It begins with Martha on her chair, napping and dreaming of chasing a ham with legs. Skits wakes her up and wants to play with her, but she falls back asleep, telling him she is having an important dream. He then tries to play with Helen, Mariella, and Daniel but they are too busy painting a picture of a dog (possibly Martha), making a flower arrangement, and watching sports on the TV respectively to play with Skits.
Then, Milo Lee and his dad Terrence move in next door, the former looking bored. Terrence asks his son what being seven is like and Milo says it's like being six but lonesome as he doesn't know anyone. Terrence says that he will meet people as he's just moved in, and shows him a red frisbee that he got for his birthday.
Skits walks down the street until he meets Milo in the garden, playing with his frisbee. They then play fetch. Terrence is on the phone, complaining to the moving company when the phone hangs up and he hears a crash. Milo introduces himself and asks Skits what his name is. Skits, of course, can't talk, so he just barks. Milo says he can't call him "woof" so he will instead call him "Mr Scruffles". They then continue to play fetch, but the frisbee lands in a tree. Skits goes to fetch it for Milo who's not allowed, when Helen and Martha then show up, coming back for Skits. Martha then explains that she'd been having a ham dream. The Lorraine family then drive off. Meanwhile, Terrence notices the frisbee which fell out of the tree and Milo picks it up, but Terrence notices his son appears to be looking for something. Milo explains he's looking for "Mr Scruffles", his new friend. Terrence thinks Mr Scruffles is imaginary (because Mr Scruffles is also a stuffed bear of Milo's and because Milo said that he could jump as high as the hedge, not to mention that Mr Scruffles is a funny name) and asks if he said he'd be friends with Milo. Milo says that "Mr Scruffles" can't talk as he's a dog.
In the car, Martha thinks Milo is imaginary and asks Skits if he has polka dots and wings like Milo the Martian on TV. Skits is offended that Martha doesn't believe in Milo.
Back at the Lee household, Terrence phones a couple of people who say it's normal for children to have imaginary friends and that one of them even set a dinner plate for his son's imaginary friend.
The next day, Skits is about to go to Milo's house but Martha tells him he doesn't need to go there as his owners (and herself) have a surprise for them: they're going to Flea Island. Skits asks (in Dog) if he can bring Milo and Martha says Milo is in the car. Skits can see he's not, and barks at Martha. Martha says "Okay, Milo's real". Helen says that Skits will have fun, and as it's a nice day, maybe Milo will also be on Flea Island.
In the Lee family backyard, Terrence is pretending to pet "Mr Scruffles", but is embarrassed, when Milo points out that the neighbours are watching. Milo then tells his dad that Mr Scruffles is real. Terrence then decides to look for Mr Scruffles in town because they might meet some kids his age.
On Flea Island, the Lorraines are having a picnic and playing fetch. In town, Milo sees a dog who is not Skits.
Back on Flea Island, Skits jumps into the rowboat.
In town, Milo shows an old lady a drawing of Skits, but she doesn't recognise it.
In the Lorraine car, Martha is sorry that Skits is disappointed but at the same time, she's angry that he misses a friend she thinks is imaginary.
On the street, Terrence thinks Milo is also disappointed. He is, but he's not all that disappointed. He then catches a glimpse of Skits in the car that drove past.
At the restaurant, Milo and Terrence show T.D. Kennelly the picture, introduce themselves, and explain that Milo thought he saw the dog in the car. T.D. says the dog looks like one of Helen's dogs and gives the newcomers the address, and says that if he gets lost, ask for the girl with the talking dog. This freaks Terrence out.
The Lorraines arrive home. Martha tells Skits that there is nothing wrong with having an imaginary friend, but he just gets angry and wants to go to Milo's house to prove Milo is real.
Meanwhile, the Lees arrive at Helen's house, and Milo asks Truman Oatley who is next door if a girl named Helen lives there. He says yes, and also Martha. Terrence asks where they can find her and he says she can be found digging, chewing on sticks, or rolling in garbage. Terrence is shocked and appalled at the idea that Martha rolls in garbage, but Truman reassures him that she takes baths twice a week so she's not smelly.
Helen then asks Skits if he's sure that they are at the right place as the name on the box says "LEE" and asks if Lee is Milo's surname. Skits doesn't know. Martha notices that there isn't much furniture in the house and wonders if its residents are moving out.
Terrence tells Milo he won't be lonesome the next day as they have each other.
In the park, Helen, Martha, T.D., and Truman are playing fetch, when the frisbee lands in the bush.The Lees toss a frisbee over into the same bush, and then Helen and Milo pick it up at the same time. Helen notices it has the name "Milo Lee" on it. She concludes Milo must be real and introduces herself. Milo asks if she has a talking dog.
Terrence is looking for Milo and finds the frisbee and Martha saying it's hers. This makes him dizzy and he walks out of the bushes. Helen and T.D. recognise the boy that she found as Milo, but Martha says that he can't be Milo as she still believes Milo to be imaginary. Then, Skits shows up and Milo recognises him as "Mr Scruffles". Terrence calls it a confusing town and Milo says that he will get used to it.