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.
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