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Executives

Jim King - Senior Vice President, Investor Relations & Corporate Affairs

David C. Evans - Chief Financial Officer, Executive Vice President

James Hagedorn - Chairman, President, Chief Executive Officer

Barry W. Sanders - Executive Vice President - North America

Dan Paradiso - Senior Vice President and General Manager, North America Lawns

Peter Korda - Vice President, Scotts Lawn Service

Mike [Kelty]

Analysts

William Chappell - SunTrust Robinson Humphrey

Olivia Tong - Merrill Lynch

Sam Darkatsh - Raymond James

Alice Longley - Buckingham Research Group, Inc.

Eric Bossard - Cleveland Research Company

Douglas Lane - Jefferies & Company, Inc.

Joseph Altobello - Oppenheimer & Company

Jim Barrett - C.L. King & Associates

Connie Maneaty - BMO Capital Markets

Jon Andersen - William Blair & Company, LLC

The Scotts Miracle-Gro Company (SMG) F3Q08 Earnings Call August 1, 2008 9:00 AM ET

Operator

Welcome to The Scotts Miracle-Gro Company third quarter 2008 earnings conference call. (Operator Instructions) If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Jim King, Senior Vice President of Investor Relations and Corporate Affairs.

Jim King

With me this morning in Marysville is Jim Hagedorn, our Chairman and Chief Executive Officer, and Dave Evans, our Chief Financial Officer. By now I’m sure you’ve seen a copy of our third quarter financial results that we issued after the close of the markets yesterday; however if you don’t have a copy, you can find it on the Investor Relations section of our website at www.scotts.com.

We’re going to start this morning with some prepared remarks from Dave who will provide some details on the results we issued last night. We’ll then turn the call over to Jim who will provide some additional context as well as commentary on our outlook as we prepare for fiscal 2009.

I want to remind all of you that our comments this morning 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 yesterday’s press release and are discussed in more detail in our filings with the SEC. As Julie stated, today’s call is being recorded. In addition to any service you may subscribe to, you’ll find an audio archive of this call on our website. One final point before we get started, if we discuss any non-GAAP measures not covered in the press release this morning, we will elaborate on those on the website as well.

With that let me turn the call over to Dave Evans to discuss the results we issued last night.

David C. Evans

As we said in our press release last night we’re very pleased with our third quarter results. By nearly any measure the last several months have posed one of the strongest tests of our organization from top to bottom of any I can recall. But we have successfully managed extremely volatile commodities, an uncertain economy, a late break to the season, and product recall and registration issues to remain on track to deliver earnings within the range provided last May. Earnings per share in the third fiscal quarter and on a year-to-date basis were effectively flat to prior year on an adjusted pro forma basis. While sure of our original plan, the results are consistent with the expectations we conveyed in May. So let’s move on to the results.

In the third quarter total sales increased 7%. Our largest segment, global consumer, posted 6% improvement which equated to a little less than 5% excluding the impact of foreign exchange rates. Within global consumer, point of sale purchases by consumers or POS and our US gardening business which includes both growing media and plant foods were up 4% for the quarter and 1% year-to-date.

We continue to increase market share within the growing media category and consumers continue to show a willingness to trade up to premium soils and mulches, the continuation of a multi-year trend.

As an illustration, shipments of our premium potting soils which include Miracle-Gro Moisture Control and Organic Choice products were up 6% year-to-date, outperforming mid-tier and commodity soils which declined 10%. Retail prices for premium potting soils are about 80% higher than those for mid-tier and commodity soils. A similar price difference exists in the mulch category. Still, Scotts Nature Scapes our premium mulch offering continue the five-year run of impressive double-digit sales growth.

POS in the lawns business, our next largest US business, which includes lawn fertilizers, grass seed and spreaders was up 17% for the quarter following a delayed start to the season and is now up 2% for the fiscal year. Unlike the growing media category, in both fertilizer and grass seed categories we’ve seen some evidence of consumers migrating to lower price points. For example within our product portfolio shipments of straight fertilizers, that means without weed or insect controls included, increased mid-single-digits for the first nine months. However much of that has been offset by a decline in shipments of more expensive fertilizer combination products like Turf Builder Plus 2 with retail prices about 50% greater than straight fertilizers. While we believe there are many factors influencing this trade down, the rapid pace of commodity-driven pricing on both fertilizer and grass seed is playing an important role in this trade down as the price gap between products and absolute price of high-end products has grown with retail price increases of over 30% since 2002.

POS in our third major US business, home protection, increased 3% for the quarter and was flat for the first nine months. Within home protection we saw growth in two categories, both having a recent innovation: Ortho Home Defense and Roundup Pump ‘N Go. Jim will discuss both of these new products in more detail. Growth in these categories was offset by modest declines in selective weed and outdoor insect categories. Remember that the insect season typically occurs in mid-to-late summer and so we remain optimistic that Home Defense will continue to help drive the overall home protection category.

From a geographic perspective, we have seen significant regional variances in POS performance. For example, in the Northeast and Midwest US where there was a late start to the season but where temperature and precipitation have otherwise been relatively average, POS is up 6% and 4.5% respectively. This growth reflects the resiliency of our business. In contrast, in Florida and California two of our largest states where unfavorable economic conditions have clearly been more pronounced, POS has declined 4% and 6%. In these cases the magnitude of the economic challenges has simply been too difficult to overcome.

Year-to-date POS for the aggregate US consumer business has increased nearly 2% through June which is in line with selling and retail inventory levels. So while we have experienced some top line pressure this year where we have had innovation combined with input costs and retail price inflation more similar to the overall consumer price index, our products have responded well. In fact we continue to believe our categories have outperformed nearly all other categories in the DIY channel and discretionary consumer products in general.

On the international side of our global consumer segment sales increased 9% for the quarter and are now up 10% year-to-date. Sales are nearly flat when excluding the impact of foreign exchange. We continue to see top line improvement in France and Central Europe where we benefit from improved marketing programs and new products, especially our expanded organic and natural line. These increases have been offset by sales in the UK where the economic environment is more challenged and competition is more aggressive.

Let’s move on to our global professional segment which continues to show outstanding results. While we saw growth in every major geography, 32% improvement in sales in the third quarter was primarily driven by Europe and emerging markets. Excluding foreign exchange global pro sales grew 22% and as we told you before, this is a more fluid market which allows us to take pricing as needed to address higher input costs. Pricing represented an additional 9% of third quarter growth. So on a purely organic basis the professional business grew by 13% during the quarter and 12% year-to-date. This is ahead of our expectations.

We continue to see strong customer demand for our proprietary Osmocote technology and don’t see any near-term growth pressures on this business.

Scotts LawnService however remains one of those areas of our portfolio more significantly impacted by macroeconomic pressures. Year-to-date sales are up 9% including a 3% improvement in the third quarter. We are pleased with the full-year growth though our current customer lags our original expectations. So on a full-year basis lawn service is likely to see about 6% sales’ growth. The team continues to adapt its marketing strategies to reflect current market conditions and focus on maximizing productivity of the existing customer base.

The other business being more affected by the economy is Smith & Hawken where sales declined 14% in the quarter. Retail sales in the business were down 24% due mainly to decreased demand for high-end teak furniture. However we continued to see strong results in furniture with lower price points. For example, purchases of metal furniture were up 29%. Nonetheless Smith & Hawken remains behind plan for the year. It is unlikely to close the gap during the fourth quarter. We’ve been taking a closer look at the performance of this business over the past few months, a point that Jim will elaborate on in a few minutes.

As I said at the outset, we’re pleased with what we saw across the business during the June quarter. Based on our earlier results for July and our forecast for the balance of the year we continue to believe that sales growth of 3% to 5% for the full year remains attainable.

If we move on to gross margins, you’ll note a 220 basis point decline in reported rate for both the quarter and year-to-date. Excluding the impact of product registration and recall matters, the decline was 210 and 120 basis points for the quarter and nine months respectively. We now expect to see gross margin rates down about 250 basis points for the full year on a reported basis or about 150 basis points down on an adjusted basis.

Commodity costs remain the key theme. Despite a recent and modest moderation in diesel and grain costs, our input costs have increased dramatically even since our last earnings call. We now expect input costs to be about $140 million higher than last year. While we believe we will offset nearly $100 million of this increase through pricing, the net effect on full-year margin rate will still be about 260 basis points. This decline will be partially mitigated by supply chain productivity improvements and a handful of other items aggregating to about 110 basis points. These full-year themes are consistent for the quarter and year-to-date though the commodity cost impact has become increasingly pronounced with each passing quarter.

While I’m on the subject, I know a lot of you have been asking about the composition of our cost of goods. Last year we gave you a pretty detailed breakdown on three major components: Direct materials, distribution and manufacturing overhead. With commodity prices moving so violently over the past several months, those facts are dated. So let me provide you with an update. Direct materials such as nitrogen, active ingredients, soil and packaging currently represent about 63% of cost of goods sold. Distribution costs which include freight and warehousing represent another 19%, and conversion costs represent the balance of about 18%.

We consider about 43% of our cost of goods sold to be commodity sensitive. This includes portions of both direct materials and distribution. Two years ago the corresponding value was about 35% with the change over this period representative of the magnitude of cost inflation. The largest commodity sensitive items are fertilizer inputs which include urea, ammonium sulfate, [maph], potash and NPK particles, diesel, grass seed and bird food. So as you can see we are managing in two different worlds: Fertilizer and grains where inflation has well exceeded 100% over the past year and a more normal environment in most other categories where inflation has tracked closer to the broader consumer price index level.

Jim will speak to our long-term outlook on commodities and the impact on our business strategies. These facts help highlight the impact on 2008 and why we believe we’ve done a reasonable job navigating in this environment.

While commodity costs have been a struggle, we continue to be pleased with our control of SG&A. The 5% increase we saw in the quarter, which I’ll point out is only 3% on a year-to-date basis and 1% excluding the impact of foreign exchange, was a very good result. We continued to make investments in the sales force, R&D, project catalyst, as well as absorb unplanned costs to build a stronger regulatory role and improve our product registration processes and controls going forward in light of recent issues. On a full-year basis we expect SG&A to be up about 4% to 5%. Our continued focus on SG&A control is going to be critical to our success next year, a point that we’ll elaborate on in a few minutes.

Finishing out the P&L, let me say a few words about our effective tax rate. As of the year-to-date reported rate of 67% is a significant variance from historic rates, though it is representative of what we expect for the full year. While 67% is the effective tax rate on reported net income, we still expect our full-year effective tax rate on adjusted net income to be about 36.2% which is in line with past guidance.

Let me try to explain why the rate on reported earnings is so high. First, approximately $20 million of our intangible impairment charge for book reporting purposes is not deductible for tax purposes as the assets have no tax basis. Because of the significance of $20 million in relation to our full-year taxable income, this creates about a 25% increase in the effective tax rate. Unfortunately it’s the law of small numbers. Second, our taxable income has dropped. As our taxable income is dropped, our state tax rates have increased. This is because a portion of our state taxes are based on net worth rather than income and as a result remain more fixed despite lower income. While the tax rate on reported income is now nearly double the previous expectations, it does not influence our cash payables but the difference will primarily be hung up on the balance sheet.

So as I started off by saying, we’re very pleased with our adjusted net income of $2.00 per share in the quarter. This result does exclude the impact of one-time charges after which we earned $0.35 per share on a GAAP basis. The difference between adjusted and reported earnings for the quarter results from additional product recall and registration charges of $0.09 per share and impairment charges of $1.56 per share.

Let me provide some additional context on both topics. First, the product recall and registration matters. On our last call we said we expected the entire impact from these matters to be as much as $40 million for the full year. At this point it appears the number will be higher probably between $55 million and $60 million for the full year. Through June we have now incurred a total of $41 million. The increase in our estimate from last quarter primarily relates to costs to rework or write-off and dispose of additional products that have been identified through the review process and increased third party legal and advisory fees.

I want to remind you that these costs are related only to executing the recalls, addressing other product registration matters that have arisen through the review process, and third party legal and consulting costs associated with the EPA and Department of Justice investigation. Our estimate does not include any potential fines or penalties which we are not in a position to estimate and it could be some time before we’re able to do so.

Jim will provide some additional comments on this process in a few minutes.

In regards to impairment, like many companies today the decline in our equity value forced us to accelerate our normal annual review process which occurs in the fourth quarter. While we do not believe the outcome of the process which is a write-down of $123 million is indicative of our long-term confidence in the business, it is reflective of our current reality which is reduced 2008 operating results and share price. The impairment review process is not entirely complete though I do not expect any material changes to these estimates. The charge is all non-cash.

So let’s move on to the balance sheet where you’ve probably already noticed a significant increase in cash and cash equivalents at the end of the quarter. The story here is entirely related to timing. Although we closed the quarter with $166 million of cash we had subsequent payments on a receivable purchase facility, a scheduled payment on our term loan, and other cash needs that have since reduced that cash position.

One final point. We continue to target full-year free cash flow of $130 million. Although increased costs associated with the product recall and registration matters will make that more challenging, we will continue to focus on using cash to repay debt, a strategy that has not changed.

While I’m on the subject of our debt, I know there are questions about our covenants so let me address those before we wrap up. Clearly the unexpected challenges we face this year have us closer to our debt covenants than we had originally planned when we recapitalized the company 18 months ago. As you know, our debt covenants stepped down 50 basis points this September and require us to have a 4.25 debt to EBITDA ratio. This ratio is a rolling four-quarter average and does not exclude any of the cash costs related to the recalls. Based on our current assumptions for the balance of the year we will finish 2008 in compliance with these covenants. If however we do fall short of our goals at the end of the year, it is possible that we may seek a waiver from our lenders asking them to exclude all or a portion of the impact of product recall and registration matters from the covenant calculations. Right now though I do not believe this will be necessary.

As for 2009 Jim will also spend time during his remarks sharing with you our current point of view on what we are focusing on accomplishing. At this stage, based on current assumptions I expect us to remain in compliance with our covenants over that period.

As I said earlier, all in all we’re very pleased with the performance we announced last night and remain confident in our outlook for the balance of the year.

At this point I want to turn the call over to Jim Hagedorn to discuss our thoughts on what we’re seeing in the market place as well as our early thoughts on 2009.

James Hagedorn

I’m not used to going last but I guess that happens when you’re out of the office for a couple of days. I was out in Oshkosh flying my P-51 earlier this week and while I was gone, King and Evans hijacked my position on the call and they told me Dave would speak first, then myself.

All kidding aside, I actually think this format works better for this quarter because much of what I’ll talk about is forward looking and I think that’s probably more in line with what our investors are thinking about these days, which will make a smoother transition into the Q&A. At least that’s the plan.

Before I get there though I want to reinforce what our first speaker had to say. The lawn and garden category has proved to be exactly what we thought it would be in a difficult economic environment, resilient. We’ve said all along that we believed the category would perform well on a relative basis and that it would likely outperform nearly all other categories at our largest retail accounts. Well, that’s what happened.

While we benefited from easy comps in April, we also saw positive POS growth throughout June. Even better we carried that momentum into July. So we’re cautiously optimistic as we move forward toward the end of the fiscal year that the guidance we provided in May is still accurate. While we’ve got a lot of good stories, commodities surely isn’t one of them. What’s the net of all this? We believe the most likely scenario is we come in within the range we provided at May, about $2.00 a share. The timing and strength of the late summer consumer activity will likely be the determining factor as to whether we exceed $2.00 or fall short.

Regardless of how the final weeks of the current year play out, we remain confident in our business with the overall category as well as our position in the market place. While there have no doubt been challenges this year, more in fact than I can ever remember in my civilian career, I believe the financial markets are overlooking many of our core strengths.

Over the past couple of months I’ve seen one analyst refer to us as “the meltdown in Marysville.” Another said, “The grass isn’t looking so green.” And several others have referred to “a perfect storm.” I’ll say only this. While we have seen unexpected challenges from sharply higher commodity costs, product recalls, a fraud investigation we couldn’t have seen coming, we remain in control of the situation and our destiny. We remain optimistic about the prospects of our business especially over the long run. And if we’re trying to navigate in a perfect storm, then I can’t think of a better ship to be sailing on.

Perhaps more than any year I can remember we’ve seen the importance in power of our core competitive strengths. Even in the difficult environment, our brands have performed well and our sales force has been even more critical in maintaining a strong relationship with our retail partners. In fact, I want to take a moment to thank our retailers for sticking with us through this season especially in light of the product recalls and other challenges. Our competitive advantage in our supply chain has also been even more important this year as our team has managed the difficult challenges of mid-year surges in fertilizer inputs, grain and diesel costs.

Frankly I believe the pressure from commodity prices which I’ll address in a moment, has been the focus of so much attention that it caused many people to lose sight of our core strengths and I believe some have also lost sight of the fact that lawn and garden remains an important category for both consumers and retailers.

Our results today I believe demonstrate the point. Dave’s already told you that consumer purchases of our growing media products are up 5% on a year-to-date basis. In the quarter growing media was up 9% and was up 10% in June. The strong double-digit improvements we’ve seen again this year in products like Miracle-Gro Potting Mix with Moisture Control and Scotts Nature Scapes Mulch reinforces our belief that consumers remain willing to trade up for value and innovation.

Looking ahead to next year we expect the overall interest in gardening especially vegetable gardening to continue. Our job will be to take advantage of this trend. We’ll be introducing new moisture control garden soil under the Miracle-Gro brand next season that we believe will be the best soil product ever offered to gardeners. We’re confident the product will allow us to expand the growing media category and increase our market share yet again.

Outside of the gardening category we’re also seeing solid performance in our home protection category. Response to our new Roundup Pump-n-Go has been tremendous leading to a 7% improvement in POS in the Roundup business. We’ve also seen a very strong start to the insect control category with Ortho. Hot and wet conditions in June and July helped accelerate purchases of Ortho Home Defense, a perimeter pest control that helps keep insects out of the house.

The 17% increase we saw in consumer purchases of lawn fertilizer in the quarter was also encouraging. The slow start to the season as well as higher prices has led the overall category to decline on a full-year basis but it’s been gaining ground since April. Here’s yet another reason for optimism. You’ll remember that during our last call we said we’d lost market share in the first half of the year to private label. We believe we’ve gained market share in the third quarter which is the largest period for fertilizers and we’ve closed the gap substantially.

This year also shows the importance of our products in geographic diversity. Our international operations continue to show strong momentum and as Dave discussed, we’re seeing market share gains in many of our European consumer categories. The strength of our global professional business also continues to show its importance. Whether in Europe or emerging markets this business is an important growth platform for us in the future.

I don’t want to sound like I’m sugar coating our challenges. I’m not. In fact a few months ago I attended a CEO conference and when I came back to Marysville, I repeatedly shared with my team a simple three-word phrase that made the conference one of the best I’ve ever attended. Embrace your reality. And we are embracing our reality. Let me share four basic assumptions that are critical to us as we prepare for 2009.

First, our raw material prices are unlikely to retreat any time soon. I’ll remind you that urea costs have more than doubled in the past year. In the long term that means the need for product innovation and alternative sources of nutrients are more important than ever. In the near term it means we need to take aggressive pricing to cover our costs. We’ve told our retail partners we’ll be taking pricing of 30% next year on lawn fertilizer and those increases could move higher depending on what happens with input costs.

The second assumption, pricing at this level will not be painless. Consumers will be even more value conscious in 2009. In an environment of double-digit increases in the cost of basic necessities, we need to be respectful of the consumer. That means our messaging to consumers must be more competitive. We have to more clearly reinforce why our products cost more and why they’re worth it. Over the past two seasons our messages have been softer focusing more on lifestyle. Next year you’ll likely see a shift in our media messages that will be more competitive and more of a focus on call to action. You’ll also see us shift more spending to promotions that are designed to drive consumers to our brands.

Our third assumption, even with these efforts unit volume and lawn fertilizer will remain under pressure in 2009. We know our pricing decisions may prompt some consumers to trade down. For those consumers we intend to have new and innovative alternatives available to keep them in the Scotts franchise. However it’s also possible that some consumers could exit the category. That’s a reality we don’t want to embrace but we continue to believe that covering our costs and protecting our profitability is essential. We’d rather run a smaller lawn fertilizer business that is more profitable and has stable margins than a larger business that’s not profitable.

Our fourth reality requires that we reassess platforms that we previously believed were the source of long-term opportunity. In this environment we need to minimize distractions and focus on our core business. While we still believe the concept of outdoor living has great potential and feel strongly about the value of the Smith & Hawken brand in the core lawn and garden category, this business continues to be a drag on our earnings. As a result we are actively pursuing strategic alternatives for this business. At a minimum we will actively review our catalog strategy and underperforming stores while also attacking our overall cost structure. However our plans could also result in the sale of Smith & Hawken. For now it remains in the portfolio and I’m sure we’ll have more to say when we talk again at year end.

As I said, we’re not sugar coating the facts. We see plenty of opportunity in front of us but also recognize the need to aggressively manage our challenges.

Without a doubt we need to take an aggressive approach to how we manage spending next year. Over the next couple of months we’ll carefully evaluate every investment decision including those related to our marketing and sales efforts. Let’s be clear. We are a sales and marketing company and that’s not going to change. But given the current environment, we must reassess how much we’re willing to invest in each of our categories and we have to balance our near-term spending decisions with the need to protect the brands for the long term. As it relates to our sales force, the same principal holds true. We must balance meeting the needs of our retailers with our need to see them grow while achieving a reasonable rate of return on that investment.

It’s too early to provide details on what our business plan and budget look like for 2009. So we’re not providing specific guidance this morning but I will say that our leadership team is in lock step in building a plan that gets us to at least $2.00 a share for next year. Let me be clear though. We are not guiding to that number. Over the weeks ahead we’ll look hard at decisions that will be needed to deliver on this aspiration of at least $2.00 per share next year. Only then will we set our targets. You can expect an update on our 09 outlook during our year-end call.

In advance of that call, here’s something you can count on. We will not sacrifice long-term projects that are critical to driving future growth and shareholder value. For example, we will continue to invest in the development of a fully organic line of products which will help us capitalize on this emerging global trend. We also continue to develop new products in our growing media business that we believe will make it easier than ever for gardeners to succeed in growing bigger and more beautiful plants and enhancing the beauty of their homes. We also remain committed to our innovation efforts in lawn fertilizer. We will continue to invest in proprietary and gain changing technology that we believe will help serve as a catalyst for this business. In 2010 and 11 we expect to begin the process of changing and vastly improving the experience of caring for your lawn. We’ve been making great progress against these efforts and will not sacrifice them for near-term gain.

On the cost side of the business we’ll also continue to invest in our efforts to create a more regional supply chain. We’re encouraged with what we’re learning from our regional distribution pilot and expect to begin moving forward more aggressively. Beginning next year you should be able to see some savings in distribution costs, and as we contemplate the opportunity for regional manufacturing we remain confident in long-term prospect of reducing supply chain costs by up to $50 million per year.

Clearly, like any consumer products company right now we’ve got our work cut out for us. But with such a rich history we know that this business has seen its fair share of challenges over the past century. In the long run we’re confident in our category; it will remain strong; our brands will continue to enjoy market leading positions; and we’ll see growth that drives shareholder value.

Before I take your questions, I know many of you are wondering about the curt situation with EPA and DOJ. As you’ve seen in our SEC filings, we have communicated additional registration issues to the EPA. The most visible of these was regarding Ortho Home Defense which we were prohibited from shipping for several days during the third quarter because of labeling concerns. Because of the labeling changes we made to the product, which were acceptable to the EPA, and because the agency exercised its enforcement discretion in this instance, we don’t expect the Home Defense issue to adversely affect our year.

From an organization perspective you should know that we’ve added expert outside staff and have put tighter controls in place to help prevent a recurrence of such an issue. We’re also in the latter stages of hiring a respected expert with substantial expertise in regulatory compliance.

As I did on our previous call, I want to apologize to our consumers, our retailers, our shareholders and most importantly to our regulators for the issues that have transpired. The good news is that we’re working aggressively to deal with our challenges and get them behind us.

I know many of you are wondering how long this process will take. I wish I could be more precise, but all I can say is that it will likely take several more months at a minimum. An independent third party has begun an extensive compliance review of all of our programs and product registrations. If we find additional issues that we believe are material to the business, we’ll not hesitate to share those with you through additional filings with the SEC. As I mentioned earlier, the EPA and DOJ investigation simply added complexity to what’s been an extremely unpredictable and volatile year.

I want to take a moment to recognize my entire team for maintaining their focus on the business and demonstrating the leadership needed to manage through this difficult period. Their leadership will remain critical as we move ahead, and given the strength of the team I’m confident we’ll succeed. While cost pressures and the EPA review continue to present challenges, we remain focused as we should on driving the business. I think the successes we’ve seen this season are a testament to that commitment, and all of us believe that the opportunities to drive long-term growth and value are no different than they were 12 months ago.

I especially want to recognize Dave as well as Barry Sanders, Bob Lopez and Mike [Kelty]. In a year in which the challenges seemed to mount quickly, they stepped up in unison and kept the organization focused and on track. Their leadership over the past months has kept our associates engaged. As a result we got through a tough spring with a renewed sense of optimism and with a spring in our step as we head into 2009.

All of us here are dedicated to continuing to provide consumers with even better solutions to meet their needs, to help our retail partners to improve their lawn and garden departments, to create an even more efficient supply chain and infrastructure, to provide a dynamic environment for our associates, and to drive shareholder value.

Thanks for your time this morning. I’ll turn the call over to you guys for your questions.

Jim King

Let’s go ahead and start the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from William Chappell - SunTrust Robinson Humphrey.

William Chappell - SunTrust Robinson Humphrey

On the quarter, I’m just trying to get a better understanding. When you talk about 80% of consumer takeaway and if we look at year-to-date the sell-in has only been up 2%, how do I make sense and maybe you can talk a little bit about inventory levels being up and where they stand going into the off season?

James Hagedorn

Are you talking about our inventory levels or retail inventory levels?

William Chappell - SunTrust Robinson Humphrey

Both because I assume you have to take some back towards the end of the season.

James Hagedorn

Barry, why don’t you take retail inventories and then I guess Dave, why don’t you take our inventories.

Barry W. Sanders

POS is what it is. Going through the quarter inventories are slightly down at the retailers so just as always in the past, year-over-year we continue to work with our retailers, try to get more efficient so the takeaway at retail is slightly higher than what we actually shipped into them. And part of that’s also pricing relative to what they price the products and so forth. So triangulated on it, there sales are going to be slightly higher than what ours are this year.

James Hagedorn

And cleaner. I think less risk on returns; not more.

David C. Evans

Bill with regard to our inventory, our inventories were up about $44 million at June 30. About half of that is just due to cost increases that we’ve seen on mostly our fertilizer products and about a quarter of it is due to foreign exchange rates on our international inventory. You also asked about kind of divergence of POS in shipments. I think for the nine months period they’re actually fairly close. As a total company our sales are up 3%, if you drill into global consumer up 6% and you back out fx, you kind of get down to 5% and you see our POS up year-to-date is 2%. There are a lot of moving parts in that but I can tell you that if we go business-by-business, meaning lawns, home protection, and gardens, the shipments out are all within call it 100 basis points in terms of change versus the POS change. So I think retail inventory’s in good shape and they’re fairly aligned at this point.

James Hagedorn

I also want to give some credit to the supply chain who I think in a very volatile sales season has done an awesome job especially if you exclude foreign exchange of managing our inventory, which at the end of the day is going to roll off into free cash flow. So they’ve done an awesome job and Luke deserves credit for that.

William Chappell - SunTrust Robinson Humphrey

On the pricing, I guess you’ve gone through the line reviews and told all the retailers about a 30% price increase on the lawn fertilizer but when do you lock in costs? It seems like urea goes up every day. So how do you gauge and do you have cushion to further price increases if need be as we go through the season?

Barry W. Sanders

Typically we would be locking into that now, so going to the line review as we present the pricing and that gets locked in. Relative to urea which I think is an extraordinary environment that we’re in, we’re evaluating that going forward and trying to manage that on an ongoing basis with our retailers. As you recall this year we had a mid-year price increase which we had to take for this year, which was the first ever as far as I’m concerned. So we’ll be evaluating that going forward and we’ll look at that late into the fall and beginning into the year and make the adjustments that we need to make relative to lawn fertilizer.

David C. Evans

With regards to the costs on urea, I think you’re aware we’ve historically been out in the market about six months ahead of our needs. Our strategy in that regard hasn’t changed, so we’re at a different point in the production cycle but we continue with that strategy.

James Hagedorn

I was speaking to the North American Finance Group this morning and I think that if prices stay where they are, I think people are comfortable on the margins based on that price increase. But it’s such an unpredictable market on sort of the nutrient side that we’ll just have to see. It might require additional pricing next year even if prices stay where it is as these costs kind of roll through our inventory. But I think right now based on where urea is, if it stays where it is, I think we’re kind of fixed.

Operator

Our next question comes from Olivia Tong - Merrill Lynch.

Olivia Tong - Merrill Lynch

Obviously you talked to the retailers about the 30% increase in fertilizers. Have you heard anything about the competitor response to that?

Barry W. Sanders

No. We focus on our pricing; not our competitors.

James Hagedorn

We’re all in the same world so I expect that they better be taking that kind of pricing. And this is not a competitive issue. I’m just saying, just because their costs will be all food barred up if they’re not. And given that I have looked at their business when it was for sale, I think they’ll need to do that.

Olivia Tong - Merrill Lynch

Based on what you’re thinking for pricing, can you give me a little idea on the component of sales growth next year, volume versus price?

James Hagedorn

I’ve got to say. I don’t believe we’re far enough into the budget. It’s all going to come down to the sort of elasticity issue of what people think and we’ve got a lot of new products. I think Dan’s got some really, really cool programs and new products that are going to be part of his 09 business that I think are helpful to the consumer and the retailer and us in this environment. I think that this is the hard part of looking people in the eyes across the table as we budget because people would like to be conservative, but with this kind of pricing I think they’re pretty nervous about elasticity with the consumer. And it’s all going to come down to that. Because that’s really what your question leads to is where units are at versus pricing, and until we internally agree on that which I’m positive will be a compromise then I don’t think we can really talk about it yet.

Olivia Tong - Merrill Lynch

How much is pricing for this quarter in consumer?

David C. Evans

Olivia, I can tell you as a company $45 million. I’m sorry. I’m misinterpreting it. It’s 4% to 5% for the quarter.

Olivia Tong - Merrill Lynch

For the total company?

David C. Evans

For North American consumer.

Olivia Tong - Merrill Lynch

All that 210 basis point year-over-year change in gross margin ex the product recall and registration costs, can you give us an idea how much is raw materials versus promotion and other factors?

David C. Evans

On a year-to-date basis, and you can do the math, but on the year-to-date basis we see our input costs up about $115 million through June. So we’re thinking full-year about $140 million; year-to-date about $115 million. If you look at pricing then year-to-date as a total company, our pricing has been around $80 million and the full year we expect our pricing to be closer to $100 million. So if you do the math on that, that’s where you’ll derive the 250 basis point challenge because of those two facts.

Operator

Our next question comes from Sam Darkatsh - Raymond James.

Sam Darkatsh - Raymond James

I know that fertilizer’s getting all the attention now and unfortunately I’m no different. Talk to me about what is your fixed cost structure fertilizer versus the other categories? And how much fixed cost under absorption might there be if you get a fairly significant leg down in volume production?

James Hagedorn

Before that gets answered, I think that the lawns team is - again this gets back to units because it’s all going to come down to the tonnage that they run through the plant - Anne has got and the lawns group has got a really, really cool plan to give consumers what they need and a promotional plan I think that is a much more competitive approach to advertising of why Scotts is better. So I think we are seriously getting down into our Pearl Harbor on the lawns business and I think this is going to be extremely attractive to the consumer; I think extremely attractive to the retailer; and I think Dan is not ready to announce it until he’s ready because it’s secret. I’m a big believer personally in it and so again I think the big leg down or whatever you called it which is tons running through the plant largely depends on how well this works. But I’ve got to say, I believe in it and I’m less concerned about absorption issues than maybe others are.

Barry W. Sanders

Let me add just another comment. With all the comments Jim just provided you, I’d say that the supply chain team is also actively looking at mitigation strategies to help offset if there is an impact. So what they’re actively doing is looking at fertilizer production and other third parties today that we could have the possibility of moving inside. So we’re doing multiple things to try to ensure that our production volume is as stable as possible year-over-year. And when you look at our manufacturing facilities for fertilizers, I’d say just as a very rough estimate with probably a third of the costs variable so the impact is somewhat diminished by that as well.

Sam Darkatsh - Raymond James

A third of what costs are variable?

Barry W. Sanders

Well you started the question I think asking about manufacturing conversion, right?

Sam Darkatsh - Raymond James

Right. So a third of what costs? You’re talking about the overhead costs being the variable versus fixed overhead?

Barry W. Sanders

Yes. It was included within the conversion element.

Sam Darkatsh - Raymond James

This may be a complete moot point because of the macroeconomic environment that we’re operating in, but I’m sure you guys have internal sensitivity historical models of demand elasticity for fertilizer for certain movements in selling prices. Can you give us a directional sense of how sensitive historically fertilizer has been to major moves in pricing in the industry?

James Hagedorn

I’m going to say no, largely because number one, nobody has ever seen this kind of change and we have always believed that - I’ll be Jim like it or not for a minute or two on this questions because it’s a big deal. We can get all complicated about what’s going on with fertilizer demand or you can look at the abortion that March was, which was in my opinion virtually all weather related. If March wasn’t March and we didn’t have the cost of goods issues, Dan would be a way happier guy and nobody would be looking over his shoulders as much as it’s happening.

You look at the business for the quarter and so while I think Dave talked about mixed issues occurring as people stepped down to straight ferts in our Turfbuilder line, if you look at Q3 business is up 17% and the Plus 2 business has performed really well in that period. I’m not sure it’s exactly clear what’s happening. I know one thing. The costs are way up, which is affecting our margins, and March sucked. We’d be probably having a completely different discussion if that wasn’t the case.

I do think though that there is some evidence and is mostly recent because we’ve never seen this before that there is some level of elasticity and that the entire category becomes challenged because you can look at it and you can see people moving into your basic commodity kind of 10-10-10s. I think that probably is some evidence to show that there is some level of elasticity.

And again, that being said, our response to it I think you’re going to see is innovative and extremely aggressive in how we’re approaching selling price points within the line both on the branded side and on a more medium mid-level tier. I think that it will be exciting but I don’t know that we have any history that is really useful here because in our lifetimes, I’m looking over at Mike Kelty, have we ever seen anything like this before?

Mike Kelty

No, not like this.

James Hagedorn

So there you go.

Sam Darkatsh - Raymond James

You mentioned that you gained share in the third quarter in fertilizer after having lost share in fertilizer and you’re still seeing however some consumer migration to lower price points. What are both of those things telling you in terms of potential consumer reaction to this, I’ll call it what it is, a very courageous move on your behalf and you’re to be commended for it. But what do those two things tell you about the likely consumer response?

James Hagedorn

I think consumers are paying more. How the hell do I know? If I could be a genius, I would tell you. Dan, it’s your business.

Dan Paradiso

The specific share numbers I won’t share with you but the trade down from the combination products to the fertilizers is a pretty significant trend that I think we’ve got to capitalize. Jim was talking about that. Other than sharing specific share numbers, I think that’s the biggest insight. So the hard core consumers are staying in the category and sort of the latent or the ones that go in and out are either exiting the category due to costs or they’re trading down. I’d say that’s how you’d sum it up quickly.

James Hagedorn

Again, I would say stay tuned because when our programs become clear and that’ll be as late as possible and working with the retailers, I think you’ll be really excited and enthused by what I would say is the courageousness of a new and innovative approach to marketing lawn products.

Barry W. Sanders

Maybe if I could sum it up, historically what we’ve seen is a half to a three-quarter point of elasticity per point for 1% price increase on the fertilizer and that’s when we’re taking mid-single-digit price increases. So in the neighborhood of 30%, we can run the models and it’s fairly hard to calculate that, but in summary what Jim is saying is we’re going to have to take those price increases but we’re working on some products that are going to try to mitigate that 30% price increase to offer the consumer products at price points that are going to give them solutions that we think will keep people in the category, address the moving from combos to straight ferts, and give the consumer the opportunity. So our plan at this point is we’re going to calculate those elasticities but what we’re also going to do is develop a plan that can maintain the volume at the price points that we think the consumers are going to buy those products. We think we have a good plan and we’re working on the manufacturing issues, pulling that stuff in, but overall what we’re going to try to pursue is keep the consumer engaged and keep the units right where they’re at on a historical basis.

Sam Darkatsh - Raymond James

You’re talking about you’re trying to get to the $2.00 bogey for next year Jim. Should we look at that as the mid-point on the bell curve or is that a stretch goal or how should we on the street right now take a look at that expectation for next year?

James Hagedorn

I think exactly what I said. It’s something we’re aspiring to. Listen, it could be plus or minus. I would not view it as the center of a bell. I think that we just haven’t done enough work yet to know but I think we understand the challenges and again it’s like everything in this conversation so far. I’m not complaining about that. It’s all about units. It’ll all come down to units and this issue of elasticity. But the business is good; it’s healthy; we’re seeing great sales right now. I don’t think there’s any fear in people. I think it’s just how the numbers are going to roll up and then what compromises we’re going to have to make. And I think that’s going to be the budget drill, dealing with the elasticity and then saying “All right. So how do we deal with our expense structure to bring it in the number that we’re looking to bring in?” I think that at this point we just don’t know enough to talk about it. I’m not being apologetic about it; we’re just not ready for that. I’ve got a Board meeting next week which we’re going to begin updating our plan that we’ve given to the Board in the past and say “This is the new reality. Where do we go from here?” and then based on the response we get from our Board, the management team will sit down and sort of roll it up and then we’ll talk to you guys at the year-end call. And we’ll give you definitely more update then.

Operator

Our next question comes from Alice Longley - Buckingham Research Group, Inc.

Alice Longley - Buckingham Research Group, Inc.

When we look at this 30% price increase for next year, you’ve got a downward shift in mix going on there because you’re going to be pushing some of the simpler fertilizers. And you also talked about the need to maybe add promotional activity to stimulate the consumer and that would come off of the sales too. How should we think about that 30% increase on like-for-like products? Once we throw in mix and promotions would it be more like 15% to 20%?

James Hagedorn

I think within our normal operating margin on sales, I don’t think you’re going to see an increase in percent margin for promotion probably or advertising. And I think Dan got a pretty big increase this year. So I don’t think you’re going to see significant at least margin shift within sort of the stat units. I think if you look at mix, I don’t know how those numbers are going to look. But again I know that right now while we would have said in the last call that the higher margin products were under stress and we’re seeing mixed downward flow, I think in Q3 the Turfbuilder Plus 2 business performed really well. I personally believe that when you see a sunny day outside, people are more willing to spend and are more optimistic and more enthused than on a grim gray day where they’re feeling like they put all their money in their gas tank and they want to save a few bucks on lawn fertilizer. I think the mix issue is something we’ll just have to work through as we budget.

Barry W. Sanders

So just to add to what Jim said, we’re talking 30% pricing. Now we then have this mix - the whole basket of promotion, programs, media - and we’re really re-examining all those costs as a basket with the general sense early on that we’re going to keep those fairly fixed but we’re going to better adapt the spending to the environment we’re in. As an example, where we may have more aspirational television advertising in this year, next year it might be moving to more aggressive hard-hitting radio or moving to more price promotion type of dollars. Right now we’re looking at that, a $0 sum pool of money that we’re just trying to optimize; not add to in aggregate.

Alice Longley - Buckingham Research Group, Inc.

You haven’t talked about pricing for other products. Could you tell us what you’re thinking of for some of the other categories?

Barry W. Sanders

It’s in the mid-single-digit range, anywhere from 3% to 5% depending on the category.

Alice Longley - Buckingham Research Group, Inc.

You’re not seeing a shift to private label anymore in fertilizer. Are you in any other categories?

Barry W. Sanders

No. Other than fertilizer, that would be the only shift.

Alice Longley - Buckingham Research Group, Inc.

I’m still confused about the third quarter number for the North American consumer. How much was that up in dollars and with the 4% to 5% pricing was it North America so we can back out what the unit shipments were? How much were the North American consumer shipments up?

David C. Evans

Global consumer shipments for the quarter are up 6%. If you back out foreign exchange, it’s closer to 5%. Of that 5% pricing is about 4%. So what we’re seeing in aggregate is about 1% organic unit growth in the global consumer segment.

Alice Longley - Buckingham Research Group, Inc.

And can you do US versus Europe?

David C. Evans

No.

James Hagedorn

But I would guess that there’s not a huge difference in those numbers.

Alice Longley - Buckingham Research Group, Inc.

Do you think that in the US your volumes have won in your pricing floor and comparable for Europe?

James Hagedorn

Barry’s saying yes.

Barry W. Sanders

Yes.

Alice Longley - Buckingham Research Group, Inc.

Again so the numbers are straight, your shipments were up 1% in the US in volume, 5% in dollars and consumer purchasing of your products was up how much?

David C. Evans

In the quarter?

Alice Longley - Buckingham Research Group, Inc.

In the quarter.

David C. Evans

It’s very hard to compare the quarter but it’s up 8% for the quarter POS.

Alice Longley - Buckingham Research Group, Inc.

And that’s you; your stuff?

David C. Evans

Yes. Our consumer purchases of Scotts products in dollars for the third fiscal quarter was up 8%.

Alice Longley - Buckingham Research Group, Inc.

Could you give us the comparable numbers for year-to-date?

David C. Evans

Year-to-date the same numbers, 2%.

Alice Longley - Buckingham Research Group, Inc.

For shipments?

David C. Evans

No.

Barry W. Sanders

Point of sale.

Alice Longley - Buckingham Research Group, Inc.

And what’s the year-to-date shipment number for US?

Barry W. Sanders

About one.

Alice Longley - Buckingham Research Group, Inc.

And the pricing in your shipment number in North America was probably what? 2% or something?

Barry W. Sanders

It was around 5%.

Alice Longley - Buckingham Research Group, Inc.

For year-to-date?

Barry W. Sanders

It’s still 5%.

Operator

Our next question comes from Eric Bossard - Cleveland Research Company.

Eric Bossard - Cleveland Research Company

The input cost data that you provided for the year suggested up $140 million and $100 million of price. What has kept you in the current year from getting sufficient price to offset all the input costs?

Dan Paradiso

Inability to price on a daily basis. If you look at our pro business, I think we priced five times this year. But as Barry said, in his memory we’ve never had a mid-year price increase like we did this year so I think the difference between the consumer business and the pro business is that it’s not effectively real-time pricing. That’s the issue.

Barry W. Sanders

Just take urea as an example. Today it’s nearly $800. A month ago it was $673. In the consumer market we do not and have not been taking pricing on a month-to-month basis. So that’s why we’re going to see in the fourth quarter increased margin degradation consistent with the trend in the third quarter but then we get to reset it again for next year.

Eric Bossard - Cleveland Research Company

The amount of price that you would assume next year that we should be thinking about next year, based on what we look at the $140 million of costs this year sounds like it could be $250 million of cost inflation. Then you’re assumption would be that you’ll get $250 million of price to offset that? Is that how we should be thinking about it?

Barry W. Sanders

Yes. When we look globally, if this year is $140 million in cost increases, we’re looking at something more like double the rate of that increase next year in costs. And as we’ve done in prior years, we go into the year with the expectation of trying to realize price increases equivalent to the dollar cost increase. So I think that’s an appropriate assumption to say those two are in bounds. But you can see when you factor that in, we’re going to have just by that alone as I recall a couple hundred basis points of margin rate degradation as you layer that into our P&L for 2009.

Eric Bossard - Cleveland Research Company

And your discussions with the retailers give you confidence at this point that you’ll get that $280 million or price increase accomplished?

Barry W. Sanders

Yes.

Eric Bossard - Cleveland Research Company

And related to this, the units in 08 you just said that the year-to-date shipments I think are up 1%. Excuse me, dollars are up 1%. And as you think about next year with that magnitude of price, what is the assumption in terms of what the shipments, I guess let’s just talk about the units which would be down 3% in 08, what would the assumption be for the units next year? I was a little confused with Barry’s comments on price elasticity. Should we assume a similar type of unit environment or should we assume the elasticity that you’ve experienced historically?

James Hagedorn

I would say none of the above. That’s what I would say. I think everybody is operating and trying to figure it out. I go back to say remember that when you look at unit volume in this year, remember that the pricing again in this business was very skewed toward lawns in 08 and so when you think of unit volume, it’s different by business. I would again tell you March was a month that was down 33% or some damn thing and a huge month it was down POS like 33%. I know it had a huge impact and without that, there’d be a very different discussion going on if March hadn’t been what it is and that the months since then have all been positive. I don’t know. I think we believe that there is some elasticity; we have I think a very aggressive response to that which will I think be very good for units; and it’s not bad for us on a margin point of view or for the retailer from a margin point of view. It’s the same question we’ve been talking about, which is “What does elasticity mean with this kind of pricing?” I don’t know. Every time somebody wants to talk on this one, you’re hearing all the internal dialogue that’s going on between us. So I’m not sure there’s much more to say on it.

Eric Bossard - Cleveland Research Company

In terms of mix, what’s the difference of your profitability on a Plus type product versus just a straight product? It sounds like the promotion and focus next year will be towards affordability for the consumer which is more of a straight product. Can you just remind us of how the math works in terms of your profitability in that situation?

David C. Evans

I’m not going to provide real specific information on product-by-product but I would say directionally we have better margin rate on combination products than straight fertilizers but that’s also the case when you look at as an example our growing media category. So when you look across the span of the entire North American enterprise this year and you try to measure what the impact is of mix from trade up and trade down, then that impact is actually fairly insignificant because we’re able to manage the downward trend in fertilizers with the corresponding upward trend in growing media. So it has not been a pronounced impact on our margin rate for this year nor have I really spoken to it because of that fact.

Eric Bossard - Cleveland Research Company

Do you think that you can accomplish enough in other categories next year as you’ve done historically to offset the trade down that’s likely to take place in fertilizer?

David C. Evans

I think that the trend we saw in growing media this year was not a one-year phenomenon. It’s been a multi-year phenomenon. I think that the challenge we have is to not just rest on our laurels and assume it’s going to repeat again next year and the marketing team is working with sales in aggressively development plans to make sure that happens.

James Hagedorn

The answer is simple in that generally when we are innovating, that’s margin positive for us and I think we have an excellent pipeline of products going forward that will allow us to innovate and buffer that.

Eric Bossard - Cleveland Research Company

The market share experience in lawn fertilizer in 3Q relative to the first half, first of all am I correct that lawn fertilizer share still looks down a bit year-to-date just improved because of third quarter’s [inaudible]?

James Hagedorn

Yes. I would say marginally down in share at this point.

Eric Bossard - Cleveland Research Company

Why was the third quarter experience than the first half experience do you think with market share?

James Hagedorn

I think Dan would say number one is like he had a lot of his advertising in Water Smart. That Water Smart advertising really hit in the quarter so I think a lot of it is his most important banging was occurring after the quarter was over in April. I think that’s part of it; I think the weather was better; I think psychologically when it’s sunny outside consumers feel better and are willing to buy. Maybe other people have better answers.

Barry W. Sanders

I think there’s one more factor: The regionality of the business. Where we saw the economics hardest hit is in the South. Florida really starts the season in our second quarter so the business was down and as you roll into April our season got pushed in. Fortunately we planned accordingly with our advertising and promotions so we just had a much better regionality of business. And the way that we ran our business was favorable and the Midwest, even some of that business actually shifted into the first quarter which where we were very strong regionally. So overall it was just a much better quarter.

James Hagedorn

And you had a very major clearance going on of an outdated product line at one of our major retailers that occurred in March as well. It was an unbelievable deal.

Operator

Our next question comes from Douglas Lane - Jefferies & Company, Inc.

Douglas Lane - Jefferies & Company, Inc.

Dave, can you tell us specifically how much urea costs for fiscal 09 are locked in? And do you have any concerns about actually obtaining physical supply with the shortages out there?

David C. Evans

To answer the first question, right now about 25% of our urea needs for next year have been locked in; the pricing. No, urea’s not an issue for us.

Douglas Lane - Jefferies & Company, Inc.

Are there other ingredients where you’re facing shortages?

Barry W. Sanders

If there are any, I’d say it’s in very niche specialty NPK type of particles. They’re more used in our professional business than in the consumer. So I’d say it’s fairly isolated exceptions.

Douglas Lane - Jefferies & Company, Inc.

Commodity cost inflation is widespread. Urea’s obviously the poster child. But are there other product categories where you’re looking to take at least double-digit price increases next year?

David C. Evans

Org food is one and maybe the only other one where we have dramatic price increases.

Douglas Lane - Jefferies & Company, Inc.

This question was sort of asked before but maybe I’ll ask it a different way. I know that this commodity cycle is unprecedented and I understand that in general, but have there been instances in the past where you have raised prices double digits that you can give us some sort of feel for elasticity in at least isolated examples historically?

Barry W. Sanders

I think this is unprecedented for us.

James Hagedorn

I grew up in this business and I’ve never seen anything like this, ever. If you look at the phosphorous, potassium, sulphur, urea; you’re talking triple-digit increases in a year.

David C. Evans

There is an example that would be the closest to this in the grass seed category. There’s a long history in grass seed of taking pricing every year to better reflect commodity. I think we’ve seen back in 07 some fairly dramatic pricing in seed and the outcome was we were able to maintain share. We didn’t see a dramatic impact in the category within seed. That’s about the only example we can find.

James Hagedorn

We may not be the average price of $10 or less but it’s still less than $20 and you get a lot of bang for your dollar in an environment where your house prices are under stress, so it’s a lot of beautification for less than $20. And I think that when people are running tight of money historically they’ve spent more time at home; they haven’t been going on vacations; they haven’t been driving as much; and they put more time and effort into their yard and keeping their home looking good.

Operator

Our next question comes from Joseph Altobello - Oppenheimer & Company.

Joseph Altobello - Oppenheimer & Company

First for Dave, the 25% of urea costs you’ve hedged thus far, I think last year you had hedged about 60% by December. Do you guys expect to be more aggressive on that front to lock in more of your costs up front?

David C. Evans

I think Joe it’s going to be fairly consistent year-over-year in the pace in which we’re locking, and we’re looking at the same mix of things to lock this year as last year.

Joseph Altobello - Oppenheimer & Company

So you’ll probably be at that 60% level by December?

David C. Evans

Yes, that would be my expectation.

Joseph Altobello - Oppenheimer & Company

And secondly for Jim, you talked about retiring probably around 2010. Has this recent commodity cost spike and turmoil that’s going on changed that at all?

James Hagedorn

Yes. I’m leaving tomorrow. No. I think that I feel like we’re working together well as a team and I will say that we meaning myself and the Board have made a lot of progress on getting me some bandwidth help so we’ll be making announcements in that regard soon. But I think that for all kinds of reasons, mostly psychological and economic, I’d like to see us get stock price back up so I would say that I’m not permanently changing my plans but I think that there’s a need and I feel like I’m part of a team that’s working well together and I’m not abandoning ship in a trying time. So I think it just means that when the company’s ready and I’m ready, I’ll leave. But right now there’s a need for everybody to be working together and of any of the top team there’s no room for anybody to bail now.

Joseph Altobello - Oppenheimer & Company

So there is some flexibility on that 2010 date it sounds like?

James Hagedorn

Yes, I’ve already made that decision.

Joseph Altobello - Oppenheimer & Company

Not to put you on the spot, but the potential successor you have in mind, is he or she in the room or on the call today?

James Hagedorn

For all kinds of reasons I’m not answering that but I think that the qualities of that person will be well-known, understood and there’ll be a lot of comfort with that. I wouldn’t say that I’m talking about my successor. I would say that it’s additional leadership bandwidth coming in to help run the business. That’s all.

Operator

Our next question comes from Jim Barrett - C.L. King & Associates.

Jim Barrett - C.L. King & Associates

Jim, obviously your advertising and doing lots of it is in your blood. If we’re entering a new period of time when natural gas prices keep moving higher and higher, would you envision fairly soon in order to maintain a reasonable amount of volume and in order to keep people in the category and considering that the company already does 80% of the industry’s advertising anyway, I know it’s a bit of a chicken-and-egg sort of dynamic, but could you see a day where you’d dramatically or significantly cut back on your advertising to achieve a reasonable return on capital to offset what might be a secular increase in energy costs?

James Hagedorn

I guess whoever follows me could think about that. I think that would be a huge mistake. I do think though that we’ve got to look at our sales and marketing expenses and they’ve got to be justified. I do think that TV is a tough place to advertise these days and I think we get a lot of bang for our dollar and I think we have experienced that this year where we can call to action advertising. I think we like radio a lot. I think we believe that this is a period where consumers are making decisions at the shelf. And I think we’ve got to be prepared to battle there just as well. So I think a better question would be “Do you think there’s a need to significantly increase the spend?” and I think the answer to that is no but I think we can spend the money better and in a much more in the battle kind of way that is much more competitive and much more responsive and much more right now. I think that you’re going to see that.

Jim King

Julie, I know we’re running short on time here so why don’t we take two more questions and if we don’t get to everybody, we can follow up with them by phone.

Operator

Our next question comes from Connie Maneaty - BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

Just a housekeeping question on the third quarter. The gross margin degradation, was it more due to diesel or urea?

David C. Evans

I believe it’s more so general NPK. We talk about urea and it’s kind of the poster child but actually there are several ingredients in the fertilizer/nutrients and those as a package have really been going up most dramatically. Recall we had hedged about two-thirds of our diesel last fall so while diesel’s going up pretty dramatically right now, the impact to us has been somewhat mitigated because of our prior hedging strategy.

Connie Maneaty - BMO Capital Markets

The pressure in the quarter was due to what then you bought on the stock market or was it hedged some months earlier?

David C. Evans

It would be hedged NPK but remember this isn’t necessarily that we waited to buy it at the peak. This has been going up all season. So what we saw running through the P&L this quarter was probably urea that we had purchased or locked last December as an example. And that’s why the thing is just kind of moving through the python here and while we’ve been six months ahead of the path on urea as one example, we see it in the pipe right now. That’s why in Q4 all the materials are bought and we already know how much it costs to buy them and they’re going to be higher than they were in the third quarter.

Connie Maneaty - BMO Capital Markets

If we could just spend a second on Scotts LawnService, how are the cancellation rates running?

Peter Korda

Cancellation rates were high through the spring in renewals; a couple hundred basis points higher than prior year. Since Memorial Day they’ve been spot on comparable to last year. And cancellation rates for new sales this year have been favorable to last year since the beginning of the year. So it kind of varies.

Connie Maneaty - BMO Capital Markets

Have you also hedged diesel for the next season for Scotts LawnService?

Peter Korda

We’ve hedged through this season. We have not yet hedged for next year.

James Hagedorn

You can make the assumption that we will be hedged on diesel.

Connie Maneaty - BMO Capital Markets

On the asset impairment charges, are they Smith & Hawken only or is the bird food in there as well?

David C. Evans

You’re making leaps of faith here. It’s not exactly as intuitive as you would think because what you initially have visibility to is what’s the different carrying values of our assets on our books. So that’s really the other piece of the puzzle. What I would tell you from a segment perspective of $123 million about $70 million of it is coming from the global consumer segment, I believe it’s about $30 million is coming from our global professional segment, and about $20 million is coming from what we call corporate and other which includes Smith & Hawken but also includes some other small trade names and things. So I wouldn’t want to lead you that 100% of corporate and other is Smith & Hawken.

Operator

Our next question comes from Jon Andersen - William Blair & Company, LLC.

Jon Andersen - William Blair & Company, LLC

One quick one on the September quarter, I know it’s a smaller quarter for you, but I’m wondering how much of the quarter is really driven by pipeline shipments and how much by consumer response to the fall gardening season? And then what you see as the key swing factors in hitting that $2.00 number for the current year?

James Hagedorn

I would say little pipeline although a lot of the stuff now, part of it will get sold but I would say not like in the past where people were buying for next season. So this would be entirely in the fall season products, some of which will be sold in Q1 but I would say little pipeline fill and almost all based on experience and consumer takeaway.

Barry W. Sanders

The retailers will do an initial set and there will be a swing based on what the consumer buys in September as far as refill. So that will be entirely consumer driven based on their activity between September and October.

Jon Andersen - William Blair & Company, LLC

And the strength that you commented on in July, is that across the consumer portfolio or were there particular pockets of strength in terms of product lines or pieces of the business?

Barry W. Sanders

It was really across all the portfolio. We’ve seen a shift moving out from earlier spring into summer activity across the entire portfolio.

Jim King

We’re going to wrap things up. If we didn’t get to everybody in the queue or you have any other questions that we didn’t touch upon, you can call me directly. That’s 937-578-5622. Otherwise, thanks and have a great day.

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Source: The Scotts Miracle-Gro Company F3Q08 (Qtr End 06/28/08) Earnings Call Transcript
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