe that that franchise is good shape and it was just delayed due to the weather that we saw in March and May last year.

We're going to hit the early markets hard with the Bonus S Max, the Bonus S down in the southern markets early and we're going to drive to straight fertilizer in the spring with the Turf Builder so we think we're in pretty good shape.

Eric Bossard – Cleveland Research

In terms of the fourth quarter, the sales were better than you thought 90 days and the margins were worse than you thought 90 days ago, and it seemed like the commodity prices got better versus 90 days ago. In 4Q what drove the gross margin down side relative to what you thought and could you comment on what the pricing and mix trend might have been in 4Q and if that contributed to it?

David Evans

From a cost perspective, while we saw costs decline, that wasn't until about September time frame when we really started to see the costs tumble. And remember, we're selling products that we manufacture one, two, three months prior to the date we recognize the sale. So it's a little bit moving through the python, these costs. So I'd say the combination of purchases we were making in July and August being higher than we thought was really what contributed to lower margin rate than what we had expected.

From a mix perspective, mix continued to be fairly small story for us in Q4. While we see some mix shifts, for example we described in fertilizers going to a negative this year, they're offset by other positive mix shifts which we discussed in the last call which is in the growing segment seeing higher growth in the value added products and then the commodity admit to your products.

So it was really more a cost story than a mix story.

James Hagedorn

This gets back to the timing of the year and weather, because if you look at our dirt business performed really well. Bird seed is doing awesomely well. I think that part of the year, March and April that struggled a little bit with the weather, that's lawn season and that's high margin season. So I think for the year, part of the negativity on margin is the fact that we got toasted on our lawn season due to weather and a lot of that other product that sells tends to be lower margin after that.

Eric Bossard – Cleveland Research

Anything in terms of incremental pricing insights in the fourth quarter? Do you see anything different? Did you get any price in 4Q or how did that shake out?

James Hagedorn

We took serious pricing for next year and that's a story in itself. I'm just glad I didn't have to go down there and announce this. I have a lot of respect for the sales force who had to implement historic pricing and need to hang on to it based on what Dave talked about. When the retailers are seeing costs go down, I think they have to look at the whole picture as Dave described it and understand that for us to maintain our strength we need that pricing and that needs to be passed through.

Eric Bossard – Cleveland Research

For specific Q4 itself?

David Evans

The only incremental pricing we would have seen would have been our Pro business for the quarter itself.

Eric Bossard – Cleveland Research

Was the consumer price flat or down in the fourth quarter?

David Evans

The consumer price at retail, I think it was up on a consistent basis in Q4 as it was in Q3 and Q2.

Operator

Your next question comes from Joseph Altobello – Oppenheimer.

Joseph Altobello – Oppenheimer

On your outlook for '09, I'm trying to figure out what you're assuming for a couple of different variables. In terms of the economy, I would imaging you're thinking we're going to be in a recession but is it sort of the 2002 variety, the '82 variety or the 1932 variety?

James Hagedorn

It feels pretty bad. That being said, from our point of view, if we look at the vortex of the tornado hit the ground in Maryville, Ohio, I felt like it was about six months ago. To me, there's a lot of positives going here, and that's what I was really trying to get through was that there's a lot of positives going for us right now.

The big unknown is the consumer. I don't know. I look at the fourth quarter and say, not so bad, and therefore it feels more like what we at Miracle-Gro saw in the '80's and early '90's. That's how it feels to me. I think a lot of it depends on what's happening to home values and the value of the equity market where it's just where people have their retirement plans. There's a lot of psychology here.

When the market was completely flipped out, you didn't see a lot of cars in parking lots of retailers. I think if we have where it feels normal in the context of what it is today, I think we feel positive about that.

Joseph Altobello – Oppenheimer

But the world seems to have changed a little bit since September and October is relatively a small month for you in terms of seasonality, but what are you seeing in October thus far in terms of trends post September.

Mark Baker

I had some experience locally when I ran Garden Centers in Florida during the late '80's and housing prices crashed in the early '90's in California, the same issue. The strength of the home improvement retailers is all about lawn and garden and driving the units, taking care of the back yards for those consumers. The retailers understand you can get that footstep into the store by advertising lawn and garden and driving variable demand.

This certainly is a worse circumstance national than regional ones were 15 to 20 years ago, it would suggest, and what we've seen so far in the year, consumers are still going to take care of their back yards. If unemployment goes dramatically higher or something really changes on the macro, that would change the bed a bit, but I'm actually pretty bullish on the consumer responding to all the marketing that's going to be thrown at them for taking care in a relatively small expenditure, their back yard.

Joseph Altobello – Oppenheimer

In terms of price increase, you're talking about plus 8% overall next year. How much leakage are you assuming in terms of volumes? Are you pricing plus 12% and assume you lose 4% from volumes?

David Evans

We looked at each and every one of our product lines and the amount of pricing we've taken on each has been different. I'd say we looked at the pricing. We've made some judgment in terms of what will happen on shelf relative to price gaps. We've looked at our new produce initiatives and I'd say we also gave some serious consideration to our more aggressive promotional campaigns and net net, I think we're still assuming that in the Hertz category which is where we focused a lot of our discussion last quarter, we're going to see volume loss that's not that inconsistent with our history on pricing.

But then we're assuming much less modest increases in all the other categories. So overall, I think in the North America consumer business, we're assuming low to mid single digit type of loss there as an outcome of the pricing.

James Hagedorn

We're trying to budget conservatively on the top line. So I think what you're going to see when we talk in detail about it is a small single digit unit decline and a single digit dollar increase. I think that's pretty conservative based on what we saw in the fourth quarter, but it's like who knows in this market?

That's how we're budgeting. It sounds like you think we know what's going on. I would say we're taking our best shot. We're trying to be conservative. We're looking at historical, trying to look at what happened last year. The problem is, it's not that simple because we had a very significant month in both '07 and '08, April in '07 and March in '08 which were historic catastrophes where unit volume for the entire industry this March was down 30%. That's factored into what we said.

And what Dave said is, if you actually look at fourth quarter volume, it's about what we said it was going to be when we talked to you before we knew any of this stuff was going down last year. I would say we think we're taking a conservative outlook, but who knows?

Joseph Altobello – Oppenheimer

In terms of the pay for performance metric you've got this year on the $2.00 number, how do you manage making decisions that might be good short term but may not be good long term?

James Hagedorn

I think balance. It's probably just one word. We're trying to balance that. That does not mean that we're not making some short term decisions because at the end of the day, when it came to $2.00 we established a very regular sit down with the management team as we went through the last half of this year.

Very clear communications, a lot of detail, who controls what, how we're doing, what we need to do going forward, and I think we did what we had to do. That's doesn't mean we did stupid things, but it means that we're trying to balance the near and long term because at the end of the day, it's a pretty squirrely time and there is a near term issue which is we made commitments to you. I was watching CNBC as I was exercised this morning and L'Oreal is in multiple call downs and they're calling down again.

When we sat down and said, here's what we're going to do, we worked pretty hard to get there and I think what we said about next year, is we've drawn a line in the sand. We have a very interesting incentive plan because it's not all on the down side. There's a lot of opportunity if we can exceed our numbers where you're happy. The management team will also be happy.

I do think that it's balanced.

Operator

Your next question comes from Olivia Tong – Merrill Lynch.

Olivia Tong – Merrill Lynch

I want to try to put together a couple of statements that you said. You've got the worsening consumer downturn, but you're sticking with your pricing even though you're seeing trade down and conceptually I agree with you that consumers are not going to abandon the back yard, but you're seeing trade down in the most staple of staples categories and delayed purchases. Can you kind of marry some of those statements you made?

James Hagedorn

You bet because the biggest opportunity for trade down, probably the only place we really saw it this year was in our lawn business and it really wasn't a mix between us and private label. It was a move into commodities where there was a pretty significant move in units into commodities, this being the 10-10-10's.

The reason I brought it up is, is trade down opportunity for the consumer? The commodities are selling next year for more than Turf Builder because of the component ingredients in those products. I think we view this as a really good opportunity for straight fords and we're seeing a lot of ion flow out of the commodity 10-10-10's where we pick up that volume next year, not lose that volume, which is what happened in the environment we were in in '08.

So we think '09 is a good opportunity for us. Actually I'm not that worried about it. In the second half of the year, we didn't see market share loss. We saw market share gain across the business. Actually it's a really good story for us in this case.

Olivia Tong – Merrill Lynch

While you add the Plus 30, is this spread between the private label names? Is that shrinking or is that expanding while you're doing that?

James Hagedorn

In percentage terms, it's staying the same. In dollars it's expanding and it's just something we're going to watch. One of the things that we spent a lot of time talking to North America about, and it's their excitement that's bleeding over to corporate here, is the opportunity for this regional promotion. Mark is saying the right stuff and the sales team is really enthusiastic about this. It's driving the business at a local level as it rolls out and serve a lot of power and moving money to our regional advertising, radio, weather dependent advertising, stuff that we've done before.

I think this is a big, big opportunity for us if we do this properly and therefore I think we can overcome the fact that the dollar difference is expanding and there's massive change winds underway right now with what's happening with private label anyway, based on what's happening with Spectrum brands. I don't know any more than anyone else does except it smells like opportunity to me.

Olivia Tong – Merrill Lynch

I understand that lawn and garden is obviously becoming a much more important category for your retailers and probably two out of three cases of your most important retailers, you're going to see lower foot traffic this year. How are you changing your messaging? How are you working with your retailers to stem that to some extent?

Mark Baker

I'd say that the good news this year is that all of our key retailers recognize the fact of the value of this brand to get customers to react and I think you'll see more promotions of the national brands which we are lead of all the retailers. As Dave pointed out, more of the listings on shelf are Scotts Miracle-Gro than ever before.

I actually would differ with you that the foot steps in certain categories may be down. My experience is in retail for a long time, but this category can drive foot steps as can also paint and fix up items, because people are still going to take care of their largest investment, even if it's down 30% from it's peak, they're going to make those investment to protect the lifestyles may be more at home than ever.

I'm bullish that the retailers are going to use our brand to drive footsteps that can make them more net neutral. I think big home improvement projects are going to be very difficult and that may be some issues for them in terms of their top line, but I think they're going to lean very strongly on Scotts Miracle-Gro to drive traffic.

Operator

Your next question comes from Sam Darkatsh – Raymond James.

Sam Darkatsh – Raymond James

You mentioned, I'm getting back to gross margins in '09. $240 million benefit from pricing, $200 million head wind from inflation, $40 million tail wind from productivity, as you said added up to $80 million. What was the offset to that $80 million besides fixed cost under absorption from lower unit volume?

Mark Baker

If you do the math here, you've got your top line grow through pricing is $240 million. Your net costs which is the cost increases offset by productivity improvements as $160 million, so you ought to roll $80 million down to your $80 million in gross margin is the outcome. So $80 million on the base of $240 million in pricing is roughly in line.

As a percent, $80 million out of $240 million is consistent with our overall gross margin percent.

Sam Darkatsh – Raymond James

You're getting $80 million incremental gross profit dollars on flat sales aren't you?

David Evans

No. Remember the sales are going to grow by $240 million because of pricing.

Sam Darkatsh – Raymond James

But sales and dollars you said are basically flat because you have 8% price increases and FX is down 5% and units are low single. So if you're looking at gross profit dollars, aren't you up by $80 million?

David Evans

No, because remember when I talked about the volume increase, we started off with about 8% growth due to pricing, but then that got reduced to nearly zero through FX and through organic volume losses. What's off setting the $80 million is the organic volume decline.

Sam Darkatsh – Raymond James

I'm trying to get a little bit of a walk between when you were looking at $2.00 a quarter ago and when you're looking at $200 now, and what's changed. What we see has changed is obviously some benefit in raw material inflation incrementally, by my math maybe $30 million or $40 million just from Urea alone. What else has changed to offset that in your mind from where we were three months ago to maintain the $2.00 and not to basically raise it?

James Hagedorn

I'm not sure it's an easy walk. It largely depends on what we input as our unit volume number and if our unit volume is flat, it's super positive for us. We have just basically gone through a process of saying we're going to set our number at a negative unit growth, and I'm not sure it's because we know. I think it's because we don't know, and I don't think we want to get out ahead of the basic rule, my view of dealing with you guys which is don't promise more than you can deliver.

This is an environment and I know you understand us, where who the heck knows what's what? I'm not sure that David, even if you spend two hours with him this afternoon, we're going to make that walk easy for you. And it's not because he's trying to. It's just because we don't know and it's largely volume based.

He can come up with all kinds of fancy stuff to try to make the lines work for you, but at the end of the day, it's all going to be based on volume.

David Evans

If volume is flat, we are super good, and if unit volume is positive, it's super, super good.

Sam Darkatsh – Raymond James

If it's super good or super, super good, how much of that super actually goes to the bottom line and how much would you reinvest to try and put the squeeze on your competitors which are in a lot of pain right now?

James Hagedorn

First, I don't think we have to help them very much. I think most will go to the bottom line, but some will go clearly into piling it on.

Operator

Your next question comes from Connie Maneaty – BMO Capital Markets.

Connie Maneaty – BMO Capital Markets

On the 30% price increase you took on fertilizer, what exactly are consumers going to see? Are they going to see a 30% price increase or are they going to see a bag that's a little bit smaller or takes care of a bigger lawn? What will the message be next year that will help mitigate what might be some sticker shock?

James Hagedorn

You've got a couple of questions in there which is what do you think will be realized by the consumer and what are we doing when the consumer is faced with a more expensive product, which by way, everybody is going up that percent and the commodity is going up even more.

Personally, I don't think they'll see 30% at the shelf because I think the retailers are going to be competitive as all get out next year. I personally think you're going to see a lot of promotion and we're going to encourage and to some extent, help that happen. And this gets back to our regional promotion plan that we start out early on. I think that retailers will see this as a category they have to fight hard in to get consumers into their parking lot.

What are we going to do differently? We're clearly going to market differently than we did last year. I liked our advertising last year. Our advertising is very much about the psychic benefit of a green lawn and gardening and flower power and all that sort of thing. I think faced with a consumer that has to make a decision to buy a more expensive product in this environment, we've got to say why our product is better, why it represents a value.

I think you're going to see way more competitive advertising, way more reasons why you should buy the premium product than you have seen before. I'm not sure it'll all end up at the consumer, that's up to the retailers, but we're trying to encourage promotion and I think we'll see that, and I think you'll see a much more focused advertising on why you should spend the money for the premium product than you have in the past.

Connie Maneaty – BMO Capital Markets

You also said that you might give greater support to retailers for private label in the future? Does that mean you would consider making private label for them, and what are the pros and cons of that decision?

James Hagedorn

The answer is yes, and we already do so we already do a lot of private label, and I think if you ask Mike Glutemier, he's say, "Bring me your unit volume. Volume is good." It helps keep his plants going and it keeps trucks full. I know there's other people and I've got to say when I started out in this business, Chuck Berger and I were not that interested in private label.

I think we can run our business better with more volume. We can manage these categories better. We can offset our, remember we're not a low cost business model. We're a very high service business model in a very unique trade which is DIY. So we have a lot of elements of what you might call DIY seasonal distribution company with brands.

So the more units we run, the more dollars we run, I think we tend to be pretty happy. I also believe from a competitive position that nobody really likes to be in the private label business. Remember, we are the brand, and those people who run private label businesses generally covet branded business, because that's where the margin is at. By the way, we wouldn't do it for free.

I would say that weakness on a private labeler, I think from a competitive point of view is good because they covet our business all the time. Their misery is not lost on us as something that we think about.

Connie Maneaty – BMO Capital Markets

Given that so much planning needs to be done for next season so far ahead of time, are you already taken share from spectrum and private labels?

James Hagedorn

I really don't want to comment on that at this point.

Connie Maneaty – BMO Capital Markets

Could you just describe again what happened in last year's December Scotts Lawn Service business so that if you report a big decline in sales in the December quarter, why am I not surprised?

David Evans

The One Service business that we told you about last Q1 was that we had shifted and changed the shape of our season and it was not going to be one time. We expect that shape to continue and we feel quarters should be comparable.

Connie Maneaty – BMO Capital Markets

Last year your first quarter sales in total were up by 13%.

David Evans

Two things happened last year in the first quarter. One was we kind of changed the shape of the season and moved service back to later in the season where it's more agronomically appropriate. We would expect to continue that this year, so on a year over year basis, we'd expect no change.

The other aspect of last year that gave us a real boost in sales is that we had an acquisition that also accelerated that growth. That's now embedded in our year over year numbers. So we wouldn't expect to see any dramatic change this year from last year as we saw in '08 versus '07.

Operator

Your next question comes from Doug Lane – Jefferies & Company.

Doug Lane – Jefferies & Company

On the global consumer sales were up 2% and then you mentioned organic growth was down 4% so I assume that's unit volumes. Can you break out the pricing and currency contribution from the positive 6% difference?

David Evans

On a global consumer basis for the full 12 months, global consumer is up 2%. Of that, you have pricing of 4% offset by organic decline by 4%, and then 2% in positive FX.

Doug Lane – Jefferies & Company

You touched on innovation next year, but I wondered if you could drill down. Maybe what are the top two news items in each of the four key categories, fertilizer, growing media, bird seed and the controls business for next season?

Barry Sanders

In our growing media business we have some extensions coming out in the new garden soils so we're taking the moisture control to garden soils and we expect some good news there. We have a new mulch coming out, some extensions on the Nature Scape that just keeps growing like crazy, so we're very bullish on that.

Bird food, we're going to continue to drive a new proprietary line of bird food under the Scotts brand that has received very good feedback so far and we're very positive on that. In our controls line we have some new extensions coming out on home defense. We're getting into new categories like rodenticides and there should be a lot of positive news from that.

Round Up, we are extending in the Pump and Go applicator to some other products, and Pump and Go is the largest new product launch that we've had and so that has been received very well. And then in the lawn category we have two new grass seed skews coming out. We have some proprietary technology that we're rolling out and that has been very well received.

We also have a new fertilizer called Ablomo which is a new formulation, a new approach that we're taking to lawn fertilizers that will position at a lower price point that should help us with that trade down business as well.

Each category we have some new things coming out and they've all been well received, they've all been listed, and those are baked into our numbers.

Doug Lane – Jefferies & Company

On the bird seed, how are viewing distribution expansion? What increase in number of stores do you think that Scotts brand will be in in '09 versus '08?

Barry Sanders

I think primarily when you look at the mass retailers, I think we're going to pretty consistent there from the store count that we have some new listings. We're seeing new store counts as what I would call an independent garden center type accounts where we've picked up a lot of volumes through our distributors. At a mass level, it's relatively consistent but more on those regional retailers where we're picking up a lot of volume.

Operator

Your next question comes from John Anderson – William Blair.

John Anderson – William Blair

Could you comment on your retail inventory levels at season end and how those relate to historical levels and your comfort level there moving into 2009?

Barry Sanders

Overall we think retail is up about 3% in dollars which means that they're down in units which is a good story. As we talked about from a unit volume, we think they're positioned well and what we work with retailers is, because of the price increases, you really need to look at this more from a unit level standpoint. So units are down and the plan we're going to try to achieve this year is at least flat volume to last year.

Instead of looking at it from a dollar perspective, manage it on units going forward, which is a different way of looking at it. At the end of the day, the retailers are very happy with where they're at from an inventory perspective going forward.

John Anderson – William Blair

You had mentioned earlier your approach to field operations may change somewhat in moving ahead to give you greater flexibility. Can you talk a little bit more about that and how that might help you in 2009?

Barry Sanders

What we just did was reconfigure our field service organization a bit. We were primarily focused on what I would call fixed waiver so full time associates calling on the stores. We have downsized that field sales group and are going to more of a variable model which will have fewer full times associates but more part time, seasonal associates. What that allows us to do is not only put more dollars in overall when the season is appropriate, it also allows us to move it around on a regional level more.

If it's going to be raining in the mid west, we don't want to have associates in the store on the weekend, so we can move those with a little more flexibility with where we need to be moving it. More hours in the store, more flexibility when we put it in, and more flexibility on a regional level to match it up to weather and when the consumers are going to be in the store.

James Hagedorn

This was not about saving money. This was about spending more.

Barry Sanders

We're spending more. We're actually going to spend more money and put more hours in the store overall, so this is just to drive our business. One of those things we said last year, we're making an investment into the field sales force. We're not quite at the same level we thought we'd be investing, but we're still investing in more and we're going to drive the number of hours where we want it to be.

Operator

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

Jim Barrett – CL King & Associates

Can you tell me how many different institutions own your debt? How much is owned by banks versus hedge funds? Any color on that at all?

David Evans

We have a consortium of approximately 40 different banking institutions that participate in our facility. We're not held by hedge funds and I'd say the largest bank participating in our facility are highly recognized names that have really been coming out as the winners throughout this process.

Names like Bank of America, J.P. Morgan, Citi are the largest participants in our facility right now.

Jim Barrett – CL King & Associates

To amend a covenant, does it require a majority of these 40 banks or does it require a unanimous vote? How does that work?

David Evans

It requires basically, they all get votes that are equivalent to the level of participation and what we require is a simple 51% vote to get an amendment.

Jim Barrett – CL King & Associates

And is there anything in the debt agreements that indicate that if you break a covenant by Y, you pay X, or is everything subject to negotiation?

David Evans

For the financial covenants are subject to renegotiation.

James Hagedorn

We've got as we've been describing it internally, a very sweet deal. I think we're LIBOR plus 125 basis points. That is not even close to the market today. That's the biggest issue, would be you'd get re-priced back to dollar one. We're working hard and we have a plan to get through the year without needing any help from the banks.

David Evans

Jim talked about if we fall below $2.00, the top 25 don't get paid. If we drop below $1.90 it expands to a much larger pool. So we've constructed a plan that there's no guarantees at all in life, but we've constructed what we think is a pretty responsible plan and that gives us an extra circuit breaker as well if the worst would happen, we'd be able to release those accruals and give us more comfort before we have to go back and have that conversation with our banks.

Jim Barrett – CL King & Associates

Any body language from the EPA as to whether they will find the company and if the do what the magnitude of the fine will be? Any color on that at all?

James Hagedorn

No. I would say that right now we're in a co-operative phase of working the EPA to get our stuff online. I think they'll go through another process on the enforcement side to make a determination on how that's going to affect us and what the consequences of what happened are. But that's not a process that's happening right now that I'm aware of.

On the DOJ side, that's something that could take months or longer as they conclude their investigation into what primarily I believe are the actions of Sheila Kendrick.

Operator

Your next question comes from Alice Longley – Buckingham Research.

Alice Longley – Buckingham Research

Since you're saying that unit volume is key going ahead, and since you said the business is weakened in September and we know that October has been bad for the consumer, what has your volume performance been in the North American consumer business in September and October?

Barry Sanders

It's been consistent. We've seen it slightly down in some categories but it's been good in other categories, so I would say it's down slightly but very consistent with where we think we are. When you look relative to our budget and what our plan is, I think we're in pretty good shape.

James Hagedorn

It means something, but the problem is the news has been debilitating to consumers and Americans in general and when I visit with our retail partners, I know this is what they're seeing in the stores.

I think we tried to address that in the script by saying assuming things are consistent and we're not in the midst of everything crashing, then I think we're looking more like we did in Q4 during the bigger months. Remember as we move in, those months get smaller.

Alice Longley – Buckingham Research

You're guiding down 3% in volume next year company wide so is your volume is down 3% in the North American business in those two months, September, October?

James Hagedorn

The volume was down a fraction of that, and I don't think we're guiding down 3%. I think we just said low single digit unit decline and a mid single digit dollar increase for '09.

Alice Longley – Buckingham Research

On marketing, you said that advertising you switched from advertising to marketing at retail or to the retailers. Can you quantify this for the fourth quarter in fiscal '08? How much advertising up or whatever and how much was the increment in marketing that comes off sales?

David Evans

For fiscal year '08, we moved roughly $8 million to $10 million from media up to on our P&L to geography in net sales. So we did that through changing the nature of our parameters becoming more promotional, more consumer rebates for programs and things like that. I think directionally, for next year, we'd be looking at spending a roughly equivalent dollar amount to '08, so roughly flat dollars.

What you can't do, because of the accounting conventions that we use, the expense doesn't necessarily occur when the media is actually run, because we expense dollars over the full year sales curve. So it's a little bit hard to say what specifically are the activities you're going to do in Q4, because there's very little activity in Q4 with the exception of some early October promotions.

It would be roughly a similar percent sales as it was in '08 in the first quarter of 2009.

Alice Longley – Buckingham Research

It doesn't sound as if the increment of sales from deal to the trade was that much in '08. It was less than half a percentage point, so just sticking with fiscal '08, was advertising flat or down as a percentage of sales?

David Evans

Advertising dollars were relatively flat, so as a percentage of sales they came down a little bit.

Alice Longley – Buckingham Research

And that's true also for '09 for the budget, flat dollars as a percentage of sales?

David Evans

It will be fairly flat again because we're calling for very nominal top line growth, and we're saying our media dollars would be relatively flat. So without getting more precise than that, I think directionally it's what we expect.

Alice Longley – Buckingham Research

So the ratio is actually flat in '09.

David Evans

Yes.

Operator

At this time there are no further questions.

Jim King

I guess that wraps things up. As I mentioned at the outset, we'll be getting a note out to all of you in the next couple of weeks as we reset out Analyst call for January and February. Have a great day.

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Source: Scotts Miracle-Gro Co. F4Q08 (Qtr End 9/30/08) Earnings Call Transcript
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